UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File Number 0-6612

ProCentury Corporation

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code

(614) 895-2000

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

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

NONE

      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 þ          No o

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

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

      The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004, based upon the closing sale price of the Common Shares on June 30, 2004 as reported on the NASDAQ National Market, was $107,624,114.

      The number of shares outstanding of the Registrant’s Common Shares, without par value, on March 23, 2005 was 13,155,195.

DOCUMENTS INCORPORATED BY REFERENCE.

      Portions of the Registrant’s definitive Proxy Statement for the 2005 annual meeting of shareholders to be held May 19, 2005, are incorporated herein by reference into Part III of this document.

TABLE OF CONTENTS

PART I

General

      ProCentury Corporation (“ProCentury,”) is a specialty property and casualty insurance holding company. We market and underwrite general liability, commercial property, multi-peril insurance and garage liability for small and mid-sized businesses primarily through Century Surety Company (“Century”), our operating insurance subsidiary. References to “Company”, “we”, “us”, and “our” refer to ProCentury and its subsidiaries, unless the context requires otherwise. We are either authorized as an admitted insurer or approved as an excess and surplus lines insurer by the state insurance regulators in 48 states plus the District of Columbia. We primarily write specialty excess and surplus lines insurance through a select group of general agents. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” typically do not cover. Our goal is to be selective in the classes of business and the coverages we write within the excess and surplus lines market. The insurance needs of this market are serviced by retail insurance brokers who maintain relationships with the general agents with whom we do business.

      As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. These targeted insured markets are often not served or are underserved by standard companies. We focus on serving the insurance needs of small and mid-sized businesses, including habitational risks, hospitality businesses, artisan contractors, daycare facilities, retail and wholesale stores, fitness centers and special event providers. Typically, the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients. We have disciplined underwriting that considers all of our applicants for insurance coverages on an individual basis. For each class we insure, we employ a number of customized limiting endorsements, rating surcharges and decreased limits to align our product offerings to the risk profile of the class and the specific insured being underwritten.

      We seek to achieve a balance between our property and casualty premiums. Property business has an inherently shorter tail than casualty business, and we emphasize short tail classes of casualty business in order to reduce pricing and reserving risk. For example, our primary casualty business is dominated by premises liability risks known in the industry as Owners, Landlords & Tenants (“OL&T”) risks, which presents a much shorter tail than a traditional excess and surplus lines book of business, which is predominated by Manufacturers & Contractors (“M&C”) risks. Short tail risks are generally known to occur at a definite point in time, and while the extent of the injury and associated costs may be unknown for some period of time, the actual occurrence is usually reported fairly quickly. In contrast, with longer tail risk the injury occurs away from the premises owned by the insured, may not be known for some period of time and may result in cumulative or progressive damage.

      We avoid high-hazard, long tail lines of business such as product liability, occurrence coverage for general contractor liability and construction contractor liability business and medical malpractice. We believe that construction trades may no longer be profitably underwritten on an occurrence general liability form in any state.

      As of December 31, 2004, we had consolidated assets of $394.9 million and consolidated shareholders’ equity of $115.2 million. For the year ended December 31, 2004, we produced gross written premiums of $191.4 million, and we had net income of $15.0 million

      Our principal executive offices are located at 465 Cleveland Ave., Westerville, Ohio 43082, and the telephone number at that address is (614) 895-2000. The Company files annual, quarterly, special reports and proxy statements with the SEC. These filings are available to the public over the Internet on the SEC’s Web site at http://www.sec.gov and at our Web site at http://www.procentury.com.

      Pursuant to Rule 12b-23 under the Securities and Exchange Act of 1934, as amended, the industry segment information included in Item 8, note 14 of Notes to Consolidated Financial Statements, is incorporated by reference in partial response to this Item 1.

Company History

      Century was formed in 1978 as a specialty insurance carrier for inland marine, surety and fidelity coverages for the surface mining industry. In 1984, Century expanded its original focus and initiated a business strategy centered on hard to place property/casualty risks. In 1992, Century acquired Continental Heritage Insurance Company (“Continental”), which wrote specialty surety and bail bond business. In 1993, Century acquired Evergreen National Indemnity Company (“Evergreen”), which wrote landfill and specialty surety business. These combined entities constituted the Century Insurance Group®.

      In 1996, Century was acquired by Century Business Services, Inc. (Nasdaq: CBIZ). In 1997, as part of a growth initiative by its former parent, Century Insurance Group® acquired the assets of the managed care workers’ compensation business of the Anthem Casualty Insurance Group.

      ProCentury was formed as an Ohio corporation in July 2000 by certain of our current shareholders and members of management. Pursuant to our management-led buyout in October 2000, ProCentury acquired Century and its subsidiaries, including Evergreen and Continental, from Century Business Services, Inc. The financing of this transaction included equity investments by five community bank holding companies, a private equity firm and other private investors, including members of current management.

      Following this transaction, the strategic direction of ProCentury focused primarily on the excess and surplus lines and involved exiting certain unprofitable businesses such as commercial automobile beginning in May 2000 and workers’ compensation in January 2002. As a result of this change in strategy, we sought to take advantage of the increase in volume and rates in the excess and surplus lines market, which began in 2001.

      On April 26, 2004, we issued 8,000,000 common shares at $10.50 per share in an initial public offering (“IPO”) and received net proceeds (before expenses) of $77.9 million. Immediately prior to the IPO, Evergreen and Continental, were spun-off to ProCentury’s existing Class A shareholders. The operations of Evergreen and Continental consisted of ProCentury’s historical surety and assumed workers’ compensation lines of insurance, which were re-classified (net of minority interest and income taxes) as discontinued operations in the accompanying financial information for all periods presented. As a result of these transactions, Century is the remaining operating subsidiary of ProCentury.

Industry Overview

      The excess and surplus lines insurance market differs significantly from the standard market. In the standard market, insurance products and coverages are largely uniform with broad coverage grants due to highly regulated rates and forms. Standard market companies tend to compete for customers primarily on the basis of rate, retain close relationships with retail insurance agents and make accommodations to the insureds to maintain the marketability of their product for their contracted direct agent.

      In contrast, the excess and surplus lines market provides coverage for risks that either do not fit the underwriting criteria of standard carriers with which the retail agent has a direct relationship, or they are of a class or risk that the standard market generally avoids since the regulated nature of that market does not allow for customized terms or rates. Non-standard risks can be underwritten profitably, however, by the excess and surplus market, by using highly specific coverage forms with terms based on individual risk assessment, rather than the risk profile of the most desirable members of the class. When a certain risk has been excluded from the standard market, the retail agents needs quick placement with the excess and surplus lines market in order to maintain coverage for the insured. As a result, the primary basis for competition within the excess and surplus lines industry can be focused more on service and availability than rate.

      The insurance industry has historically been cyclical. From 1987 to 2001, the industry generally experienced intensified competition for standard and excess and surplus lines insurers, resulting in rate decreases in many lines. In early 2001, a return to risk-based underwriting disciplines in the standard market

caused a noticeable increase in submissions to the excess and surplus lines market of risks that no longer qualified for coverage from the standard carriers and higher premium rates. Since 2001, we have benefited from this increase in rates and volume, as well as reduced capacity in the excess and surplus lines market, insurance industry consolidation, corporate downsizing and the increased use of communications technology and personal computers, which, among other factors, have contributed to the high growth in the number of small businesses. In addition, low interest rates have resulted in increased rates and more conservative coverage terms because, as investment returns have moderated over the past few years, property and casualty carriers have been forced to adopt more profitable underwriting practices. For property business, this pattern continued until the second half of 2003, when rates first plateaued, and then slowly began to decline. This moderate decline continued throughout much of 2004, with some stabilization seen after the October hurricanes in Florida. For casualty business, rates remained firm throughout 2003 and stabilized in 2004 with only slight declines.

      We expect that rate adequacy for our specialty and excess and surplus lines products will continue, as a result of the following factors:

Lines of Business

      The following table sets forth an analysis of gross and net written premiums by segment and major product groupings during the periods indicated:

      Casualty Business. We target shorter tail classes of casualty business focusing on what are commonly referred to as “OL&T” (owners, landlords and tenants) classes of business and have de-emphasized what are commonly referred to as “M&C” (manufacturers and contractors) classes of business. We believe these shorter tail OL&T classes of business present less rating and reserving risk to us compared to longer tail casualty lines. At the time of our management-led buyout in October 2000, 46.5% of our property/casualty gross written premiums comprised OL&T or shorter tail classes. For the year ended December 31, 2004, 71.8% of our property/casualty gross written premiums comprised OL&T or shorter tail classes. With respect to the M&C classes of business we continue to write, we focus on artisan contractors and light manufacturers that present no significant durable products liability exposure.

      Our insurance policies provide coverage limits generally ranging from $25,000 to $1.0 million per occurrence, with the majority of our policies having limits between $500,000 and $1.0 million. Generally, through reinsurance, we are subject to the first $500,000 of an individual loss for the current accident year. Our general liability policies usually provide coverage for defense and related expenses in addition to per occurrence and aggregate policy limits. For certain products, defense expenses are included in the policy limits.

      Other Casualty Business. We also offer garage liability and commercial umbrella policies to supplement our commercial multi-peril and commercial general liability writings. On garage liability we write up to a maximum of $1.0 million per occurrence or accident. This product is only offered by surplus lines carriers. Commercial umbrella policies provide excess liability coverage above the limits of standard liability policies and may also provide coverage for risks not covered under standard liability policies. We write commercial umbrella insurance for limits up to $5.0 million total aggregate above the minimum underlying limits of $1.0 million per occurrence and $2.0 million aggregate. Although most of our umbrella and excess business is written to support our primary policies, we will occasionally accept other carriers as primary, provided they are rated “A-” or better by A.M. Best.

      Property Business. Following our management-led buyout in October 2000, we have increased our property gross written premiums as a percentage of our total property/casualty written premiums. For the nine months ended September 30, 2000, property business and casualty business accounted for 17.9% and 82.1%, respectively, of our total property/casualty gross written premiums. For the year ended December 31, 2004, 35.5% and 64.5% of our total property/casualty gross written premiums comprised property business and casualty business, respectively. Consistent with our focus on shorter tail casualty lines, we believe that the inherent short tail property business presents less rating and reserving risk to us. Our property business represents classes of business that were chronically under-priced by the standard market admitted insurers in the late 1990s and have since been pushed to the excess and surplus lines market. These classes include apartments, commercial buildings and low value dwellings

      Our commercial property lines provide coverage limits of up to $25.0 million, but the vast majority of our written premiums in 2004 were written at limits of less than $2.0 million. Through the use of reinsurance, we retain the first $500,000 of each individual loss for the current accident year.

      Package Business. We write commercial multi-peril policies that provide our insureds with commercial property and general liability coverages bundled together as a “package.” The targeted classes, limits and pricing on these policies are the same as if written separately.

      Other (Including Exited Lines) We write a limited amount of landfill and specialty surety bond business on a direct and assumed basis. As of December 31, 2004, these bonds are ceded through a 100% quota share reinsurance agreement with Evergreen. We continue to write surety business in order to maintain our U.S. Treasury Listing. We do not expect our surety segment to exceed 4% of our total gross written premium for any given year.

      In addition, in connection with our management-led buyout in October 2000, we changed our strategic direction to focus primarily on the excess and surplus lines and the exiting of certain unprofitable business. As a result, we exited the commercial automobile line in May 2000 and the workers’ compensation line effective as of January 1, 2002.

      The following table sets forth the geographic distribution of our gross written premiums for the periods indicated:

      We attempt to minimize catastrophic risk by diversifying in different geographical regions. Our primary catastrophic risk is structural property exposures as a result of hurricanes, tornados, hail storms, winter storms and freezing. We maintain property catastrophe coverage by evaluating the probable maximum loss using a catastrophe exposure model developed by independent experts. We do not write wind coverage in Florida or within two counties of the Gulf of Mexico and the eastern seaboard states.

Underwriting and Pricing

      We underwrite our commercial property/casualty business on a binding authority and a brokerage basis.

      Binding Authority. Binding authority business represents risks that may be quoted and bound with a policy subsequently issued on our behalf by our general agents. This business is produced in accordance with specific and detailed rules set forth in our Electronic Underwriting Manual (“EUM”) that is provided to our general agents. There are limited classes and no premium credits available to the general agency underwriter. We monitor the classes of business subject to agents’ binding authority, considering market conditions, competition, underwriting results and other factors and we frequently change these guidelines by amending our EUM.

      Our EUM provides that some prospective insureds must be submitted to our underwriters for specific approval prior to the agent quoting or binding the risk. The most frequent reason for this specific approval requirement is the size of the risk involved. Any prospective property risk with a total insured value (“TIV”) over $1.0 million is automatically required to be submitted for prior approval. Similarly, any prospective casualty risk with a premium of $25,000 or greater is required to be submitted for prior approval.

      The economics of the binding business are generally different than those of the brokerage business due to the differing characteristics of each type of business. It is important to provide binding authority for the less difficult binding classes because the binding book has greater persistency than the brokerage business and is less likely to be “shopped” at renewal as a result of our general agent’s authority to issue the policy immediately.

      Binding authority business accounted for 56.5% of our total core property/casualty gross written premiums for the year ended December 31, 2004. Our EUM outlines our risk eligibility, pricing, underwriting guidelines and policy issuance instructions. We monitor the underwriting quality of our business by re-underwriting each piece of business produced by our general agents in accordance with their underwriting authority.

      We provide additional incentives to our general agents to produce profitable business through a contingent profit commission structure that is tied directly to underwriting profitability. This contingent profit commission applies only to business produced pursuant to our general agents’ underwriting authority (i.e., binding business) where the agent plays a role in underwriting the risk. In addition, beginning in 2005, we are

providing a bonus incentive to agents based the overall growth of the book of business that the agent places with us.

      Brokerage Business. Brokerage business represents risks that exceed the limits of underwriting authority that we are willing to grant to our general agents. Many of our brokerage accounts are classes of insurance that are not permitted to be written at all by our general agents pursuant to their binding authority. However, most of our brokerage business is produced on risks that produce individual TIV or premium above levels we believe prudent to allow for agency binding and issuance authority. For property business, any risk with a TIV over $1,000,000 is automatically classified as a brokerage account. For casualty business, the threshold is $25,000 in premium. If there is a package policy where either the property or casualty portion is indicated as a brokerage account, the entire account is classified as brokerage business. Commissions on brokerage policies are 3.5% lower than on binding contracts, and there is no contingent profit commission available to our general agents on brokerage business. Brokerage business accounted for approximately 43.5% of our total core property/casualty gross written premiums for the year ended December 31, 2004.

      Pricing. In the commercial property and casualty market, the rates and terms of coverage provided by property and casualty insurance carriers are frequently based on benchmarks and forms promulgated by the Insurance Services Office, also known as ISO. ISO makes available to its members advisory rating, statistical and actuarial services, policy language and other related services. ISO currently provides these services to more than 1,500 property and casualty insurance companies in the United States. One of the services that ISO provides is an actuarial-based estimate of the expected loss cost for risks in each of approximately 1,000 risk classifications. These benchmark loss costs reflect an analysis of the loss and allocated loss adjustment expenses on claims reported to ISO. ISO statistics, however, include only claims and policy information reported to ISO, and therefore do not reflect all of the loss experience for each class.

      We primarily use ISO loss costs as the foundation for establishing our rates for all lines of business. We then develop “loss cost multipliers,” or LCMs, which are designed to support our operating expenses, acquisition expenses and targeted return on equity. On our property business, we employ a proprietary class rating matrix that employs a series of ISO commercial fire rating schedule-based charges determined by construction, occupancy, protection and geographical concerns. We multiply our LCMs by ISO loss cost to produce our final rates. We also employ minimum premiums based on the limit and coverage provided that can only increase the effective rate. Our final rates are regionalized to incorporate variables such as historic loss experience, the types and lines of business written, competition and state regulatory considerations. For business that we write on an admitted, or licensed, basis, we must obtain advance regulatory approval of rates in a number of states. We do not provide our general agents with downward pricing flexibility on a per policy basis. All agency underwritten business is re-underwritten by our binding unit to check for mistakes or other results that may be inconsistent with the rules set forth in our EUM.

Marketing and Distribution

      As of December 31, 2004, we marketed our products through 104 agents, including 84 agents with binding authority. These agents maintain 117 offices in 35 states. This wholesale general agency force makes our products available to licensed retail agencies throughout the United States. We believe that our distribution network enables us to efficiently access at a relatively low fixed cost the numerous small markets our product offerings target. These general agents and their retail insurance agents and brokers have local market knowledge and expertise that enable us to more effectively access these markets. We generally confine our general agents marketing territory to three or fewer states.

      We strive to preserve each general agent’s franchise value with us in that general agent’s marketing territory. We seek to increase our written premiums with these general agents and to develop long-term, profitable relationships by providing a high level of service and support. For example, we try to respond to our general agents’ requests for quotes on their proposals within 48 hours. We believe that the performance of the business that we ultimately write is measurably improved when produced by general agents who have increased familiarity and experience with our underwriting requirements.

Claims Management and Administration

      Our approach to claims management is to:

Our general agents have no authority to settle claims or otherwise exercise control over the claims process. Our claims management staff supervises and processes all claims. Claims adjusters have reserving authority based upon their skill level and experience. We have a formal claims review process, and changes in loss and loss expense reserves on all claims valued greater than $25,000 are reviewed on a weekly basis by senior claims and underwriting management and the President of Century.

Loss and Loss Expense Reserves

      We are liable for loss and loss expense reserves under the terms of the insurance policies that we write. In many cases, several years may lapse between the occurrence of an insured loss, the reporting of the loss to us and our settlement of that loss. We reflect our liability for the ultimate payment of all incurred losses and loss expenses by establishing loss and loss expense reserves as balance sheet liabilities for both reported and unreported claims. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and loss expenses.

      When a claim is reported, our claim department establishes a “case reserve” for the estimated amount of the ultimate payment within 90 days of the receipt of the claim. The estimate of the amount of the ultimate loss is based upon various factors such as:

      In addition to case reserves, we establish reserves on an aggregate basis to provide for losses and loss expenses that have been incurred but not reported, commonly referred to as “IBNR.” Case reserves and IBNR comprise the total loss and loss expense reserves.

      Our internal actuaries apply multiple traditional actuarial techniques to compute loss and loss expense reserve estimates for claim liabilities other than construction defect. Each individual technique produces a unique loss and loss expense reserve estimate for the line being analyzed. The set of techniques applied together produces a range of loss and loss expense reserve estimates. From these estimates, the actuaries form a best estimate which considers the assumptions and factors discussed below that influence ultimate claim costs. For construction defect claim liabilities, our internal actuaries apply one actuarial technique, under various sets of assumptions, which considers the factors that influence ultimate claim costs as discussed below. The actuarial technique for construction defect claims includes several variables relating to the number of IBNR claims and the average cost per IBNR claim. In addition to computing best estimate parameter values for the actuarial projection, the actuaries also consider the impact on resulting IBNR related to reasonably foreseeable fluctuations in these variables.

      The actuarial techniques for computing loss and loss expense reserve estimates use the following factors, among others:

      Although many factors influence the actual cost of claims and our corresponding reserve estimates, we do not measure and estimate values for all of these variables individually. This is due to the fact that many of the factors that are known to impact the cost of claims cannot be measured directly, such as the impact on claim costs due to economic inflation, coverage interpretations and jury determinations. In most instances, we rely on our historical experience or industry information to estimate values for the variables that are explicitly used in our reserve analyses. We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of future effects of these factors. Where we have reason to expect a change in the effect of one of these factors, we perform analysis to quantify the necessary adjustments.

      We periodically review these estimates and, based on new developments and information, we include adjustments of the probable ultimate liability in operating results for the periods in which the adjustments are made. In general, our initial reserves are based upon the actuarial and underwriting data utilized to set pricing levels and are reviewed as additional information, including claims experience, becomes available. The establishment of loss and loss expense reserves makes no provision for the broadening of coverage by legislative action or judicial interpretation or for the extraordinary future emergence of new types of losses not sufficiently represented in our historical experience or which cannot yet be quantified. We regularly analyze our reserves and review our pricing and reserving methodologies so that future adjustments to prior year reserves can be minimized. However, given the complexity of this process, reserves will require continual updates and the ultimate liability may be higher or lower than previously indicated.

      Our Actuarial Unit has three actuaries, each of whom is a Fellow of the Casualty Actuarial Society and Member of the American Academy of Actuaries. The duties of the Actuarial Unit include:

Due to the inherent uncertainty in estimating reserves for losses and loss expenses, there can be no assurance that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on our results of operations and financial condition. Based on the current assumptions used in calculating reserves, management believes our overall reserve levels at December 31, 2004 make a reasonable provision for our future obligations.

      Activity in the liability for loss and loss expense reserves is summarized as follows:

An explanation of significant components of loss and loss expense reserve development by segment (net of reinsurance, unless otherwise indicated) follows.

      Casualty. Our changes in the reserve estimates related to prior accident years for the years ended December 31, 2004, 2003 and 2002 for the casualty lines resulted in increases in incurred losses and loss expenses of $12.8 million, $22.2 million, and $13.5 million respectively. A significant portion of our casualty reserves relate to construction defect claims in certain states. See “Business — General.” Starting with California in December 2000, we began to exit contractors’ liability business. By the end of the first quarter of 2001, we had significantly reduced our contractors’ liability underwriting in all states, and completely eliminated contractors’ liability underwriting in Arizona, California, Colorado, Hawaii, Louisiana, Nevada, New Jersey, North Carolina, Oregon, South Carolina and Washington. Reserves and claim frequency on this business may also be impacted by legislation recently enacted in California, which generally provides consumers who experience construction defects a method other than litigation to obtain reimbursement for construction defect repairs. This legislation may impact claim severity, frequency and length to settlement assumptions underlying our reserves. Accordingly, our ultimate liability may exceed or be less than current estimates due to this variable, among others.

      Of our construction defect net loss and loss expense reserves at December 31, 2004, 61.0% was for incurred but not reported losses (which are referred to as IBNR) and 52.5% of our construction defect net loss and loss expense reserves at December 31, 2003 was for IBNR. As of December 31, 2004, we had 566 open claims relating to construction defects, compared to 597 open claims as of December 31, 2003. During 2004, 986 new claims were reported and 1,017 existing claims were settled or dismissed. Our net loss and loss expense reserves for construction defects as of December 31, 2004 were $19.0 million. The adverse development recognized in 2004 and 2003, related to construction defect was $8.3 million and $13.4 million, respectively. The re-estimation of construction defect reserves primarily affected the 1996 and 1997 accident years and the 1999 to 2001 accident years.

      In addition, during 2004 and 2003, we also experienced development above expectations on our non-construction defect casualty reserves for the 2000 to 2002 years that led to reassessments of the initial loss ratio expectations and the claim reporting and settlement patterns. The adverse development recognized in 2004 and 2003, related to our non-construction defect casualty reserves was $4.6 million and $8.8 million, respectively.

      As of December 31, 2004, the projected loss and loss expense ratios, after the effects of reinsurance, for the casualty lines were 48.9%, 44.0% and 57.8% for accident periods 2004, 2003, and 2002, respectively.

      Property. Our changes in estimate for the years ended December 31, 2004, 2003 and 2002 for the property lines resulted in increases (decreases) of ($3.2) million, $2.3 million and ($22,000), respectively. These amounts primarily relate to changes in the selected development patterns on all accident years, as the number of claims and claim severity exceeded expectations at December 31, 2002, and were below expectations at December 31, 2003 and 2001.

      As of December 31, 2004, the projected loss and loss expense ratios, after the effects of reinsurance, for the property lines were 58.8%, 50.3% and 57.2% for accident periods 2004, 2003 and 2002, respectively.

      We began writing commercial automobile coverage for commercial vehicles and trucks in 1997. In 2000, we exited the commercial automobile line of business due to unsatisfactory underwriting results. At December 31, 2004, all of our net loss and loss expense reserves related to commercial automobile was for case reserves. At December 31, 2003, 0.6% of our commercial automobile net loss and loss expense reserves was for IBNR and 99.4% was for case reserves. As of December 31, 2004, we had 38 open claims relating to commercial automobile, compared to 63 open claims as of December 31, 2003. During 2004, eight new claims were reported and 33 existing claims were settled or dismissed. Our net loss and loss expense reserves for commercial automobile as of December 31, 2004 were $1.8 million.

      We offered workers’ compensation coverage from 1997 through January 2002. We exited this line of business beginning January 1, 2002 due to unsatisfactory underwriting results and the lack of availability of acceptable reinsurance. Until July 2000, we purchased 100% quota share reinsurance on this book of business. Beginning in 2000, we started to retain some risk. No new policies have been written since the first quarter of 2002. Of our net loss and loss expense reserves at December 31, 2004, 49.8% related to workers’ compensation claims IBNR, and 2.3% of our net loss and loss expense reserves at December 31, 2003 was for workers’ compensation IBNR. As of December 31, 2004, we had 257 open claims relating to workers’ compensation compared to 414 open claims as of December 31, 2003. During 2004, 13 new claims were reported, and 170 existing claims were settled or dismissed. Our net loss and loss expense reserves for workers’ compensation as of December 31, 2004 were $3.4 million.

      The table provided below presents the development of reserves, net of reinsurance, from 1995 through 2004. The top line of the table presents the reserves at the balance sheet date for each of the periods indicated. This represents the estimated amounts of loss and loss expenses for claims arising in the period that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The upper portion of the table presents the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding period, including cumulative payments made since the end of the respective

period. The estimate changes as more information becomes known about the payments, as well as the frequency and severity of claims for individual periods. Favorable loss development, shown as a cumulative redundancy in the table, exists when the original reserve estimate is greater than the re-estimated reserves. The lower portion of the table presents the cumulative amounts paid as of the end of each successive period with respect to those claims. Information with respect to the cumulative development of gross reserves (that is, without deduction for reinsurance ceded) also appears at the bottom portion of the table.

      In evaluating the information in the table provided below, note that each amount entered incorporates the cumulative effects of all changes in amounts entered for prior periods. The table does not present accident or policy year development data. In addition, conditions and trends that have affected the development of liability in the past may not necessarily recur in the future.

Analysis of Loss and Loss Adjustment Expense Development

Reinsurance

      We purchase reinsurance to reduce our exposure to liability on individual risks and claims and to protect against catastrophic losses. Reinsurance involves an insurance company transferring, or “ceding,” a portion of its exposure on a risk to another insurer, the reinsurer. The reinsurer assumes the exposure in return for a portion of the premium. The ceding of liability to a reinsurer does not legally discharge the primary insurer from its liability for the full amount of the policies on which it obtains reinsurance. The primary insurer remains liable for the entire loss if the reinsurer fails to meet its obligations under th reinsurance agreement.

      In formulating our reinsurance programs, we are selective in our choice of reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize our exposure to the insolvency of our reinsurers, we evaluate the acceptability and review the financial condition of each reinsurer annually. Our policy is to use only those reinsurers that have an A.M. Best rating of “A-” (excellent) or better and that have at least $500 million in policyholders’ surplus, or Lloyds of London syndicates that have an A.M. Best rating of “A-” (excellent) or better. In the event that a reinsurer’s policyholders’ surplus falls below $500 million or the A.M. Best rating falls below an “A-,” we will attempt to replace the reinsurer with a reinsurer that fits our criteria, or we will try to commute the contract. Retention levels are reviewed each year to maintain a balance between the growth in surplus and the cost of reinsurance.

      The following is a summary of our 2004 and 2005 multiple-line excess of loss reinsurance treaty:

      Since 2004, we have maintained “casualty clash” coverage of $19.0 million in excess of $1.0 million to cover exposures such as punitive damages and other extra-contractual obligations, losses in excess of policy limits (such as bad faith and errors and omissions) and exposure to a larger single loss than intended due to losses incurred under two or more coverages or policies for the same event.

      In 2004, we maintained property catastrophe coverage of $17.0 million above $3.0 million of cumulative net property retentions. In 2005, we maintain property catastrophe coverage of 95.0% of the $16.0 million layer above $4.0 million of cumulative net property retentions. We annually evaluate the probable maximum loss using a catastrophe exposure model developed by independent experts. The most recent model suggests we are insured for a 250 year catastrophic event. Our primary catastrophic risk is structural property exposures as a result of hurricane, tornados, hail storms, winter storms and freezing. We do not write wind coverage in Florida or within two counties of the Gulf of Mexico and the eastern seaboard states.

      In 2004, we participated in a reinsurance program which reduced our net retention under the Terrorism Risk Insurance Act of 2002. For 2005, we analyzed our terrorism exposure using terrorism catastrophe modeling software. After comparing the results of this analysis to the proposed costs of continuing in this program, we decided not to renew our participation in the program in 2005.

      The following is a summary of our top ten reinsurers, based on net amount recoverable, as of December 31, 2004:

      The reinsurance market has changed dramatically over the past few years as a result of inadequate pricing, poor underwriting and the significant losses incurred in conjunction with the terrorist attacks on September 11, 2001. As a result, reinsurers have exited some lines of business, reduced available capacity and implemented provisions in their contracts designed to reduce their exposure to loss.

Investment Portfolio

      Our investment strategy is designed to capitalize on our ability to generate positive cash flow from our underwriting activities. Preservation of capital is our first priority, with a secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient liquidity from operations, investing and financing activities to meet our anticipated insurance obligations and operating and capital expenditure needs. The majority of our fixed-maturity portfolio is rated investment grade to mitigate our exposure to credit risk. Our investment portfolio is managed by two outside independent investment managers that operate under investment guidelines approved by Century’s investment committee. Century’s investment committee meets at least quarterly and reports to the board of directors. In addition, we employ stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security. In limited circumstances, we will invest in non-investment grade fixed maturity securities that have an appropriate risk adjusted return, subject to satisfactory credit analysis performed by us and our investment managers.

      Our cash and investment portfolio totaled $312.4 million as of December 31, 2004 and is summarized by type of investment as follows:

Competition

      The property and casualty insurance industry is highly competitive. We compete with domestic and international insurers, many of which have greater financial, marketing and management resources and experience than we do. We also may compete with new market entrants in the future. Competition is based on many factors, including the perceived market strength of the insurer, pricing and other terms and conditions, services provided, the speed of claims payment, the reputation and experience of the insurer and ratings assigned by independent rating organizations such as A.M. Best. Century has a rating from A.M. Best of “A-” (excellent). Ratings for an insurance company are based on its ability to pay policyholder obligations and are not directed toward the protection of investors.

      Today our primary competitors are Nationwide Mutual Insurance Company (Scottsdale Insurance), Markel Corporation (Essex Insurance Company), Burlington Insurance Group, W.R. Berkley Corporation (Nautilus Insurance Company), The Argonaut Group (Colony Insurance Company), Penn-America Insurance Company and RLI Corp. We generally compete on the basis of service, as most market competitors have maintained both pricing and underwriting discipline. Moreover, the market we serve has increased as standard carriers have exited many lines and classes of business served by the excess and surplus lines market.

Ratings

      A.M. Best, which rates insurance companies based on factors of concern to policyholders, issued a rating of “A-” (excellent) as its 2004 annual rating of our property and casualty insurance subsidiary. A.M. Best assigns 16 ratings to insurance companies, which currently range from “A++” (superior) to “F” (in liquidation). In evaluating a company’s financial and operating performance, A.M. Best reviews the company’s profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its loss and loss expense reserves, the adequacy of its surplus, its capital structure, the experience and competence of its management

and its market presence. A.M. Best’s ratings reflect its opinion of an insurance company’s financial strength, operating performance and ability to meet its obligations to policyholders and are not evaluations directed to purchasers of an insurance company’s securities.

Regulatory Environment

      Insurance Regulation. We are regulated by insurance regulatory agencies in the states in which we conduct business. State insurance regulations generally are designed to protect the interests of policyholders, state insurance consumers or claimants rather than shareholders or other investors. The nature and extent of state regulation varies by jurisdiction, and state insurance regulators generally have broad administrative power relating to, among other matters, setting capital and surplus requirements, licensing of insurers and agents, establishing standards for reserve adequacy, prescribing statutory accounting methods and the form and content of statutory financial reports, regulating certain transactions with affiliates, and prescribing the types and amounts of investments.

      Regulation of insurance companies constantly changes as governmental agencies and legislatures react to real or perceived issues. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and some state legislatures have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems. Further, the National Association of Insurance Commissioners (“NAIC”) and some state insurance regulators are re-examining existing laws and regulations specifically focusing on issues relating to the solvency of insurance companies, interpretations of existing laws and the development of new laws. Although the federal government does not directly regulate the business of insurance, federal initiatives often affect the insurance industry in a variety of ways.

      Required Licensing. In its home state of Ohio and the states of Arizona, Indiana, Maine, West Virginia and Wisconsin, Century operates on an admitted, or licensed, basis. Each of Century’s licenses in these states are in good standing as of December 31, 2004. Insurance licenses are issued by state insurance regulators upon application and may be of perpetual duration or may require periodic renewal. We must apply for and obtain appropriate new licenses before we can expand into a new state on an admitted basis or offer new lines of insurance that require separate or additional licensing.

      In most states, Century operates on a surplus lines basis. While Century does not have to apply for and maintain a license in those states, it is subject to maintaining suitability standards or approval under each particular state’s surplus lines laws to be included as an approved carrier. Century maintains surplus lines approvals in all states except where it is admitted, as identified above, and Massachusetts and Rhode Island. In states in which it operates on a surplus lines basis, Century has freedom of rate and form limitations on the majority of its business. This means that Century can implement a change in policy form, underwriting guidelines, or rates for a product on an immediate basis.

      Insurers operating on an admitted basis must file premium rate schedules and policy or coverage forms for review and approval by the insurance regulators. In many states, rates and policy forms must be approved prior to use, and insurance regulators have broad discretion in judging whether an insurer’s rates are adequate, not excessive and not unfairly discriminatory. Property and casualty insurers generally are unable to implement rate increases until they show that costs associated with providing such coverage have exceeded premiums.

      Insurance Holding Company Regulation. We operate as an insurance holding company system and are subject to regulation in the jurisdictions in which Century conducts business. These regulations require that each insurance company in the system register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system domiciled in that state. The insurance laws similarly provide that all transactions among members of a holding company system must be fair and reasonable. Transactions between insurance subsidiaries and their parents and affiliates generally must be disclosed to the state regulators, and prior approval of the applicable state insurance regulator generally is required for any material or extraordinary transaction. In addition, a change of

control of a domestic insurer or of any controlling person requires the prior approval of the state insurance regulator. Generally, any person who acquires 10% or more of the outstanding voting securities of the insurer or its parent company is presumed to have acquired control of the domestic insurer.

      Restrictions on Paying Dividends. ProCentury is a holding company with no business operations of its own. Consequently, our ability to pay dividends to shareholders and meet debt payment obligations will be largely dependent on dividends and other distributions from Century. State insurance law restricts the ability of Century to declare shareholder dividends. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. The amount of an insurer’s surplus following payment of any dividends must be reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial needs. Further, prior approval from the Ohio Department of Insurance generally is required in order for Century to declare and pay “extraordinary dividends”. An extraordinary dividend is defined as any dividend or distribution that, together with other distributions made within the preceding 12 months, exceeds the greater of 10% of the insurer’s surplus as of the preceding December 31st, or the insurer’s net income for the 12 month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. The maximum amount of dividends our insurance subsidiary can pay us during 2005 without regulatory approval is $13.8 million. State insurance regulatory authorities that have jurisdiction over the payment of dividends by our insurance subsidiary may in the future adopt statutory provisions more restrictive than those currently in effect.

      Guaranty Funds. Under state insurance guaranty fund laws, insurers doing business on an admitted basis in a state can be assessed for certain obligations of insolvent insurance companies to policyholders and claimants. Maximum contributions required by law in any one year vary between 1% and 2% of annual premiums written in that state. In most states, guaranty fund assessments are recoverable either through future policy surcharges or offsets to state premium tax liability. Except for New Jersey, the business that is written on a surplus line basis is not subject to state guaranty fund assessments.

      Investment Regulation. Century is subject to state law which requires diversification of its investment portfolios and limits the amount of investments in certain categories. Failure to comply with these laws and regulations would cause non-conforming investments to be treated as non-admitted assets in the states in which we are licensed to sell insurance policies for purposes of measuring statutory surplus and, in some instances, would require us to sell those investments.

      Restrictions on Cancellation, Non-Renewal or Withdrawal. Many states have laws and regulations that limit the ability of an insurance company licensed by that state to exit a market. For example, certain states limit an automobile insurer’s ability to cancel or not renew policies. Some states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan approved by the state insurance regulator, which may disapprove a plan that may lead to market disruption. Increasingly, state statutes, explicitly or by interpretation, apply these restrictions to insurers operating on a surplus line basis.

      Licensing of Our Employees and Adjustors. In certain states in which we operate, insurance claims adjusters are also required to be licensed and some must fulfill annual continuing education requirements. In most instances, our employees who are negotiating coverage terms are underwriters and employees of the company and are not required to be licensed agents. Approximately thirty of our employees currently maintain requisite licenses for these activities in most states in which we conduct business.

      Privacy Regulations. In 1999, the United States Congress enacted the Gramm-Leach-Bliley Act, which, among other things, protects consumers from the unauthorized dissemination of certain personal information. Subsequently, a majority of states have implemented additional regulations to address privacy issues. These laws and regulations apply to all financial institutions, including insurance and finance companies, and require us to maintain appropriate procedures for managing and protecting certain personal information of our customers and to fully disclose our privacy practices to our customers. We may also be exposed to future privacy laws and regulations, which could impose additional costs and impact our results of operations or financial condition. A recent NAIC initiative that impacted the insurance industry in 2001 was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further

facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. We have adopted a privacy policy for safeguarding customer information and our insurance subsidiaries follow procedures pertaining to applicable customers to comply with the Gramm-Leach-Bliley related privacy requirements.

      Trade Practices. The manner in which insurance companies and insurance agents conduct the business of insurance is regulated by state statutes in an effort to prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices. Prohibited practices include, but are not limited to, disseminating false information or advertising; unfair discrimination, rebating, and false statements. We set business conduct policies and provide regular training to make our employee-agents and other sales personnel aware of these prohibitions, and we require them to conduct their activities in compliance with these statutes.

      Unfair Claims Practices. Generally, insurance companies, adjusting companies and individual claims adjusters are prohibited by state statutes from engaging in unfair claims practices on a flagrant basis or with such frequency to indicate a general business practice. Unfair claims practices include, but are not limited to, misrepresenting pertinent facts or insurance policy provisions; failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies; and attempting to settle a claim for less than the amount to which a reasonable person would have believed such person was entitled. We set business conduct policies and conduct regular training to make our employee-adjusters and other claims personnel aware of these prohibitions, and we require them to conduct their activities in compliance with these statutes.

      Quarterly and Annual Financial Reporting. We are required to file quarterly and annual financial reports with state insurance regulators utilizing statutory accounting practices (“SAP”) rather than generally accepted accounting principles (“GAAP”). In keeping with the intent to assure policyholder protection, SAP financial reports generally are based on a liquidation concept. For a summary of the significant differences for our insurance subsidiaries between statutory accounting practices and GAAP, see Note 13 to our audited consolidated financial statements included in this report.

      Periodic Financial and Market Conduct Examinations. The Ohio Department of Insurance conducts on-site visits and examinations of Century’s affairs, including its financial condition and its relationships and transactions with affiliates, every three to five years, and may conduct special or target examinations to address particular concerns or issues at any time. Insurance regulators of other states in which we do business also may also conduct examinations. The results of these examinations can give rise to regulatory orders requiring remedial, injunctive or other corrective action.

      Risk-Based Capital. Risk-Based Capital (“RBC”) requirements laws are designed to assess the minimum amount of capital that an insurance company needs to support its overall business operations and to ensure that it has an acceptably low expectation of becoming financially impaired. Regulators use RBC to set capital requirements considering the size and degree of risk taken by the insurer and taking into account various risk factors including asset risk, credit risk, underwriting risk and interest rate risk. As the ratio of an insurer’s total adjusted capital and surplus decreases relative to its risk-based capital, the RBC laws provide for increasing levels of regulatory intervention culminating with mandatory control of the operations of the insurer by the domiciliary insurance department at the so-called mandatory control level. At December 31, 2004, Century maintained an RBC level in excess of an amount that would require any corrective actions on our part.

      IRIS Ratios. The NAIC Insurance Regulatory Information System or IRIS is part of a collection of analytical tools designed to provide state insurance regulators with an integrated approach to screening and analyzing the financial condition of insurance companies operating in their respective states. IRIS is intended to assist state insurance regulators in targeting resources to those insurers in greatest need of regulatory attention. IRIS consists of two phases: statistical and analytical. In the statistical phase, the NAIC database generates key financial ratio results based on financial information obtained from insurers’ annual statutory statements. The analytical phase is a review of the annual statements, financial ratios and other automated solvency tools. The primary goal of the analytical phase is to identify companies that appear to require

immediate regulatory attention. A ratio result falling outside the usual range of IRIS ratios is not considered a failing result; rather, unusual values are viewed as part of the regulatory early monitoring system. Furthermore, in some years, it may not be unusual for financially sound companies to have several ratios with results outside the usual ranges. An insurance company may fall out of the usual range for one or more ratios because of specific transactions that are in themselves immaterial.

      As of December 31, 2004, Century had four IRIS ratios outside the usual range, as set forth in the following table:

Our results for these ratios are attributable to the significant growth in premiums and surplus, low investment yields due to the current interest rate environment and adverse development of prior years’ loss and loss expense reserves. We have provided our regulators with an explanation of these unusual results and do not expect any material regulatory action.

      We are monitoring the following:

      Broker Contingent Commission. In 2004, the New York attorney general began an investigation into insurance broker activities connected with contingent commission agreements. The investigation led to lawsuits and prompted other attorneys general and state insurance departments to conduct further investigations. We have not received any formal inquiries from state attorneys general and insurance departments. However, we did conduct an internal investigation of our contingent commission arrangements and related underwriting practices and found no improper actions. The NAIC has proposed a model act on these agreements for agents and brokers, and several states have indicated they will adopt the model act or some variation of the proposed act. We continue to closely monitor all proposals.

      Federal Insurance Charter. The Senate Commerce Committee recently has held hearings on federal involvement in the regulation of the insurance industry. The hearings included a discussion of a proposed federal charter that would allow companies to operate under federal, rather than state, regulation. Any proposed legislation would have a significant impact on the insurance industry, and we continue to monitor all proposals. We anticipate there will be further legislative activity during 2005.

      Terrorism Exclusion Regulatory Activity. After the events of September 11, 2001, the NAIC urged states to grant conditional approval to commercial lines endorsements that excluded coverage for acts of terrorism consistent with language developed by the Insurance Services Office, Inc (ISO). The ISO endorsement included certain coverage limitations. Many states allowed the endorsements for commercial lines, but rejected such exclusions for personal exposures.

      On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (TRIA) became law. The act provides for a federal backstop for terrorism losses as defined by the act and certified by the Secretary of the Treasury in concurrence with the Secretary of State and the U.S. Attorney General. Under TRIA, coverage provided for losses caused by acts of terrorism is partially reimbursed by the United States under a formula whereby the government pays 90% of covered terrorism losses exceeding a prescribed deductible to the insurance company providing the coverage. The deductible is calculated as 15% of gross earned premium net of a few excludable lines. Coverage under the act must be made available, with certain limited exceptions, in all commercial property and casualty policies. The immediate effect on state regulation was to nullify terrorism exclusions to the extent they exclude losses that would otherwise be covered under the act. We are in compliance with the requirements of TRIA and have made terrorism coverage available to policyholders. Given the challenges associated with attempting to assess the potentiality of future acts of terror exposures and assign an appropriate price to the risk, we have taken a conservative underwriting position on most of our

products. In 2004, the House Financial Services Committee approved an extension of TRIA to December 31, 2007. It is expected that Congress will vote on the extension in mid-2005, or the act will expire on December 31, 2005.

      Mold Contamination. The property/casualty insurance industry experienced an increase in claim activity beginning in 2001 pertaining to mold contamination. Significant plaintiffs’ verdicts and increased media attention to the subject have caused insurers to develop and/or refine relevant insurance policy language that excludes mold coverage. The insurance industry foresees increased state legislative activity pertaining to mold contamination. We will closely monitor regulatory and litigation trends and continue to review relevant insurance policy exclusion language.

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

Employees

      We employ approximately 269 people. Our employees are not covered by any collective bargaining agreements.

Forward Looking Statements

      Forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 appear throughout this report. Forward looking statements, which generally include words such as “anticipates,” “expects,” “believes,” “intends,” “estimates” and similar expressions and include those statements regarding our expectations, hopes, beliefs, intentions, goals or strategies regarding the future and are based on certain underlying assumptions by us. Such assumptions are, in turn, based on information available and internal estimates and analyses of general economic conditions, competitive factors, conditions specific to the property and casualty insurance industry, claims development and the impact thereof on our loss reserves, the adequacy of our reinsurance programs, developments in the securities market and the impact on our investment portfolio, regulatory changes and conditions, and other factors. Actual results could differ materially from those in forward looking statements. We assume no obligation to update any such statements. You should review the various risks, uncertainties and other factors listed from time to time in our Securities and Exchange Commission filings.

Risks Related To Our Business and Industry

      We are liable for loss and loss expenses under the terms of the insurance policies we underwrite. In many cases, several years may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss. We establish loss and loss expense reserves for the ultimate payment of all loss and loss expenses incurred. If any of our reserves should prove to be inadequate, we will be required to increase reserves resulting in a reduction in our net income in the period in which the inadequacy is identified. Future loss experience substantially in excess of established reserves could also cause our future earnings, liquidity and financial rating to decline. These reserves are based on historical data and estimates of future events and by their nature are imprecise. Our ultimate loss and loss expenses may vary from established reserves.

      Furthermore, factors that are subject to change, such as:

may have a substantial impact on our future loss experience. Additionally, we have established loss and loss expense reserves for certain lines of business we have exited, but circumstances could develop that would make these reserves insufficient. As of December 31, 2004, unpaid loss and loss expense reserves (net of reserves ceded to our reinsurers) were $123.8 million, consisting of case loss and loss expense reserves of $45.3 million and incurred but not reported loss and loss expense reserves of $78.5 million.

      We have re-estimated our loss and loss expense reserves attributable to insured events in prior years, which includes re-estimations with respect to excess and surplus lines and products we no longer write. These re-estimations resulted in an increase in reserves of $11.1 million, $27.0 million and $16.8 million for the years ended December 31, 2004, 2003 and 2002, respectively.

      Our insurance subsidiary received an “A-” (excellent) annual rating for 2004 from A.M. Best, the fourth highest of 16 A.M. Best ratings. A.M. Best assigns ratings that generally are based on an insurance company’s ability to pay policyholder obligations (not towards protection of investors) and focus on capital adequacy, loss and loss expense reserve adequacy and operating performance. A reduction in our performance in these criteria could result in a downgrade of our rating. A downgrade of our rating could cause our current and future general agents, retail brokers and insureds to choose other, more highly rated competitors.

      General. Century is subject to regulations, administered primarily by Ohio, our domiciliary state, and to a lesser degree, the five other states in which Century is licensed or admitted to sell insurance. Most insurance regulations are designed to protect the interests of insurance policyholders, as opposed to the interests of shareholders. These regulations, generally are administered by a department of insurance in each state and relate to, among other things, excess and surplus lines of business authorizations, capital and surplus requirements, rate and form approvals, investment parameter restrictions, underwriting limitations, affiliate transactions, dividend limitations, changes in control and a variety of other financial and non-financial components of our business. Significant changes in these laws and regulations could further limit our discretion or make it more expensive to conduct our business. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.

      Required Licensing. Regulatory authorities have broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, where there is uncertainty as to applicability, we follow practices based on our interpretations of regulations or practices that we believe generally to be followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our

business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.

      Risk-Based Capital. The NAIC has adopted a system to test the adequacy of statutory capital, known as “risk-based capital.” This system establishes the minimum amount of risk-based capital necessary for a company to support its overall business operations. It identifies property and casualty insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation or liquidation. Failure to maintain our risk-based capital at the required levels could cause our insurance subsidiary to lose its regulatory authority to conduct its business. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for a discussion of our risk-based capital as of December 31, 2004.

      IRIS Ratios. The NAIC Insurance Regulatory Information System (“IRIS”) is part of a collection of analytical tools designed to provide state insurance regulators with an integrated approach to screening and analyzing the financial condition of insurance companies. IRIS has two phases of screening: statistical and analytical. In the statistical phase, the NAIC database generates financial ratios based on financial information obtained from insurance companies’ annual statutory statements. The analytical phase is a review of the annual statements, financial ratios and other automated solvency tools. A ratio result falling outside the usual range of IRIS ratios is viewed as part of the regulatory early monitoring system. As of December 31, 2004, Century had four IRIS ratios outside the usual range, as described in “Business — Regulatory Environment — IRIS Ratios,” which could result in regulatory action.

      As of December 31, 2004, we underwrote 56.5% of our property and casualty premiums on a binding authority basis. Binding authority business represents risks that may be quoted and bound by our general agents prior to our underwriting review. If a general agent exceeds this authority by binding us on a risk that does not comply with our underwriting guidelines, we are at risk for claims under that policy that occur during the period from its issue date until we receive the policy and cancel it. Since current management assumed control in 2000, there have been two instances in which we have recovered paid loss amounts from a general agent due to a violation of underwriting authority. Such funds were covered by the required errors and omissions insurance carried by each of our agents.

      To cancel a policy for exceeding underwriting authority, we must receive and cancel the policy within statutorily prescribed time limits, typically 60 days. Our general agents are required by contract to have bound policies issued and a copy sent to our office within 30 days of the effective date of coverage. Our policy review generally takes two to four weeks, depending on the time of year. Upon review of a policy, we issue instructions to cure any material errors discovered. If cancellation of the policy is the only cure, we order the cancellation of the policy at that time pursuant to state law. As a result, we may be bound by a policy that does not comply with our underwriting guidelines, and until we can effect a cancellation, we may incur loss and loss expenses related to that policy.

      Our future success will depend, in large part, upon the efforts of our executive officers and other key personnel. We rely substantially upon the services of Edward F. Feighan, our Chairman of the Board, President and Chief Executive Officer, Charles D. Hamm, our Executive Vice President, Chief Financial Officer and Treasurer and Christopher J. Timm, our Executive Vice President and Director. Each of Messrs. Feighan, Hamm and Timm has an employment agreement with us. The loss of any of these officers or other key personnel could cause our ability to implement our business strategies to be delayed or hindered. We do not have key person insurance on the lives of any of our key management personnel, except one officer. As

we continue to grow, we will need to recruit and retain additional qualified personnel, but we may not be able to do so. As we have grown, we have generally been successful in filling key positions, but our ability to continue to recruit and retain such personnel will depend upon a number of factors, such as our results of operations, prospects and the level of competition then prevailing in the market for qualified personnel.

      Our results of operations depend, in part, on the performance of our investments. Fluctuations in interest rates affect our returns on and the fair value of fixed-maturity securities. Unrealized gains and losses on fixed-maturity securities are recognized in accumulated other comprehensive income, net of taxes and minority interest, and increase or decrease our shareholders’ equity. Interest rates in the United States are currently low relative to historical levels. An increase in interest rates could reduce the fair value of our investments in fixed-maturity securities. In addition, defaults by third parties who fail to pay or perform obligations could reduce our investment income and realized investment gains and could result in investment losses in our portfolio.

      We had fixed-maturity and equity investments with a fair value of $301.7 million as of December 31, 2004 that are subject to:

      Our fixed-maturity investment portfolio includes mortgage-backed and other asset-backed securities. As of December 31, 2004, mortgage-backed securities, asset-backed securities and collateralized mortgage obligations constituted 24.2% of our cash and investments. As with other fixed-maturity investments, the fair value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Changes in interest rates can expose us to prepayment risks on these investments. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities and other asset-backed securities are paid more quickly, requiring us to reinvest the proceeds at the then current market rates.

      Our equity portfolio totaled $37.1 million as of December 31, 2004. This total includes $18.2 million of investments in preferred and common securities of individual companies, which are subject to economic loss from the decline in preferred and common share prices. As a result, the value of these investments will be determined by the specific financial prospects of these individual companies, as well as the equity markets in general. In addition, we have $18.9 million invested in bond mutual funds. Each of the bond mutual funds in which we invest is highly diversified, rated AAA by Standard & Poor’s and has a duration of less than one year.

      Since the end of 2002, the U.S. financial markets have experienced a moderate rise in the value of the broader equity markets and a high degree of volatility in interest rates, which affect the value of our fixed-maturity securities. Our fixed-maturity securities, preferred shares and bond mutual funds, which represent $298.7 million, or 95.6% of our total cash and investments, are subject to changes in fair value based on fluctuations in interest rates. As of December 31, 2004, a 200 basis point decline in interest rates would result in a $26.3 million, or 8.8%, increase in fair value of our portfolio and a 200 basis point increase would result in a $27.5 million, or 9.2%, decrease in fair value of our portfolio. As of December 31, 2004, our investment portfolio had a net unrealized investment gain, before the effect of income taxes and minority interest of $1.2 million. However, these unrealized gains may not persist in the current economic environment or may not be realized.

      We distribute our products through a select group of general agents. Approximately 44.3% of our gross written premiums for the year ended December 31, 2004 were distributed through five general agents. Those relationships may be discontinued, or if they do continue, they may not remain profitable for us. In 2004, Bass Underwriters, Inc. accounted for $38.6 million (20.2%) of our total gross written premiums. A loss of all or substantially all the business produced by one or more of these general agents could have a negative impact on our revenues.

      We purchase reinsurance by transferring part of the risk we have assumed (known as ceding) to a reinsurance company in exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us (the reinsured) of our liability to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. That is, our reinsurers may not pay claims made by us on a timely basis, or they may not pay some or all of these claims. Either of these events would increase our costs and reduce our revenues. As of December 31, 2004, we had $33.4 million of amounts recoverable from our reinsurers that we would be obligated to pay if our reinsurers failed to pay. We have recorded a provision for uncollectible amounts of $1.3 million at December 31, 2004, which relates to balances due from a reinsurer that are in dispute.

      We currently purchase excess of loss reinsurance to stop our loss from a single occurrence on any one coverage part from any one policy at $500,000. For example, if we issue a policy that provides $600,000 of coverage for a risk, we purchase excess of loss reinsurance from a reinsurer for $100,000 to provide coverage for any claim under the policy that is greater than $500,000. Further, we purchase catastrophe reinsurance to stop losses arising from any single occurrence, regardless of how many policyholders are involved or the extent of their loss, at $1.5 million. However, we may choose in the future to re-evaluate the use of reinsurance to increase, decrease or eliminate the amount of liability we cede to reinsurers, depending upon the cost and availability of reinsurance.

      Market conditions beyond our control determine the availability and cost of the reinsurance protection that we purchase. The reinsurance market has changed dramatically over the past few years as a result of inadequate pricing, poor underwriting and the significant losses incurred in conjunction with the terrorist attacks on September 11, 2001. As a result, reinsurers have exited some lines of business, reduced available capacity and implemented provisions in their contracts designed to reduce their exposure to loss. In addition, the historical results of reinsurance programs and the availability of capital also affect the availability of reinsurance. Our reinsurance facilities generally are subject to annual renewal. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase, which could increase our costs, or, if we were unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments, especially catastrophe exposed risks, which would reduce our revenues. To the extent that we are forced to pay more for reinsurance or retain more liability than we do currently, we may need to reduce the volume of insurance we write. Due to the underwriting profile of our business, we have not been impacted significantly by the changes in the reinsurance market described above, including the events of September 11, 2001, either in claims or reinsurance terms and pricing.

      Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns. Although an individual insurance company’s financial performance is dependent

on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. This cyclicality is due in large part to the actions of industry participants, such as inadequate pricing and increasingly broad policy terms, and general economic factors, such as low interest rates and the impact of terrorist attacks, that are not within our control. These cyclical patterns cause our revenues and net income to fluctuate, which may cause the price of our common shares to be volatile.

      We compete with a large number of other companies in our selected lines of business. We face competition from specialty insurance companies, underwriting agencies and intermediaries, as well as from diversified financial services companies that are significantly larger than we are and that have significantly greater financial, marketing, management and other resources than we do. Some of these competitors also have significantly greater experience and market recognition than we do.

      In its Annual Review of the Excess & Surplus Lines Industry, published in September 2004, A.M. Best stated that large insurance carriers continue to dominate the excess and surplus lines market, with the top 25 insurance groups commanding an 85.3% share of the market, and while opportunities are available in this market, the leading insurance carriers have a firm stronghold. Based on the A.M. Best report, we would not be one of the 25 largest insurance carriers in the excess and surplus lines market. Competition in this market is generally based on many factors, including the perceived market strength of the insurer, pricing, service, speed of claims payment and the reputation and experience of the insurer. We compete primarily on the basis of service.

      We may incur increased costs in competing for underwriting revenues. If we are unable to compete effectively in the markets in which we operate or to expand our operations into new markets, our underwriting revenues and net income may decline.

      A number of new, proposed or potential legislative and industry developments could further increase competition in our industry. These developments include:

      New competition from these developments could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our products at attractive rates and thereby affect our underwriting results.

      We also may compete with new entrants in the future. Competition is based on many factors, including:

      Ultimately, this competition could affect our ability to attract business at premium rates that are likely to generate underwriting profits.

      All of our property business is exposed to the risk of severe weather conditions and other catastrophes. Catastrophes can be caused by various events, including natural events such as severe winter weather, tornadoes, windstorms, earthquakes, hailstorms, severe thunderstorms and fires, and other events such as explosions, terrorist attacks and riots. The incidence and severity of catastrophes and severe weather conditions are inherently unpredictable. Severe weather conditions and catastrophes can cause losses in all of our property lines and generally result in an increase in the number of claims incurred as well as the amount of compensation sought by claimants because every geographic location in which we provide insurance policies is subject to the risk of severe weather conditions. As of December 31, 2004, we have not been materially impacted by severe weather. It is possible that a catastrophic event or multiple catastrophic events could cause our loss and loss expense reserves to increase and our liquidity and financial condition to decline.

      We are an insurance holding company and our principal asset is the shares we hold in Century. Dividends and other payments from this company are our primary source of funds to pay expenses and dividends. The payment of dividends by Century to us is limited by statute. In general, these restrictions limit the aggregate amount of dividends or other distributions that Century may declare or pay within any twelve-month period without advance regulatory approval. Generally, this limitation is the greater of statutory net income for the preceding calendar year or 10% of the statutory surplus at the end of the preceding calendar year. In addition, insurance regulators have broad powers to prevent reduction of statutory surplus to inadequate levels and could refuse to permit the payment of dividends of the maximum amounts calculated under any applicable formula. As a result, we may not be able to receive dividends from our subsidiary at times and in amounts necessary to meet our debt service obligations or to pay dividends to our shareholders or corporate expenses. The amount of dividends that could have been paid to us from our subsidiary in 2004 and 2003 without regulatory approval was $5.9 million and $5.7 million, respectively.

      In November 2003, we moved our corporate headquarters to a newly-constructed approximately 44,000 square foot office building located in Westerville, Ohio. We lease this building pursuant to a lease agreement with an initial term of ten years and have an option to renew the lease agreement for two five-year terms.

      We also lease an aggregate of approximately 20,000 square feet of office space in Phoenix, Arizona, which we first occupied in September 2003. Our lease of this space has an initial term that expires in 2009.

      We are named from time to time as defendants in various legal actions that are incidental to our business and arise out of or are related to claims made in connection with our insurance policies, claims handling,

premium finance agreements and other contracts and employment related disputes. The plaintiffs in some of these lawsuits have alleged bad faith or extracontractual damages and some have claimed punitive damages. We believe that the resolution of these legal actions will not have a material adverse effect on our financial position or results of operations.

      In addition, state and federal regulators have commenced investigations or other proceedings relating to compensation and bidding arrangements and possible anti-competitive activities between insurance producers and brokers and issuers of insurance products, and unsuitable sales by producers on behalf of either the issuer or the purchaser. Related investigations and proceedings may be commenced in the future. The Company has not been formally contacted by regulatory agencies and state attorneys general for information relating to these investigations into compensation and bidding arrangements, anti-competitive activities and unsuitable sales practices. These proceedings are expected to continue in the future, and could result in legal precedents and new industry-wide legislation, rules and regulations that could significantly affect the financial services industry.

      There were no matters submitted to a vote of security holders in the fourth quarter of 2004.

      Information regarding our executive officers is contained in Item 10 of Part III of this report and incorporated by reference into Part I.

PART II

      ProCentury Corporation (symbol: PROS) common shares are listed on the NASDAQ National Market. As of February 28, 2005, there were 22 holders of record of the 13,155,995 outstanding common shares of the Company. The high, low and closing sale prices of our common shares for each quarter in 2004 are listed below:

      The Company declared a $0.02 per share cash dividend in the third and fourth quarters of 2004. As an insurance holding company, our principal asset is the shares we hold in Century. The dividends and other payments from Century are our primary source of funds, however, the payment of dividends by Century to us is limited by statute. As a result, we may not be able to receive funds at times and in amounts necessary to meet our debt service obligations or to pay dividends to our shareholders or corporate expenses.

SELECTED CONSOLIDATED FINANCIAL DATA

      The following table sets forth selected consolidated financial information for the periods ended and as of the dates indicated. The selected data presented below under the captions “Operating Data” and “Balance Sheet Data” for, and as of the end of, each of the periods in the five-year period ended December 31, 2004 are derived from our consolidated financial statements, which financial statements have been audited by KPMG LLP, an independent registered public accounting firm. The consolidated financial statements as of December 31, 2004 and 2003 and for each of the periods in the three-year period ended December 31, 2004, and the report thereon, are included elsewhere in this report. The KPMG report states that we adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangibles” in 2002. These historical results are not necessarily indicative of results to be expected from any future period. You should read this selected consolidated financial information together with our consolidated financial statements and related notes and the section of this report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

      The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes to those statements included in this report. The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors described in “Risks Related to Our Business and Industry” and elsewhere in this report that could cause our actual growth, results of operations, performance and business prospects and opportunities in 2005 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements. See “Forward-Looking Statements.”

Overview

      ProCentury is a holding company that underwrites selected property and casualty and surety insurance through its subsidiaries collectively known as the Century Insurance Group®. As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks and risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” specifically refuse to write. When we underwrite within the excess and surplus lines market, we are selective in the lines of business and types of risks we choose to write. Typically, the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients.

      We evaluate our insurance operations by monitoring key measures of growth and profitability. We measure our growth by examining our gross written premiums. We generally measure our operating results by examining our net income, return on equity and loss, expense and combined ratios. The following provides further explanation of the key measures that we use to evaluate our results:

      Gross Written Premiums. Gross written premiums is the sum of direct written premiums and assumed written premiums. We use gross written premiums, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.

      Net Written Premiums. Net written premiums is the sum of direct written premiums and assumed written premiums less ceded written premiums. We use net written premiums, primarily in relation to gross written premiums, to measure the amount of business retained after cessions to reinsurers.

      Loss Ratio. Loss ratio is the ratio (expressed as a percentage) of losses and loss expenses incurred to premiums earned. Loss ratio generally is measured on both a gross (direct and assumed) and net (gross less ceded) basis. We use the gross loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our consolidated financial statements.

      Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. We reduce our operating expenses by ancillary income (excluding net investment income and realized gains (losses) on securities) to calculate our net operating expenses. Due to our historically high levels of reinsurance, we calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in evaluating our financial results that are net of ceded reinsurance, as reflected in our consolidated financial statements, we believe that the gross expense ratio better reflects the operational efficiency of the underlying business and is a better measure of future trends. Interest expense is not included in the calculation of the expense ratio.

      Combined Ratio. Combined ratio is the sum of the loss ratio and the expense ratio and measures a company’s overall underwriting profit. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). We use the combined ratio in evaluating our overall underwriting profitability and as a measure for comparing our profitability relative to the profitability of our competitors.

Critical Accounting Policies

      It is important to understand our accounting policies in order to understand our consolidated financial statements. Management considers certain of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

      Our most critical accounting policies involve the reporting of loss and loss expense reserves (including losses that have occurred but were not reported to us by the financial reporting date), reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and federal income taxes.

      Loss and Loss Expense Reserves. Loss and loss expense reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate resolution, judicial theories of liability and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. Additional information regarding our loss and loss expense reserves can be found in “Results of Operations — Expenses — Losses and Loss Expenses Incurred,” “Business — Loss and Loss Expense Reserves,” and Note 4 to our audited consolidated financial statements, all of which are included in this report.

      Reinsurance Recoverables. Reinsurance recoverables on paid and unpaid losses, net, are established for the portion of our loss and loss expense reserves that are ceded to reinsurers. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See “Business — Reinsurance” and Note 5 to our audited consolidated financial statements, both included in this report.

      Impairment of Investments. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. Under the Company’s accounting policy for equity securities and fixed-maturity securities that can be contractually prepaid or otherwise settled in a way that may limit the Company’s ability to fully recover cost, an impairment is deemed to be other-than-temporary unless the Company has both the ability and intent to hold the investment for a reasonable period until the security’s forecasted recovery and evidence exists indicating that recovery will occur in a reasonable period of time.

      For other fixed-maturity and equity securities, an other-than-temporary impairment charge is taken when the Company does not have the ability and intent to hold the security until the forecasted recovery or if it is no longer probable that the Company will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; the Company’s intent to hold or dispose of the security; and current economic conditions. Other-than-

temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment. For additional detail regarding our investment portfolio at December 31, 2004 and 2003, including disclosures regarding other-than-temporary declines in investment value, see “Investment Portfolio” below and Note 2 to our audited consolidated financial statements, both included in this report.

      Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums. See Note 7 to our audited consolidated financial statements included in this report.

      Federal Income Taxes. We provide for federal income taxes based on amounts we believe the ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, we may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.

      We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 9 to our audited consolidated financial statements included in this report.

Results of Operations

      The table below summarizes certain operating results and key measures we use in monitoring and evaluating our operations. The information is intended to summarize and supplement information contained in our consolidated financial statements and to assist the reader in gaining a better understanding of our results of operations:

Overview of Operating Results

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Net income increased to $15.0 million for the year ended December 31, 2004, compared to net income of $314,000 for the same period in 2003. The increase in net income was primarily attributable to an increase in net earned premium of $40.4 million principally from an increase in the volume of business and slightly offset by rate declines in both the property and casualty lines of business. In addition, we experienced $3.5 million of growth in our investment income that was driven by higher investment balances as a result of the IPO and operational cash flow and an increase in investment yield.

      Our combined ratio also improved from 109.0% in 2003 to 91.8% in 2004. The primary reason for the combined ratio improvement was the decrease in amount of re-estimation of prior accident years’ loss and loss expense reserves that negatively impacted our pre-tax results by $27.0 million in 2003 compared to $11.1 million in 2004 offset by an increase in the current accident year loss and loss expenses. As of December 31, 2004, our current accident year loss and loss expense ratios for accident years 2004 and 2003 were 52.5% and 49.8%, respectively, and reflect the overall rate declines experienced in 2004. The overall expense ratio declined from 34.2% in 2003 to 31.9% in 2004. This decrease in expense ratio is directly attributable to the Company’s cost containment efforts that began in the fourth quarter of 2003.

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net income decreased to $314,000 for the year ended December 31, 2003, compared to net income of $6.1 million for the same period in 2002. The decrease in net income was primarily attributable to the re-estimation of prior accident years’ loss and loss expense reserves that negatively impacted our pre-tax results by $27.0 million in 2003 compared to $16.8 million in 2002. This decrease was largely offset by improved underwriting results from decreasing

current accident year loss and expense ratios, an increase in premium volume that provided additional underwriting margins, and an increase in net investment income. In addition, in the years ended December 31, 2003 and 2002, we realized a pre-tax loss on sale of minority interest in subsidiary, net, of $503,000 (net of transaction fees of $815,000) and a pre-tax gain of $9.7 million (net of transaction fees of $450,000), respectively, from the sale of shares of Evergreen to certain waste companies.

Revenues

      Premiums include insurance premiums underwritten by Century (which are referred to as direct premiums) and insurance premiums assumed from other insurers generally in states where Century is not licensed (which are referred to as assumed premiums). We refer to direct and assumed premiums together as gross premiums.

      Written premiums are the total amount of premiums billed to the policyholder less the amount of premiums returned, generally as a result of cancellations, during a given period. Written premiums become premiums earned as the policy ages. Barring premium changes, if an insurance company writes the same mix of business each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

      We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and also to limit our exposure to loss. Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order to maintain a net written premiums to statutory surplus ratio of less than 2-to-1.

      Our underwriting business is currently divided into two primary segments:

      Our property/casualty segment primarily includes general liability, commercial property and multi-peril insurance for small and mid-sized businesses. The other (including exited lines) segment primarily includes our surety business, including landfill and specialty surety that is written in order to maintain Century’s U.S. Treasury listing, workers’ compensation, which was exited in January 2002, and commercial auto, which was exited in May 2000.

      The following table presents our gross written premiums in our primary segments and provides a summary of gross, ceded and net written premiums and net premiums earned for the periods indicated.

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Gross written premiums increased $41.7 million or 27.9% for the year ended December 31, 2004 compared to the same period in 2003. This increase was due primarily to increased business in our property/casualty segment which increased $39.7 million or 26.3%. The growth in the property/casualty segment resulted principally from an increase in volume in our casualty lines of business of $39.3 million or 46.9%. Our property lines of business remained constant at $67.5 million in 2004 compared to $67.2 million in 2003 due to a rate plateau followed by a moderate decline that continued throughout much of the year. For casualty business, rates slightly increased throughout 2003 and stabilized in 2004.

      In addition, gross written premium for the other (including exited lines) segment was $814,000 for 2004, which represents surety premium amounts directly written and assumed by us and then ceded under a 100% quota share agreement with Evergreen. The 2002 and 2003 amounts for the surety were reclassified as discontinued operations as a result of the disposition of Evergreen in 2004.

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Gross written premiums increased $49.2 million or 48.9% for the year ended December 31, 2003 compared to the same period in 2002. This increase was due primarily to increased market penetration in our property/casualty segments, which was slightly offset by amounts representing returned premiums for our other (including exited lines) segment. During the year ended December 31, 2003, gross written premiums for our property/casualty segment increased $52.6 million or 53.5% due to continued favorable market conditions that have allowed us to increase our premium volume and prices for the third consecutive year. The decrease in written premiums for the other (including exited lines) segment represents returned premium primarily on the workers’ compensation line that we exited in January 2002.

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Net written premiums for the year ended December 31, 2004 were $166.0 million, representing an increase of 25.9% compared to the same period in 2003. Net written premiums were 86.7% of gross written premiums for the year ended December 31, 2004, compared to 88.1% for the same period in 2003, reflecting a slightly higher percentage of business ceded due to an overall increase in reinsurance rates offset by the change in our retention level from $300,000 in 2003 to $500,000 in 2004. In addition, we increased the amount of cession on our surety business with the quota share agreement with Evergreen that was effective January 1, 2004. Net premiums earned, a function of net written premiums, amounted to $148.7 million for the year ended December 31, 2004 and equaled 89.6% of net written premiums compared to 82.1% in 2003. This increase directly relates to a stabilization of the rate of growth in 2004 compared to that of 2003.

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net written premiums for the year ended December 31, 2003 were $131.8 million, representing an increase of 68.2% compared to the same period in 2002. Net written premiums were 88.1% of gross written premiums for the year ended December 31, 2003, compared to 77.9% for the same period in 2002, reflecting a change in reinsurance agreements that resulted in a slightly lower percentage of business ceded during the current period. Net premiums earned, a function of net written premiums, amounted to $108.3 million for the year ended December 31, 2003 and equaled 82.1% of net written premiums, which is comparable to the relationship of net premiums earned to net written premiums during the same period in 2002.

      In addition, during 2003, we made significant improvements in the collections of premiums in the course of collection. These improvements include hiring additional staff, weekly monitoring of account aging and improved communication with our agents. Due to these improvements we have significantly lowered our aged amounts, which has allowed us to maintain a lower provision for uncollectible accounts despite higher amounts of gross receivables. As of December 31, 2003, we had $11.5 million (before a $204,000 allowance for uncollectible amounts) of amounts recoverable compared to $2.0 million as of December 31, 2002 (before an $898,000 allowance for uncollectible amounts).

      We evaluate the collectibility of our agents’ balances both individually and on a general basis. In the event that we determine that an individual agent balance is in question, we will record a provision in part or in whole for that agent’s balance. On a aggregate basis, we evaluate historical write-offs and premium growth rates to determine a general allowance. As of December 31, 2003, we have recorded a provision for uncollectible amounts of $204,000 compared to a provision of $898,000 in 2002. The $694,000 decrease in the allowance in 2003 is primarily due to the write-off of two individual reserves for $461,000 where all collection efforts had been exhausted and our improved agency management that has decreased the amount of outstanding receivables.

      Our investment portfolio generally consists of liquid, readily marketable and investment-grade fixed-maturity securities. Net investment income is primarily comprised of interest earned on these securities, net of related investment expenses.

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Net investment income increased to $10.0 million for the year ended December 31, 2004, compared to $6.5 million for the same period in 2003. The increase was due primarily to an increase in investments and cash, which was supplemented by a slight increase in investment yields. Investments and cash, increased 82.5% to $312.4 million as of December 31, 2004 from $171.2 million as of December 31, 2003 as a direct result of the proceeds from the IPO and an increase in our operational cash float. Our average investment yield for 2004 was 4.1%, compared to 4.0% for the same period in 2003.

      In 2004, we increased our allocation to municipal bonds in an effort to increase our tax equivalent yield. On a tax equivalent yield basis, our yield increased to 4.8% in 2004 compared to 4.0% in 2003.

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net investment income increased to $6.5 million for the year ended December 31, 2003, compared to $5.1 million for the same period in 2002. The increase was due primarily to an increase in investments and cash, which was partially offset by a decrease in investment yields. Investments and cash increased 31.6% to $171.2 million as of December 31, 2003 from $130.1 million as of December 31, 2002. Our average investment yield for 2003 was 4.0%, compared to 4.4% for the same period in 2002. The decrease was a result of generally declining market interest rates during this period and our efforts to reduce the duration of our investment portfolio.

      Realized gains and losses on securities are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities we hold as investments.

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. We realized net gains of $50,000 on the sale of securities for the year ended December 31, 2004 and $1.9 million for the same period in 2003. These gains included a realized loss of $87,000 attributable to adjustments for other-than-temporary impairment of securities for the year ended December 31, 2003 and no impairment losses in 2004.

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. We realized net gains of $1.9 million on the sale of securities for the year ended December 31, 2003 and $2.4 million for the same period in 2002. These gains included a realized loss of $87,000 attributable to adjustments for other-than-temporary impairment of securities for the year ended December 31, 2003 and $38,000 for the same period in 2002.

Expenses

      Losses and loss expenses represent our largest expense item and include (1) payments made to settle claims, (2) estimates for future claim payments and changes in those estimates for current and prior periods, and (3) costs associated with settling claims. The items that influence the incurred losses and loss expenses for a given period include, but are not limited to, the following:

      We performed our first internal actuarial analysis as of September 30, 2003. Since then, we have performed this analysis quarterly. We establish or adjust (for prior accident quarters) our best estimate of the ultimate incurred losses and loss expenses to reflect loss development information and trends that have been updated for the most recent quarter’s activity. As of December 31 of each year, we have an independent actuarial analysis performed of the adequacy of our reserves. Our estimate of ultimate loss and loss expenses is evaluated and re-evaluated by accident year and by major coverage grouping and changes in estimates are reflected in the period the additional information becomes known.

      Our reinsurance program significantly influences our net retained losses. In exchange for premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our reinsurers assume a portion of the losses and loss expenses incurred. See “Business — Reinsurance.” We remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations under the agreements (due to, for example, disputes with the reinsurer or the reinsurer’s insolvency).

      The following table presents our incurred losses and loss expenses (net of the effects of reinsurance) from the most current accident year and from re-estimation of ultimate losses on prior accident years and provides a summary of losses incurred to premiums earned (loss and loss expense ratio) for the periods indicated.

      Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Net loss and loss expenses increased to $89.1 million for the year ended December 31, 2004 from $81.0 million for the same period in 2003, as a result of the factors discussed below. Net loss and loss expense ratios for the year ended December 31, 2004 and 2003 were 59.9% and 74.8%, respectively.

      Our reserve for losses and loss expenses as of December 31, 2004 was $153.2 million (before the effects of reinsurance) and $123.8 million (after the effects of reinsurance), as estimated through our internal actuarial analysis. During 2004, we concluded, through our actuarial analysis, that the December 31, 2003 reserve for losses and loss expenses of $92.5 million (after the effects of reinsurance) was deficient by $11.1 million.

      Our reserve for losses and loss expenses (net of the effects of reinsurance) at December 31, 2004 by line was as follows:

      Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net loss and loss expenses increased to $81.0 million for the year ended December 31, 2003 from $45.4 million for the same period in 2002, as a result of the factors as discussed below. Net loss and loss expense ratios for the year ended December 31, 2003 and 2002 were 74.8% and 71.7%, respectively.

      Our reserve for losses and loss expenses as of December 31, 2003 was $129.2 million (before the effects of reinsurance) and $92.5 million (after the effects of reinsurance), as estimated through our internal actuarial analysis. During 2003, we concluded, through our actuarial analysis, that the December 31, 2002 reserve for losses and loss expenses of $59.0 million (after the effects of reinsurance) was deficient by $27.0 million.

      Our reserve for losses and loss expenses (net of the effects of reinsurance) at December 31, 2003 by line was as follows:

      An explanation of significant components of reserve development by segment (net of reinsurance unless otherwise indicated) is as follows:

      Casualty. Our change in reserve estimate related to prior accident years for the year ended December 31, 2004 for the casualty lines was $12.8 million. A significant portion of our casualty reserves relates to construction defect claims in certain states. Starting with California in December 2000, we began to exit contractors’ liability business. By the end of the first quarter of 2001, we had significantly reduced our contractors’ liability underwriting in all states, and completely eliminated construction contractors’ liability underwriting in Arizona, California, Colorado, Hawaii, Louisiana, Nevada, New Jersey, North Carolina, Oregon, South Carolina and Washington. Reserves and claim frequency on this business may also be negatively impacted by legislation recently implemented in California, which generally provides consumers who experience construction defects a method other than litigation to obtain construction defect repairs. In addition, a 2001 California court decision expanded insurers’ duty to defend certain additional insureds under subcontractors’ policies, producing an industry-wide increase in the number of newly reported construction defect claims filed during 2002 and 2003. The recent legislation and court decisions referenced above are believed to have had an impact on the number of claims reported as well as the cost of settling claims; however, their impact cannot be measured directly. These changes in the legal environment are reflected in our reserves to the extent that the changes have impacted the number and cost of claims received to date. It is important to note that changes in the number and cost of claims due to these or other changes in the legal environment could cause our ultimate liability to exceed or be less than current estimates.

      During 2004, the Company’s newly reported construction defect claims were 36.9% greater than expected as of December 31, 2003. Based on the Company’s experience during 2004 and industry information, the Company substantially increased its projected ultimate construction defect claim count as of December 31,

2004. The increase in ultimate claim count projections and strengthening of claims pending as of December 31, 2003 accounted for $8.3 million of adverse development incurred during 2004.

      During 2003, the Company’s newly reported construction defect claims were 118.8% greater than expected as of December 31, 2002. Based on the Company’s experience during 2003 and industry information, the Company substantially increased its projected ultimate construction defect claim count as of December 31, 2003. The increase in ultimate claim count projections and strengthening of claims pending as of December 31, 2002 accounted for $13.4 million of adverse development incurred during 2003.

      During 2002, the Company’s newly reported construction defect claims and severities were greater than expected as of December 31, 2001. The increase in ultimate claim count projections and strengthening of claims pending as of December 31, 2001 accounted for $10.4 million of adverse development incurred during 2002.

      Of our construction defects net loss and loss expense reserves at December 31, 2004, 61.0% was for incurred but not reported losses (which are referred to as IBNR), and 52.5% of our construction defect net loss and loss expense reserves at December 31, 2003 was for IBNR. As of December 31, 2004, we had 566 open claims relating to construction defects, compared to 597 open claims as of December 31, 2003. During 2004, 986 new claims were reported and 1,017 existing claims were settled or dismissed. Our net loss and loss expense reserves for construction defects as of December 31, 2004 were $19.0 million. The re-estimation of construction defect reserves primarily affected the 1996 and 1997 accident years and the 1999 to 2001 accident years.

      Of our construction defects net loss and loss expense reserves at December 31, 2003, 52.5% was for incurred but not reported losses (which are referred to as IBNR), and 54.2% of our construction defect net loss and loss expense reserves at December 31, 2002 was for IBNR. As of December 31, 2003, we had 597 open claims relating to construction defects, compared to 596 open claims as of December 31, 2003. During 2003, 1,084 new claims were reported and 1,083 existing claims were settled or dismissed. Our net loss and loss expense reserves for construction defects as of December 31, 2003 were $18.6 million. The re-estimation of construction defect reserves primarily affected the 1996 and 1997 accident years and the 1999 to 2001 accident years.

      Our internal actuaries generally apply actuarial techniques in the analysis of loss and loss expense reserves using the following factors, among others:

      Although many factors influence the actual cost of claims and our corresponding reserve estimates, we do not measure and estimate values for all of these variables individually. This is due to the fact that many of the factors that are known to impact the cost of claims cannot be measured directly, such as the impact on claim costs due to economic inflation, coverage interpretations and jury determinations. In most instances, we rely on our historical experience or industry information to estimate values for the variables that are explicitly used in our reserve analyses. We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of future effects of these factors. Where we have reason to expect a change in the effect of one of these factors, we perform analysis to quantify the necessary adjustments.

      For claim liabilities other than construction defect, our internal actuaries apply multiple traditional actuarial techniques to compute loss and loss expense reserve estimates. Each technique produces a unique loss and loss expense reserve estimate for the line being analyzed. The set of techniques applied produces a range of loss and loss expense reserve estimates. From these estimates, the actuaries form a best estimate which considers the assumptions and factors that influence ultimate claim costs, including but not limited to those identified above. As of December 31, 2004, for casualty lines, excluding construction defect claims, the low end of the actuarial range was 12.7% below the actuarial best estimate, and the high end of the actuarial range was 6.2% above the actuarial best estimate. These low and high loss and loss expense reserve estimates reflect the fact that the methodologies applied do not produce identical estimates, and these estimates do not constitute the range of all possible outcomes. It is important to note that actual claim costs will vary from the selected estimate, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated at this time.

      For construction defect claim liabilities, our internal actuaries apply one actuarial technique, under various sets of assumptions, which considers the factors that influence ultimate claim costs. The actuarial technique for construction defect claim liabilities includes several variables relating to the number of IBNR claims and the average cost per IBNR claim. In addition to computing best estimate parameter values for the actuarial projection, the actuaries also consider the impact on resulting IBNR related to reasonably foreseeable fluctuations in these variables, which is used to quantify an actuarial range of loss and loss expense reserves for construction defect. As of December 31, 2004, for construction defect claims the low end of the actuarial range was 21.5% below the actuarial best estimate and the high end of the actuarial range was 29.1% above the actuarial best estimate. These low and high loss and loss expense reserve estimates reflect the uncertainty in estimating the parameter values, and these estimates do not constitute the range of all possible outcomes. It is important to note that actual claim costs will vary from the selected estimate, perhaps by substantial amounts, due to the inherent variability of these types of claims, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated at this time.

      Our change in reserve estimates for the years ended December 31, 2004 and 2003 for the casualty lines other than construction defect resulted in an increase in incurred losses and loss expenses of $4.6 million and $8.8 million, respectively. No reserve development was recognized in 2002 for the other than construction defect line of business. During 2004 and 2003, we incurred development above expectations on our non-construction defect casualty reserves for the 2000 through 2002 accident years. In 2004 and 2003, both closed claim severities and pending claims severities (as measured by average incurred amount per reported claim) increased. The increase in claim counts and average severities produced loss development during 2004, 2003 and 2002 exceeded our expectations, resulting in an increase in the loss development factors and initial expected loss ratios used in the December 31, 2004 and December 31, 2003 actuarial loss reserve analysis.

      As of December 31, 2004, the projected loss and loss expense ratios, after the effects of reinsurance, for the casualty lines were 48.9%, 44.0% and 57.8% for accident periods 2004, 2003 and 2002, respectively.

      Property. Our change in reserve estimates for the years ended December 31, 2004, 2003 and 2002 for the property lines resulted in a decrease in incurred losses and loss expenses of $3.2 million for 2004, an increase in incurred losses of $2.3 million for 2003, of which $1.9 million related to the 2002 accident year and $433,000 related to the 2001 accident year and a decrease in reserve estimates of $22,000 for 2002. During 2004, we experienced negative case incurred development on the 2003 accident year. As a result of the 2003 experience, we decreased the loss development factors and initial expected loss ratios used in the December 31, 2003 actuarial loss reserve analysis. During 2003, we experienced significant development on claims pending as of December 31, 2002, most of which was attributable to twelve large claims. This resulted in incurred loss development during 2003 in excess of the levels anticipated as of December 31, 2002. As a result of the 2003 experience, we increased the loss development factors and initial expected loss ratios used in the December 31, 2003 actuarial loss reserve analysis.

      As of December 31, 2003, the projected loss and loss expense ratios, after the effects of reinsurance, for the property lines were 58.8%, 50.3% and 57.2% for accident periods 2004, 2003 and 2002, respectively.

      Our internal actuaries apply multiple actuarial techniques utilizing the same factors discussed above under “Casualty” to compute loss and loss expense reserve estimates for property claim liabilities. Each technique produces a unique loss and loss expense reserve estimate for the line being analyzed. The set of techniques applied produces a range of loss and loss expense reserve estimates. From these estimates, the actuaries form a best estimate that considers assumptions and factors, as discussed above, that influence ultimate claim costs. As of December 31, 2004, for property lines the low end of the actuarial range was 10.6% below the actuarial best estimate and the high end of the actuarial range was 17.2% above the actuarial best estimate. These low and high loss and loss expense reserve estimates reflect the fact that the methodologies applied do not produce identical estimates, and these estimates do not constitute the range of all possible outcomes. It is important to note that actual claim costs will vary from the selected estimate, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated at this time.

      We began writing commercial automobile coverage for vehicles and light trucks in 1997. In 2000, we exited the commercial automobile line of business due to unsatisfactory underwriting results. Our change in reserve estimate for the years ended December 31, 2004, 2003 and 2002 for the commercial automobile line resulted in an increase in incurred losses and loss expenses of $789,000 in 2004 related to the 2000 accident year, $1.4 million in 2003, of which $839,000 related to the 2000 accident year, $439,000 related to the 1999 accident year and $263,000 in 2002 related to the 1999 and 2000 accident years. This re-estimation was due to changes in the selected development patterns on the 2000 and 1999 accident years, as the number of claims and claim severity exceeded our expectations.

      At December 31, 2004, all of our net loss and loss expense reserves related to commercial automobile was for case reserves. At December 31, 2003, 0.6% of our commercial automobile net loss and loss expense reserves was for IBNR and 99.4% was for case reserves. As of December 31, 2004, we had 38 open claims relating to commercial automobile, compared to 63 open claims as of December 31, 2003. During 2004, 8 new claims were reported and 33 existing claims were settled or dismissed. Our net loss and loss expense reserves for commercial automobile as of December 31, 2004 were $1.8 million.

      Of our net loss and loss expense reserves at December 31, 2003, 0.6% related to commercial automobile IBNR and 1.9% of our net loss and loss expense reserves at December 31, 2002 was for commercial automobile IBNR. As of December 31, 2003, we had 63 open claims relating to commercial automobile compared to 127 open claims as of December 31, 2002. During 2003, 15 new claims were reported and 79 existing claims were settled or dismissed. Our net loss and loss expense reserves for commercial automobile as of December 31, 2003 were $3.5 million.

      We offered workers’ compensation coverage from 1997 through January 2002. In December 2001, we announced that we were exiting this line of business due to unsatisfactory underwriting results and the lack of availability of acceptable reinsurance. Until July 2000, we purchased 100% quota share reinsurance on this book of business. Beginning in 2000, we started to retain some risk. No new policies have been written since the first quarter of 2002.

      Of our net loss and loss expense reserves at December 31, 2004, 49.8% related to workers’ compensation claims IBNR, and 2.3% of our net loss and loss expense reserves at December 31, 2003 was for workers’ compensation IBNR. As of December 31, 2004, we had 257 open claims relating to workers’ compensation compared to 414 open claims as of December 31, 2003. During 2004, 13 new claims were reported, and 170 existing claims were settled or dismissed. Our net loss and loss expense reserves for workers’ compensation as of December 31, 2004 were $3.4 million.

      Of our net loss and loss expense reserves at December 31, 2003, 2.3% related to workers’ compensation IBNR, and 3.4% of our net loss and loss expense reserves at December 31, 2002 were for workers’ compensation IBNR. As of December 31, 2003, we had 414 open claims relating to workers’ compensation compared to 764 open claims as of December 31, 2002. During the year ended 2003, 28 new claims were

reported, and 378 existing claims were settled or dismissed. Our net loss and loss expense reserves for workers’ compensation as of December 31, 2003 were $4.0 million.

      Our change in reserve estimates for the years ended December 31, 2004, 2003 and 2002 for the workers’ compensation line resulted in an increase in incurred losses and loss expenses of $664,000, $1.2 million and $3.0 million, respectively. These re-estimations were due to changes in the selected development patterns on the 2000 to 2002 accident years, as the number of claims and claim severity exceeded our expectations.

      Operating expenses include the costs to acquire a policy (included in amortization of deferred policy acquisition costs), other operating expenses (including corporate expenses) and interest expense. The following table presents our amortization of deferred policy acquisition costs, other operating expenses and related ratios and interest expense for the periods indicated: