ENSTAR GROUP INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________TO____________

COMMISSION FILE NUMBER 0-07477

THE ENSTAR GROUP, INC.
(Exact name of registrant as specified in its charter)

GEORGIA 63-0590560
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
401 MADISON AVENUE 36104
MONTGOMERY, ALABAMA (Zip Code)
(Address of principal executive offices)

(334) 834-5483
(Registrant's telephone number, including area code)

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

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

Title of Class
COMMON STOCK, $.01 PAR VALUE
(including rights attached thereto)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

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

Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]

The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant as of March 21, 2002, was $81,179,397 (Based on
the closing price on such date on the OTC Bulletin Board maintained by the
National Association of Securities Dealers, Inc.).

The number of shares of the Registrant's Common Stock, $.01 par value per
share, outstanding at March 21, 2002 was 5,465,753.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2002 Annual Meeting of Shareholders
are incorporated herein by reference in Part III.
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TABLE OF CONTENTS

THIS FORM 10-K AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY THE
ENSTAR GROUP, INC. OR MEMBERS OF ITS MANAGEMENT TEAM CONTAIN STATEMENTS WHICH
MAY CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES
ACT OF 1933, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995, 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF THE ENSTAR GROUP, INC. AND MEMBERS OF ITS MANAGEMENT
TEAM, AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-K, AND ARE
HEREBY INCORPORATED BY REFERENCE. THE ENSTAR GROUP, INC. UNDERTAKES NO
OBLIGATION TO UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED
ASSUMPTIONS, THE OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE
OPERATING RESULTS OVER TIME.

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PART I

ITEM 1. BUSINESS

GENERAL

The Enstar Group, Inc., a Georgia corporation (the "Company"), currently
holds assets, aggregating approximately $99.6 million at December 31, 2001,
consisting primarily of cash, cash equivalents, short-term certificates of
deposit and partially owned equity affiliates. The Company is actively engaged
in the search for one or more additional operating businesses which meet the
Company's acquisition criteria. See "-- Strategy for Business Acquisitions."

In November 2001, the Company, together with Trident II, L.P. ("Trident")
and the shareholders and senior management (the "Castlewood Principals") of
Castlewood Limited ("Castlewood"), completed the formation of a new venture,
Castlewood Holdings Limited ("Castlewood Holdings"), to acquire and manage
insurance and reinsurance companies, including companies in run-off, and provide
management, consulting and other services to the insurance and reinsurance
industry (the "Castlewood Holdings Transaction"). The Castlewood Principals
contributed at closing all the shares of Castlewood to Castlewood Holdings and
received in exchange a 33 1/3% economic interest in the newly-formed Castlewood
Holdings, plus notes and cash totaling $4.275 million. As part of the
transaction, the Company and Trident made capital commitments of $39.5 million
each, totaling $79 million, in exchange for their 33 1/3% economic interests in
Castlewood Holdings. The Company received 50% of the voting stock of Castlewood
Holdings and the Castlewood Principals and Trident each received 25% of
Castlewood Holdings' voting stock. Castlewood is a private Bermuda-based firm,
experienced in managing and acquiring reinsurance operations. The Company's
ownership in Castlewood Holdings is accounted for using the equity method of
accounting.

Immediately following the closing of the Castlewood Holdings Transaction,
the Company and Trident each contributed $12.5 million to Castlewood Holdings.
The Company's capital contribution to Castlewood Holdings was derived from cash
on hand; the Company expects to use internal funds to satisfy its remaining
commitment to Castlewood Holdings.

In conjunction with the closing of the Castlewood Holdings Transaction, the
Company also transferred its shares in Revir Limited ("Revir"), a newly-formed
Bermuda holding company, at cost to Castlewood Holdings. Revir then completed
the acquisition of two reinsurance companies, River Thames Insurance Company
Limited, based in London, England, and Overseas Reinsurance Corporation Limited,
based in Bermuda, (collectively, the "River Thames Transaction") from Rivers
Group Limited and Sedgwick Group Limited.

In July 2000, the Company, through B.H. Acquisition Limited ("B.H.
Acquisition"), a newly-formed joint venture with Castlewood and an entity
controlled by Trident, acquired as an operating business, two reinsurance
companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The reinsurance
companies, Brittany Insurance Company, Ltd., incorporated under the laws of
Bermuda ("Brittany"), and Compagnie Europeenne d'Assurances Industrielles S.A.,
a Belgium corporation ("CEAI"), were purchased by B.H. Acquisition for
approximately $28.5 million. In exchange for a capital contribution of
approximately $9.6 million, the Company received 50% of the voting stock and a
33% economic interest in B.H. Acquisition. As part of the transaction,
Castlewood received 33% of the voting stock and a 45% economic interest in B.H.
Acquisition. Brittany and CEAI are principally engaged in the active management
of books of reinsurance business from the international markets.

As a result of the contribution of Castlewood's outstanding stock to
Castlewood Holdings, the Company's 33% direct economic interest in B.H.
Acquisition increased by an additional 15% indirect economic interest through
Castlewood Holdings. The Company has retained its 50% voting interest in B.H.
Acquisition.

ORGANIZATIONAL STRUCTURE

The Company's executive offices are located at 401 Madison Avenue,
Montgomery, Alabama 36104, and its telephone number is (334) 834-5483. The
Company has seven employees whose principal duties currently

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include managing the assets of the Company, seeking and evaluating potential
acquisition candidates, fulfilling reporting requirements associated with being
a publicly traded company, and handling various other accounting and tax
matters. The Company is a Georgia corporation and successor by a 1996 merger to
a Delaware corporation of the same name.

SUBSIDIARIES

The Company has one wholly-owned subsidiary, Enstar Financial Services,
Inc., a Florida corporation, which currently is inactive.

STRATEGY FOR BUSINESS ACQUISITIONS

The Company's strategy for making a suitable acquisition is to utilize the
considerable experience, knowledge and business contacts of the Company's
executive officers and directors. Each of the Company's directors has been asked
by management to assist the Company actively in its pursuit of additional
acquisitions. Management follows up on the leads and meets with various
prospective targets. This pursuit occupies a significant amount of the time of
the Company's senior officers. The Company conducts rigorous financial and legal
due diligence with respect to any entity about which it has a strong interest.

The Company primarily focuses on the financial services industry in a
global market which would complement its current operating businesses,
investigating acquisition opportunities both within and outside the United
States when management believes that such opportunities might be attractive. The
Company may pay consideration in the form of cash, securities of the Company or
some combination of both. The Company may also borrow money in connection with
an acquisition. In that event, the Company's shareholders would be subject to
the risks normally associated with leveraged transactions. Depending upon the
level of indebtedness, a leveraged transaction could have important consequences
to the Company, including the following: (i) if the acquired business is unable
to achieve satisfactory operating results, the Company could prove unable to
service such indebtedness; (ii) a substantial portion of the Company's cash flow
from operations may be dedicated to the payment of principal and/or interest on
its indebtedness and would not be available for other purposes; (iii) the
Company's ability to obtain additional financing in the future for working
capital, capital expenditures or other acquisitions may be limited; and (iv) the
Company's level of indebtedness could limit its flexibility in planning for, or
reacting to, changes in its industry.

COMPETITION

The Company faces intense competition in its search for one or more
additional operating businesses. See "-- Strategy for Business Acquisitions." In
this regard, the Company competes with strategic buyers, financial buyers and
others who are looking to acquire suitable operating businesses, many of whom
have greater financial resources than the Company or have greater flexibility in
structuring acquisition transactions or strategic relationships.

HISTORY

In May 1991, the Company filed for bankruptcy under Chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code") and operated as a
reorganized debtor pursuant to its Second Amended Plan of Reorganization, as
modified (the "Reorganization Plan"), until July 1997 when the United States
Bankruptcy Court for the Middle District of Alabama (the "Bankruptcy Court")
closed the Company's Chapter 11 proceedings by final order. Prior to its
bankruptcy filing, the Company was a publicly traded holding company with
subsidiaries operating primarily in the specialty retail business and the
financial services business. Prior to November 1989, the Company's name was
Kinder-Care, Inc., and prior to January 1987, the Company's name was Kinder-Care
Learning Centers, Inc. The Company originally was incorporated in October 1970
in the state of Delaware.

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ITEM 2. PROPERTIES

The Company does not currently own any real property. In June 1999, the
Company signed a three year lease on an office building at 401 Madison Avenue,
Montgomery, Alabama which serves as the corporate headquarters. Additionally,
pursuant to an oral agreement, the Company leases space in a warehouse at 703
Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases
the office building and warehouse space from unaffiliated third parties for
$2,500 and $350 per month, respectively. The Company believes the rental amounts
are competitive with market rates. The cancellation or termination of either of
these leases would not have a material adverse effect on the Company's results
of operations.

ITEM 3. LEGAL PROCEEDINGS

In February 1997, fifteen former shareholders of the Company filed a
lawsuit against the Company in the Circuit Court of Montgomery County, Alabama
(the "Circuit Court") styled Peter N. Zachary, et al. v. The Enstar Group, Inc.,
Case No. CV-97-257-Gr. The complaint, which dealt with actions occurring prior
to the Company's filing for bankruptcy in 1991, alleged that the Company along
with its then principal officers and others defrauded the plaintiffs in
violation of the Alabama Securities Act and other Alabama statutory provisions.
The plaintiffs sought compensatory damages in the amount of their alleged losses
of approximately $2 million and unspecified punitive damages. The complaint was
virtually identical to a complaint brought by these plaintiffs against the
Company's former chairman, former president and others in December 1991, during
the pendency of the Company's bankruptcy case and prior to the confirmation of
the Reorganization Plan. The plaintiffs alleged that the Bankruptcy Court issued
an order in January 1997, allowing them to litigate their claims against the
Company. The Bankruptcy Court's order actually held that the plaintiffs could
not bring a late claim against the Company in its bankruptcy case and then went
on to state that because of facts relating to these particular plaintiffs, they
were not bound by the provisions of the Reorganization Plan and their claims
were not subject to discharge under the Bankruptcy Code. In March 1997, the
Company filed a motion to dismiss and/or for summary judgment in response to the
complaint on the basis that the claims asserted were barred by the applicable
statute of limitations. In November 2000, the Circuit Court granted the
Company's motion and dismissed the plaintiffs' claims. In December 2000, the
plaintiffs appealed the Circuit Court's judgment to the Alabama Supreme Court.
In October 2001, the Alabama Supreme Court affirmed the decision of the Circuit
Court, dismissing the plaintiffs' claims.

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

No matters were submitted to a vote of shareholders of the Company during
the quarter ended December 31, 2001.

SUPPLEMENTARY ITEM. CERTAIN RISK FACTORS

See "The Enstar Group, Inc. Private Securities Litigation Reform Act of
1995 Safe Harbor Compliance Statement For Forward-Looking Statements," included
as Exhibit 99.1 to this Form 10-K and incorporated herein by reference.

PART II

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

The Company's common stock (the "Common Stock" or "Shares") is traded in
the over-the-counter market on the OTC Bulletin Board maintained by the National
Association of Securities Dealers, Inc. The

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following table reflects the range of high and low selling prices of the
Company's Common Stock by quarter for 2001 and 2000, as reflected in the OTC
Bulletin Board Daily Trade and Quote Summary Report:

At March 21, 2002, there were approximately 3,091 holders of record of the
Company's Common Stock.

The Company has not declared or paid a cash dividend on any of its
securities since 1989. The Company currently intends to retain its earnings to
finance the growth and development of its future business and does not
anticipate paying cash dividends in the foreseeable future. The payment of cash
dividends in the future will depend upon such factors as the Company's earnings,
capital requirements, financial condition, contractual restrictions and other
factors deemed relevant by the Board of Directors. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."

In November 2001, the Company sold 200,000 shares of common stock (100,000
per individual) to Nimrod T. Frazer, the Company's Chairman and Chief Executive
Officer, and John J. Oros, the Company's President and Chief Operating Officer
for approximately $3.7 million, pursuant to Regulation D promulgated under the
Securities Act of 1933. See Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Related Party Transactions."

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial information with respect
to the Company for each of the five years in the period ended December 31, 2001
and is derived in part from the audited consolidated financial statements of the
Company. The data set forth below should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations (Item 7) and the audited consolidated financial statements, including
the related notes thereto.

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(1) Pro forma amounts per common share assuming that all shares issued
(4,549,060) as of December 31, 1997 had been outstanding for all of 1997.

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

The following discussion should be read in conjunction with the Selected
Financial Data (Item 6) and the audited consolidated financial statements,
including the related footnotes thereto. Historical results of operations and
the percentage relationships among any amounts included in the Consolidated
Statements of Income, and any trends which might appear to be inferable
therefrom, should not be taken as being necessarily indicative of trends in
operations or the results of operations for any future period. See "Business"
for a description of the business of the Company.

RECENT ACQUISITIONS

In November 2001, the Company, together with Trident and the Castlewood
Principals, completed the formation of a new venture, Castlewood Holdings, to
acquire and manage insurance and reinsurance companies, including companies in
run-off, and provide management, consulting and other services to the insurance
and reinsurance industry. The Castlewood Principals contributed at closing all
the shares of Castlewood to Castlewood Holdings and received in exchange a
33 1/3% economic interest in the newly-formed Castlewood Holdings, plus notes
and cash totaling $4.275 million. As part of the transaction, the Company and
Trident made capital commitments of $39.5 million each, totaling $79 million, in
exchange for their 33 1/3% economic interests in Castlewood Holdings. The
Company received 50% of the voting stock of Castlewood Holdings and the
Castlewood Principals and Trident each received 25% of Castlewood Holdings'
voting stock. Castlewood is a private Bermuda-based firm, experienced in
managing and acquiring reinsurance operations. The Company's ownership in
Castlewood Holdings is accounted for using the equity method of accounting.

Immediately following the closing of the Castlewood Holdings transaction,
the Company and Trident each contributed $12.5 million to Castlewood Holdings.
The Company's capital contribution to Castlewood Holdings was derived from cash
on hand; the Company expects to use internal funds to satisfy its remaining
commitment to Castlewood Holdings.

In conjunction with the closing of the Castlewood Holdings Transaction, the
Company also transferred its shares in Revir, a newly-formed Bermuda holding
company, at cost to Castlewood Holdings. Revir then completed the River Thames
Transaction.

In July 2000, the Company, through B.H. Acquisition, a newly-formed joint
venture with Castlewood and an entity controlled by Trident, acquired as an
operating business, two reinsurance companies of Petrofina S.A., a subsidiary of
TotalFina Elf S.A. The reinsurance companies, Brittany, incorporated under the
laws of Bermuda, and CEAI, a Belgium corporation, were purchased by B.H.
Acquisition for approximately $28.5 million. In exchange for a capital
contribution of approximately $9.6 million, the Company received 50% of the
voting stock and a 33% economic interest in B.H. Acquisition. As part of the
transaction, Castlewood received 33% of the voting stock and a 45% economic
interest in B.H. Acquisition. Brittany and CEAI are principally engaged in the
active management of books of reinsurance business from the international
markets.

As a result of the contribution of Castlewood's outstanding stock to
Castlewood Holdings, the Company's 33% direct economic interest in B.H.
Acquisition increased by an additional 15% indirect economic interest through
Castlewood Holdings. The Company has retained its 50% voting interest in B.H.
Acquisition.

LIQUIDITY AND CAPITAL RESOURCES

The Company's assets, aggregating approximately $99.6 million at December
31, 2001, consist primarily of approximately $73.4 million in cash and cash
equivalents, approximately $4.0 million in certificates of deposit and
approximately $20.9 million in partially owned equity affiliates.

The Company is currently engaged in the active search for one or more
additional operating businesses. The Company primarily focuses on the financial
services industry in a global market which would complement its current
operating businesses, investigating acquisition opportunities both within and
outside the United

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States when management believes that such opportunities might be attractive. The
Company may pay consideration in the form of cash, securities of the Company or
some combination of both. The Company may also borrow money in connection with
an acquisition. With the exception of various expenses incurred in connection
with the Company's search for one or more suitable acquisitions, its only needs
are to fund normal operating expenses and its remaining commitment to Castlewood
Holdings.

FINANCIAL CONDITION

The Company had total assets of approximately $99.6 million at December 31,
2001 compared to approximately $93.3 million at December 31, 2000. The increase
in total assets was due in part to the receipt of approximately $3.7 million
from two of the Company's executive officers in connection with the purchase of
200,000 shares of the Company's Common Stock. See "-- Related Party
Transactions." In addition, total assets increased $2.1 million from the
earnings of partially owned equity affiliates.

The Company's total liabilities were approximately $2.0 million at December
31, 2001 compared to approximately $1.9 million at December 31, 2000.

In March 2000, Mr. J. Christopher Flowers, Vice Chairman of the Board of
Directors of the Company, repaid a $15 million note with accrued interest to the
Company. The note was originally due in December 2000, and resulted from the
Company's sale of 1,158,860 newly issued shares of the Company's Common Stock to
Mr. Flowers in December 1998 (the "Flowers Transaction"). In connection with the
early repayment, the Company reversed the unamortized discount on the note of
approximately $411,000.

RESULTS OF OPERATIONS

2001 Compared to 2000

Interest income was approximately $3.3 million in 2001 compared to
approximately $4.6 million in 2000. Interest income was earned from cash, cash
equivalents, certificates of deposit and in 2000, the note receivable from Mr.
Flowers. Interest income decreased due to a reduction in 2001 of interest rates
earned on the Company's cash, cash equivalents and certificates of deposit.

Earnings of partially owned equity affiliates were approximately $2.1
million in 2001 compared to $6.7 million in 2000. The Company recorded equity in
earnings of $1.6 million and $6.3 million from B.H. Acquisition in 2001 and
2000, respectively. The Company's equity in earnings from B-Line LLC ("B-Line")
was $657,000 in 2001 compared to $393,000 in 2000. In addition, the Company
recorded equity in losses of $136,000 from Castlewood Holdings in 2001.

In 2001, the Company recorded net litigation expense of $25,000 compared to
$5,000 in 2000. Litigation expense arose from a lawsuit filed against the
Company by fifteen former shareholders in February 1997. In October 2001, all
claims against the Company in this case were dismissed.

General and administrative expenses were approximately $3.5 million in 2001
compared to approximately $2.5 million in 2000. The Company recorded
approximately $1.1 million in non-cash compensation expense in 2001 relating to
stock purchase and stock option agreements (see "-- Related Party
Transactions"). This increase was partially offset by a substantial decrease in
the expense for Alabama shares tax in 2001 due to a change in Alabama tax law.
In addition, 2000 reflects a $411,000 decrease in general and administrative
expenses resulting from the reversal of the unamortized portion of the discount
recorded on the note receivable in the Flowers Transaction. General and
administrative expenses also include legal and professional fees as well as
travel expenses incurred in connection with the Company's search for one or more
additional operating companies. Most variances in legal and professional fees
and travel expenses can be attributed to the number of potential acquisition
candidates the Company locates as well as the degree of interest the Company may
have in such candidates. The stronger the interest in a candidate, the more
rigorous financial and legal due diligence the Company will incur with respect
to that candidate.

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Income tax expense was $299,000 in 2001 compared to $530,000 in 2000. The
Company's effective tax rate remains substantially less than statutory rates
primarily due to the availability of net operating loss carryforwards ("NOLs")
for federal tax purposes.

Consolidated net income was approximately $1.6 million in 2001 compared to
approximately $8.3 million in 2000. The decrease in 2001 from 2000 can primarily
be attributed to reduced interest rates in 2001, resulting in a decrease in
interest income; a decrease in earnings of partially owned equity affiliates;
and an increase in general and administrative expenses resulting primarily from
non-cash compensation in 2001.

2000 Compared to 1999

Interest income was approximately $4.6 million in 2000 compared to
approximately $4.4 million in 1999. Interest income was earned from cash, cash
equivalents, certificates of deposit and the note receivable from Mr. Flowers.

Earnings of partially owned equity affiliates were approximately $6.7
million in 2000 compared to $37,000 in 1999. This increase can primarily be
attributed to the Company's investment in B.H. Acquisition in July 2000 and an
increase in earnings of B-Line. The Company recorded equity in earnings of $6.3
million from B.H. Acquisition in 2000. The Company's equity in earnings from
B-Line was $393,000 in 2000 compared to $37,000 in 1999.

In 2000, the Company recorded net litigation expense of approximately
$5,000 compared to net litigation income of approximately $244,000 in 1999. The
1999 litigation income resulted from the receipt of additional proceeds from the
earlier settlement of the Company's claim against a former officer of the
Company.

General and administrative expenses were approximately $2.5 million in 2000
compared to approximately $2.4 million in 1999. In connection with the early
repayment of the note in the Flowers Transaction, the Company reversed the
unamortized portion of the discount recorded on the note. This reversal resulted
in a decrease of approximately $411,000 in general and administrative expenses
in 2000. This decrease was offset by additional expense resulting from a new
shares tax imposed by the State of Alabama. In addition to these and other
normal operating expenses, general and administrative expenses include legal and
professional fees as well as travel expenses incurred in connection with the
Company's search for one or more additional operating companies. Most variances
in legal and professional fees and travel expenses can be attributed to the
number of potential acquisition candidates the Company locates as well as the
degree of interest the Company may have in such candidates. The stronger the
interest in a candidate, the more rigorous financial and legal due diligence the
Company will incur with respect to that candidate.

Income tax expense was $530,000 in 2000 compared to $124,000 in 1999. The
Company's effective tax rate remains substantially less than statutory rates
primarily due to the availability of NOLs for federal tax purposes.

Consolidated net income was approximately $8.3 million in 2000 compared to
approximately $2.1 million in 1999. The increase in 2000 from 1999 is primarily
due to the increase in earnings of partially owned equity affiliates.

RELATED PARTY TRANSACTIONS

In connection with the Castlewood Holdings Transaction, the Company had
entered into stock purchase and stock option agreements with Nimrod T. Frazer,
the Company's Chairman and Chief Executive Officer, and John J. Oros, the
Company's President and Chief Operating Officer. The agreements proposed to (a)
sell a total of 100,000 shares (50,000 per individual) of the Company's Common
Stock at $19.25 per share and (b) grant options under the 1997 Amended Omnibus
Incentive Plan, as amended (the "Incentive Plan") to purchase a total of 100,000
additional shares (50,000 per individual) at $19.25 per share to Messrs. Frazer
and Oros. The options vest on various dates from the date of consummation of the
Castlewood Holdings Transaction through July 2004 and may not be exercised prior
to September 2002.

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The Company had also entered into agreements with Messrs. Frazer and Oros
to (a) sell a total of 100,000 shares (50,000 per individual) of the Company's
Common Stock at $18.00 per share and (b) grant options under the Incentive Plan
to purchase a total of 100,000 additional shares (50,000 per individual) at
$18.00 per share in connection with the River Thames Transaction. These options
vest on various dates from the date of consummation of the River Thames
Transaction through July 2004 and may not be exercised prior to June 2002.

After the closing of the Castlewood Holdings Transaction and the River
Thames Transaction in November 2001, the Company received a total of
approximately $3.7 million from Messrs. Frazer and Oros in payment for the
200,000 shares (100,000 per individual) under the above mentioned agreements.
Since the market price per share of the Company's Common Stock on the closing
date of the Castlewood Holdings Transaction and the River Thames Transaction
exceeded the selling prices, the Company recognized a charge to earnings in 2001
of approximately $855,000 relating to these shares. In addition, the market
price per share of the Company's Common Stock on the date of grant of the above
mentioned stock options exceeded the exercise prices, resulting in a charge to
earnings in 2001 of approximately $232,000. The Company will recognize
additional charges to earnings over the remaining vesting period of these
options totaling approximately $623,000.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Pursuant to the Castlewood Holdings Transaction, the Company made a capital
commitment of $39.5 million in exchange for its 33 1/3% economic interest in
Castlewood Holdings. Following the closing of the Castlewood Holdings
Transaction, the Company contributed $12.5 million to Castlewood Holdings from
cash on hand. The remaining commitment of the Company is to be paid, in part or
in whole, within 21 days of receipt of a resolution of the board of directors of
Castlewood Holdings for the purpose of funding future investments and/or
providing working capital. The Company expects to use internal funds to satisfy
its remaining commitment to Castlewood Holdings.

In June 1999, the Company signed a three year lease on an office building
which serves as the corporate headquarters. Additionally, pursuant to an oral
agreement, the Company leases space in a warehouse at 703 Howe Street,
Montgomery, Alabama on a month-to-month basis. The Company leases the office
building and warehouse space from unaffiliated third parties for $2,500 and $350
per month, respectively. The Company believes the rental amounts are competitive
with market rates. The cancellation or termination of either of these leases
would not have a material adverse effect on the Company's results of operations.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the FASB issued SFAS 141, "Business Combinations", which
eliminates the pooling-of-interests method of accounting for transactions
initiated after June 30, 2001. Additionally, goodwill and intangibles that arise
as a result of purchase transactions initiated during the period July 1, 2001 to
December 31, 2001 follow the guidance prescribed by SFAS 142, described below.

In July 2001, the FASB also issued SFAS 142, "Goodwill and Other Intangible
Assets." This statement is effective for fiscal years beginning after December
15, 2001 and prescribes that goodwill should no longer be amortized upon
adoption of the standard. Instead, goodwill will be tested annually for
impairment, and on an interim basis if certain impairment indicators are
present. It requires the Company to perform a transitional assessment of whether
there is an indication that goodwill is impaired as of the date of adoption. Any
goodwill impairment loss will be recognized as the cumulative effect of a change
in accounting principle no later than the end of the fiscal year of adoption.
Additionally, intangible assets with an indefinite, economic useful life may not
be amortized. The Company will adopt this statement on January 1, 2002 and is
currently evaluating the impact of adoption on its financial statements. In
addition, BH Acquisition, a partially owned equity affiliate, expects to
recognize a one time pre-tax gain of $2,969,394 upon adoption of this statement
as a result of the reversal of negative goodwill. The Company expects to record
its proportionate share of this gain upon adoption of this statement. The
Company had approximately $552,000 of unamortized goodwill included in

8

partially owned equity affiliates at December 31, 2001 and had recorded
amortization expense of approximately $80,000 in 2001 as part of general and
administrative expense.

CRITICAL ACCOUNTING POLICIES

In the ordinary course of business, the Company has made a number of
estimates and assumptions relating to the reporting of results of operations and
financial condition in the preparation of its financial statements in conformity
with accounting principles generally accepted in the United States of America.
Actual results could differ significantly from those estimates under different
assumptions and conditions. The most significant accounting estimates inherent
in the preparation of the Company's consolidated financial statements include
estimates associated with its evaluation of income tax reserves.

Income Tax Valuation Reserve -- The Company recognizes deferred tax assets
and liabilities for the expected future tax consequences of events that have
been included in the financial statements or tax returns. The effect of
temporary differences on the financial statements includes certain operating
loss carryforwards and tax credit carryforwards. The Company has established a
valuation allowance for the uncertainty of the realization of these and any
other net deferred tax assets. However, utilization of the remaining deferred
tax assets at December 31, 2001 is based on management's assessment of the
Company's earnings history, expectations of future taxable income, and other
relevant considerations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The Company is exposed to market risk from changes in interest rates. The
Company had cash and cash equivalents of approximately $73.4 million in interest
bearing accounts (interest at floating rates) and approximately $4.0 million of
short-term certificates of deposit (interest at fixed rates) at December 31,
2001. Accordingly, each one percent change in market interest rates would change
interest income by approximately $774,000 per annum. However, any future
transactions affecting the Company's cash and cash equivalents and certificates
of deposit will change this estimate. Additionally, although interest rate
changes would affect the fair value of the Company's certificates of deposits,
the weighted average original term of certificates held by the Company at
December 31, 2001 was approximately six months. The short-term nature of these
certificates limits the Company's risk of changes in the fair value of these
certificates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

9

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders of
The Enstar Group, Inc.:

We have audited the accompanying consolidated balance sheets of The Enstar
Group, Inc. and Subsidiary (the "Company") as of December 31, 2001 and 2000, and
the related consolidated statements of income, comprehensive income,
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company at
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001 in conformity
with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia
March 25, 2002

10

THE ENSTAR GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

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

11

THE ENSTAR GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

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

12

THE ENSTAR GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)

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

13

THE ENSTAR GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)

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

14

THE ENSTAR GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

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

15

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: NATURE OF BUSINESS

The Enstar Group, Inc., (the "Company"), is a publicly traded company
engaged in the active search for one or more additional operating businesses
which meet its acquisition criteria.

In July 2000, the Company, through B.H. Acquisition Limited ("B.H.
Acquisition"), a joint venture, acquired as an operating business, two
reinsurance companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The
two companies are principally engaged in the active management of books of
reinsurance business from the international markets. In November 2001, the
Company, together with Trident II, L.P. ("Trident") and the shareholders and
senior management (the "Castlewood Principals") of Castlewood Limited
("Castlewood"), completed the formation of a new venture, Castlewood Holdings
Limited ("Castlewood Holdings"), to acquire and manage insurance and reinsurance
companies, including companies in run-off, and provide management, consulting
and other services to the insurance and reinsurance industry (the "Castlewood
Holdings Transaction") (Note 3).

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation -- The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiary, Enstar
Financial Services, Inc., an inactive company. All significant intercompany
balances and transactions have been eliminated in consolidation.

(b) Use of Estimates -- The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America 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.

(c) Cash Equivalents -- Cash equivalents consist of short term, highly
liquid investments with original purchased maturities of three months or less.

(d) Partially Owned Equity Affiliates -- The Company accounts for its 8.34%
interest in B-Line LLC ("B-Line"), its 33% economic interest in B.H. Acquisition
and its 33 1/3% economic interest in Castlewood Holdings under the equity method
(Note 3).

(e) Property and Equipment -- Property and equipment is stated at cost less
accumulated depreciation and is depreciated using the straight line method over
the estimated useful lives of the related assets, principally 5 to 7 years.

(f) Financial Instruments -- The Company invests in certificates of deposit
("CDs") offered by commercial banks. These certificates, which had a weighted
average maturity of approximately six months at December 31, 2001, are
classified by the Company as "held to maturity" securities. The estimated fair
value of CDs at December 31, 2001 and 2000, based on interest rates available on
CDs of comparable amounts, maturities, and credit quality, was approximately
equal to their carrying values.

(g) Income Taxes -- The Company computes deferred tax assets and
liabilities based on the differences between the financial statement and tax
bases of assets and liabilities using enacted tax rates in effect for the years
in which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.

(h) Comprehensive Income -- The Company recognizes its proportionate share
of other comprehensive income as reported by its partially owned equity
affiliates. As of December 31, 2001, the Company has recognized other
comprehensive income relating to unrealized holding losses on investments
arising during the period and a currency translation adjustment of Castlewood
Holdings.

16

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(i) Derivative Instruments -- In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133, as amended by SFAS 137 and 138, became
effective January 1, 2001. SFAS 133 establishes accounting and reporting
standards for derivative instruments including certain derivative instruments
embedded in other contracts, and for hedging activities. SFAS 133 requires the
Company to recognize all derivatives as either assets or liabilities in the
balance sheet measured at fair value. The Company's January 1, 2001 adoption of
SFAS 133, as amended, had no impact on the Company's consolidated financial
position or results of operations as the Company has no derivative instruments.

(j) Recent Accounting Pronouncements -- In July 2001, the FASB issued SFAS
141, "Business Combinations", which eliminates the pooling-of-interests method
of accounting for transactions initiated after June 30, 2001. Additionally,
goodwill and intangibles that arise as a result of purchase transactions
initiated during the period July 1, 2001 to December 31, 2001 follow the
guidance prescribed by SFAS 142, described below.

In July 2001, the FASB also issued SFAS 142, "Goodwill and Other Intangible
Assets." This statement is effective for fiscal years beginning after December
15, 2001 and prescribes that goodwill should no longer be amortized upon
adoption of the standard. Instead, goodwill will be tested annually for
impairment, and on an interim basis if certain impairment indicators are
present. It requires the Company to perform a transitional assessment of whether
there is an indication that goodwill is impaired as of the date of adoption. Any
goodwill impairment loss will be recognized as the cumulative effect of a change
in accounting principle no later than the end of the fiscal year of adoption.
Additionally, intangible assets with an indefinite, economic useful life may not
be amortized. The Company will adopt this statement on January 1, 2002 and is
currently evaluating the impact of adoption on its financial statements. In
addition, BH Acquisition, a partially owned equity affiliate, expects to
recognize a one time pre-tax gain of $2,969,394 upon adoption of this statement
as a result of the reversal of negative goodwill. The Company expects to record
its proportionate share of this gain upon adoption of this statement. The
Company had approximately $552,000 of unamortized goodwill included in partially
owned equity affiliates at December 31, 2001 and had recorded amortization
expense of approximately $80,000 in 2001 as part of general and administrative
expense.

(k) Reclassifications -- Certain prior year amounts have been reclassified
in the financial statements to conform with the current year presentation.

NOTE 3: PARTIALLY OWNED EQUITY AFFILIATES

(a) B-Line -- In November 1998, the Company purchased membership units of
B-Line for $965,000 including expenses. Based in Seattle, Washington, B-Line
provides services to credit card issuers and other holders of similar
receivables. B-Line also purchases credit card receivables and recovers payments
on these accounts.

At the time of the purchase, the Company's membership units represented
approximately 8.77% of the outstanding units of B-Line. The Company also
purchased a one-year warrant to acquire additional B-Line units, with an
aggregate exercise price of $950,000. Other investors also purchased membership
units and warrants in B-Line. In November 1999, the Company's warrants expired
unexercised while certain other warrant holders exercised their warrants. As a
result, the Company's ownership percentage decreased to approximately 7.99%. As
a result of B-Line repurchasing one of its member's interests, the Company's
ownership percentage was approximately 8.34% at December 31, 2001.

The Company's B-Line membership units are accounted for under the equity
method. The operations of B-Line are reported by the Company three months in
arrears. Approximately $803,000 of the original $950,000 paid was recorded as
goodwill and was being amortized over a period of 10 years. Approximately

17

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$251,000 of the original $803,000 recorded as goodwill had been amortized at
December 31, 2001. Upon the adoption by the Company of SFAS 142 in January 2002,
goodwill will no longer be amortized. (Note 2).

(b) B.H. Acquisition -- In July 2000, the Company, through B.H.
Acquisition, a newly-formed joint venture with Castlewood and an entity
controlled by Trident, acquired as an operating business, two reinsurance
companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The reinsurance
companies, Brittany Insurance Company Ltd. ("Brittany") and Compagnie Europeenne
d'Assurances Industrielles S.A. ("CEAI") were purchased by B.H. Acquisition for
$28.5 million. Brittany and CEAI are principally engaged in the active
management of books of reinsurance business from international markets. In
exchange for a capital contribution of approximately $9.6 million, the Company
received 50% of the voting stock and a 33% economic interest in B.H.
Acquisition. As part of the transaction, Castlewood received 33% of the voting
stock and a 45% economic interest in B.H. Acquisition. In October 2000, the
Company received $3.9 million representing the Company's proportionate share of
a capital distribution from B.H. Acquisition. In March 2001, the Company
received approximately $6.3 million from B.H. Acquisition representing the
Company's proportionate share of a dividend from B.H. Acquisition. The Company's
ownership in B.H. Acquisition is accounted for using the equity method of
accounting. The acquisition of the two reinsurance companies has been accounted
for by B.H. Acquisition using the purchase method of accounting.

(c) Castlewood Holdings Limited -- In November 2001, the Company, together
with Trident and the Castlewood Principals, completed the formation of a new
venture, Castlewood Holdings, to acquire and manage insurance and reinsurance
companies, including companies in run-off, and provide management, consulting
and other services to the insurance and reinsurance industry. The Castlewood
Principals contributed at closing all the shares of Castlewood to Castlewood
Holdings and received in exchange a 33 1/3% economic interest in the newly
incorporated Castlewood Holdings, plus notes and cash totaling $4.275 million.
As part of the transaction, the Company and Trident made capital commitments of
$39.5 million each, totaling $79 million, in exchange for their 33 1/3% economic
interests in Castlewood Holdings. The Company received 50% of the voting stock
of Castlewood Holdings and the Castlewood Principals and Trident each received
25% of Castlewood Holdings' voting stock. Castlewood is a private Bermuda-based
firm, experienced in managing and acquiring reinsurance operations.

As a result of the contribution of Castlewood's outstanding stock to
Castlewood Holdings, the Company's 33% direct economic interest in B.H.
Acquisition increased by an additional 15% indirect economic interest through
Castlewood Holdings. The Company has retained its 50% voting interest in B.H.
Acquisition. The Company's ownership in Castlewood Holdings is accounted for
using the equity method of accounting.

Immediately following the closing of the Castlewood Holdings Transaction,
the Company and Trident each contributed $12.5 million to Castlewood Holdings.
The Company's capital contribution to Castlewood Holdings was derived from cash
on hand; the Company expects to use internal funds to satisfy its remaining
commitment to Castlewood Holdings.

In conjunction with the closing of the Castlewood Holdings Transaction, the
Company also transferred its shares in Revir Limited ("Revir"), a newly formed
Bermuda holding company, at cost to Castlewood Holdings. Revir then completed
the acquisition of two reinsurance companies, River Thames Insurance Company
Limited ("River Thames"), based in London, England, and Overseas Reinsurance
Corporation Limited ("Overseas Reinsurance"), based in Bermuda, (collectively,
the "River Thames Transaction") from Rivers Group Limited and Sedgwick Group
Limited. The acquisition of the two reinsurance companies has been accounted for
by Revir using the purchase method of accounting.

18

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following unaudited pro forma information of the Company for the years
ended December 31, 2001 and 2000 gives effect to the Company's 33% economic
interest in B.H. Acquisition and its 33 1/3% economic interest in Castlewood
Holdings as if the acquisitions had occurred on January 1, 2000:

The unaudited pro forma consolidated information is not necessarily
indicative of the results that would have been reported had such acquisitions
occurred on such dates, nor is it indicative of the Company's future operations.

(d) Summarized Financial Information -- In accordance with Accounting
Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock", the Company prepared summarized financial
information for B-Line, B.H. Acquisition and Castlewood Holdings as of and for
the years ended December 31, 2001 and 2000. Such information is derived from the
unaudited financial statements of B-Line and the audited financial statements of
B.H. Acquisition and Castlewood Holdings.

This summarized financial information reflects the results of B-Line for
all years presented. The results of B.H. Acquisition and Castlewood Holdings are
presented from their respective dates of ownership. The purchase of Brittany and
CEAI by B.H. Acquisition and the acquisition of River Thames and Overseas
Reinsurance by Castlewood Holdings, through Revir, are recorded as purchases in
accordance with APB Opinion No. 16, "Business Combinations."

NOTE 4: COMMITMENTS AND CONTINGENCIES

In February 1997, fifteen former shareholders of the Company filed a
lawsuit against the Company. The complaint, which dealt with actions occurring
prior to the Company's filing for bankruptcy in 1991, alleged that the Company
along with its then principal officers and others defrauded the plaintiffs in
violation of the Alabama Securities Act and other Alabama statutory provisions.
The plaintiffs sought compensatory damages in the amount of their alleged losses
of approximately $2.0 million and unspecified punitive damages. The Company
filed a motion to dismiss and/or for summary judgment in March 1997. The motion
filed by the Company contended that the claims asserted are barred by the
applicable statutes of limitations. In November

19

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2000, the Circuit Court granted the Company's motion and dismissed the
plaintiffs' claims. In December 2000, the plaintiffs appealed the Circuit
Court's judgment to the Alabama Supreme Court. In October 2001, the Alabama
Supreme Court affirmed the decision of the Circuit Court, dismissing the
plaintiffs' claims.

Pursuant to the Castlewood Holdings Transaction, the Company made a capital
commitment of $39.5 million in exchange for its 33 1/3% economic interest and
50% voting control in Castlewood Holdings. Following the closing of the
Castlewood Holdings Transaction, the Company contributed $12.5 million to
Castlewood Holdings from cash on hand. The remaining commitment of the Company
is to be paid, in part or in whole, within 21 days of receipt of a resolution of
the board of directors of Castlewood Holdings for the purpose of funding future
investments and/or providing working capital. The Company expects to use
internal funds to satisfy its remaining commitment to Castlewood Holdings. (Note
3).

In June 1999, the Company signed a three year lease on an office building
at 401 Madison Avenue, Montgomery, Alabama which serves as the corporate
headquarters. Future minimum payments under this lease total $12,500 in 2002. At
the expiration of this lease on May 31, 2002, the Company has an option to renew
for an additional 24 months at $2,750 per month. Additionally, pursuant to an
oral agreement, the Company leases space in a warehouse at 703 Howe Street,
Montgomery, Alabama on a month-to-month basis. The Company also leases certain
office equipment on a month-to-month basis. Rent expense was approximately
$38,000, $38,000 and $36,000 in 2001, 2000 and 1999, respectively.

NOTE 5: INCOME TAXES

The provision for income taxes consists of the following components:

The reconciliation of income taxes computed at statutory rates to the
actual tax provision is as follows:

20

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts reported for income tax purposes. The following items
comprise the Company's deferred taxes at December 31, 2001 and 2000:

The Company has established a valuation allowance for the uncertainty of
the realization of deferred tax assets which is dependent on future taxable
income of sufficient amounts to utilize the net operating loss carryforwards
("NOLs"), tax credit carryforwards and other deferred tax assets. In addition,
because there are possible applications of certain provisions of the Internal
Revenue Code of 1986, as amended that may limit the Company's use of the NOLs in
future tax returns, there can be no assurance that the Company will be able to
utilize its NOLs fully. During 2001, 2000 and 1999, the Company decreased the
valuation allowance by approximately $1.9 million, approximately $4.9 million
and $1.3 million, respectively, to approximately $13.6 million, approximately
$15.5 million and approximately $20.4 million, respectively.

At December 31, 2001, the Company had federal NOLs of approximately $36.9
million, which, if not utilized, expire in various years from 2004 through 2011.

NOTE 6: SHAREHOLDERS' EQUITY

(a) Note Receivable -- In October 1998, the Company and J. Christopher
Flowers ("Flowers") entered into an agreement whereby the Company agreed to sell
to Flowers 1,158,860 newly issued shares of the Company's common stock at a
price of $12.94375 per share, for a total purchase price of $15.0 million, in
exchange for a full recourse promissory note from Flowers (the "Flowers
Transaction"). In December 1998, the Company consummated the sale of the shares
to Flowers, resulting in Flowers owning approximately 23% of the outstanding
common stock of the Company at that time. Since the interest rate on the note
was less than the rate an independent lender would have charged Flowers, the
note was recorded at a discount so as to yield a then current "market rate" of
interest. The discount was being amortized over the term of the note. The note
was repaid in full with accrued interest in March 2000. In connection with the
repayment, the Company reversed the unamortized discount on the note of
approximately $411,000.

(b) Share Purchase Rights Plan -- In January 1997, the Board of Directors
of the Company adopted a Share Purchase Rights Plan (the "Rights Plan"). The
Rights Plan entitles shareholders to a right to purchase one share of common
stock for each outstanding share of common stock of the Company (a "Right").

Until the occurrence of a "Distribution Triggering Event" as described
below, all future issuances of common stock by the Company will also carry the
Rights. The Rights will have no dividend or voting rights and will expire on the
tenth anniversary of their issuance unless exercised or redeemed prior to that
time.

21

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Rights may not be exercised and are not detached from the common stock
until ten days after the occurrence of a Distribution Triggering Event. The
exercise price of the Rights is fixed at $40. The Rights generally are
redeemable by the Board of Directors of the Company at a nominal price of $.01
per Right at any time prior to the time that they are detached from the common
stock and separate certificates evidencing the Rights are delivered. As of
December 31, 2001, no Rights were exercised.

Distribution Triggering Events. Shortly after a person or group acquires
beneficial ownership of a fifteen percent (15%) interest or announces its
intention to commence a tender or exchange offer, the consummation of which
would result in beneficial ownership of fifteen percent (15%) of the Company's
common stock (a "Distribution Triggering Event"), the Rights will separate from
the common stock. Upon distribution of the Rights, they become exercisable and
are transferable separately from the Company's common stock. Each Right (other
than Rights beneficially owned by the acquiror) is then immediately converted
into the right to buy that number of shares of common stock of the Company (or
in certain circumstances, shares of stock of the acquiring company) that has a
market value of two times the exercise price of the Right.

In connection with the Flowers Transaction described above, the Board of
Directors approved an amendment to the Rights Plan for the sole purpose of
exempting the Flowers Transaction from being a Distribution Triggering Event.

(c) Treasury Stock -- In April 1998, the Company announced a stock
repurchase program under which the Company could repurchase up to $5.0 million
of its common stock in the open market at prices per share deemed favorable from
time to time by the Company. The Company has repurchased 54,525 shares of its
common stock for approximately $815,000 as part of this plan. Through this plan
and a similar plan completed in the first quarter of 1998, the Company has
repurchased a total of 442,351 shares for approximately $5.8 million as of
December 31, 2001.

NOTE 7: STOCK COMPENSATION

(a) Deferred Compensation and Stock Plan for Non-Employee Directors -- In
September 1997, the Company adopted a Deferred Compensation and Stock Plan for
Non-Employee Directors. The purposes of this plan are to enable the Company to
attract and retain qualified persons to serve as non-employee directors, to
solidify the common interests of its non-employee directors and shareholders by
enhancing the equity interest of non-employee directors in the Company, and to
encourage the highest level of non-employee director performance by providing
such non-employee directors with a proprietary interest in the Company's
performance and progress by permitting non-employee directors to receive all or
a portion of their retainer and meeting fees in common stock and to defer all or
a portion of their retainer and meeting fees in stock units.

All non-employee directors have elected to receive 100% of their
compensation in stock units in lieu of cash payments for the retainer and
meeting fees. Approximately $464,000 and $352,000 in stock compensation has been
deferred under this plan as of December 31, 2001, and 2000, respectively.

(b) Long-Term Incentive Program -- In January 1997, the Company adopted a
long-term incentive program made up of three stock option/incentive plans. Under
the program, the Company established the 1997 Amended CEO Stock Option Plan (the
"CEO Plan"), the 1997 Amended Outside Directors' Stock Option Plan (the "1997
Directors' Plan"), and the 1997 Amended Omnibus Incentive Plan (the "Incentive
Plan"). In May 2001, the Company adopted the 2001 Outside Directors' Stock
Option Plan (the "2001 Directors' Plan") and amended certain provisions of the
Incentive Plan.

Under the CEO Plan, Nimrod T. Frazer, the Company's Chief Executive Officer
and Chairman, was granted options for 150,000 shares of common stock with an
exercise price of $10.50 in 1997. The options granted under the CEO Plan vested
in four equal installments of 37,500 options through January 1, 2000, and expire
in January 2007.

22

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Under the 1997 Directors' Plan, each of the Company's four outside
directors was granted options for 25,000 shares of common stock in 1997. The
options have an exercise price of $10.8125 and vested in five equal installments
of 5,000 options through January 1, 2001. The options granted under the 1997
Directors' Plan expire in January 2007.

The Incentive Plan was established for the benefit of key employees and
directors which provides generally for stock appreciation awards, incentive
stock options and nonqualified stock options. In March 2000, John J. Oros, the
Company's President and Chief Operating Officer, was granted options for 100,000
shares of common stock with an exercise price of $12.75. These options vest in
three installments: 50,000 on March 2, 2001 and 25,000 each on March 2, 2002 and
2003. These options expire in February 2010.

In connection with the consummation of the River Thames Transaction in
November 2001, Messrs. Frazer and Oros were granted options under the Incentive
Plan to purchase a total of 100,000 shares (50,000 per individual) at $18.00 per
share. These options vest on various dates through July 2004 and may not be
exercised prior to June 2002. The options expire in June 2011. Since the market
price per share of the Company's common stock on the date of grant exceeded the
exercise price, the Company recognized a charge to earnings in 2001 of
approximately $133,000. The Company will recognize additional charges to
earnings totaling approximately $357,000 through July 2004 relating to these
options.

In connection with the consummation of the Castlewood Holdings Transaction
in November 2001, Messrs. Frazer and Oros were granted options under the
Incentive Plan to purchase a total of 100,000 shares (50,000 per individual) at
$19.25 per share. These options vest on various dates through July 2004 and may
not be exercised prior to September 2002. The options expire in September 2011.
Since the market price per share of the Company's common stock on the date of
grant exceeded the exercise price, the Company recognized a charge to earnings
in 2001 of approximately $99,000. The Company will recognize additional charges
to earnings totaling approximately $266,000 through July 2004 relating to these
options.

Under the 2001 Directors' Plan, the Company's three current outside
(non-employee) directors were each granted options in June 2001 for 15,000
shares of common stock with an exercise price of $18.90 per share. Options
granted to each of the three outside directors under the plan will vest in three
equal installments of 5,000 shares in each of January 2002, January 2003 and
January 2004; provided, however, that such shares will vest only so long as the
recipient remains a director of the Company. The options granted under this plan
must be exercised no later than January 2011, or 60 days after the director
ceases to be a director of the Company other than by reason of death, mandatory
retirement or disability.

As of December 31, 2001, a total of 595,000 options have been issued or
reserved for issuance under the long-term incentive program, none of which have
been exercised.

23

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The fair values for options granted under the Company's stock option plans
were calculated using the Black-Scholes option pricing model, as modified. The
fair values, along with the assumptions used in their calculation are as
follows:

The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees", in accounting for its stock option plans. Under the provisions of
APB 25, the Company recognizes compensation expense on stock option plans where
the fair market values of the common shares exceed the option prices on the
dates of grant. Had compensation cost for grants under the Company's stock
option plans been determined based on the fair value at the date of grant
consistent with the method of SFAS 123, "Accounting for Stock-Based
Compensation," the Company's pro forma net income and net income per share for
2001, 2000 and 1999 would have been as follows:

(c) Stock Purchase Agreements -- In June 2001, the Company entered into
agreements with Messrs. Frazer and Oros to sell a total of 100,000 shares
(50,000 per individual) of the Company's common stock at $18.00 per share, the
closing trading price on the date of the agreements, to Messrs. Frazer and Oros,
subject to the consummation of the River Thames Transaction on or before
December 31, 2001. After the closing of the River Thames Transaction in November
2001, the Company received $900,000 each from Messrs. Frazer and Oros in payment
of their shares. Since the market price per share of the Company's common stock
on the closing date of the transaction exceeded the selling price, the Company
recognized a charge to earnings in 2001 of approximately $490,000 relating to
these shares.

In addition, the Company entered into stock purchase agreements with
Messrs. Frazer and Oros relating to the Castlewood Holdings Transaction. The
agreements proposed to sell a total of 100,000 shares (50,000 per individual) of
the Company's common stock at $19.25 per share, the closing trading price on
September 28, 2001, to Messrs. Frazer and Oros, subject to the consummation of
the Castlewood Holdings Transaction on or before December 31, 2001. After the
closing of the Castlewood Holdings Transaction in November 2001, the Company
received $962,500 each from Messrs. Frazer and Oros in payment of their shares.
Since the market price per share of the Company's common stock on the closing
date of the transaction exceeded the selling price, the Company recognized a
charge to earnings in 2001 of approximately $365,000 relating to these shares.

NOTE 8: INCOME PER SHARE

The table below illustrates the reconciliation between net income per
common share -- basic and net income per common share -- assuming dilution for
2001, 2000 and 1999. Net income per common share -- basic is computed by
dividing net income by the weighted average shares outstanding. Net income per

24

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

common share -- assuming dilution is computed by dividing net income by the sum
of the weighted average shares outstanding and common share equivalents. Common
share equivalents consist of stock units deferred under the Deferred
Compensation and Stock Plan for Non-Employee Directors and stock options granted
under the Long-Term Incentive Program (Note 7).

NOTE 9: SEGMENT INFORMATION

The Company evaluates the performance of B-Line, B.H. Acquisition and
Castlewood Holdings, the Company's only operating segments, based on 100% of
their financial results. The consolidated financial information for B-Line is
reported for all years presented. The consolidated financial information for
B.H. Acquisition and Castlewood Holdings are reported from July 3, 2000 and
November 29, 2001, their respective dates of acquisition by the Company. A
reconciliation of B-Line's, B.H. Acquisition's and Castlewood

25

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Holdings' consolidated financial information to the Company's consolidated
financial statements as of and for the years ended December 31, 2001 and 2000 is
as follows:

The operations of B-Line are reported by the Company three months in
arrears. The Company's ownership percentage in B-Line has varied between 7.99%
and 8.77% from September 30, 1999 to September 30, 2001, the periods reported in
the above tables. The Company's ownership percentages for

26

THE ENSTAR GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

B-Line used in the above tables represent weighted averages. The Company's
ownership percentages in B-Line were 8.34% and 7.99% at December 31, 2001 and
2000, respectively.

NOTE 10: UNAUDITED QUARTERLY FINANCIAL INFORMATION

A summary of the Company's unaudited quarterly results of operations for
the years ended December 31, 2001 and 2000 are as follows:

General and administrative expenses for the fourth quarter of 2001 include
non-cash compensation expense of approximately $1.1 million. General and
administrative expenses for the first quarter of 2000 include a reversal of a
$411,000 discount on the note receivable from the Flowers Transaction offset by
a $500,000 expense resulting from a new shares tax imposed by the State of
Alabama.

27

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item with respect to directors and
executive officers of the Registrant, is included under the sections entitled,
"Election of Directors", "Executive Officers" and "Other Matters -- Section
16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement for the
2002 Annual Meeting of Shareholders and such sections are deemed incorporated
herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is included under the sections
entitled, "Employment Agreements", "Executive Compensation", "Stock Option
Grants", "Stock Option Exercises", "Election of Directors -- Compensation of
Directors", and "Compensation Committee Interlocks and Insider Participation" of
the Proxy Statement for the 2002 Annual Meeting of Shareholders and such
sections are deemed incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is included under the sections
entitled, "Common Stock Ownership by Management" and "Principal Shareholders"
appearing in the Proxy Statement for the 2002 Annual Meeting of Shareholders and
such sections are deemed incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is included under the sections
entitled, "Certain Transactions", "Election of Directors -- Compensation of
Directors" and "Executive Compensation" appearing in the Proxy Statement for the
2002 Annual Meeting of Shareholders and such section is deemed incorporated
herein by reference.

PART IV

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

(a) 1. Financial Statements

The following financial statements included in Item 8 of this Annual
Report are for the fiscal period ended December 31, 2001 and are
incorporated herein by reference.

Independent Auditors' Report.
Consolidated Balance Sheets as of December 31, 2001 and 2000.
Consolidated Statements of Income for the years ended December 31, 2001,
2000 and 1999.
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2001, 2000 and 1999.
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2001,
2000 and 1999.
Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2000 and 1999.
Notes to Consolidated Financial Statements.

28

2. Financial Statement Schedules

The following financial statements of Castlewood Holdings included in this
Annual Report are for the fiscal period ended December 31, 2001.

The following financial statements of B.H. Acquisition included in this
Annual Report are for the fiscal period ended December 31, 2001.

3. Exhibits

(b) Reports on Form 8-K

On December 13, 2001, the Company filed a Current Report on Form 8-K
pursuant to Item 2 -- Acquisition or Disposition of Assets.

31

SIGNATURES

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

THE ENSTAR GROUP, INC.

By: /s/ NIMROD T. FRAZER
------------------------------------
Nimrod T. Frazer
Chairman of the Board of Directors,
and Chief Executive Officer

April 1, 2002

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

/s/ NIMROD T. FRAZER Chairman of the Board of April 1, 2002
---------------------------------------------------- Directors, and Chief
Nimrod T. Frazer Executive Officer

/s/ CHERYL D. DAVIS Chief Financial Officer, Vice April 1, 2002
---------------------------------------------------- President and Secretary
Cheryl D. Davis (Principal Accounting
Officer)

/s/ JOHN J. OROS President and Chief Operating April 1, 2002
---------------------------------------------------- Officer
John J. Oros

/s/ J. CHRISTOPHER FLOWERS Vice Chairman of the Board of April 1, 2002
---------------------------------------------------- Directors
J. Christopher Flowers

/s/ T. WHIT ARMSTRONG Director April 1, 2002
----------------------------------------------------
T. Whit Armstrong

/s/ T. WAYNE DAVIS Director April 1, 2002
----------------------------------------------------
T. Wayne Davis

/s/ JEFFREY S. HALIS Director April 1, 2002
----------------------------------------------------
Jeffrey S. Halis

32

CASTLEWOOD HOLDINGS LIMITED

CONSOLIDATED FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT

DECEMBER 31, 2001

INDEPENDENT AUDITORS' REPORT

To the Shareholders of
Castlewood Holdings Limited

We have audited the accompanying consolidated balance sheet of Castlewood
Holdings Limited and subsidiaries as at December 31, 2001 and the related
consolidated statements of loss and deficit, comprehensive loss, shareholders'
equity and cash flows for the period from August 16, 2001 (date of
incorporation) to December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Castlewood Holdings Limited and
subsidiaries as at December 31, 2001 and the results of their operations and
their cash flows for the period from August 16, 2001 (date of incorporation) to
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America.

/S/ DELOITTE & TOUCHE

Hamilton, Bermuda
March 18, 2002

F-1

CASTLEWOOD HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEET
AS AT DECEMBER 31, 2001
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)

ASSETS
Cash and cash equivalents (Note 3).......................... $ 71,906
Investments in marketable securities (Note 4)............... 175,068
Accrued interest............................................ 3,445
Accounts receivable......................................... 2,994
Reinsurance balance receivable (Note 5)..................... 238,162
Investment in partly-owned company (Note 6)................. 9,923
Goodwill.................................................... 22,558
Other assets................................................ 3,789
--------
Total assets...................................... $527,845
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Losses and loss adjustment expenses (Note 7)................ $419,717
Reinsurance balances payable................................ 32,792
Accounts payable and accrued liabilities.................... 2,978
Notes payable to shareholders (Note 8)...................... 3,013
Due to shareholders (Note 9)................................ 1,581
Income taxes payable........................................ 314
Other liabilities........................................... 3,754
--------
Total liabilities................................. 464,149
--------
Shareholders' equity
Share capital (Note 10)
Authorized issued and fully paid, par value $1 each
Ordinary voting shares.................................... 18
Ordinary non-voting redeemable shares..................... 39,494
Contributed surplus (Note 11)............................... 24,988
Accumulated other comprehensive income (loss):
Unrealized holding loss on investments.................... (450)
Currency translation adjustment........................... 53
Deficit................................................... (407)
--------
63,696
--------
$527,845
========

See accompanying notes to the consolidated financial statements

Approved by the Board of Directors

- --------------------------------------------- ---------------------------------------------
Director Director

F-2

CASTLEWOOD HOLDINGS LIMITED

CONSOLIDATED STATEMENT OF LOSS AND DEFICIT
FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)

Income
Consulting fees........................................... $ 983
Share of net income of partly-owned company............... 389
Net investment income (note 4)............................ 990
Other income.............................................. 90
------
2,452
------
Expenses
Salaries and benefits..................................... 690
General and administrative expenses....................... 1,416
Interest expenses......................................... 13
Foreign exchange loss..................................... 595
------
2,714
------
Loss before income taxes.................................... (262)
Income taxes................................................ (145)
------
Loss and deficit, end of period............................. $ (407)
======

See accompanying notes to the consolidated financial statements

F-3

CASTLEWOOD HOLDINGS LIMITED

STATEMENT OF COMPREHENSIVE LOSS
FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)

Net Loss.................................................... $(407)
-----
Other comprehensive income (loss):
Unrealized holding losses on investments arising during
the period............................................. (450)
Currency translation adjustment........................... 53
-----
Other comprehensive loss:................................. (397)
-----
Comprehensive loss.......................................... $(804)
=====

See accompanying notes to the consolidated financial statements

F-4

CASTLEWOOD HOLDINGS LIMITED

STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)

See accompanying notes to the consolidated financial statements

F-5

CASTLEWOOD HOLDINGS LIMITED

CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)

Operating activities:
Loss...................................................... $ (407)
Adjustments to reconcile net income to cash flows provided
by operating activities:
Share of net income of partly-owned company............ (389)
Depreciation and amortization.......................... 12
--------
(784)
Changes in assets and liabilities:
Accrued interest.......................................... 1,199
Accounts receivable....................................... 2,365
Reinsurance balance receivable............................ 2,036
Other assets.............................................. 7
Losses and loss adjustment expenses....................... 5,751
Reinsurance balances payable.............................. 5,010
Account payable and accrued liabilities................... (1,375)
Interest on notes payable to shareholders................. 13
Due to shareholders....................................... (1,954)
Income taxes payable...................................... 94
Other liabilities......................................... (62)
--------
Net cash flows provided by operating activities........ 12,300
--------
Investing activities:
Cash acquired on purchase of subsidiaries................. 54,367
Cash used for acquisition of subsidiaries................. (16,636)
Purchase of debt securities available-for-sale............ (10,177)
Redemption of debt securities available-for-sale.......... 7,000
--------
Net cash flows provided by investing activities........ 34,554
--------
Financing activities:
Proceeds on issuance of common stock...................... 12
Contributed to surplus.................................... 24,988
--------
Net cash flows provided by financing activities........ 25,000
--------
Translation adjustment...................................... 52
--------
Net increase in cash and cash equivalents, being cash and
cash equivalents, end of period........................... $ 71,906
--------

See accompanying notes to the consolidated financial statements

F-6

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
(Expressed in thousands of U.S. dollars)

1. DESCRIPTION OF BUSINESS

Castlewood Holdings Limited ("Castlewood Holdings") was incorporated under
the laws of Bermuda on August 16, 2001, and on November 29, 2001, acquired 100%
of the common shares of Castlewood Limited ("Castlewood"), for consideration of
$46,637 in shares, cash and notes payable. Castlewood Holdings did not operate
prior to November 29, 2001.

Castlewood Holdings and its subsidiaries (the "Company") acquire and manage
insurance and reinsurance companies in run-off, and provide management,
consultancy and other services to the insurance and reinsurance industry.

The acquisition of Castlewood by Castlewood Holdings has been accounted for
using the purchase method of accounting, which requires that the acquirer record
the assets and liabilities acquired at their estimated fair value.

The purchase price and fair value of assets acquired are as follows:

Purchase price
Castlewood Holdings Class C voting shares................. $ 6
Castlewood Holdings Class E non-voting redeemable
shares................................................. 39,494
Notes payable bearing interest at 5%, payable after May 1,
2002................................................... 3,000
Cash...................................................... 1,275
Direct costs of the acquisition........................... 2,862
-------
Total purchase price........................................ 46,637
Net tangible assets acquired at fair value.................. 24,079
-------
Excess of purchase price over net tangible assets
(Goodwill)................................................ $22,558
-------

Immediately after the acquisition of Castlewood, a wholly owned subsidiary
of Castlewood Holdings, Revir Limited ("Revir") completed the acquisition of two
reinsurance companies, River Thames Insurance Company Limited, ("River Thames")
based in London, England, and Overseas Reinsurance Corporation Limited,
("Overseas Re") based in Bermuda and an underwriting agency, Regis Agencies
Limited ("Regis"), from Sedgwick Group Limited.

The acquisitions have been accounted for using the purchase method of
accounting, which requires that the acquirer record the assets and liabilities
acquired at their estimated fair value.

F-7

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The purchase price and fair value of assets acquired are as follows:

Purchase price
Purchase price............................................ $15,075
Direct costs of the acquisition........................... 148
-------
Total purchase price........................................ 15,223
Net tangible assets acquired at fair value
River Thames.............................................. 37,753
Overseas Re............................................... (22,570)
Regis..................................................... 40
-------
Total net tangible assets acquired at fair value............ 15,223
-------
Excess of purchase price over net tangible assets........... $ --
-------

2. SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PREPARATION

The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount 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.

BASIS OF CONSOLIDATION

The consolidated financial statements include the assets, liabilities and
results of operations of Castlewood Holdings from its incorporation date of
August 16, 2001 to December 31, 2001, and for its wholly owned subsidiaries from
November 29, 2001 to December 31, 2001. From its incorporation date of August
16, 2001 to November 29, 2001, the Company did not engage in any significant
activities. Intercompany transactions are eliminated on consolidation.

CASH AND CASH EQUIVALENTS

For purposes of the consolidated statement of cash flows, the Company
considers all highly liquid debt instruments purchased with an initial maturity
of three months or less to be cash and cash equivalents.

INVESTMENTS

Debt and equity securities are classified as available-for-sale securities
and are carried at fair value, with unrealized holding gains and losses excluded
from net income and reported as a separate component of accumulated other
comprehensive income.

Realized gains and losses on sales of securities classified as
available-for-sale are recognized in net investment income on the specific
identification basis.

INVESTMENT IN PARTLY-OWNED COMPANY

Investment in partly-owned company is carried on the equity basis whereby
the investment is initially recorded at cost and adjusted to reflect the
Company's share of after-tax earnings or losses and reduced by dividends
received.

F-8

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

PREMIUMS

Premiums are recognized as revenue on a pro-rata basis over the periods of
the respective policies and contracts of reinsurance. Premiums which are subject
to adjustments are estimated based upon available information. Any variances
from the estimates are recorded in the periods in which they become known.

LOSSES AND LOSS ADJUSTMENT EXPENSES

The liability for losses and loss adjustment expenses includes an amount
determined from loss reports and individual cases and an amount, based on
historical loss experience and industry statistics, for losses incurred but not
reported. These estimates are continually reviewed and are necessarily subject
to the impact of future changes in such factors as claim severity and frequency.
While the directors and management believe that the amount is adequate, the
ultimate liability may be significantly in excess of, or less than, the amounts
provided. Any adjustments will be reflected in the periods in which they become
known.

REINSURANCE

Reinsurance premiums ceded are accounted for on a pro-rata basis over the
terms of the respective reinsurance contracts. Commissions on reinsurance ceded
are deferred and amortized over the terms of the contracts of reinsurance to
which they relate.

CONSULTING FEES

Fixed fees are recognized on a straight-line basis over the term of the
agreement. Fees based on hourly charge rates are recognized as incurred.
Performance fees are recognized upon completion of all the requirements as
specified in the agreement.

TRANSLATION OF FOREIGN CURRENCIES

At each balance sheet date, recorded balances that are denominated in a
currency other than the functional currency of the Company are adjusted to
reflect the current exchange rate. Revenue and expense items are translated into
U.S. dollars at average rates of exchange for the years. The resulting exchange
gains or losses are included in net income.

Assets and liabilities of subsidiaries are translated into U.S. dollars at
the year-end rates of exchange. Revenues and expenses of subsidiaries are
translated into U.S. dollars at the average rates of exchange for the years. The
resultant translation adjustment is classified as a separate component of other
comprehensive income.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Estimated fair value of financial instruments held by the Company
approximates carrying value except for the note payable to shareholders. As the
Company does not have financial instruments with third parties with similar
qualities with regards to repayment term and security it is not practicable to
determine the fair value of the note payable to shareholders. The estimated
value of the investments is based on quoted market value.

GOODWILL

Starting January 1, 2002, the Company will complete a goodwill impairment
test on an annual basis or more frequently if certain indicators are
encountered.

For the purpose of testing goodwill for impairment, acquired assets and
assumed liabilities shall be assigned to a reporting unit as of the acquisition
date if the asset will be employed in or the liability relates to
F-9

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the operations of a reporting unit and the asset or liability will be considered
in determining the fair value of the reporting unit. The excess goodwill over
the fair value of these assets will be recorded in net income.

3. PLEDGED ASSETS

Cash and cash equivalents in the amount of $ 5,189 as of December 31, 2001
are pledged as collateral against letters of credit in the same amounts.

4. INVESTMENTS

The amortized cost and estimated fair value of investments in debt
securities available-for-sale are as follows:

Mutual funds invest in high credit quality securities (minimum "A")
including fixed income and money market securities denominated in US dollars,
with an average duration of nine months target.

The amortized cost and estimated fair values of debt securities classified
as available-for-sale by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.

Major categories of net investment income are summarized as follows:

Interest from debt securities and mutual funds.............. $867
Interest on cash and cash equivalents....................... 212
Amortization of bond premium or discount.................... (89)
----
$990
====

5. INVESTMENT IN PARTLY-OWNED COMPANY

Castlewood Holdings holds 45% of the common shares of BH Acquisition Ltd.
("BH"). The common shares held by Castlewood Holdings have 33% of BH's voting
rights. BH wholly owns two insurance

F-10

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

companies in run-off, Brittany Insurance Company Ltd., incorporated in Bermuda,
and Compagnie Europeenne d'Assurances Industrielles S.A. incorporated in
Belgium.

Investment as at November 29, 2001.......................... $9,534
Share of net income......................................... 389
------
Investment as at December 31, 2001.......................... $9,923
======

As of December 31, 2001, consolidated retained earnings includes $389
undistributed earnings of companies accounted for by the equity method.

6. REINSURANCE BALANCES RECEIVABLE

Recoverable from reinsurers on:
Paid losses............................................... $ 42,952
Outstanding losses........................................ 86,280
Losses incurred but not reported.......................... 108,930
--------
$238,162
========

The Company uses retrocessional agreements to reduce its exposure to the
risk of reinsurance assumed. The Company remains liable to the extent the
retrocessionaires do not meet their obligations under these agreements, and
therefore the Company evaluates and monitors concentration of credit risk.
Provisions are made for amounts considered potentially uncollectable. The
allowance for uncollectable reinsurance recoverable was $13,059 at December 31,
2001.

At December 31, 2001, reinsurance receivables with a carrying value of
$53,377 were associated with three single reinsurers, each of whom represented
10% or more of total reinsurance recoverables. In the event that all or any of
the reinsuring companies are unable to meet their obligations under existing
reinsurance agreements, the Company will be liable for such defaulted amounts.

7. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Outstanding................................................. $169,269
Incurred but not reported................................... 250,448
--------
$419,717
========

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

Balance at November 29 (date of acquisition)................ $416,299
Less reinsurance recoverables............................. 192,192
--------
224,107
Effect of exchange rate change............................ 2,750
Incurred related to prior years........................... --
Paid related to prior years............................... (2,350)
--------
Net balance at December 31, 2001.......................... 224,507
Plus reinsurance recoverables............................. 195,210
--------
Balance at December 31, 2001.............................. $419,717
========

F-11

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's reserve for unpaid losses and loss adjustment expenses as of
December 31, 2001 included $66,067 that represents an estimate of its net
ultimate liability for asbestos and environmental claims. The gross liability
for such claims as at December 31, 2001 was $194,069.

In establishing the liability for unpaid claims and claim adjustment
expenses related to asbestos and environmental claims, management considers
facts currently known and the current state of the law and coverage litigation.
Liabilities are recognized for known claims (including the cost of related
litigation) when sufficient information has been developed to indicate the
involvement of a specific insurance policy, and management can reasonably
estimate its liability. In addition, liabilities have been established to cover
additional exposures on both known and unasserted claims. Estimates of the
liabilities are reviewed and updated continually. Developed case law and
adequate claim history do not exist for such claims, especially because
significant uncertainty exists about the outcome of coverage litigation and
whether past claim experience will be representative of future claim experience.

8. NOTES PAYABLE TO SHAREHOLDERS

Notes payable, bearing interest of 5% per annum, were issued as part of the
purchase consideration for Castlewood Limited (see Note 1), and are repayable
after May 1, 2002.

9. DUE TO SHAREHOLDERS

Due to shareholders represents pre-acquisition costs and structuring fees
in relation to the acquisition of Castlewood. Structuring fees are due for
payment on May 1, 2002.

10. SHARE CAPITAL

Authorized, issued, fully paid shares of par value $1 each

6,000 Class A ordinary voting shares........................ $ 6
6,000 Class B ordinary voting shares........................ 6
6,000 Class C ordinary voting shares........................ 6
39,494,000 Class E ordinary non-voting redeemable shares.... 39,494
-------
$39,512
=======

Class E non-voting redeemable shares are held by Class C shareholders and
will be redeemed based upon distributions to Class A and Class B shareholders.

11. CONTRIBUTED SURPLUS

During the period, shareholders of the Company have made contributions to
surplus in the amount of $24,988.

As part of the acquisition of Castlewood (see Note 1), certain of the
shareholders of the Company made commitments to contribute capital of $79,000
upon request of the Board of Directors of the Company. As of December 31, 2001,
the remaining capital commitments of these shareholders amount to $54,012.

F-12

CASTLEWOOD HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. RELATED PARTY TRANSACTIONS

During the period ended December 31, 2001, Castlewood earned consulting
fees of $104 from subsidiaries of its partly-owned company.

13. TAXATION

Under current Bermuda law, the Company and its Bermuda subsidiaries are not
required to pay taxes in Bermuda on either income or capital gains. The Company
and its Bermuda subsidiaries have received an undertaking from the Bermuda
government that, in the event of income or capital gains taxes being imposed,
the Company and its Bermuda subsidiaries will be exempted from such taxes until
the year 2016.

United Kingdom subsidiaries have recorded income taxes based upon their
graduated statutory rate of 30%. Deferred income taxes arise from the
recognition of temporary differences between income determined for financial
reporting purposes and income tax purposes. Such differences result from
differing bases of depreciation and amortization for tax and book purposes.

River Thames' effective tax rate is approximately 30%. River Thames has tax
loss carry-forwards of approximately $43,750, which do not expire. A valuation
allowance has been provided for the tax benefit of these loss carry-forwards as
follows:

Benefit of loss carry-forward............................... $13,125
Valuation allowance......................................... (13,125)
-------
$ --
=======

14. STATUTORY REQUIREMENTS

The reinsurance subsidiaries are required to file annual statements with
insurance regulatory authorities prepared on an accounting basis prescribed or
permitted by such authorities ("statutory basis"), maintain minimum levels of
solvency and liquidity, and comply with risk-based capital requirements and
licensing rules. As at December 31, 2001, the reinsurance subsidiaries',
solvency, liquidity, surplus and risk based capital amounts were in excess of
the minimum levels required.

F-13

B.H. ACQUISITION LTD.

CONSOLIDATED FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT

DECEMBER 31, 2001 AND 2000

F-14

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
B.H. Acquisition Ltd.

We have audited the accompanying consolidated balance sheets of B.H.
Acquisition Ltd. as of December 31, 2001 and 2000, and the related consolidated
statements of income and retained earnings and cash flows for the year ended
December 31, 2001 and for the period from April 3, 2000 (date of incorporation)
to December 31, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of B.H. Acquisition Ltd. as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for the year ended December 31, 2001 and for the period from April 3, 2000 (date
of incorporation) to December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America.

/S/ DELOITTE & TOUCHE

Hamilton, Bermuda
March 8, 2002

F-15

B.H. ACQUISITION LTD.

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2000
(EXPRESSED IN U.S. DOLLARS)

See accompanying notes to the consolidated financial statements.

F-16

B.H. ACQUISITION LTD.

CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 2001 AND
THE PERIOD FROM APRIL 3, 2000 (DATE OF INCORPORATION) TO DECEMBER 31, 2000
(EXPRESSED IN U.S. DOLLARS)

See accompanying notes to the consolidated financial statements.

F-17

B.H. ACQUISITION LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2001 AND
THE PERIOD FROM APRIL 3, 2000 (DATE OF INCORPORATION) TO DECEMBER 31, 2000
(EXPRESSED IN U.S. DOLLARS)

See accompanying notes to the consolidated financial statements.

F-18

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
(EXPRESSED IN U.S. DOLLARS)

1. NATURE OF OPERATIONS

B.H. Acquisition Ltd. ("B.H.") was incorporated under the laws of Bermuda
on April 3, 2000, and on July 3, 2000, acquired 100% of the common shares of
Brittany Insurance Company Ltd. ("Brittany") and Compagnie Europeenne
d'Assurances Industrielles S.A. ("CEAI") (collectively "the Company") for cash
consideration of $20,500,000 and $8,000,000, respectively. B.H. did not operate
prior to July 3, 2000.

Brittany is incorporated under the laws of Bermuda and is in run-off. Prior
to run-off, its principal activity was to reinsure property, casualty and excess
liability risks, such as environmental and health exposures, of its former
affiliates and third parties. Brittany novated its entire book of related party
business prior to the acquisition.

CEAI is incorporated under the laws of Belgium and is in run-off. Its
principal activity is the run-off of its insurance and reinsurance risks
throughout the world.

Both acquisitions have been accounted for using the purchase method of
accounting, which requires that the acquirer record the assets and liabilities
acquired at their estimated fair value at the date of acquisition.

Negative goodwill on the purchase of Brittany and CEAI is calculated as
follows:

Purchase price of Brittany and CEAI......................... $28,500,000
Direct costs of the acquisitions............................ 441,931
-----------
28,941,931
Fair value of net assets acquired........................... 33,183,925
-----------
Negative goodwill at acquisition............................ $(4,241,994)
===========

2. SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PREPARATION

The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount 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.

BASIS OF CONSOLIDATION

The accompanying consolidated balance sheets include the accounts and
operations of B.H. and its wholly owned subsidiaries, Brittany and CEAI. All
significant intercompany accounts and transactions have been eliminated upon
consolidation

CASH AND CASH EQUIVALENTS

For purposes of the statements of cash flows, the Company considers all
money market funds and highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents.

F-19

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

INVESTMENTS

Debt and equity securities are classified as trading securities and are
carried at fair value, with unrealized holding gains and losses included in net
income. Realized gains and losses on sales of securities are recognized in net
income on the specific identification basis.

NEGATIVE GOODWILL

Negative goodwill represents the excess of the fair value of the net assets
acquired over the purchase price of Brittany and CEAI. The Company amortizes
goodwill over five years on the straight-line basis. Accumulated amortization as
of December 31, 2001 and 2000 was $1,272,600 and $424,200, respectively.

RUN-OFF PROVISION

Run-off provision is amortized over the five-year period estimated to
complete the run-off.

PREMIUMS

Premiums are recognized as revenue on a pro-rata basis over the periods of
the respective policies and contracts of reinsurance.

Premiums which are subject to adjustments are estimated based upon
available information. Any variances from the estimates are recorded in the
periods in which they become known.

LOSSES AND LOSS ADJUSTMENT EXPENSES

The liability for losses and loss adjustment expenses includes an amount
determined from loss reports and individual cases and an amount, based on
historical loss experience and industry statistics, for losses incurred but not
reported. These estimates are continually reviewed and are necessarily subject
to the impact of future changes in such factors as claim severity and frequency.
While the directors and management believe that the amount is adequate, the
ultimate liability may be significantly in excess of, or less than, the amounts
provided and any adjustments will be reflected in the periods in which they
become known.

TRANSLATION OF FOREIGN CURRENCIES

At each balance sheet date, recorded balances that are denominated in a
currency other than the functional currency of the company are adjusted to
reflect the current exchange rate. Revenue and expense items are translated into
U.S. dollars at average rates of exchange for the years. The resulting exchange
gains or losses are included in net income.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Estimated fair value of financial instruments held by the Company
approximates carrying value. The estimated fair value of investments is based on
quoted market value.

ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instrument
and Hedging Activities" (SFAS 133). SFAS 133, which became effective in the
first quarter of 2001, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The adoption of SFAS 133
did not have a material impact on the Company's financial position or results
from operations.
F-20

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

On July 20, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 141 "Business Combinations" (SFAS
141) and Statement of Financial Accounting Standards No. 142 "Goodwill and Other
Intangible Assets" (SFAS 142). The statements will change the accounting for
business combinations and goodwill in two significant ways.

SFAS 141 requires that the purchase method of accounting be used for all
business combination initiated after June 30, 2001. Use of the
pooling-of-interests method will be prohibited.

SFAS 142 changes the accounting for goodwill from an amortization method to
an impairment-only approach. For the purpose of testing goodwill for impairment,
acquired assets and assumed liabilities shall be assigned to a reporting unit as
of the acquisition date if the asset will be employed in, or the liability
relates to the operations of a reporting unit and the asset or liability will be
considered in determining the fair value of the reporting unit. The excess
goodwill over the fair value of these assets will be recorded in net income. In
the case of negative goodwill, negative goodwill shall be recorded in net income
and recognized as the effect of a change in accounting principle upon adoption
of that statement, which for the Company will be January 1, 2002.

The adoption of SFAS 142 will result in the recognition of a gain of
$2,969,394 on January 1, 2002.

3. PLEDGED ASSETS

Cash equivalents and investments in the amount of $13,854,925 and
$16,142,265 as of December 31, 2001 and 2000, respectively, are pledged as
collateral against letters of credit in the amount of $12,389,762 and
$14,074,233 as of December 31, 2001 and 2000, respectively.

4. INVESTMENTS

Estimated fair values of trading investments are as follows:

The mutual funds invest in high credit quality sectors (minimum "A")
including US Treasury, US Government Agency, corporate and asset backed and
money market instruments denominated in US dollars.

Major categories of net investment income are summarized as follows:

F-21

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

5. LOSSES AND LOSS ADJUSTMENT EXPENSES RECOVERABLE FROM REINSURERS

The fair value adjustment, determined based upon the estimated timing of
loss and loss adjustment expense recoveries and an assumed interest rate of
3.5%, is amortized over the estimated recovery period using the constant yield
method.

The Company used retrocessional agreements to reduce its exposure to the
risk of reinsurance assumed. The Company remains liable to the extent the
retrocessionaires do not meet their obligations under these agreements, and
therefore the Company evaluates and monitors concentration of credit risk.
Provisions are made for amounts considered potentially uncollectable. The
allowance for uncollectable reinsurance recoverable was $4,594,491 and
$8,130,292 at December 31, 2001 and 2000 respectively.

At December 31, 2001 and 2000, reinsurance receivables with a carrying
value of $12,994,000 and $16,897,034 respectively, were associated with two
reinsurers, each of whom represented 10% or more of total reinsurance
recoverables. In the event that all or any of the reinsuring companies are
unable to meet their obligations under existing reinsurance agreements, the
Company will be liable for such defaulted amounts.

6. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

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

The fair value adjustment, determined based on the estimated timing of loss
and loss adjustment expense payments and an assumed interest rate of 3.5%, is
amortized over the estimated payout period using the constant yield method.

F-22

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

Run-off costs provision represents the Company's estimate of the future
administrative costs of managing the run-off of Brittany and CEAI.

The Company's reserve for unpaid losses and loss expenses as of December
31, 2001 and 2000 included $13,091,270 and $11,829,277, respectively, that
represents an estimate of its net ultimate liability for asbestos and
environmental claims. The gross liability for such claims as at December 31,
2001 and 2000 was $22,864,268 and $22,832,763, respectively.

In establishing the liability for unpaid claims and claim adjustment
expenses related to asbestos and environmental claims, management considers
facts currently known and the current state of the law and coverage litigation.
Liabilities are recognized for known claims (including the cost of related
litigation) when sufficient information has been developed to indicate the
involvement of a specific insurance policy, and management can reasonably
estimate its liability. In addition, liabilities have been established to cover
additional exposures on both known and unasserted claims. Estimates of the
liabilities are reviewed and updated continually. Developed case law and
adequate claim history do not exist for such claims, especially because
significant uncertainty exists about the outcome of coverage litigation and
whether past claim experience will be representative of future claim experience.

7. DUE TO SHAREHOLDERS

Due to shareholders at December 31, 2000 represented direct costs of the
acquisitions paid by the shareholders on behalf of B.H., and was repaid during
2001. The balance was unsecured and interest free.

8. RELATED PARTY TRANSACTIONS

The Company was charged administration fees and expenses for the years
ended December 31, 2001 and, 2000 amounting to $1,250,000 and $800,000,
respectively, by one of the shareholders.

9. CONTRIBUTED SURPLUS

On July 3, 2000, B.H.'s shareholders injected contributed surplus in the
amount of $29,141,900 into the Company. On October 6, 2000, the Company returned
contributed surplus in the amount of $11,900,000 to its shareholders.

10. CONTINGENCIES

On or about July 8, 1997, Brittany was informed by correspondence that an
underwriting agency company who provided underwriting agency and run off
services has claimed that they are owed run-off remuneration totaling $2,321,000
for the period January 1, 1984 to December 31, 1996. The parent of the
underwriting agency is currently in liquidation. Brittany continues to deny any
liability under this claim, and will vigorously defend this position.

11. TAXATION

Under current Bermuda law, B.H. and Brittany are not required to pay taxes
in Bermuda on either income or capital gains. B.H. and Brittany have received an
undertaking from the Bermuda government that, in the event of income or capital
gains taxes being imposed, they will be exempted from such taxes until the year
2016.

F-23

B.H. ACQUISITION LTD.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

CEAI's effective tax rate is approximately 40%. CEAI has tax loss
carry-forwards at December 31, 2001 and 2000 of approximately $30,800,000 and
$33,400,000, respectively, which do not expire. A valuation allowance has been
provided for the tax benefit of these loss carry-forwards as follows:

12. STATUTORY REQUIREMENT

B.H.'s ability to pay dividends and its operating expenses is dependent on
cash dividends from its reinsurance subsidiaries Brittany and CEAI.

The reinsurance subsidiaries are required to file annual statements with
insurance regulatory authorities prepared on an accounting basis prescribed or
permitted by such authorities ("statutory basis"), maintain minimum levels of
solvency and liquidity, and comply with risk-based capital requirements and
licensing rules. As of December 31, 2001 and 2000, the reinsurance subsidiaries
solvency, liquidity, surplus and risk based capital amounts were in excess of
the minimum levels required.

13. COMPARATIVE FIGURES

Certain of the 2000 figures have been reclassified to conform to the
presentation adopted in 2001.

F-24