UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d) of
The Securities Exchange Act of 1934

GAINSCO, INC.

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

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 herein, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

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

Yes   [  ]   No   [X]

The aggregate market value of the registrant’s Common Stock ($.10 par value), the registrant’s only class of voting or non-voting common equity stock, held by non-affiliates of the registrant (19,288,908 shares) as of the close of the business on June 30, 2003 was $5,400,894 (based on the closing sale price of $0.28 per share on that date on the OTC Bulletin Board).

As of February 29, 2004, there were 21,169,736 shares of the registrant’s Common Stock ($.10 par value) outstanding.

Incorporation by Reference

Portions of the Company’s Proxy Statement for its Annual Meeting of Shareholders to be held on May 12, 2004 are incorporated by reference herein in response to Items 10, 11, 12, 13 and 14 of Part III of Form 10-K.

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Table of Contents

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

General Description

     GAINSCO, INC. (“GNAC”) is a holding company that provides administrative and financial services for its wholly owned subsidiaries. The term “Company” as used in this document includes GNAC and its subsidiaries unless the context otherwise requires. GNAC was incorporated in Texas on October 11, 1978. It completed its initial public offering on November 14, 1986.

     The Company is a property and casualty insurance company concentrating its efforts on the nonstandard personal automobile market as it concurrently exits the commercial insurance business. The Company’s insurance operations for most of 2003 were conducted through two insurance companies: General Agents Insurance Company of America, Inc. (“General Agents”), an Oklahoma corporation and MGA Insurance Company, Inc. (“MGAI”), a Texas corporation. See “Recent Developments” for information regarding the Company’s actions to cease writing what had been its primary line of business, commercial insurance, diversify geographically its nonstandard personal automobile business and sell its management contract controlling GAINSCO County Mutual Insurance Company (“GCM”).

     During 2003 the Company was approved to write insurance in 41 states and the District of Columbia on a non-admitted basis and in 44 states and the District of Columbia on an admitted basis. The Company currently markets its nonstandard personal auto line of insurance on an admitted basis through approximately 1,000 non-affiliated retail agencies. Approximately 95% of the Company’s gross premiums written during 2003 resulted from risks located in Florida.

     The Company’s only line of insurance currently being written is nonstandard personal auto and it is written on classes of risks which are not generally insured by many of the standard companies. The strategy of the Company is to identify various classes of risks where it can price its coverages profitably and competitively. For a description of the product lines presently written by the Company, see “Recent Developments” and “Product Lines.” The Company sets its premiums by applying judgment after consideration of statistical analysis, the risks involved and the competition.

Recent Developments

Nonstandard Personal Auto Line

     The only line of insurance currently being written by the Company is nonstandard personal auto. This business is currently profitable and the Company believes that meaningful potential opportunities exist through a geographic diversification strategy. Previously the business has been written primarily in the state of Florida. However, in furtherance of the objective to diversify the business to targeted territories, the Company began writing nonstandard personal auto policies in Texas during the fourth quarter of 2003 and began its market introduction in Arizona in 2004. The Company expects any potential profits generated in Texas and Arizona in 2004 will not be material due to the start up nature of the two business initiatives. Approximately $600,000 of additional annualized wage and rent expenses are associated with these initiatives. See “Focus on Obligations to Preferred Stock — Board Focus” with respect to limitations on the Company’s ability to pursue opportunities to further expand its nonstandard personal auto business.

Discontinuance of Commercial Lines

     On February 7, 2002, the Company announced its decision to cease writing commercial insurance due to continued adverse claims development and unprofitable results. As a result, the Company had only 31 commercial policies remaining in force at December 31, 2003. The discontinuance of writing commercial lines has resulted in the Company ceasing to be approved to write insurance in several states however, this state action has not materially restricted geographic expansion of the Company’s personal auto lines thus far.

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     The Company continues to settle and reduce its inventory of commercial lines claims. At year-end 2003, there were 525 claims associated with the Company’s overall runoff book outstanding, compared to 1,062 a year earlier. Due to the long tail and litigious nature of these claims, the Company anticipates it will take a substantial number of years to complete the adjustment and settlement process with regard to existing claims and the additional claims it expects to receive in the future from its past business writings. Most of the remaining claims are in suit and the Company’s future results may or may not be impacted either negatively or positively based on its ability to settle the remaining claims and anticipated new claims within its established reserve level. In the course of reducing its employee count, in the first quarter of 2003 the Company outsourced certain of its information technology operations related to the run-off of its commercial lines to an unaffiliated third party provider with which Richard A. Laabs, a former senior executive of the Company, and three other former employees of the Company are affiliated.

Sale of GAINSCO County Mutual Insurance Company

     On December 2, 2002, the Company completed the sale and transfer of the management contract controlling GCM to an affiliate of Liberty Mutual Insurance Company (“Liberty”), for a purchase price of up to $10 million, of which $1 million was paid at closing and the balance is payable in contingent payments through September 2009, but each payment is contingent on there being no material adverse change in the regulatory treatment of GCM specifically, or county mutuals generally, from legislative or regulatory administrative actions prior to the applicable payment date.

     In the session of the Texas Legislature ended June 2, 2003, changes were made in the statutes governing the regulatory treatment of county mutual insurance companies in Texas. These changes prejudice the rights of the Company to receive contingent payments from Liberty, depending upon how the statutory changes and the Company’s agreement with Liberty are interpreted. The Company contacted Liberty to discuss its obligation to make the contingent payments in light of the recent legislation. Liberty’s position is that they have no obligation to make any of the $9 million contingent payments under the agreement. The Company has fully reserved its receivable due from Liberty of $484,967 (representing the excess of the Company’s cost basis in GCM over the $1,000,000 received from Liberty at the closing of the sale transaction) as potentially uncollectible because of the statutory changes in 2003.

Transactions with Goff Moore Strategic Partners, L.P.

     1999 GMSP Transaction. On October 4, 1999, the Company sold to Goff Moore Strategic Partners, L.P. (“GMSP”), for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock (stated value of $1,000 per share), which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant expiring October 4, 2004 to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant expiring October 4, 2006 to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing the Company and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of these transactions (the “1999 GMSP Transaction”) concluded a strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes.

     2001 GMSP Transaction. On March 23, 2001, the Company consummated a transaction with GMSP (the “2001 GMSP Transaction”) pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock (stated value of $ 1,000 per share) to GMSP in exchange for an aggregate purchase price of $3 million in cash. The annual dividend rate on the Series C Preferred Stock is 10% until March 23, 2004 and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company’s option after March 23, 2006 and at the option of the majority holders after March 23, 2007 at a price of $1,000 per share plus accrued and unpaid dividends. The Series C Preferred Stock is not convertible into Common Stock.

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     The agreement with GMSP in connection with the 2001 GMSP Transaction was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were reduced to $2.25 per share and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 shares of Common Stock, subject to adjustment. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share and, should the Company pay dividends on its Common Stock, the Series A Preferred Stock would be entitled to dividends as if converted into Common Stock. On March 23, 2001, the Series A Preferred Stock was called for redemption by the Company so that on January 1, 2006 the Company will be obligated to pay $1,000 per share for 31,620 shares ($31.6 million) to the holder to the extent that it can legally do so and, to the extent it cannot do so, the Company will be obligated to pay quarterly an amount equal to 8% interest per annum on any unpaid balance. See “Focus on Obligations to Preferred Stock”.

     The 2001 agreement with GMSP provided an opportunity to convert the Company’s illiquid investments with a cost of $4.2 million to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase the illiquid investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the illiquid investments to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. During the second quarter of 2001, the Company recognized a permanent impairment of these investments and wrote down the carrying value to the amount recoverable from GMSP under the put option. In February 2002, GMSP consented to the early exercise of the Company’s option, and the Company exercised its option to require GMSP purchase the illiquid investments for approximately $2.1 million.

     2002 Amendment to Investment Management Agreements. In August 2002, the Company’s Investment Management Agreements with GMSP were amended to reduce, effective as of October 1, 2002, the minimum aggregate monthly payment to GMSP from $75,000 to $63,195 (with respect to each calendar month from October 2002 through September 2003), $53,750 (with respect to each calendar month from October 2003 through September 2004), and $45,417 (with respect to each calendar month after September 2004). The amendment also extended the date upon which either party to each of the investment management agreements can terminate such agreements at its sole option from October 4, 2002 to September 30, 2005.

Transactions with Robert W. Stallings

     On March 23, 2001, the Company sold to Robert W. Stallings for $3 million in cash, 3,000 shares of its newly created Series B Preferred Stock and a warrant expiring March 23, 2006 to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share (the “Stallings Transaction”). The annual dividend provisions and the redemption provisions of the Series B Preferred Stock (stated value of $1,000 per share) are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. Mr. Stallings also entered into a consulting agreement pursuant to which he provides consulting services (including strategic planning advice, analysis of the subsidiaries’ performance in various sectors of their respective business and recommendations for growth strategies and opportunities for new markets and products) to the Company’s insurance subsidiaries for a period of five years ending on March 22, 2006 for $300,000 per annum. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company, and on September 6, 2001, he was elected non-executive Chairman of the Board.

Focus on Obligations to Preferred Stock

     Preferred Stock in Relation to Capital Base. At December 31, 2003, the capital base (total assets less total liabilities) of the Company was $45,535,405 and consisted of Shareholders’ Equity of $13,412,885 and three series of Redeemable Preferred Stock, which are classified under GAAP as mezzanine financing in the aggregate amount of $32,122,520. At December 31, 2003, $7,370,001 was included within Additional paid-in capital, and had yet to be charged to Shareholders’ Equity, related to the accretion of the discount on the redeemable Preferred Stock. Almost all of this unaccreted discount will be charged to Shareholders’ Equity by January 1, 2006, the redemption date of the Series A Preferred Stock. At December 31, 2003, the per common share Shareholders’ Equity was

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approximately $0.63, including unaccreted discount on Redeemable Preferred Stock of $0.34; less such unaccreted discount, the per common share Shareholders’ Equity was approximately $0.29. The aggregate redemption value of the Preferred Stock was $39,492,520 ($37,620,000 stated value plus accrued dividends of $1,872,520) at December 31, 2003.

     Obligation to Redeem Series A Preferred Stock on January 1, 2006. On March 23, 2001, the Series A Preferred Stock was called for redemption so that on January 1, 2006 the Company will be obligated to pay $31,620,000 to the holder of the Series A Preferred Stock, subject to the conditions described below. The Company’s obligation to redeem the Series A Preferred Stock generally is conditioned upon (i) the redemption not contravening any credit or financing arrangement in excess of $3,000,000 and approval by at least one director nominated by the Series A Preferred Stock (no such indebtedness is now outstanding); (ii) the holder of the Series A Preferred Stock not receiving a purchase offer to purchase shares of the Series A Preferred Stock prior to January 1, 2006 from a financially responsible unaffiliated third party for a price equal to or greater than the liquidation value of the Series A Preferred Stock; and (iii) the payment of the redemption price not contravening the provisions of Article 2.38 of the Texas Business Corporation Act (which generally prohibits the amount to be paid to the holder of the Series A Preferred Stock in respect of the redemption from exceeding the net assets of the Company or leaving the Company insolvent) or any other applicable federal and state laws. The Board of Directors is contractually obligated to use its best efforts to take such actions as will cause the redemption to not contravene Article 2.38 or other applicable law. To the extent that the Company is restricted from redeeming the Series A Preferred Stock because of the conditions described above, the Company will be obligated to pay quarterly an amount equal to 8% interest per annum on any unpaid balance.

     Obligation to Redeem Series B and Series C Preferred Stock on March 23, 2007. The Series B and Series C Preferred Stock become redeemable at the option of holders commencing March 23, 2007 for the aggregate liquidation amount of $6,000,000 plus accrued dividends, subject to conditions on the Company’s obligation to redeem the Series B and Series C Preferred Stock similar to those conditions on the Company’s obligation to redeem the Series A Preferred Stock.

     Dividends on Series B and Series C Preferred Stock. The Company declared dividends aggregating $2,111,267 in respect of the Series B and Series C Preferred Stock to be paid on April 1, 2004, which would bring dividends current to that point. From and after April 1, 2004, dividends accrue at the rate of 20% per annum, of which at least half (or at least $150,000 in the aggregate in respect of the Series B and Series C Preferred Stock) must be paid quarterly.

     Board Focus. The Board of Directors has been focusing on the Company’s obligations to the holders of the Preferred Stock, which are affiliates of three of the Company’s eight directors, recognizing that the Company does not have, or expect that its operations will generate, sufficient funds to redeem the Series A Preferred on January 1, 2006. Also, the Board of Directors has considered how the need for capital to satisfy those obligations may limit the Company’s ability to pursue opportunities to further expand the Company’s nonstandard personal auto business. The interests of the holders of the Preferred Stock in assuring that these obligations are met in a timely manner may differ from those of other shareholders. As a result, the Board of Directors formed a Special Committee of independent directors to address the alternatives for providing for these obligations. The Special Committee consists of director Joel C. Puckett, Chairman, and directors Harden H. Wiedemann and John H. Williams, with director Sam Rosen acting as an advisory member. The Special Committee first considered, with the assistance of an investment banking firm, proposals from holders of Preferred Stock for the recapitalization of the Company, including a proposal that would have involved an investment by two consultants and the President of the Company. No agreement was reached with the holders of the Preferred Stock, and all recapitalization proposals were withdrawn. The Board of Directors then expanded the mandate of the Special Committee to consider alternatives that might be available with unaffiliated third parties. The Special Committee intends to engage an investment banking firm to advise it as to any such alternatives that may be available to the Company. No prediction can be made at this time as to the outcome or length of this process.

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     Through March 15, 2004, the Company had spent approximately $400,000, including financial advisory and legal fees, in respect of the Special Committee’s consideration of alternatives for dealing with its obligations to the holders of its Preferred Stock. These amounts will be expensed in the first quarter of 2004.

Net Operating Loss Carryforwards

     As a result of losses in prior years, as of December 31, 2003 the Company has net operating loss carryforwards for tax purposes aggregating $72,692,450. These net operating loss carryforwards of $1,639,333, $22,806,147, $33,950,174, $13,686,532 and $610,264, if not utilized, will expire in 2018,2020,2021,2022 and 2023, respectively. The tax benefit of the net operating loss carryforwards is $24,715,433 which is calculated by applying the Federal statutory income tax rate of 34% against the net operating loss carryforwards of $72,692,450.

     In certain circumstances, Section 382 of the Internal Revenue Code may apply to materially limit the amount of the Company’s taxable income that may be offset in a tax year by the Company’s net operating losses carried forward from prior years (the “§ 382 Limitation”). The annual § 382 Limitation generally is an amount equal to the value of the Company (immediately before an “ownership change”) multiplied by the long-term tax-exempt rate for the month in which the change occurs (e.g., 4.58% if the ownership change occurred in April 2003). This annual limitation would apply to all years to which the net operating losses can be carried forward.

     In general, the application of Section 382 is triggered by an increase of more than 50% in the ownership of all of the Company’s currently issued and outstanding stock (determined on the basis of value) by one or more “5% shareholders” during the applicable “testing period” (usually the three year period ending on the date on which a transaction is tested for an ownership change). The determination of whether an ownership change has occurred under Section 382 is made by aggregating the increases in percentage ownership for each 5% shareholder whose percentage ownership (by value) has increased during the testing period. For this purpose, all stock owned by persons who own less than 5% of the Company’s stock is generally treated as stock owned by a single 5% shareholder.

     In general, a 5% shareholder is any person who owns 5% or more of the stock (by value) of the Company at any time during the testing period. The determination of whether an ownership change has occurred is made by the Company as of each “testing date.” For this purpose, a testing date generally is triggered whenever there is an “owner shift” involving any change in the respective stock ownership of the Company and such change affects the percentage of stock owned (by value) by any person who is a 5% shareholder before or after such change. A testing date also may be triggered by the Company’s issuance of options in certain limited circumstances. Examples of owner shifts that may trigger testing dates include a purchase or disposition of Company stock by a 5% shareholder, an issuance, redemption or recapitalization of Company stock that affects the percentage of stock owned (by value) by a 5% shareholder, and certain corporate reorganizations that affect the percentage the percentage of stock owned (by value) by a 5% shareholder.

Accounting for Preferred Stock

     In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). This statement does not have an impact on the current accounting by the Company as all of the Company’s series of Preferred Stock are not considered “mandatory redeemable financial instruments” based on SFAS 150’s definition, and therefore are not subject to the accounting treatment under paragraph 9 of SFAS 150. All three series of Preferred Stock are currently classified as temporary equity pursuant to SEC ASR 268 and EITF Topic No. D-98. Rule 5-02.28 of SEC Regulation S-X requires preferred securities that are redeemable for cash or other assets to be classified outside of permanent equity if they are redeemable (1) at a fixed or determinable price on a fixed or determinable date; (2) at the option of the holder; or (3) upon the occurrence of an event that is not solely within the control of the issuer.

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Product Lines

     The Company’s principal products previously served certain nonstandard markets within the commercial lines and personal lines. On February 7, 2002, the Company announced its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The Company continues to serve the nonstandard personal auto market. The following table sets forth, for each product line, gross premiums written (before ceding any amounts to reinsurers), percentage of gross premiums written for the periods indicated and the number of policies in force at the end of each period.

Commercial Lines: The Company announced on February 7, 2002 its decision to discontinue writing commercial lines insurance business due to continued adverse claims development and unprofitable results. The commercial lines of insurance previously written by the Company included:

     Commercial Auto The commercial auto coverage underwritten by the Company included risks associated with local haulers of specialized freight, tradespersons’ vehicles and trucking companies.

     Garage The Company’s garage product line included garage liability, garage keepers’ legal liability and dealers’ open lot coverages. The Company targeted its coverage to used car dealers, recreational vehicle dealers, automobile repair shops and wrecker/towing risks.

     General Liability The Company underwrote general liability insurance for businesses such as car washes, janitorial services, small contractors, apartment buildings, rental dwellings and retail stores.

     Property The Company underwrote commercial property coverages that included fire, extended coverage and vandalism on commercial establishments packaged with its liability product or on a monoline basis.

     Specialty Lines The Company underwrote and managed programs in professional liability for lawyers, real estate agents, educators and other general professions, as well as directors and officers liability.

Personal Lines: The personal lines of insurance currently written by the Company is in the nonstandard personal auto market only and is primarily written with liability limits generally not in excess of $40,000. The personal lines of insurance previously written by the Company also included:

     Umbrella The Company wrote personal umbrella risks which did not have access to the preferred markets.

     Property The Company wrote nonstandard dwelling fire risks.

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Reinsurance

     The Company may purchase reinsurance in order to reduce its liability on individual risks and to protect against catastrophe claims. A reinsurance transaction takes place when an insurance company transfers, or “cedes,” to another insurer a portion or all of its exposure. The reinsurer assumes the exposure in return for a portion or the entire premium. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company is required to pay the claim if the reinsurer fails to meet its obligations under the reinsurance agreement.

Commercial Lines

     Prior to 1999 and again beginning in 2001, the Company wrote commercial casualty policy limits up to $1,000,000. For policies with an effective date occurring from 1995 through 1998 and policies with an effective date occurring during 2001 or 2002, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 limits, resulting in a maximum net claim retention per risk of $500,000 for such policies. During 1999 and 2000, the Company wrote commercial casualty policy limits up to $5,000,000. For policies with an effective date occurring in 1999 or 2000, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to $1,000,000 and second excess casualty reinsurance for 100% of casualty claims exceeding $1,000,000 up to the $5,000,000 limits, resulting in a maximum net claim retention per risk of $500,000. The Company has facultative reinsurance for policy limits written in excess of the limits reinsured under the excess casualty agreements.

     Effective December 31, 2000, the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 through December 31, 2001, the Company entered into a quota share reinsurance agreement whereby the Company ceded 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company’s ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $89,650,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. Also in connection with this agreement, the Company was required to maintain assets in a trust fund with a fair value at least equal to the funds held liability. The trust fund was established during the third quarter of 2001 and at December 31, 2001 the assets in the trust had a fair value of $49,553,698. Because the Company’s statutory policyholders’ surplus fell below certain levels specified in the agreement, the reinsurer had the option to direct the trustee to transfer the assets of the trust to the reinsurer. On March 29, 2002, the reinsurer exercised this option and the trust assets were transferred to the reinsurer. As a result, investments and funds held under reinsurance agreements were reduced by approximately $44,000,000. The Company recorded a realized gain of approximately $486,000 as a result of the transfer. The reinsurer continues to be responsible for reimbursing the Company for claim payments covered under this agreement.

     For 1998 through 2001, the Company also has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. For 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident.

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     For its lawyers professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $500,000.

     For its real estate agents professional liability coverages with policy effective dates prior to August 1, 2001, the Company has quota share reinsurance for 25% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For policies with an effective date occurring on August 1, 2001 through April 15, 2002, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000.

     For its educators professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 60% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $400,000.

     For its directors and officers liability coverages with policy effective dates occurring prior to 2001, the Company has quota share reinsurance for 90% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For policies with an effective date occurring during 2001, the Company has quota share reinsurance for 85% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000.

     For its miscellaneous professional liability coverages with policy effective dates occurring during 2001 or prior, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000.

Personal Lines

     The Company’s nonstandard personal auto business is produced by National Specialty Lines, Inc. (“NSL”) and, prior to August 1, 2001, Tri-State or written on a direct basis through MCIC. For business produced by NSL with an effective date of April 1, 2000 through December 31, 2000, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 20% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $20,000. For business produced by NSL with an effective date of January 1, 2001 through December 31, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. Effective December 31, 2001, the Company’s personal lines excess of loss and quota share reinsurance treaties expired and were not replaced, as satisfactory treaties could not be arranged. Under the terms of these treaties, the reinsurer remains liable for claims with regard to policies in force at the date of expiration. For 2002 the Company wrote nonstandard personal auto policies with limits up to $25,000. In 2003 and 2004 nonstandard personal auto policy limits do not exceed $40,000.

     For business produced by Tri-State or written on a direct basis with MCIC with an effective date prior to August 1, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500.

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     For its umbrella coverages for 1999 through 2001, the Company has excess casualty reinsurance for 100% of umbrella claims exceeding $1,000,000 up to $10,000,000 policy limits. For policies with an effective date occurring prior to February 1, 2001, the Company also has quota share reinsurance for 75% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $250,000. For policies with an effective date occurring on February 1, 2001 through December 31, 2001, the Company has quota share reinsurance for 77.5% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $225,000.

     For its nonstandard personal auto coverages for 1998 through 2001, the Company has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. In 2002, the Company has excess casualty clash reinsurance for 35% of $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident.

Commercial and Personal Lines

     Certain reinsurance carried by the Company includes “extra-contractual obligations” coverage. This coverage protects the Company against claims arising out of certain legal liability theories not directly based on the terms and conditions of the Company’s policies of insurance. Extra-contractual obligation claims are covered 90% under the quota share, excess casualty and excess casualty clash reinsurance treaties up to their respective limits.

     Prior to 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $500,000 but do not exceed $17,500,000 for a single catastrophe. In 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $1,500,000 but do not exceed $13,000,000 for a single catastrophe as well as second event catastrophe property reinsurance for 100% of $1,000,000 excess of $500,000 on a second catastrophic event. In 2002, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for property claims that exceed $500,000 but do not exceed $7,000,000. The Company did not have catastrophe reinsurance for business written in 2003 because of the exit from commercial lines and because the cost for coverage for the remaining personal lines was determined to be excessive in relation to the evaluation of risks to be retained. For 2004 the Company has catastrophe reinsurance on its nonstandard personal auto physical damage business for property claims of $1,500,000 in excess of $500,000 for a single catastrophe, as well as aggregate catastrophe property reinsurance for $1,500,000 in excess of $750,000 in the aggregate.

     The Company has signed contracts in force for its reinsurance agreements for all years through 2004.

Marketing and Distribution

     Certain coverages, such as auto liability, may only be written in some states by companies with the authority to write insurance on an admitted basis in such states. The Company currently is approved to write insurance on a non-admitted basis in 41 states and the District of Columbia and on an admitted basis in 44 states and the District of Columbia.

     The Company markets its nonstandard personal auto insurance through approximately 1,000 non-affiliated retail agencies that are compensated on a commission basis. The retail agents may represent several insurance companies, some of which may compete with the Company.

     The Company utilizes the retail agency market because they are in direct contact with the insurance buyers. The Company requires that its retail agents have a specified level of errors and omissions insurance coverage.

     The Company has developed underwriting manuals to be used by its retail agents. The retail agents are authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company’s underwriting manuals.

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Unpaid Claims and Claim Adjustment Expenses

     Accidents generally result in insurance companies paying under the insurance policies written by them amounts to individuals or companies for the risks insured. Months and sometimes years may elapse between the occurrence of an accident, reporting of the accident to the insurer and payment of the claim. Insurers record a liability for estimates of claims that will be paid for accidents reported to them, which are referred to as “case reserves”. In addition, since accidents are not always reported promptly upon the occurrence and because the assessment of existing known claims may change over time with the development of new facts, circumstances and conditions, insurers estimate liabilities for such items which are referred to as “IBNR” reserves.

     The Company maintains such reserves for the payment of claims and claim adjustment expenses for both case and IBNR under policies written by its subsidiaries. These claims reserves are estimates, at a given point in time, of amounts that the Company expects to pay on incurred claims based on facts and circumstances then known. The amount of case claim reserves is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of IBNR claims reserves is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.

     The process of establishing claims reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. The actual emergence of claims and claim adjustment expenses may vary, perhaps materially, from the Company’s estimate thereof, because (a) estimates of claims and claim adjustment expense liabilities are subject to large potential errors of estimation as the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred (e.g., jury decisions, court interpretations, legislative changes (even after coverage is written and reserves are initially set) that broaden liability and policy definitions and increase the severity of claims obligations, subsequent damage to property, changes in the medical condition of claimants, public attitudes and social/economic conditions such as inflation), (b) estimates of losses do not make provision for extraordinary future emergence of new classes of losses or types of losses not sufficiently represented in the Company’s historical data base or which are not yet quantifiable, and (c) estimates of future costs are subject to the inherent limitation on the ability to predict the aggregate course of future events.

     Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. Beginning in the third quarter of 2002 and for each quarter thereafter, the Company set reserves equal to the selected reserve estimate as established by an independent actuarial firm. Formerly reserves were set based upon actuarial analysis by an actuary who was an employee of the Company and these reserves were reviewed annually by an independent actuarial firm.

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     The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company’s consolidated financial statements for the periods indicated:

     The decrease in the unpaid claims and claim adjustment expenses during 2003 is primarily attributable to the exiting of commercial lines and the ongoing settlement of the remaining commercial lines claims. The commercial general liability lines recorded unfavorable development of $7.6 million primarily in the 2000 and 2001 accident years, which was offset to some extent with favorable development recorded for the commercial auto and nonstandard personal auto lines of $5.4 million primarily in the 1999 and 2002 accident years. For 2002 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto claims primarily for the 2001 and 2000 accident years and commercial general liability claims for the 2001, 2000, 1999, 1997 and 1993 accident years. For 2001 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto and commercial general liability claims primarily for the 2000, 1999 and 1998 accident years. At December 31, 2003 the Company believes that the unpaid claims and claim adjustment expenses and the reinsurance agreements currently in force are sufficient to support the future emergence of prior year claim and claim adjustment expenses.

     The following table sets forth, as of December 31, 2003, 2002 and 2001, differences between the amount of net unpaid claims and claim adjustment expenses reported in the Company’s statements, prepared in accordance with statutory accounting principles (“SAP”), and filed with the various state insurance departments, and those reported in the consolidated financial statements prepared in accordance with accounting principles generally accepted for financial reporting in the United States of America (“GAAP”):

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     The following table represents the development of GAAP balance sheet reserves for the years ended December 31, 1993 through 2003. The top line of the table shows the reserves for unpaid claims and claim adjustment expenses for the current and all prior years as recorded at the balance sheet date for each of the indicated years. The reserves represent the estimated amount of claims and claim adjustment expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including claims that have been incurred but not yet reported to the Company.

     The second portion of the following table shows the net cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The third portion of the table shows the reestimated amount of the previously recorded net unpaid claims and claim adjustment expenses based on experience as of the end of each succeeding year, including net cumulative payments made since the end of the respective year. For example, the 1995 liability for net claims and claim adjustment expenses reestimated eight years later (as of December 31, 2003) was $94,609,000 of which $92,060,000 has been paid, leaving a net reserve of $2,549,000 for claims and claim adjustment expenses in 1995 and prior years remaining unpaid as of December 31, 2003.

     “Net cumulative deficiency” represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1995 net unpaid claims and claim adjustment expenses indicate a $24,248,000 net deficiency from December 31, 1995 to December 31, 2003 (eight years later). Conditions and trends that have affected development of liability in the past may or may not necessarily occur in the future. Accordingly, it may or may not be appropriate to extrapolate future redundancies or deficiencies based on this table.

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     For the year ended December 31, 2003 the net cumulative deficiency reported was $2.6 million. The Commercial General Liability lines recorded unfavorable development in the 2000 and 2001 accident years, which was offset to some extent with favorable development recorded for the Commercial Auto Liability and Nonstandard Personal Auto lines in the 1999 and 2002 accident years. In the aggregate, claims closed in 2003 were settled for amounts well below applicable internal pessimistic estimates, but this favorable development was more than offset by unfavorable development on unresolved claims.

     The Company and the independent actuary complete a full actuarial analysis of unpaid claims and claim adjustment expenses on a quarterly basis for each of its coverage lines. Based upon this actuarial analysis and the new information that became available during the quarter, unpaid claims and claim adjustment expenses are reset each quarter. The deficiencies noted above were recognized throughout the year 2003 consistent with this quarterly analysis.

     Net unpaid claims and claim adjustment expenses at December 31, 2003 were approximately $76.6 million, which the Company believes is adequate; they are set equal to the selected estimate determined by an independent actuarial firm. Of this amount, 95% is related to the Company’s three primary reserve coverage areas: Commercial General Liability ($33.3 million); Commercial Auto Liability ($27.9 million); and Nonstandard Personal Auto ($11.7 million). The remaining $3.7 million (5%) relates to eight smaller professional and miscellaneous commercial areas.

     The Company’s provision for unpaid claims and claim adjustment expenses was selected by an independent actuarial firm based on that firm’s actuarial analysis of the Company’s claims and claims adjustment expense experience. The independent actuary has opined that the unpaid claims and claims adjustment expenses selected: a) meet the requirements of the applicable state insurance laws; b) are consistent with amounts computed in accordance with the Casualty Actuarial Society Statement of Principles Regarding Property and Casualty Loss and Loss Adjustment Expense Reserves and relevant standards of practice promulgated by the Actuarial Standards Board; and c) make a reasonable provision for all unpaid claims and claims adjustment expense obligations of the Company under the terms of its contracts and agreements.

     The independent actuary has commented that in evaluating whether the selected reserves make a reasonable provision for unpaid claims and claims adjustment expenses, it is necessary to estimate future claims and claims adjustment expense payments and that actual future losses and loss adjustment expenses will not develop exactly as estimated and may, in fact, vary significantly from the estimates. With respect to the three primary insurance areas identified above, the independent actuary’s multiple actuarial test methods produced data points that are both higher and lower than selected amounts. The selection exceeds the average of these actuarial tests for the three principal reserve coverage areas as follows: Commercial General Liability, (+$2.7 million); Commercial Auto Liability (+$4.2 million); and Nonstandard Personal Automobile (+$1.0 million). The Commercial Automobile Liability amount is before the application of the Company’s Reserve Reinsurance Cover Agreement. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Subsidiaries, Principally Insurance Operations.” The independent actuary opined that there are still significant risks and uncertainties that could potentially result in material adverse deviation of the unpaid claims and claim adjustment expenses, and considered approximately $6 million net (15% of statutory surplus) to be material for this purpose.

     The independent actuary identified that significant risk factors in its evaluation included the adverse development in the Company’s unpaid claims and claims adjustment expense in recent years (see preceding table) and the Company’s decision in 2002 to discontinue writing commercial lines. See “Recent Developments – Discontinuance of Commercial Lines.” The independent actuary further indicated that its selected projections made no provision for extraordinary future emergence of new classes of claims or types of claims not sufficiently represented in the Company’s historical base or which are not yet quantifiable. The independent actuary also noted that other risk factors not cited in its report could be identified in the future as having been a significant influence on the Company’s unpaid claims and claim adjustment expenses.

     Management has reviewed and discussed the results of the actuarial analysis with the independent actuary, and believes the unpaid claims and claim adjustment expenses estimate selected by the independent actuary to be the best estimate for the Company at this time. With reference to its discontinued lines in particular, the Company believes the results of the independent actuary’s selections for the Commercial General Liability and Commercial Auto Liability areas are consistent with a separate internal case-by-case pessimistic analysis of remaining indemnity claims which, through comparison with the independent actuary’s selection, allows for approximately $11 million (before application of reinsurance except excess casualty reinsurance) in new claims still expected to be received, potential commutation exposures and additional unforeseen adverse development, all subject to the risks identified by the independent actuary. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Subsidiaries, Principally Insurance Operations.”

Insurance Ratios

Claims, Expense and Combined Ratios:

     Claims and expense ratios are traditionally used to interpret the underwriting experience of property and casualty insurance companies. Claims and claim adjustment expenses are stated as a percentage of net premiums earned (claims ratio). Commissions, change in deferred acquisition costs, underwriting expenses and operating expenses (for the insurance subsidiaries only) are stated as a percentage of net premiums earned (expense ratio). Underwriting profit is achieved when the combined ratio is less than 100%.

     The following table presents the insurance subsidiaries’ claims, expense and combined ratios on a GAAP basis:

     The holding company provides administrative and financial services for its wholly owned subsidiaries. The allocation of the holding company’s expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented.

     The decrease in the claim ratio for 2003 is primarily the result of significantly less unfavorable development from commercial lines than in 2002. The decrease in 2003 for the expense ratio is primarily related to the continued runoff of commercial lines. The decrease in the claims ratio for 2002 is primarily the result of significantly less unfavorable development from commercial lines than in 2001. The decrease in 2002 for the expense ratio is primarily related to the exiting of commercial lines and the associated expense reductions implemented in 2001, which fully impacted 2002.

Net Leverage Ratios:

     The following table shows, for the periods indicated, the SAP net leverage ratios for the insurance subsidiaries and their industry peer group – professional nonstandard personal auto writers.

	(1)		After dividend of $4.2 million from SAP surplus to GNAC in March 2004.
	(2)		A.M. Best’s “Aggregates and Averages – 2003”

     Net leveraged ratios represents the sum of the SAP net premiums to SAP surplus leverage ratio and the SAP net liability to SAP surplus leverage ratio. Added together, the net leverage ratio measures the combination of a company’s exposure to underwriting/pricing error on its current book of business (net premium leverage) and including unpaid claim and claim adjustment expense and unearned premium.

Net Premiums Written Leverage Ratios:

     The following table shows, for the periods indicated, the SAP net premiums written leverage ratios for the insurance subsidiaries and their industry peer group — professional nonstandard personal auto writers.

(1) After dividend of $4.2 million from SAP surplus to GNAC in March 2004. (2) A.M. Best’s “Aggregates and Averages — 2003”

     The net premiums written leverage ratio represents the ratio of SAP net retained writings in relation to SAP surplus. This ratio measures a company’s exposure to pricing errors on its current book of business.

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Investment Portfolio Historical Results and Composition

     The following table sets forth, for the periods indicated, the Company’s investment results before income tax effects:

(1)		Average investments is the average of beginning and ending investments at amortized cost, computed on an annual basis.
(2)		Includes taxable and tax-exempt securities.
(3)		Includes net unrealized gains (losses) for total investments.

     The following table sets forth the composition of the investment portfolio of the Company.

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     At December 31, 2003 the Standard & Poor’s ratings on the Company’s bonds available for sale were in the following categories: 30% AAA, 7% AA, 24% A, 14% BBB, 20% B and 5% CCC. The Company does not have any securities for which a fair value cannot be obtained by reference to public markets.

     The maturity distribution of the Company’s investments in fixed maturities is as follows:

     As of December 31, 2003, the Company did not have any non-performing fixed maturity securities. In 2001 the Company recognized an other than temporary impairment on a non-rated security by recording a charge to earnings of $489,554, net of deferred income taxes of $252,195. In March 2002, the Company reduced the carrying value of this non-rated security to $0 resulting in a write down of approximately $2,010,000 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which has disrupted the cash flow stream sufficiently to virtually eliminate future cash flows (see Note 1(c) of Notes to Consolidated Financial Statements).

Investment Strategy

     Commencing with the closing of the 1999 GMSP Transaction on October 4, 1999, the investment portfolios of GNAC and its insurance company subsidiaries are managed by GMSP pursuant to its Investment Management Agreements with the respective companies. The investment policies are subject to the oversight and direction of the Investment Committees of the Boards of Directors of the respective companies. The respective Investment Committees consist entirely of directors not affiliated with GMSP.

     The investment policies of the insurance subsidiaries, which are also subject to the respective insurance company legal investment laws of the states in which they are organized, are to maximize after-tax yield while maintaining safety of capital together with adequate liquidity for insurance operations. See Item 7A “Quantitative and Qualitative Disclosures About Market Risk.” The insurance company portfolios may also be invested in equity securities within limits prescribed by applicable legal investment laws.

Rating

     Best’s has assigned the Company a pooled rating of “B-” (Fair), with a stable outlook. Best’s ratings represent an opinion based upon a comprehensive and qualitative evaluation of the company’s balance sheet strength, operating performance and business profile.

Government Regulation

     The Company’s insurance companies are subject to varied governmental regulation in the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the Company’s business and is concerned primarily with the protection of policyholders rather than shareholders. The Company’s statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its insurance companies that are subject to Risk Based Capital requirements.

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     The Company is also subject to statutes governing insurance holding company systems in the states of Oklahoma and Texas. These statutes require the Company to file periodic information with the state regulatory authorities, including information concerning its capital structure, ownership, financial condition and general business operation. These statutes also limit certain transactions between the Company and its insurance companies, including the amount of dividends that may be declared and paid by the insurance companies (see Note 7 of Notes to Consolidated Financial Statements). Additionally, the Oklahoma and Texas statutes restrict the ability of any one person to acquire 10% or more of the Company’s voting securities without prior regulatory approval.

Competition

     The property and casualty insurance industry is highly competitive. However, few barriers exist to prevent property and casualty insurance companies from entering into the Company’s segment of the industry. To the extent this occurs, the Company can be at a competitive disadvantage because many of these companies have substantially greater financial and operational resources.

Employees

     As of December 31, 2003, the Company employed 123 persons, of whom 11 were officers, 110 were staff and administrative personnel, and 2 were part-time employees. The Company is not a party to any collective bargaining agreement.

ITEM 2. PROPERTIES

     The Company has no material real estate properties.

ITEM 3. LEGAL PROCEEDINGS

     Securities litigation has been filed in United States District Court, Southern District of Florida against the Company and two of its officers (one of whom is also a director). The plaintiffs seek class certification for the litigation and principally allege violations of securities laws in respect of the Company’s previously acquired and divested of Tri-State, Ltd. subsidiary. The plaintiffs have not specified the amount of damages they seek. The Company believes the allegations are without merit and intends to vigorously defend the proceedings.

     In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company’s management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company’s consolidated financial position or results of operations. The Company’s management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims that arise in the normal course of its insurance business.

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

     None.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

     The Company’s Common Stock is listed on the OTC Bulletin Board (Symbol: GNAC). The following table sets forth for the fiscal periods indicated the high and low closing sales prices per share of the Common Stock as reported by the NYSE for the period first quarter 2001 to April 14, 2002 and reported by the OTC Bulletin Board for the period April 15, 2002 through the March 18, 2004. The prices reported reflect actual sales transactions.

     In February 2001, the Company discontinued quarterly dividends on the Common Stock.

     As of February 29, 2004, there were 236 shareholders of record of the Company’s Common Stock.

ITEM 6. SELECTED FINANCIAL DATA

     The selected consolidated financial data presented in the following tables for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 2003 and 2002, and the consolidated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2003, and the independent auditors report thereon are included elsewhere in this document. The information presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” consolidated financial statements and the notes thereto, and the other financial information included herein.

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(1)		Excludes premiums of $35,000 in 2003, $1,727,000 in 2002, $16,627,000 in 2001, $26,973,000 in 2000 and $58,137,000 in 1999 from the Company’s fronting arrangements, the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company was a servicing carrier and the reinsurance arrangement in Florida whereby MGAI premiums are ceded to a non-affiliated reinsurer and assumed by General Agents.
(2)		Includes after tax net realized gains (losses) from securities transactions of $1,353,000, $1,352,000, $2,822,000, $(1,258,000) and $400,000 for 2003, 2002, 2001, 2000 and 1999, respectively.
(3)		Based on 21,169,736 shares of Common Stock outstanding at the end of 2003, 2002, 2001 and 2000 and 20,919,833 shares at the end of 1999. This assumes redemption would occur on all series of Preferred Stock. Future changes in Shareholders’ equity will impact these numbers. See Note 7 of Notes to Consolidated Financial Statements.

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

Business Operations

Overview

     In 2003 the Company recorded net income of $3,375,772 as it experienced profitable operating results from its nonstandard personal auto business in Florida, compared with a 2002 net loss of $8,761,087 attributable primarily to unfavorable claims experience and goodwill impairment. Management continued in 2003 to implement actions intended to enhance the profit potential of the Company’s only active insurance line, nonstandard personal auto. Significant improvement in the combined ratio for this business is the primary reason for its level of profitability. This business is currently profitable and the Company believes that meaningful potential opportunities exist through a geographic diversification strategy. Previously the business has been written primarily in the state of Florida. However, in furtherance of the objective to diversify the business to targeted territories, the Company began writing nonstandard personal auto policies in Texas during the fourth quarter of 2003 and has begun its market introduction in Arizona in 2004. The Company’s focus on its obligations to the holders of its Preferred Stock, however, is limiting the Company’s ability to pursue opportunities to further expand its personal auto business. See “Liquidity and Capital Resources – Focus on Obligations to Preferred Stock.”

     The source of revenues for the Company are premiums written on nonstandard personal auto risks, net investment income from the investment portfolio of the Company, net realized gains from the sale of investments, fee income from insurance agency operations and gains from a reinsurance transaction entered into in 2001.

     In 2003, the Company continued its exit from commercial lines. The loss of $75,607,047 recorded in 2001 was primarily a result of unfavorable claims experience, goodwill impairment and a valuation allowance for deferred Federal income taxes. The Company recorded GAAP combined ratios of 105.1% in 2003, 125.9% in 2002 and 173.0% in 2001.

Discontinuance of Commercial Lines

     On February 7, 2002, the Company announced its decision to cease writing commercial insurance, due to continued adverse claims development and unprofitable results. As a result, the Company had only 31 commercial policies remaining in force at December 31, 2003. The discontinuance of writing commercial lines has resulted in the Company ceasing to be approved to write insurance in several states, however, this state action has not materially restricted the geographic expansion of the Company’s personal auto lines thus far.

     The Company continues to settle and reduce its inventory of commercial lines claims. At year-end 2003, there were 525 claims associated with the Company’s overall runoff book outstanding, compared to 1,062 a year earlier. Due to the long tail and litigious nature of these claims, the Company anticipates it will take substantial number of years to complete the adjustment and settlement process with regard to existing claims and the additional claims it expects to receive in the future from its past business writings. Most of the remaining claims are in suit and the Company’s future results may or may not be impacted either negatively or positively based on its ability to settle the remaining claims and anticipated new claims within its established reserve level. In the course of reducing its employee count, in the first quarter of 2003 the Company outsourced certain of its information technology operations related to the run-off of its commercial lines to an unaffiliated third party provider with which Richard A. Laabs, a former senior executive of the Company, and three other former employees of the Company are affiliated.

Sale of GAINSCO County Mutual

     On December 2, 2002, the Company completed the sale and transfer of the management contract controlling GAINSCO County Mutual Insurance Company (“GCM”) to an affiliate of Liberty Mutual Insurance Company (“Liberty”), for a purchase price of up to $10 million, of which $1 million was paid at closing and the balance is payable in contingent payments through September 2009, but each payment is contingent on there being no material adverse change in the regulatory treatment of GCM specifically, or county mutuals generally, from legislative or regulatory administrative actions prior to the applicable payment date.

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     In the session of the Texas Legislature ended June 2, 2003, changes were made in the statutes governing the regulatory treatment of county mutual insurance companies in Texas. These changes prejudice the rights of the Company to receive contingent payments from Liberty, depending upon how the statutory changes and the Company’s agreement with Liberty are interpreted. The Company contacted Liberty to discuss its obligation to make the contingent payments in light of the recent legislation. Liberty’s position is that they have no obligation to make any of the $9 million contingent payments under the agreement. The Company has fully reserved its receivable due from Liberty of $484,967 (representing the excess of the Company’s cost basis in GCM over the $1,000,000 received from Liberty at the closing of the sale transaction) as potentially uncollectible because of the recent statutory changes in 2003.

Results of Operations

     The discussion below primarily relates to the Company’s insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The expense item “Underwriting and operating expenses” includes the operating expenses of GNAC.

     Gross premiums written in 2003 were 22% below 2002 and in 2002 they were 62% below 2001. The Company’s decision in the first quarter of 2002 to discontinue writing commercial lines is primarily the reason for the decrease in 2003 and 2002. In the first quarter of 2002 nonstandard personal auto, which is included in Personal Lines, became the only line of insurance marketed by the Company. The following table compares the major product lines between the years for gross premiums written:

     Commercial lines decreased 85% in 2003 and 82% in 2002. The Company’s decision to discontinue writing commercial lines insurance in the first quarter of 2002 due to continued adverse claims development and unprofitable results is the reason for the decrease in 2003 and in 2002. Virtually no direct commercial premiums were written in 2003, almost all of the commercial premiums written came from assumed premiums the Company received in conjunction with the commutation of several reinsurance agreements with one reinsurance participant.

     Personal lines increased 2% in 2003 but decreased 34% in 2002. The increase in 2003 was primarily due to slight growth in nonstandard personal auto in Florida. The decrease in 2002 was primarily related to the Company’s decision to discontinue writing nonstandard personal auto in the upper Midwest and to discontinue writing personal umbrella. Also contributing to the decrease in 2002 was the fact that most nonstandard personal auto policies written in 2002 were six month policies, whereas in 2001 a significant amount were twelve month policies. A six-month policy gives the Company greater flexibility in managing the business with regards to underwriting selection and rate adequacy.

     Net premiums earned decreased 43% in 2003 and 12% in 2002 primarily as a result of the continued earning out of the discontinued commercial lines premiums written. Because virtually no direct commercial premiums were written in 2003, the decrease was even greater than in 2002.

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     Net investment income decreased 28% and 47% in 2003 and 2002, respectively. The decrease for both years was primarily attributed to the decline in investment balances, due to principal payments on the note payable, commercial claim payments and declining premiums written, and the short-term investments comprising a significantly greater portion of investments each year.

     The Company recorded net realized capital gains of $2,050,236, $2,048,848 and $4,275,192 in 2003, 2002 and 2001, respectively. Variability in the timing of realized investment gains should be expected. During 2002, the Company reduced the carrying value of a non-rated commercial mortgage backed security to $0 resulting in a write down of $2,010,670 (recorded as a realized loss in the statement of operations) as a result of a significant increase in the default rate in the underlying commercial mortgage portfolio, which has disrupted the cash flow stream sufficiently to make future cash flows unpredictable. This write-down was offset by net realized gains of $3,604,462 recorded from the sale of various bond securities and other investments in 2002 and the gain of $455,056 recognized from the sale of the home office building.

     During the second quarter of 2003 the Company reclassified the revenues and expenses of the personal auto agency operation because of its increasing materiality. This reclassification was made for all periods presented and had no impact on net income. The revenues of this operation are now presented as a component of Other income and the expenses are presented as a component of Underwriting and operating expenses. Previously the revenues and expenses were netted and shown as a component of Other income in 2002 and as a component of Commissions in the first quarter of 2003. Other income decreased $2,085,012 from 2002, primarily as a result of amortization of deferred reinsurance recoveries from claim payments under the reserve reinsurance cover agreement of $1,544,410 in 2003. Amortization is based upon claims recovered from the reinsurer in relation to the amount of the reinsured layer under the reserve reinsurance cover agreement. In accordance with GAAP, the reinsurance recoveries from these reserve increases are recorded as deferred revenue and not immediately recognized as reductions to C & CAE. Other income increased $3,957,583 in 2002 over 2001, primarily as a result of amortization of deferred reinsurance recoveries. For 2002, $4,082,469 was recognized from deferred reinsurance recoveries, while only $1,112,469 was recognized in 2001. At December 31, 2003, $2,310,652 remains as deferred reinsurance recoveries that will ultimately be amortized into Other income in future periods.

     Claims and claim adjustment expenses (“C & CAE”) decreased $30,897,174 in 2003 from 2002 and decreased $31,012,337 in 2002 from 2001. The C & CAE ratio was 74.2% in 2003, 93.6% in 2002 and 127.2% in 2001. The decrease in the C&CAE ratio in 2003 is due to smaller increases in estimated ultimate liabilities recorded in 2003 than was recorded in 2002. The commercial general liability lines recorded increases in the 2000 and 2001 accident years, but this was offset to some extent with decreases recorded in the commercial auto and personal auto lines for the 1999 and 2002 accident years. The decrease in the C & CAE ratio in 2002 is primarily due to smaller increases in estimated ultimate liabilities recorded in 2002 for commercial lines than was recorded in 2001. The commercial general liability lines recorded increases in the 2000 and 2001 accidents years. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related coverages in its policies. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.

     The ratio of commissions and the change in deferred policy acquisition costs and deferred ceding commission income to net premiums earned was 13% in 2003, 15% in 2002 and 18% in 2001. The progressive decrease in this ratio is primarily due to the shift in the mix of business to nonstandard personal auto, which has lower acquisition costs than commercial lines.

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     Commissions are comprised of commission expenses (which vary with gross premiums written), offset by commission income, (which varies with ceded premium written). Commission expenses are paid to agents to produce the business for the Company. Commission income is received by the Company from reinsurers as compensation to the Company for business the Company cedes to the reinsurers. Commissions decreased in 2003 and in 2002 primarily as a result of the decrease in gross premiums written discussed previously.

     Change in deferred policy acquisition costs (“DPAC”) and deferred ceding commission income (“DCCI”) represents the change during the period in the asset “Deferred policy acquisition cost”. This asset item is comprised of commission expenses, premium taxes and certain marketing and underwriting expenses, which are deferred, offset by commission income received from reinsurers, which is also deferred. This net asset DPAC is amortized into the results of operations through “Change in deferred policy acquisition costs and deferred ceding commission income,” as the underlying gross premiums written and ceded premiums written are earned. Change in DPAC and DCCI resulted in a charge in 2003 of $382,861, a charge in 2002 of $1,513,880 and a credit in 2001 of $886,282. The charge in 2002 is primarily attributable to the amortization of previous DPAC and DCCI exceeding DPAC and DCCI incurred for 2002 as a result of the decision to discontinue writing commercial lines in 2002. The credit in 2001 is primarily the result of the DPAC and DCCI incurred in 2001 exceeding the amortization of previous DPAC and DCCI. The amortization of previous DPAC and DCCI included a significant amount of DCCI recorded in the 2000 year.

     Interest expense from the note payable decreased in 2003 and in 2002 primarily as a result of principal payments on the note. The Company paid principal amounts of $3,700,000, $7,100,000 and $5,200,000 in 2003, 2002 and 2001, respectively. The note payable was paid in full in the fourth quarter of 2003.

     There is no amortization expense in 2003 and 2002 due to the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (see Note 1(h) of Notes to Consolidated Financial Statements).

     Underwriting and operating expenses were down 25% in 2003 and they were down 39% in 2002. The decrease in 2003 was primarily due to continued expense reductions, primarily salaries and salary related expenses, and a decrease in the allowance for doubtful reinsurance balances receivable. The decrease for 2002 was primarily due to expense reductions implemented as a result of the decision to discontinue writing commercial lines.

     Goodwill impairment in 2002 is a result of the Company positioning itself for an exit from the personal auto business in the second quarter of 2002 and the consideration of a sale of the Lalande Group. A re-evaluation of goodwill for the Lalande Group was made during this period and an additional impairment of $2,859,507 was recorded. This re-evaluation was based upon market indications of value contained in a proposal from a potential acquirer and upon the uncertainty of achieving value levels. Goodwill impairment in 2001 was a result of the Company’s decision to no longer pursue a long-term geographic expansion strategy in nonstandard personal auto beyond that of its core operation in Florida and to sell its Tri-State agency subsidiary. Tri-State was acquired by the Company in the first quarter of 2000, but ultimately it proved marginally unprofitable under the Company’s ownership. Because of the profitability issues surrounding the Lalande Group, (see below), the Company decided in the second quarter of 2001 to sell Tri-State to its former owner so that the Company could focus all of its nonstandard personal auto efforts solely on the Lalande Group. As a result, the remaining goodwill associated with the Tri-State acquisition was written off in the second quarter of 2001. In December 2001 the Company recorded an impairment of $13,360,603 on the goodwill associated with the 1998 acquisition of the Lalande Group. The Company acquired the Lalande Group in the fourth quarter of 1998, it produced a small profit in 1999, but in 2000 it produced a loss. At the end of 2000 the Company was expecting a significant improvement and profitability from the Lalande Group in 2001. During 2001 the Company continued to implement actions throughout the year to return this business to profitability. While results in 2001 showed improvement, they remained unprofitable. In the fourth quarter of 2001 the Company concluded that the value of this operation was significantly below what the Company had paid and accordingly recorded the impairment against goodwill based upon then current estimated market valuation levels of agencies in the nonstandard personal auto marketplace.

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     The Company recognized a current tax benefit of $2,607,796 in 2002 as a result of a carry back of alternative minimum tax losses. A change in the tax law during 2002 extended the carry back period for losses to offset income in earlier periods. As a result, the Company was entitled to a tax refund, which it received in October 2002. The Company recorded deferred tax expense during the first quarter of 2002 due to an increase in the deferred tax asset valuation allowance, as a result of excluding the effects of unrealized gains in the deferred tax asset. The Federal income tax expense for 2001 is a result of the Company recording a valuation allowance of $31,534,712 against its deferred Federal income tax asset offset by the income tax benefit generated by the net loss from operations. Establishing the valuation allowance was necessary because of the uncertainty of future profitability levels. The Company does not lose the right to utilization of its net operating loss carry forwards for Federal income tax purposes in the future. During 2001 the Company continued to implement actions to return to profitability, both in commercial lines and the personal lines. However, earnings in 2001 did not materialize and in the first quarter of 2002 the Company announced it was discontinuing the writing of its largest line of business, commercial lines, due to continued adverse claims development and unprofitable results. At that time the prospects for significant profits in personal lines, its only remaining line of business, were unclear. Because the Company had no near-term expectation of profitable results, it was necessary to fully reserve the deferred tax asset due to uncertainty of future taxable results, which could utilize this asset. In 2002 the Company continued to record taxable losses and had no expectation of significant taxable income at that time. In 2003 the Company recorded a small taxable loss. Current expectations are that the Company will begin to record taxable income in 2004 and into the future, at which time the reserve for the deferred tax asset will be re-evaluated. However, as of December 31, 2003 the deferred tax asset remains fully reserved. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note 6 of Notes to Consolidated Financial Statements.

     The cumulative effect of change in accounting principle recorded in 2001 was a result of EITF 99-20, which became effective April 1, 2001. This amount represents the write down of an investment that was considered temporarily impaired and was written down in the first quarter of 2001 through accumulated other comprehensive income. EITF 99-20 changed the definition of impairment which resulted in this asset being reclassified as an impairment other than temporary which requires recognition through the statement of operations.

Legal Proceedings

     Securities litigation has been filed in United States District Court, Southern District of Florida against the Company and two of its officers (one of whom is also a director). The plaintiffs seek class certification for the litigation and principally allege violations of securities laws in respect of the Company’s previously acquired and divested of Tri-State, Ltd. subsidiary. The plaintiffs have not specified the amount of damages they seek. The Company believes the allegations are without merit and intends to vigorously defend the proceedings.

     In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company’s management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company’s consolidated financial position or results of operations. The Company’s management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims that arise in the normal course of its insurance business.

Capital Transactions

Transactions with Goff Moore Strategic Partners, L.P.

     1999 GMSP Transaction. On October 4, 1999, the Company sold to Goff Moore Strategic Partners, L.P. (“GMSP”), for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock (stated value $1,000 per share), which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant expiring October 4, 2004 to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant expiring October 4, 2006 to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share.

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At closing the Company and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of these transactions (the “1999 GMSP Transaction”) concluded a strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes.

     2001 GMSP Transaction. On March 23, 2001, the Company consummated a transaction with GMSP (the “2001 GMSP Transaction”) pursuant to which, among other things, the Company issued 3,000 shares of its newly created Series C Preferred Stock (stated value of $1,000 per share) to GMSP in exchange for an aggregate purchase price of $3 million in cash. The annual dividend rate on the Series C Preferred Stock is 10% until March 23, 2004 and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company’s option after March 23, 2006 and at the option of the majority holders after March 23, 2007 at a price of $1,000 per share plus accrued and unpaid dividends. The Series C Preferred Stock is not convertible into Common Stock.

     The agreement with GMSP in connection with the 2001 GMSP Transaction was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were reduced to $2.25 per share and $2.5875 per share, respectively. Each of these warrants provides for the purchase of 1,550,000 shares of Common Stock, subject to adjustment. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share and, should the Company pay dividends on its Common Stock, the Series A Preferred Stock would be entitled to dividends as if converted into Common Stock. On March 23, 2001, the Series A Preferred Stock was called for redemption by the Company so that on January 1, 2006 the Company will be obligated to pay $1,000 per share for 31,620 shares ($31.6 million) to the holder to the extent that it can legally do so and, to the extent it cannot do so, the Company will be obligated to pay quarterly an amount equal to 8% interest per annum on any unpaid balance. See “Liquidity and Capital Resources - Focus on Obligations to Preferred Stock.”

     The 2001 agreement with GMSP provided an opportunity to convert the Company’s illiquid investments with a cost of $4.2 million to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase the illiquid investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the illiquid investments to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. During the second quarter of 2001, the Company recognized a permanent impairment of these investments and wrote down the carrying value to the amount recoverable from GMSP under the put option. In February 2002, GMSP consented to the early exercise of the Company’s option, and the Company exercised its option to require GMSP purchase the illiquid investments for approximately $2.1 million.

     2002 Amendment to Investment Management Agreements. In August 2002, the Company’s Investment Management Agreements with GMSP were amended to reduce, effective as of October 1, 2002, the minimum aggregate monthly payment to GMSP from $75,000 to $63,195 (with respect to each calendar month from October 2002 through September 2003), $53,750 (with respect to each calendar month from October 2003 through September 2004), and $45,417 (with respect to each calendar month after September 2004). The amendment also extended the date upon which either party to each of the investment management agreements can terminate such agreements at its sole option from October 4, 2002 to September 30, 2005.

Transactions with Robert W. Stallings

     On March 23, 2001, the Company sold to Robert W. Stallings, for $3 million in cash, 3,000 shares of its newly created Series B Preferred Stock (stated value of $1,000 per share) and a warrant expiring March 23, 2006 to purchase an aggregate of 1,050,000 shares of Common Stock at $2.25 per share (the “Stallings Transaction”). The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at $2.25 per share. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. Mr. Stallings also entered into a consulting agreement pursuant to which he provides consulting services (including strategic planning advice, analysis of the subsidiaries’ performance in various sectors of their respective business

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and recommendations for growth strategies and opportunities for new markets and products) to the Company’s insurance subsidiaries for a period of five years ending on March 22, 2006 for $300,000 per annum. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company, and on September 6, 2001, he was elected non-executive Chairman of the Board.

Liquidity and Capital Resources

Parent Company

     GAINSCO, INC. (“GNAC”) is a holding company that provides administrative and financial services for its wholly owned subsidiaries. GNAC needs cash during the next twelve months primarily for: (1) preferred stock dividends, (2) administrative expenses, and (3) investments. The primary source of cash to meet these obligations are statutory permitted payments from its insurance subsidiary, General Agents Insurance Company of America, Inc. (“General Agents”), an Oklahoma corporation. Statutes in Oklahoma restrict the payment of dividends by the insurance company to the available surplus funds. The maximum amount of cash dividends that General Agents may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders’ surplus as of the previous December 31. On March 22, 2004, General Agents paid dividends to GNAC of $4,171,727, based upon 10% of its surplus amounts at December 31, 2003. GNAC believes the cash dividends from General Agents should be sufficient to meet its expected obligations for 2004.

Focus on Obligations to Preferred Stock

     Preferred Stock in Relation to Capital Base. At December 31, 2003, the capital base (total assets less total liabilities) of the Company was $45,535,405 and consisted of Shareholders’ Equity of $13,412,885 and three series of Redeemable Preferred Stock, which are classified under GAAP as mezzanine financing in the aggregate amount of $32,122,520. At December 31, 2003, $7,370,001 was included within Additional paid-in capital, and had yet to be charged to Shareholders’ Equity, related to the accretion of the discount on the redeemable Preferred Stock. Almost all of this unaccreted discount will be charged to Shareholders’ Equity by January 1, 2006, the redemption date of the Series A Preferred Stock. At December 31, 2003, the per common share Shareholders’ Equity was approximately $0.63, including unaccreted discount on Redeemable Preferred Stock of $0.34; less such unaccreted discount, the per common share Shareholders’ Equity was approximately $0.29. The aggregate redemption value of the Preferred Stock was $39,492,520 ($37,620,000 stated value plus accrued dividends of $1,872,520) at December 31, 2003.

     Obligation to Redeem Series A Preferred Stock on January 1, 2006. On March 23, 2001, the Series A Preferred Stock was called for redemption so that on January 1, 2006 the Company will be obligated to pay $31,620,000 to the holder of the Series A Preferred Stock, subject to the conditions described below. The Company’s obligation to redeem the Series A Preferred Stock generally is conditioned upon (i) the redemption not contravening any credit or financing arrangement in excess of $3,000,000 and approval by at least one director nominated by the Series A Preferred Stock (no such indebtedness is now outstanding); (ii) the holder of the Series A Preferred Stock not receiving a purchase offer to purchase shares of the Series A Preferred Stock prior to January 1, 2006 from a financially responsible unaffiliated third party for a price equal to or greater than the liquidation value of the Series A Preferred Stock; and (iii) the payment of the redemption price not contravening the provisions of Article 2.38 of the Texas Business Corporation Act (which generally prohibits the amount to be paid to the holder of the Series A Preferred Stock in respect of the redemption from exceeding the net assets of the Company or leaving the Company insolvent) or any other applicable federal and state laws. The Board of Directors is contractually obligated to use its best efforts to take such actions as will cause the redemption to not contravene Article 2.38 or other applicable law. To the extent that the Company is restricted from redeeming the Series A Preferred Stock because of the conditions described above, the Company will be obligated to pay quarterly an amount equal to 8% interest per annum on any unpaid balance.

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     Obligation to Redeem Series B and Series C Preferred Stock on March 23, 2007. The Series B and Series C Preferred Stock become redeemable at the option of holders commencing March 23, 2007 for the aggregate liquidation amount of $6,000,000 plus accrued dividends, subject to conditions on the Company’s obligation to redeem the Series B and Series C Preferred Stock similar to those conditions on the Company’s obligation to redeem the Series A Preferred Stock.

     Dividends on Series B and Series C Preferred Stock. The Company declared dividends aggregating $2,111,267 in respect of the Series B and Series C Preferred Stock to be paid on April 1, 2004, which would bring dividends current to that point. From and after April 1, 2004, dividends accrue at the rate of 20% per annum, of which at least half (or at least $150,000 in the aggregate in respect of the Series B and Series C Preferred Stock) must be paid quarterly.

     Board Focus. The Board of Directors has been focusing on the Company’s obligations to the holders of the Preferred Stock, which are affiliates of three of the Company’s eight directors, recognizing that the Company does not have, or expect that its operations will generate, sufficient funds to redeem the Series A Preferred on January 1, 2006. Also, the Board of Directors has considered how the need for capital to satisfy those obligations may limit the Company’s ability to pursue opportunities to further expand the Company’s nonstandard personal auto business. The interests of the holders of the Preferred Stock in assuring that these obligations are met in a timely manner may differ from those of other shareholders. As a result, the Board of Directors formed a Special Committee of independent directors to address the alternatives for providing for these obligations. The Special Committee consists of director Joel C. Puckett, Chairman, and directors Harden H. Wiedemann and John H. Williams, with director Sam Rosen acting as an advisory member. The Special Committee first considered, with the assistance of an investment banking firm, proposals from holders of Preferred Stock for the recapitalization of the Company, including a proposal that would have involved an investment by two consultants and the President of the Company. No agreement was reached with the holders of the Preferred Stock, and all recapitalization proposals were withdrawn. The Board of Directors then expanded the mandate of the Special Committee to consider alternatives that might be available with unaffiliated third parties. The Special Committee intends to engage an investment banking firm to advise it as to any such alternatives that may be available to the Company. No prediction can be made at this time as to the outcome or length of this process.

     Through March 15, 2004, the Company had spent approximately $400,000 including financial advisory and legal fees, in respect of the Special Committee’s consideration of alternatives for dealing with its obligations to the holders of its Preferred Stock. These amounts will be expensed in the first quarter of 2004.

Net Operating Loss Carryforwards

     As a result of losses in prior years, as of December 31, 2003 the Company has net operating loss carryforwards for tax purposes aggregating $72,692,450. These net operating loss carryforwards of $1,639,333, $22,806,147, $33,950,174, $13,686,532 and $610,264, if not utilized, will expire in 2018, 2020, 2021, 2022 and 2023, respectively. The tax benefit of the net operating loss carryforwards is $24,715,433, which is calculated by applying the Federal statutory income tax rate of 34% against the net operating loss carryforwards of $72,692,450.

     In certain circumstances, Section 382 of the Internal Revenue Code may apply to materially limit the amount of the Company’s taxable income that may be offset in a tax year by the Company’s net operating losses carried forward from prior years (the “§ 382 Limitation”). The annual § 382 Limitation generally is an amount equal to the value of the Company (immediately before an “ownership change”) multiplied by the long-term tax-exempt rate for the month in which the change occurs (e.g., 4.58% if the ownership change occurred in April 2003). This annual limitation would apply to all years to which the net operating losses can be carried forward.

     In general, the application of Section 382 is triggered by an increase of more than 50% in the ownership of all of the Company’s currently issued and outstanding stock (determined on the basis of value) by one or more “5% shareholders” during the applicable “testing period” (usually the three year period ending on the date on which a transaction is tested for an ownership change). The determination of whether an ownership change has occurred under Section 382 is made by aggregating the increases in percentage ownership for each 5% shareholder whose percentage ownership (by value) has increased during the testing period. For this purpose, all stock owned by persons who own less than 5% of the Company’s stock is generally treated as stock owned by a single 5% shareholder.

     In general, a 5% shareholder is any person who owns 5% or more of the stock (by value) of the Company at any time during the testing period. The determination of whether an ownership change has occurred is made by the Company as of each “testing date.” For this purpose, a testing date generally is triggered whenever there is an “owner shift” involving any change in the respective stock ownership of the Company and such change affects the percentage of stock owned (by value) by any person who is a 5% shareholder before or after such change. A testing date also may be triggered by the Company’s issuance of options in certain limited circumstances. Examples of owner shifts that may trigger testing dates include a purchase or disposition of Company stock by a 5% shareholder, an issuance, redemption or recapitalization of Company stock that affects the percentage of stock owned (by value) by a 5% shareholder, and certain corporate reorganizations that affect the percentage the percentage of stock owned (by value) by a 5% shareholder.

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Subsidiaries, Principally Insurance Operations

     The primary sources of the insurance subsidiaries’ liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 2003, the insurance subsidiaries held short-term investments and cash that the insurance subsidiaries believe are adequate liquidity for the payment of claims and other short-term commitments.

     With regard to long term liquidity, the average duration of the investment portfolio is approximately 1.2 years. The fair value of the fixed maturity portfolio at December 31, 2003 was $2,962,335 above amortized cost, before taxes. Unrealized losses were not material at December 31, 2003. (See Note 2 of Notes to the Consolidated Financial Statements.) Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2003 and 2002, the balance on deposit for the benefit of such policyholders totaled $11,902,432 and $14,185,018, respectively.

     Net cash used for operating activities was $1,000,446 in 2003, $62,050,686 in 2002 and $61,384,654 in 2001. The cash used in 2002 was primarily attributable to the transfer of trust assets to the reinsurer for the reserve reinsurance cover agreement in the first quarter of 2002. The cash used in 2001 was primarily related to the decrease in premium writings and the ongoing payment of claims and claim adjustment expense related to the commercial lines business.

     Investments decreased primarily due to principal payments on the note payable of $3,700,000 and negative cash flows from operations due to commercial claim payments and declining premiums written. At December 31, 2003, 91% of the Company’s investments were investment grade with an average duration of approximately 1.2 years, including approximately 62% that were held in short-term investments. On a taxable equivalent basis the return on average investments was 2.8% in 2003, 3.9% in 2002 and 4.3% in 2001. The Company classifies its bond securities as available for sale. In February 2002 GMSP purchased the equity investments and the note receivable, classified as “Other investments” for approximately $2,087,000 which was their carrying value at December 31, 2001. In March 2002, the Company reduced the carrying value of a non-rated security to $0 resulting in a write down of $2,010,670 as a result of a significant increase in the default rate in January and February of 2002 in the underlying collateral, which had disrupted the cash flow stream sufficiently to virtually eliminate future cash flows. The unrealized gain associated with the investment portfolio was $1,955,141 (net of tax effects) at December 31, 2003. The duration of the bonds available for sale approximates the average expected payout of claims.

     Premiums receivable increased primarily as a result of the increase in writings in nonstandard personal auto. This balance is comprised primarily of premiums due from insureds for nonstandard personal auto. The nonstandard personal auto premiums are written with a down payment of 34% and monthly payment terms of up to four months. The Company has recorded an allowance for doubtful accounts of $275,000, which it considers adequate at the present time.

     Reinsurance balances receivable decreased primarily as a result of C & CAE claims paid under the reserve reinsurance cover agreement for commercial lines. This balance is primarily comprised of ceded unpaid claims and claims adjustment expenses under the reserve reinsurance cover agreement and claims and claim adjustment expenses paid by the Company and due from reinsurers under the Company’s various reinsurance agreements which was $13,785,337. An allowance for doubtful accounts of $122,484 was recorded for 2003 and $1,001,461 had been recorded for 2002 as a result of concern regarding the collectibility of amounts due from specific reinsurers. The decrease in the allowance for doubtful accounts in 2003 was due to the successful recovery of an amount that had been included in the allowance in 2002 from a reinsurer whose participation was commuted on several reinsurance agreements in the fourth quarter of 2003. Balances written off in previous years have been immaterial. The Company considers the allowance adequate at the present time.

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     Ceded unpaid claims and claim adjustment expenses (C&CAE) decreased as a result of the decrease in unpaid claims and claim adjustment expenses with regard to commercial claims subject to the commercial quota share reinsurance agreement. This balance represents unpaid claims and claim adjustment expenses which have been ceded to reinsurers under the Company’s various reinsurance agreements, other than the reserve reinsurance cover agreement. These amounts are not currently due from the reinsurers but are expected to become due in the future when the Company pays the claim and requests reimbursement from the reinsurers.

     Current Federal income taxes at December 31, 2002 were received in January 2003. Deferred Federal income taxes have a valuation allowance for its full amount recorded against the asset. This asset is primarily a tax benefit from net operating loss carry forwards, which can be used to offset tax expense on future operating earnings or capital gains. See earlier discussion under “Results of Operations.” A change in ownership of the Company’s stock greater than 50% (as specified under Internal Revenue Code Section 382) could severely limit the Company’s ability to recover this asset in future periods. See “Net Operating Loss Carryforwards.”

     Funds held by reinsurers decreased as a result of a decrease in assumed paid and unpaid C&CAE and a decrease in commissions payable both of which are due to reinsurers. Funds held by reinsurers collateralize obligations of the Company to the reinsurers.

     Goodwill of $609,000 is associated with the 1998 acquisition of the Lalande Group and reflects a value no less than the estimated fair valuation levels of combined agency and claims handling operations of this type in the personal automobile marketplace. Effective in 2002, goodwill is no longer amortized but is subject to an impairment test based on its estimated fair value. Additional impairment losses could be recorded in future periods.

     Unpaid claims and claim adjustment expenses (“C&CAE”) decreased primarily as a result of the settlement of claims in the normal course and a decrease in the ultimate expected liabilities in personal auto, which were partially offset by an increase in ultimate expected liabilities in commercial lines. As of December 31, 2003, the Company had $75,569,400 in net unpaid claims and claim adjustment expenses. This amount represents management’s best estimate, as derived from the actuarial analysis and was set equal to the selected reserve estimate as established by an independent actuary. The independent actuary identified the recent adverse development in the Company’s unpaid C&CAE and the Company’s decision in 2002 to discontinue writing commercial lines as risk factors. In consideration of these risk factors the independent actuary believes that there are significant risks and uncertainties that could result in material adverse deviation of the unpaid C&CAE. The independent actuary has opined that the unpaid C&CAE: (a) meets the requirements of the insurance laws of the states, (b) are consistent with amounts computed in accordance with the Casualty Actuarial Society Statement of Principles Regarding Property and Casualty Loss and Loss Adjustment Expense Reserves and relevant standards of practice promulgated by the Actuarial Standards Board; and (c) make a reasonable provision for all unpaid C&CAE obligations of the Company under the terms of its contracts and agreements. Management has reviewed and discussed the results of the actuarial analysis with the actuary and believes the reserve estimate selected by the actuary to be the best estimate of reserves at this time.

     As of December 31, 2003, in respect of its commercial and runoff lines, the Company had $64,894,298 in reserves for unpaid claims and claim adjustment expenses. Historically, the Company has experienced significant volatility in its reserve projections for its commercial lines. This volatility has been primarily attributable to its commercial automobile and general liability product lines. See Item 1 “Business Operations - Unpaid Claims and Claim Adjustment Expenses.” On February 7, 2002, the Company announced it had decided to discontinue writing commercial lines insurance due to continued adverse claims development and unprofitable results. The Company has been settling and reducing its remaining inventory of commercial claims. See “Business Operations –Recent Developments – Discontinuance of Commercial Lines.” As of December 31, 2003, 525 commercial and runoff claims remained. Included in these claims are 69 product liability claims, 27 construction defect type claims, and 1 environmental claim. The Company has no asbestos related claims. The average commercial lines claim at December 31, 2003 was approximately $123,608 per claim, at December 31, 2002 the average commercial lines claim was approximately $78,779 per claim.

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     As of December 31, 2003, in respect of its nonstandard personal auto line, the Company had $11,675,102 in unpaid claims and claim adjustment expenses. These claims generally are shorter tailed than the Company’s commercial and runoff lines claims. At December 31, 2003, the Company had 1,370 nonstandard personal auto claims. The average nonstandard personal auto claim at December 31, 2003 was approximately $8,522 per claim, at December 31, 2002 the average nonstandard personal auto claim was approximately $7,276.

     The Company considers the unpaid claims and claim adjustment expenses to be adequate; they are set to equal the selected reserve estimate determined by an independent actuarial firm.

     Commissions payable decreased primarily due to contingent commission settlements made with the commercial quota share reinsurers during the second quarter of 2003.

     Deferred revenues decreased primarily as a result of reinsurance recoveries under the reserve reinsurance cover agreement. This balance is primarily comprised of C & CAE recoveries under this agreement which will be recognized as Other income in future periods based upon the ratio of actual C & CAE paid to the total of potential C & CAE payable under this reinsurance agreement.

     Note payable decreased due to the Company paying in full the remaining principal amount in the fourth quarter of 2003.

     Deferred Federal income taxes is comprised of the taxes on the unrealized gains of the bonds available for sale. The unrealized gains have been recorded net of taxes in “Accumulated other comprehensive income.”

     Accumulated other comprehensive income of $1,955,141 was recorded at December 31, 2003 as a result of the unrealized gains on bonds available for sale, net of tax.

     The increase in Retained deficit of $388,634 is attributable to the net income of $3,375,772, offset by the accretion of discount on the Series A and Series B Preferred Stock of $3,024,000 and the accrual of dividends on the Series B and Series C Preferred Stock of $740,406.

     The Company is not aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on the Company’s liquidity, capital resources or results of operations. The Company’s statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its insurance companies. Risk Based Capital is a method for establishing the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The tragic events of September 11, 2001 did not impact the Company’s financial results for 2001, 2002 and 2003.

Contractual Obligations

     The following table summarizes the Company’s contractual obligations as of December 31, 2003.

     On January 1, 2006 the Company will be obligated to pay $31,620,000 to the holder of the Series A Preferred Stock, subject to conditions as described in Liquidity and Capital Resources — “Obligation to Redeem Series A Preferred Stock on January 1, 2006.” On March 23, 2007 the Company will be obligated to pay $6,000,000 plus accrued dividends to the holders of the Series B and Series C Preferred Stock, subject to similar conditions. From and after April 1, 2004 dividends on the Series B and Series C Preferred Stock accrue at a rate of 20% per annum, of which at least half (or at least $150,000) must be paid quarterly.

     See Item 1, “Business – Unpaid Claims and Claim Adjustment Expenses” and Note 1(k) of Notes to Consolidated Financial Statements with respect to liabilities to policy holders in respect of insurance policies written by the Company.

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Off-Balance Sheet Transactions and Related Matters

     There are no off-balance sheet transactions, arrangements, obligations (including contingent obligations), or other relationships of the Company with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources of the Company.

Critical Accounting Policies

     The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions.

     Critical accounting policies are defined as those that are reflective of significant judgements and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s critical accounting policies are described below. For a detailed discussion on the application of these and other accounting policies (see Note 1 of the Notes to Consolidated Financial Statements).

Investments

     Bonds available for sale are stated at fair value with changes in fair value recorded as a component of comprehensive income. Short-term investments are stated at cost. The “specific identification” method is used to determine costs of investments sold. Provisions for possible losses are recorded only when the values have experienced impairment considered “other than temporary” by a charge to realized losses resulting in a new cost basis of the investment. The Company’s policy is to review investments on a regular basis to evaluate whether or not each investment has experienced an “other than temporary” impairment. Interest rate fluctuations and credit quality of the issuer impact the variability in the fair value. See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” for a discussion of variability of estimates.

Deferred Policy Acquisition Costs and Deferred Ceding Commission Income

     Policy acquisition costs, principally commissions, premium taxes and certain marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The change in the resulting deferred asset is charged (credited) to operations. The Company utilizes investment income when assessing recoverability of deferred policy acquisition costs. Recoverability is based upon assumptions as to loss ratios, investment income and maintenance expenses and would vary with changes in these estimates.

Goodwill

     Goodwill represents the excess of purchase price over fair value of net assets acquired. The Company periodically reviews the recoverability of goodwill based on an assessment of undiscounted cash flows of future operations to ensure it is appropriately valued. The recoverability of goodwill is evaluated on a separate basis for each acquisition.

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     In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (“Statement 141”) and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“Statement 142”). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.”

     The Company adopted the provisions of Statement 141 effective July 1, 2001 and Statement 142 effective January 1, 2002. The adoption of Statement 141 had no impact on the consolidated financial statements. The adoption of Statement 142 resulted in the Company no longer amortizing goodwill.

     Goodwill of $609,000 is associated with the 1998 acquisition of the Lalande Group and reflects a value no less than the estimated fair valuation levels of combined agency and claims handling operations of this type in the personal automobile marketplace.

Unpaid Claims and Claim Adjustment Expenses

     Accidents generally result in insurance companies paying under the insurance policies written by them amounts to individuals or companies for the risks insured. Months and sometimes years may elapse between the occurrence of an accident, reporting of the accident to the insurer and payment of the claim. Insurers record a liability for estimates of claims that will be paid for accidents reported to them, which are referred to as “case reserves”. In addition, since accidents are not always reported promptly upon the occurrence and because the assessment of existing known claims may change over time with the development of new facts, circumstances and conditions, insurers estimate liabilities for such items, which are referred to as “IBNR” reserves.

     The Company maintains reserves for the payment of claims and claim adjustment expenses for both case and IBNR under policies written by its subsidiaries. These claims reserves are estimates, at a given point in time, of amounts that the Company expects to pay on incurred claims based on facts and circumstances then known. The amount of case claim reserves is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of IBNR claims reserves is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.

     The process of establishing claims reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. The actual emergence of claims and claim adjustment expenses may vary, perhaps materially, from the Company’s estimate thereof, because (a) estimates of claims and claim adjustment expense liabilities are subject to large potential errors of estimation as the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred (e.g., jury decisions, court interpretations, legislative changes (even after coverage is written and reserves are initially set) that broaden liability and policy definitions and increase the severity of claims obligations, subsequent damage to property, changes in the medical condition of claimants, public attitudes and social/economic conditions such as inflation), (b) estimates of losses do not make provision for

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extraordinary future emergence of new classes of losses or types of losses not sufficiently represented in the Company’s historical data base or which are not yet quantifiable, and (c) estimates of future costs are subject to the inherent limitation on the ability to predict the aggregate course of future events.

     Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. Beginning in the third quarter of 2002 and for each quarter thereafter, the Company set reserves equal to the selected reserve estimate as established by an independent actuarial firm. Formerly reserves were set based upon its actuarial analysis by an actuary who was an employee of the Company and these reserves were reviewed annually by an independent actuarial firm.

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Income Taxes

     The Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the “asset and liability” method which provides for temporary differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses, net operating loss carry forwards and the nondeductible portion of the change in unearned premiums.

     In assessing the realization of its deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon management’s consideration of expected reversal of deferred tax liabilities and projected future taxable income and FASB statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, management believes it is appropriate to continue to fully reserve the deferred tax assets as of December 31, 2003.

Accounting Pronouncements

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     In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“Statement 149”). This statement clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. This statement is generally effective for contracts entered into or modified after September 30, 2003, and all provisions should be applied prospectively. The Company adopted Statement 149 on October 1, 2003. Statement 149 did not have a material effect on the Company’s financial statements.

     In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“Statement 150”). This statement does not have an impact on the current accounting by the Company as all of the Company’s series of Preferred Stock are not considered “mandatory redeemable financial instruments” based on Statement 150’s definition, and therefore are not subject to the accounting treatment under paragraph 9 of Statement 150. All three series of Preferred Stock are currently classified as temporary equity pursuant to SEC ASR 268 and EITF Topic No. D-98. Rule 5-02.28 of SEC Regulation S-X requires preferred securities that are redeemable for cash or other assets to be classified outside of permanent equity if they are redeemable (1) at a fixed or determinable price on a fixed or determinable date; (2) at the option of the holder; or (3) upon the occurrence of an event that is not solely within the control of the issuer.

     In December 2003, the FASB issued a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” that was originally issued in January 2003. This interpretation as revised addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. This Interpretation requires certain disclosures in financial statements issued after January 31, 2003. The Company adopted FASB Interpretation No. 46 as revised January 2003. FASB Interpretation 46 as revised did not have a material effect on the Company’s financial statements.

Forward Looking Statements

     Statements made in this report that are qualified with words such as “will be,” “may,” “anticipates,” “intends to engage,” “expects,” etc., are forward-looking statements. Investors are cautioned that important factors, representing certain risks and uncertainties, could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, (a) the Company’s ability to effectively adjust and settle remaining claims associated with it’s exit from the commercial insurance business, (b) heightened competition from existing competitors and new competitor entrants into the Company’s markets, (c) the extent to which market conditions firm up, the acceptance of higher prices in the market place and the Company’s ability to realize and sustain higher rates, (d) contraction of the markets for the Company’s business, (e) acceptability of the Company’s A.M. Best rating to its end markets,(f) the Company’s ability to meet its obligations in respect of its Redeemable Preferred Stock, (g) the ongoing level of claims and claims-related expenses and the adequacy of claim reserves, (h) the outcome of pending litigation, (i) the effectiveness of investment strategies implemented by the Company’s investment manager, (j) continued justification of recoverability of goodwill in the future, (k) the availability of reinsurance and the ability to collect reinsurance recoverables, including amounts that may become recoverable from two reinsurers with less than A.M. Best “Secure” ratings, (l) the Company’s ability to invest in new endeavors that are successful, (m) the limitation on the Company’s ability to use net operating loss carryforwards as a result of constraints caused by ownership changes within the meaning of Internal Revenue Code

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Section 382, (n) the ability of the Company to realize contingent acquisition payments in connection with its sale of the management contract controlling GCM, which was prejudiced by legislation passed in the session of the Texas Legislature ended June 2, 2003 and (o) general economic conditions, including fluctuations in interest rates. In addition, the actual emergence of losses and loss expenses may vary, perhaps materially, from the Company’s estimate thereof, because (a) estimates of loss and loss expense liabilities are subject to large potential errors of estimation as the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred (e.g., jury decisions, court interpretations, legislative changes, subsequent damage to property, changes in the medical condition of claimants, public attitudes and social/economic conditions such as inflation), (b) estimates of losses do not make provision for extraordinary future emergence of new classes of losses or types of losses not sufficiently represented in the Company’s historical data base or which are not yet quantifiable, and (c) estimates of future costs are subject to the inherent limitation on the ability to predict the aggregate course of future events. A forward-looking statement is relevant as of the date the statement is made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which the statements are made.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company’s consolidated balance sheets include assets whose estimated fair values are subject to market risk. The primary market risk to the Company is interest rate risk associated with investments in fixed maturities. The Company has no foreign exchange, commodity or equity risk.

Interest Rate Risk

     The Company’s fixed maturity investments are subject to interest rate risk. Increases and decreases in interest rates typically result in decreases and increases in the fair value of these investments.

     Most of the Company’s investable assets are in the portfolios of the insurance company subsidiaries and come from premiums paid by policyholders. These funds are invested predominately in high quality fixed maturities with relatively short durations and short term investments. The fixed maturity portfolio had an average duration of 3.0 years at December 31, 2003. The fixed maturity portfolio is exposed to interest rate fluctuations; as interest rates rise, fair values decline and as interest rates fall, fair values rise. The changes in the fair value of the fixed maturity portfolio are presented as a component of shareholders’ equity in accumulated other comprehensive income, net of taxes.

     The effective duration of the fixed maturity portfolio is managed with consideration given to the estimated duration of the Company’s liabilities. The Company has investment policies that limit the maximum duration and maturity of the fixed maturity portfolio.

     The Company utilizes the modified duration method to estimate the effect of interest rate risk on the fair values of its fixed maturity portfolio. The usefulness of this method is to a degree limited, as it is unable to accurately incorporate the full complexity of market interactions.

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     The table below summarizes the Company’s interest rate risk and shows the effect of a hypothetical change in interest rates as of December 31, 2003. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios (dollars in thousands):

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following consolidated Financial Statements are on pages 50 through 91

The following Consolidated Financial Statements Schedules are on pages 92 through 103