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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

OR

FOR THE TRANSITION PERIOD FROM __________ TO __________

Commission File Number 000-22761

PMA Capital Corporation
(Exact name of registrant as specified in its charter)

(215) 665-5046
(Registrant’s telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

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

There were 31,328,922 shares outstanding of the registrant’s Class A Common Stock, $5 par value per share, as of the close of business on October 31, 2002.

INDEX

Part I. Financial Information
Item 1. Financial Statements

PMA Capital Corporation
Consolidated Balance Sheets

See accompanying notes to the consolidated financial statements.

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PMA Capital Corporation
Consolidated Statements of Operations
(Unaudited)

See accompanying notes to the consolidated financial statements.

2

PMA Capital Corporation
Consolidated Statements of Cash Flows
(Unaudited)

See accompanying notes to the consolidated financial statements.

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PMA Capital Corporation
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)

        See accompanying notes to the consolidated financial statements.

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PMA Capital Corporation

Notes to the Consolidated Financial Statements

1. BUSINESS DESCRIPTION

The accompanying consolidated financial statements include the accounts of PMA Capital Corporation and its subsidiaries (collectively referred to as “PMA Capital” or the “Company”). PMA Capital is an insurance holding company that operates specialty risk management businesses:

PMA Re — PMA Capital’s reinsurance operations offer excess of loss and pro rata property and casualty reinsurance protection mainly through reinsurance brokers. PMA Re focuses on risk-exposed business, which it believes allows it to best utilize its underwriting and actuarial expertise.

The PMA Insurance Group — The PMA Insurance Group writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance, primarily in the eastern part of the United States. Currently, approximately 90% of The PMA Insurance Group’s business is produced through independent agents and brokers.

Run-off Operations — Prior to May 1, 2002, the Company operated a third specialty risk management business, Caliber One, which wrote excess and surplus lines of business throughout the United States, generally through surplus lines brokers. Effective May 1, 2002, the Company announced its decision to withdraw from the excess and surplus lines marketplace. As a result of this decision, the results of this segment are reported as Run-off Operations commencing with the second quarter of 2002. See Notes 2B and 8 for additional information.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. Basis of Presentation – The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. It is management’s opinion that all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform to the 2002 presentation.

The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Due to this and certain other factors, such as the seasonal nature of portions of the insurance business as well as competitive and other market conditions, operating results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year.

The information included in this Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in its 2001 Annual Report to Shareholders and incorporated by reference in its Form 10-K for the year ended December 31, 2001.

B. Recent Accounting Pronouncements – In May 2002, the Company announced its decision to withdraw from the excess and surplus lines marketplace previously served by its Caliber One operating segment. The Company accounted for the discontinuation of this business under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which are effective January 1, 2002. SFAS No. 144 supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” and establishes a single accounting model for the disposal of long-lived assets and asset groups.

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The Company has entered into a definitive agreement to sell the capital stock of Caliber One Indemnity Company. Pursuant to the agreement, the Company will retain all assets and liabilities related to in-force policies and outstanding claim obligations and will run-off such in-force policies and claim obligations. Accordingly, under SFAS No. 144, the results of operations of this segment are reported in results from continuing operations, and will continue to be reported as such until all in-force policies and outstanding claim obligations are run-off, at which point the Company will report the results of the Run-off segment as discontinued operations. The long-lived assets of this segment were tested for impairment in the second quarter of 2002 in accordance with the provisions of SFAS No. 144. See Note 8 for additional information.

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Accordingly, this standard does not apply to the Company’s exit from the excess and surplus lines business, which was announced in May 2002.

Effective January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” In accordance with SFAS No. 142, the Company no longer amortizes goodwill, but instead tests it periodically for impairment. As of September 30, 2002, the Company had approximately $3.0 million of goodwill, which is included in other assets on the balance sheet. Amortization of goodwill was $240,000, or $0.01 per basic and diluted share, and $720,000, or $0.03 per basic and diluted share, for the three and nine months ended September 30, 2001, respectively. For the nine months ended September 30, 2002, the Company recognized an impairment charge of $1.3 million associated with the goodwill of the Run-off Operations, which is included in operating expenses.

Effective January 1, 2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as “derivatives”) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. The Company does not have any derivative instruments that are impacted by the accounting requirements of SFAS No. 133 and does not currently participate in any hedging activities. Accordingly, the adoption of SFAS No. 133 did not have a material impact on the Company’s financial condition, results of operations or liquidity.

3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

At September 30, 2002, the Company estimated that under all insurance policies and reinsurance contracts issued by its insurance businesses the ultimate amount that it would have to pay for all events that occurred as of September 30, 2002 is $2,304.3 million. This amount includes estimated losses from claims plus estimated expenses to settle claims. This estimate includes amounts for losses occurring prior to September 30, 2002 whether or not these claims have been reported to the Company.

Unpaid losses and loss adjustment expenses (“LAE”) reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process for determining the Company’s unpaid losses and LAE, actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

During the first quarter of 2002, company actuaries conducted a quarterly reserve review to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an

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updated range of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by Caliber One. Management’s selection of the ultimate losses resulting from this review indicated that net loss reserves needed to be increased by $40.0 million, net of $21.0 million of ceded losses. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in the first quarter of 2002 on casualty lines of business, primarily professional liability policies for the nursing homes class of business; general liability, including policies covering contractors’ liability for construction defects; and commercial automobile, mainly for accident years 2000 and prior.

For the three and nine months ended September 30, 2001, PMA Re’s pre-tax results were adversely impacted by approximately $30 million as a result of losses from the September 11^th terrorist attack on the World Trade Center. The pre-tax charge of approximately $30 million consists of total assumed losses of approximately $130 million, which is before (1) reinsurance recoveries, (2) additional premiums due to PMA Re’s retrocessionaires, and (3) additional premiums due to PMA Re on its assumed business. Of the gross losses, approximately 80% were property losses, primarily from property excess of loss and property catastrophe coverages. The remaining 20% were casualty losses, primarily from umbrella coverages and, to a lesser extent, workers’ compensation coverages. Caliber One’s net losses and LAE for the three and nine months ended September 30, 2001, include approximately $1 million of net property losses related to the September 11^th terrorist attack on the World Trade Center, net of $9 million of ceded losses. These estimates are based on our analysis to date of known exposures. However, it is difficult to fully estimate our losses from the attack given the uncertain nature of damage theories and loss amounts and the development of additional facts related to the attack. As more information becomes available, these estimates may need to be increased.

Management believes that its unpaid losses and LAE are fairly stated at September 30, 2002. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, judicial theories of liability, regulatory trends on benefit levels for both medical and indemnity payments, social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at September 30, 2002, the related adjustments could have a material adverse impact on the Company’s financial condition, results of operations and liquidity.

4. REINSURANCE

In the ordinary course of business, PMA Capital’s reinsurance and insurance subsidiaries assume premiums from and cede premiums to other insurance companies and are members of various insurance pools and associations. The reinsurance and insurance subsidiaries cede business in order to limit the maximum net loss from large risks and limit the accumulation of many smaller losses from a catastrophic event. The reinsurance and insurance subsidiaries remain primarily liable to their clients in the event their reinsurers are unable to meet their financial obligations. In January 2002, the Company supplemented its in-force reinsurance programs for PMA Re and The PMA Insurance Group with a reinsurance contract providing coverage for any loss development on its business for accident years prior to 2002. The program provides coverage of up to $125 million in losses in return for $55 million of funding from the Company. During the nine months ended September 30, 2002, the Company funded $50 million of the $55 million by selling short-term investments which is included in investing activities on the Company’s statement of cash flows for the nine months ended September 30, 2002. Cessions of losses under this contract may require the Company to cede additional premiums.

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The components of net premiums written, net premiums earned and losses and LAE incurred are as follows:

5. DEBT

At September 30, 2002, the Company had $55 million of outstanding debt representing borrowings under the Company’s new credit facility (“Credit Facility”), which was executed in September and replaced the Company’s existing bank facility that was scheduled to mature at December 31, 2002. On October 23, 2002, the Company increased its borrowing capacity under the Credit Facility to $65 million by adding a lender. The proceeds from the Credit Facility were used to repay the existing bank facility, which had $62.5 million outstanding. Under the terms of the Credit Facility, the aggregate commitments under the Credit Facility may be increased to $75 million upon securing commitments from additional lenders. The Credit Facility will mature in September 2003, or the Company may convert the outstanding principal amount into a one-year term loan next September, if the Company meets certain financial performance targets in 2003. At September 30, 2002, the interest rate on the utilized portion of the Credit Facility was 3.6%, which equals the London InterBank Offered Rate (“LIBOR”) plus 1.8%. The Credit Facility carries a facility fee on the unutilized portion of 0.375% per annum.

In October 2002, the Company issued $86.25 million aggregate principal amount of 4.25% convertible senior debentures (“Convertible Debt”) due September 30, 2022 from which the Company received net proceeds of approximately $83.7 million. The Convertible Debt bears interest at a rate of 4.25% per annum, payable semi-annually, beginning on March 30, 2003. In addition, contingent interest may be payable by the Company to the holders of the Convertible Debt commencing September 30, 2006, under certain circumstances. Each $1,000 principal amount of the Convertible Debt is convertible into 61.0948 shares of the Company’s Class A common stock from and after certain events specified in the indenture under which the Convertible Debt was issued. Further, holders of the Convertible Debt, at their option, may require the Company to repurchase all or a portion of their debentures on September 30, 2006, 2008, 2010, 2012 and 2017, or subject to specified exceptions, upon a change in control. The Company may choose to pay the repurchase price in cash or shares of Class A common stock. The Convertible Debt is redeemable in cash, in whole or in part, at the Company’s option at any time on or after September 30, 2006.

6. COMMITMENTS AND CONTINGENCIES

The Company’s businesses are subject to a changing social, economic, legal, legislative and regulatory environment that could affect them. Such changes could include various legislative and regulatory changes, which may affect the pricing or profitability of the insurance products sold by the Company. In addition, it is always possible that judicial reinterpretation of insurance contracts after the policies were written may result in coverage unanticipated by the Company at the time the

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policies were issued, such as coverage for asbestos and environmental, tobacco and mold claims. The eventual effect on the Company of the changing environment in which it operates remains uncertain.

In the event a licensed property and casualty insurer operating in a jurisdiction where the Company’s licensed insurance subsidiaries also operate becomes or is declared insolvent, state insurance regulations provide for the assessment of other licensed insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. The Company is not aware of any material potential assessments at September 30, 2002 that were not included in the financial statements.

The Company has provided guarantees of approximately $9.4 million, primarily related to loans on properties in which the Company has an interest.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded recoverables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

7. EARNINGS PER SHARE

A reconciliation of the shares used as the denominator of the basic and diluted earnings per share computations is presented below. For all periods presented, there were no differences in the numerator, net income (loss), for the basic and diluted earnings per share calculation.

The effects of 1.2 million and 3.4 million stock options were excluded from the computation of diluted earnings per share for the three months ended September 30, 2002 and 2001, respectively, because they would have been anti-dilutive. The effects of 3.2 million and 922,000 stock options were excluded from the computation of diluted earnings per share for the nine months ended September 30, 2002 and 2001, respectively, because they would have been anti-dilutive.

8. RUN-OFF OPERATIONS

In May 2002, the Company announced its decision to withdraw from the excess and surplus lines marketplace previously served by its Caliber One operating segment. The Company has ceased underwriting substantially all new business in this operation. The Company is taking required actions to not renew business, and has terminated its relationships with substantially all of its appointed brokers. The Company has entered into a definitive agreement to sell the capital stock of this business. Pursuant to the agreement, the Company will retain all assets and liabilities related to the in-force policies and outstanding claim obligations. As a result of the Company’s second quarter decision to exit the excess and surplus lines business, the results of this segment are reported as Run-off Operations.

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As a result of the decision to exit from and run off this business, the Company’s results for the nine months ended September 30, 2002 include a charge of $43 million pre-tax ($28 million after-tax). Components of the pre-tax charge include expenses associated with the recognition of liabilities of approximately $20 million, including reinsurance costs of approximately $9 million, long-term lease costs of approximately $7 million and involuntary employee termination benefits of approximately $3 million. In addition, the $43 million pre-tax charge includes approximately $23 million to write-down assets to their estimated net realizable value, including a non-cash charge of approximately $7 million for leasehold improvements and other fixed assets and $1.3 million for goodwill. The charge was included in operating expenses (approximately $34 million) and net premiums earned (approximately $9 million) in the statement of operations in the quarter ended June 30, 2002.

In mid-July 2002, approximately 60 employees were terminated in accordance with the Company’s exit plan. All of the terminated employees worked for Caliber One, primarily in the underwriting area. Approximately 35 positions, primarily claims and accounting staff, remain after the mid-July terminations. These remaining positions are expected to be eliminated over the next 18 months, in accordance with the Company’s exit plan. Involuntary employee termination benefits of $1.1 million were paid as of September 30, 2002.

9. BUSINESS SEGMENTS

The Company’s total revenues, substantially all of which are generated within the U.S., and pre-tax operating income (loss) by principal business segment were as follows:

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Net premiums earned by business segment and other components of operating revenues are as follows:

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our financial condition as of September 30, 2002, compared with December 31, 2001, and our results of operations for the three and nine months ended September 30, 2002, compared with the same periods last year. This discussion should be read in conjunction with Management’s Discussion and Analysis included in our 2001 Annual Report to Shareholders (pages 28 through 48), to which you are directed for additional information. The term “GAAP” refers to generally accepted accounting principles.

Consolidated Results of Operations

The major components of operating revenues, pre-tax operating income (loss) and net income (loss) are as follows:

(1)   Operating income (loss) differs from net income (loss) under GAAP because operating income (loss) excludes net realized investment gains and losses. Pre-tax operating income (loss) is defined as income (loss) before income taxes, excluding net realized investment gains and losses. We exclude net realized investment gains (losses) from the profit and loss measure we utilize to assess the performance of our operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of current operating fundamentals or future performance and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments.

(2)   In May 2002, we announced our decision to withdraw from the excess and surplus lines marketplace previously served by the Caliber One operating segment. As a result of our second quarter decision to exit the excess and surplus lines business, the results of this segment are now reported as Run-off Operations.

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Consolidated operating revenues for the three and nine months ended September 30, 2002, were $274.9 million and $802.5 million, respectively, compared to $208.8 million and $614.2 million for the same periods last year. The increases in operating revenues primarily reflect higher net premiums earned by PMA Re and The PMA Insurance Group. Included in operating revenues as a component of other revenues for the nine months ended September 30, 2001 is a $9.8 million gain on the sale of real estate properties recorded in Corporate and Other.

Operating income (loss) is one of the primary performance measures we use to monitor and assess the performance of our insurance operations. Operating income (loss) differs from net income (loss) under GAAP because operating income (loss) excludes net realized investment gains and losses. We recorded pre-tax operating income of $18.7 million and a pre-tax operating loss of $37.3 million for the three and nine months ended September 30, 2002, compared to pre-tax operating losses of $22.3 million and $20.4 million for the same periods last year. Pre-tax operating results for the nine months ended September 30, 2002 include operating losses from the Run-off Operations of $87.5 million, primarily reflecting unfavorable prior year loss development of $40 million in the first quarter and a charge of $43 million in the second quarter associated with our decision to exit from and run off our excess and surplus lines business. Pre-tax operating results for 2001 include operating income from the Run-off Operations of $50,000 for the third quarter and operating losses of $22.2 million for the first nine months.

Excluding the Run-off Operations, pre-tax operating income was $18.7 million and $50.2 million for the three and nine months ended September 30, 2002, respectively, compared to pre-tax operating losses of $22.3 million and operating income of $1.8 million for the same periods last year. The third quarter and nine months results for 2001 include a charge of approximately $30 million pre-tax ($20 million after-tax) relating to losses resulting from the attack on the World Trade Center. The improvement in pre-tax operating results in 2002 also reflects improved underwriting results at both PMA Re and The PMA Insurance Group. A pre-tax gain of $9.8 million on the sale of certain real estate properties recorded in Corporate and Other is included in pre-tax operating income for the nine months ended September 30, 2001.

We recorded after-tax operating income of $11.9 million and operating losses of $24.6 million for the three and nine months ended September 30, 2002, respectively, compared to after-tax operating losses of $14.5 million and $3.8 million for the same periods in 2001. After-tax operating results for the nine months ended September 30, 2002 include operating losses from the Run-off Operations of $56.9 million. After-tax operating results for 2001 include operating losses of $1.1 million and $15.6 million from the Run-off Operations for the third quarter and nine months ended September 30, 2001, respectively. Excluding the Run-off Operations, after-tax operating income was $11.9 million and $32.3 million for the three and nine months ended September 30, 2002, compared to operating losses of $13.4 million and operating income of $11.7 million for the same periods last year. After-tax operating income for the nine months ended September 30, 2001 includes a tax benefit of $10.1 million resulting from the completion of an IRS examination of our 1996 tax return.

We recorded net income of $9.4 million and a net loss of $37.6 million for the three and nine months ended September 30, 2002, respectively, compared to a net loss of $13.7 million and net income of $481,000 for the same periods last year. Net income (loss) includes after-tax gains and losses from investments. After-tax net realized investment losses were $2.5 million and $13.0 million for the three and nine months ended September 30, 2002, compared to after-tax net realized investment gains of $876,000 and $4.3 million for the same periods in 2001. After-tax net realized investment losses for the quarter and nine months ended September 30, 2002 include impairment losses of $4.1 million and $14.4 million after-tax, respectively, on fixed income securities. See “Investments” on page 24 for additional information.

Impact on 2001 Results from the September 11th Attack on the World Trade Center

For the three and nine months ended September 30, 2001, PMA Re’s pre-tax results were adversely impacted by approximately $30 million as a result of losses from the September 11^th terrorist attack on the World Trade Center. The pre-tax charge of approximately $30 million consists of total assumed losses of approximately $130 million, which is before (1) reinsurance recoveries, (2) additional premiums due to PMA Re’s retrocessionaires, and (3) additional premiums due to PMA Re on its assumed business. Of these losses, approximately 80% were property losses, primarily from property excess of loss and property catastrophe coverages. The remaining 20% were casualty losses, primarily from umbrella coverages and, to a lesser extent, workers’ compensation coverages. Caliber One’s net losses and LAE for the three and nine months ended September 30, 2001, include approximately $1 million of net property losses related to

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the September 11^th terrorist attack on the World Trade Center, net of $9 million of ceded losses. These estimates are based on our analysis to date of known exposures. However, it is difficult to fully estimate our losses from the attack given the uncertain nature of damage theories and loss amounts and the development of additional facts related to the attack. As more information becomes available, our estimate may need to be increased.

Business Outlook

Based on management’s current expectations, the estimated range of consolidated 2002 after-tax operating income from continuing operations is between $1.40 and $1.45 per diluted share, excluding losses from Run-off Operations, as well as the costs to exit from and run off this business. We expect price strengthening to remain at current levels for the remainder of 2002, providing for strong growth in premium levels of approximately 40-50%. We expect the price strengthening to continue to outpace loss cost and expense trends, and that embedded underwriting margins will remain strong. We expect these conditions to allow us to achieve our combined ratio goal of 100% or better for PMA Re and 104% or better for The PMA Insurance Group.

For 2003, management currently estimates that consolidated after-tax operating income will be between $1.65 and $1.80 per diluted share, which equates to a 9-10% return on beginning book value per share. This estimate is based on management’s current expectation that rate adequacy will continue to improve as prices continue to increase in 2003. As a result, we believe that PMA Re and The PMA Insurance Group should achieve an underwriting result in 2003 that is better than their 2002 combined ratio goals of 100% and 104%.

These estimated amounts of after-tax operating earnings per diluted share for 2002 and 2003 assume that loss trends run at a similar pace as year-to-date 2002 levels, excluding catastrophes, and that loss reserves continue to be adequate for prior accident years. In addition, our estimates of 2002 and 2003 after-tax operating earnings per diluted share do not reflect any potential dilution from our recently issued 4.25% convertible senior debentures.

This Business Outlook section represents our expectations as of the date of this Form 10-Q, and we disclaim any obligation to update the Business Outlook herein. The foregoing statements are forward-looking, and actual results may differ materially. In addition to the various factors discussed above, please see the Cautionary Statements on page 29 that follow for the factors that may cause actual results to differ materially from our current expectations, as well as the risk factors on pages 30 to 34 of our Form 10-K for the year ended December 31, 2001, as updated by the risk factors in Part II, Item 5 of this Form 10-Q.

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PMA Re

Summarized financial results of PMA Re are as follows:

PMA Re’s pre-tax operating income improved to $15.2 million and $41.9 million for the three and nine months ended September 30, 2002, respectively, compared to pre-tax operating losses of $24.7 million and $12.1 million for the same periods in 2001. PMA Re’s results for 2001 were impacted by a pre-tax charge of approximately $30 million relating to the September 11^th attack on the World Trade Center. Operating results for the third quarter of 2002 reflect improved underwriting results, partially offset by lower net investment income. Operating results for the first nine months of 2002 reflects improved underwriting results and higher net investment income.

Premiums

PMA Re’s gross premiums written by business unit and major lines of business are as follows:

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PMA Re’s net premiums written by business unit and major lines of business are as follows:

Gross premiums written were $186.5 million and $575.0 million for the three and nine months ended September 30, 2002, compared with $159.8 million and $352.1 million for the same periods last year. Net premiums written were $153.9 million and $453.2 million for the three and nine months ended September 30, 2002, compared with $104.9 million and $254.0 million for the same periods last year.

Gross premiums written for the nine months ended September 30, 2002 include an additional $58.1 million of gross premiums written recorded in the second quarter of 2002 as a result of a change in our estimate of ultimate premiums written. Because premiums from ceding companies are typically reported on a delayed basis, we monitor and update as appropriate the estimated ultimate premiums written. Our periodic review of estimated ultimate premiums written, which compares actual reported premiums and originally estimated premiums based on ceding company estimates, indicated that premiums written in recent years, primarily in the Traditional- and Specialty-Treaty units, were higher than originally estimated. The increase in net premiums earned of $35.5 million caused by this adjustment was offset by losses and LAE and acquisition expenses.

The attack on the World Trade Center had a negative effect on net premiums written for the three and nine months ended September 30, 2001. Contractual provisions under certain of PMA Re’s assumed business in the Finite Risk and Financial Products unit provided for approximately $30 million of additional premium due because losses were ceded to PMA Re under the terms of these contracts. Offsetting these additional premiums were approximately $40 million of ceded premiums payable by PMA Re to its retrocessionaires because PMA Re ceded a portion of its gross losses incurred to these retrocessionaires.

Excluding the effects in 2002 of the change in our estimate of ultimate premiums written and the attack on the World Trade Center in 2001:

o      Gross premiums written increased approximately $57 million, or 44%, for the third quarter and approximately $195 million, or 61%, for the first nine months of 2002, compared to the same periods last year, primarily reflecting higher premiums in the Traditional- and Specialty-Treaty units. We have been able to obtain significant price increases, and improved terms and conditions on business written in 2002. Rate increases in 2002, as measured by the level of premium increase on renewed in-force business, averaged approximately 35% on PMA Re’s Traditional- and Specialty-Treaty business. Partially offsetting the higher premiums written in the third quarter were lower premiums written in the Finite Risk and Financial Products unit.

o      Ceded premiums written increased by approximately $19 million and $51 million for the three and nine months ended September 30, 2002, compared to the same periods last year. The increase in ceded premiums primarily reflects the increase in gross premiums written and an increase in premiums charged by retrocessionaires.

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o      Net premiums written increased by approximately $38 million and $144 million, or 33% and 54%, while net premiums earned increased by approximately $45 million and $97 million, or 49% and 38%, for the three and nine months ended September 30, 2002, compared to the same periods in 2001. Traditionally, trends in net premiums earned follow patterns similar to net premiums written. Premiums are earned principally on a pro rata basis over the coverage periods of the underlying policies. However, with respect to policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustments may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premium in the period in which the adjustment is made.

Losses and Expenses

The components of the GAAP combined ratios are as follows:

PMA Re’s 2001 combined ratios and the individual components of the combined ratio were impacted by the unfavorable loss activity related to the attack on the World Trade Center. Excluding the impact of the attack, PMA Re’s loss and LAE ratio would have been approximately 81% and 81%, and the combined ratio would have been approximately 108% and 107% for the three and nine months ended September 30, 2001, respectively. For additional information, see “Impact on 2001 Results from the September 11^th Attack on the World Trade Center” beginning on page 13.

Excluding the effects of the attack on the World Trade Center from the 2001 ratios, the loss and LAE ratios for the three and nine months ended September 30, 2002 improved approximately 13 points and 11 points, compared to the loss and LAE ratios for the same periods in 2001. The improvements are primarily due to an improved current accident year loss and LAE ratio, reflecting price increases as well as improvements in terms and conditions.

We believe that our year-to-date calendar year loss and LAE ratio is approximately two to three points higher than the loss and LAE ratio for business that we have underwritten in 2002, reflecting prior year loss development which has been substantially offset by the aforementioned premium adjustment or by cessions under our existing retrocessional program.

Net premiums earned, which are used in calculating the components of the expense ratio, were positively impacted by the premium adjustment in 2002 and adversely impacted by the attack on the World Trade Center in 2001. Excluding the effect of these items, the acquisition expense ratio increased 5.2 points and 5.1 points, and the operating expense ratio decreased 4.8 points and 2.6 points for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. The increase in the acquisition expense ratio is primarily due to lower ceding commissions received on our retrocessional programs. The improvement in the operating expense ratio occurs primarily because of the growth in net premiums earned, combined with a lower level of operating expenses in 2002 than in 2001.

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Net Investment Income

Net investment income was $9.2 million for the third quarter of 2002, compared to $10.9 million for the same period in 2001, primarily reflecting lower yields on the investment portfolio that more than offset the growth in invested assets. Net investment income was $37.1 million for the nine months ended September 30, 2002, compared to $34.7 million for the same period last year, reflecting higher interest earned on invested assets and funds held assets, partially offset by lower yields on the portfolio.

The PMA Insurance Group

Summarized financial results of The PMA Insurance Group are as follows:

Pre-tax operating income for The PMA Insurance Group improved to $6.7 million and $19.5 million for the three and nine months ended September 30, 2002, compared to $6.0 million and $17.5 million for the same periods in 2001. The increases in operating income were primarily due to improved underwriting results, partially offset by lower net investment income.

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Premiums

Direct workers’ compensation and integrated disability premiums written increased by $22.7 million and $86.8 million for the three and nine months ended September 30, 2002 primarily due to weighted average price increases of 17% on workers’ compensation business and, to a lesser extent, an increase in the volume of risks underwritten for the workers’ compensation and integrated disability lines of business. Direct writings of commercial lines of business other than workers’ compensation, such as commercial auto, general liability, umbrella, multi-peril and commercial property lines (collectively, “Commercial Lines”), increased by $1.5 million and $9.7 million for the three and nine months ended September 30, 2002, compared to the same periods in 2001, primarily due to rate increases for commercial auto and commercial multi-peril lines.

Total ceded premiums decreased $2.3 million and increased $1.4 million for the three and nine months ended September 30, 2002, compared to the same periods in 2001. Premiums ceded for workers’ compensation and integrated disability increased by $665,000 and $8.5 million as a result of the increase in direct premiums written as well as higher rates being charged by reinsurers. Premiums ceded for Commercial Lines were lower by $3.0 million and $7.1 million, primarily as a result of higher retentions in the Commercial Lines’ reinsurance programs. Effective January 1, 2002, we increased our net retention for these lines to $500,000 per risk from $250,000 per risk.

Net premiums earned increased 13% and 22% for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. Generally, trends in net premiums earned follow patterns similar to net premiums written adjusted for the customary lag related to the timing of premium writings within the year. Direct premiums are earned principally on a pro rata basis over the terms of the policies. However, with respect to policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustment may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premium in the period in which the adjustment is made. Generally, in periods of premium growth, the increase in net premiums written will be greater than the increase in net premiums earned, as was the case in 2002.

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Losses and Expenses

The components of the GAAP combined ratios are as follows:

(1)The expense ratio and the combined ratio exclude $3.1 million and $8.3 million for the three and nine months ended September 30, 2002, respectively, and $2.5 million and $6.6 million for the three and nine months ended September30, 2001, respectively, for direct expenses related to service revenues, which are not included in premiums earned.
(2)The combined ratio computed on a GAAP basis is equal to losses and LAE, plus acquisition expenses, operating expenses and policyholders’dividends, all divided by net premiums earned.

The loss and LAE ratios for the three and nine months ended September 30, 2002 increased slightly, compared to the same periods last year. For the third quarter of 2002, the unfavorable effects of prior year loss development and net discount accretion were partially offset by an improved current accident year loss and LAE ratio. For the nine months ended September 30, 2002, the unfavorable effects of prior year loss development were partially offset by the favorable impact of net discount accretion.

The PMA Insurance Group recorded $1.2 million and $1.1 million of unfavorable prior year reserve development for the three and nine months ended September 30, 2002, respectively, compared to $103,000 of unfavorable prior year development and $111,000 of favorable prior year development for the same periods last year. The unfavorable development in the first nine months of 2002 is due to higher than expected claims handling costs. The third quarter unfavorable development is due to unfavorable loss experience on rent-a-captive business.

The current accident year loss and LAE ratio improved by 1.1 points to 74.2% for the third quarter, and was essentially flat for the nine months ended September 30, 2002 at 74.3%, compared to the same periods in 2001. The current accident year loss and LAE ratios for all lines of business reflect price increases and a slight decline in claims frequency. However, a slowdown in the United States economy may change the trend of declining claims frequency. In most economic slowdowns, we have generally experienced increasing claims severity. Further, medical cost inflation continues, which may contribute to increased severity of losses, despite our attempt to mitigate medical cost inflation through our affiliation with a national preferred provider organization. Along with the increased loss severity, we have also seen an increase in reinsurance costs.

The loss and LAE ratio is negatively impacted by accretion of discount on prior year reserves and favorably impacted by the recording of discount for current year reserves. The net of these is referred to as net discount accretion. The accretion of discount on prior year reserves exceeded the recording of discount by $308,000 for the third quarter of 2002, while the recording of discount exceeded the accretion of discount on prior years’ reserves by $23,000 for the same period last year. The recording of discount exceeded the accretion of discount on prior years’ reserves by $596,000 and $36,000 for the nine months ended September 30, 2002 and 2001, respectively.

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Overall, the total expense ratio for the three months ended September 30, 2002 increased slightly, compared to the same period last year. The total expense ratio for the nine months ended September 30, 2002 improved by 0.8 points, compared to the same period in 2001, as premium growth outpaced the increase in expenses.

The policyholders’ dividend ratio was 1.4% and 2.4% for the three and nine months ended September 30, 2002, respectively, compared to 4.0% and 4.1% for the same periods last year. Under policies that are subject to dividend plans, the customer may earn a dividend based upon favorable loss experience during the policy period. The decreases in the policyholders’ dividend ratio occurred primarily because The PMA Insurance Group has sold less business under dividend plans in the three and nine months ended September 30, 2002, compared to the same periods in 2001, and has written business under lower paying dividend plans in 2002, compared to 2001. In addition, the dividend ratio related to the rent-a-captive business was lower during the third quarter of 2002, as a result of the aforementioned unfavorable loss experience.

Net Investment Income

Net investment income was $9.0 million and $27.0 million for the three and nine months ended September 30, 2002, compared to $10.0 million and $29.7 million for the same periods in 2001. The decrease in net investment income primarily reflects lower invested asset yields and a lower invested asset base resulting from the paydown of loss reserves from prior accident years.

Run-off Operations

Summarized financial results of the Run-off Operations are as follows:

In May 2002, we announced our decision to withdraw from the excess and surplus lines marketplace previously served by the Caliber One operating segment. We have ceased underwriting substantially all new business in this operation. We are taking required actions to not renew business, and have terminated our relationships with substantially all of our appointed brokers. We have entered into a definitive agreement to sell the capital stock of this business. Pursuant to the agreement, we will retain all assets and liabilities related to the in-force policies and outstanding claim obligations. As a result of our decision to exit this business, the results of this segment are reported as Run-off Operations.

Pre-tax operating results for the Run-off Operations were essentially breakeven for the third quarters of 2002 and 2001. The Run-off Operations recorded pre-tax operating losses of $87.5 million for the nine months ended September 30, 2002. As a result of our decision to exit from and run off this business, results for the nine months ended September 30, 2002 include a charge of $43 million pre-tax. Components of the charge include expenses associated with the recognition of liabilities of approximately $20 million, including reinsurance costs of approximately $9 million, long-term lease costs of approximately $7 million and involuntary employee termination benefits of approximately $3 million. In addition, the $43 million charge includes approximately $23 million to write-down assets to their estimated net realizable value, including a non-cash charge of approximately $7 million for leasehold improvements and other fixed assets and $1.3

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million for goodwill. The charge was included in operating expenses (approximately $34 million) and net premiums earned (approximately $9 million) for the nine months ended September 30, 2002.

In mid-July 2002, approximately 60 employees were terminated in accordance with our exit plan. All of the terminated employees worked for Caliber One, primarily in the underwriting area. Approximately 35 positions, primarily claims and accounting staff, remain after the mid-July terminations. These remaining positions are expected to be eliminated over the next 18 months, in accordance with our exit plan. Involuntary employee termination benefits of $1.1 million were paid as of September 30, 2002.

Pre-tax operating results for the nine months ended September 30, 2002 also include net unfavorable prior year development of $40.0 million. During the first quarter of 2002, company actuaries conducted a quarterly reserve review to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated range of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by this segment. Management’s selection of the ultimate losses resulting from this review indicated that net loss reserves needed to be increased by $40.0 million, net of $21.0 million of ceded losses. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in the first quarter of 2002 on casualty lines of business, primarily professional liability policies for the nursing homes class of business; general liability, including policies covering contractors’ liability for construction defects; and commercial automobile, mainly for accident years 2000 and prior.

The Run-off Operations recorded a pre-tax operating loss of $22.2 million for the nine months ended September 30, 2001. Losses and LAE for 2001 include net unfavorable prior year development of $18.0 million, which is net of losses of $12.0 million ceded to a third party reinsurer under an existing reinsurance contract. These losses reflect higher than expected claim frequency and severity that emerged in the first quarter of 2001 on certain casualty lines of business, primarily professional liability policies for the nursing homes class of business and, to a lesser extent, property lines of business. As a result of its first quarter 2001 reserve review, Caliber One revised its estimate of ultimate expected claim activity and, accordingly, increased its estimate of ultimate losses, substantially all for accident years 1999 and 2000.

Loss Reserves

At September 30, 2002, we estimated that under all insurance policies and reinsurance contracts issued by our insurance businesses the ultimate amount that we would have to pay for all events that occurred as of September 30, 2002 is $2,304.3 million. This amount includes estimated losses from claims plus estimated expenses to settle claims. Our estimate includes amounts for losses occurring prior to September 30, 2002 whether or not these claims have been reported to us.

Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to us. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process for determining our unpaid losses and LAE, actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

Management believes that its unpaid losses and LAE are fairly stated at September 30, 2002. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, judicial theories of liability, regulatory trends on benefit levels for both medical and indemnity payments, social attitudes and economic conditions, the estimates are revised accordingly. If our ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at September 30, 2002, the related adjustments could have a material adverse effect on our financial condition, results of operations and liquidity.

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See the discussion under Run-off Operations beginning on page 21 for additional information regarding its 2002 and 2001 loss reserve increases. See the discussion under “Impact on 2001 Results from the September 11^thAttack on the World Trade Center”beginning on page 13 for additional information regarding PMA Re’s higher than expected losses in 2001. For additional discussion of loss reserves and reinsurance, see pages 38 to 41 of the Management’s Discussion and Analysis included in our 2001 Annual Report to Shareholders, as well as pages 14 to 20 of our Form 10-K for the year ended December 31, 2001.

Corporate and Other

The Corporate and Other segment includes unallocated investment income, expenses, including debt service, as well as the results of certain of our real estate properties. Corporate and Other recorded pre-tax operating losses of $3.2 million and $11.2 million for the three and nine months ended September 30, 2002, compared to $3.7 million and $3.6 million for the same periods in 2001. During the first quarter of 2001, we sold certain real estate properties for net proceeds totaling $14.4 million, resulting in a pre-tax gain of $9.8 million, which was recorded in other revenues.

Absent the gain on sale of real estate in 2001, pre-tax operating results for Corporate and Other improved in the three and nine months ended September 30, 2002, compared to the same periods last year, primarily due to declines in interest expense of $876,000 and $3.7 million for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. The declines in interest expense reflect a lower amount of debt outstanding and lower interest rates.

Liquidity and Capital Resources

Liquidity is a measure of an entity’s ability to secure sufficient cash to meet its contractual obligations and operating needs. At the holding company level, our primary sources of liquidity are dividends from subsidiaries, net tax payments received from subsidiaries and capital raising activities (both debt and equity). We utilize cash to pay debt obligations, including interest costs; dividends to shareholders; taxes to the Federal government; and corporate expenses. In addition, we utilize cash resources to repurchase shares of our common stock and to capitalize subsidiaries from time to time.

Our domestic insurance subsidiaries’ ability to pay dividends to us is limited by the insurance laws and regulations of Pennsylvania. All of our domestic insurance entities are owned by PMA Capital Insurance Company (“PMACIC”). As a result, dividends from the Pooled Companies and Caliber One Indemnity Company may not be paid directly to PMA Capital. Instead, only PMACIC, a Pennsylvania domiciled company, may pay dividends directly to PMA Capital. Approximately $56 million of dividends are available to be paid by PMACIC to PMA Capital in 2002 without the prior approval of the Pennsylvania Insurance Commissioner during 2002. The PMA Insurance Group’s Pooled Companies can pay up to $27.4 million in dividends to PMACIC during 2002. Under Delaware law, Caliber One Indemnity Company can not pay dividends to PMACIC in 2002. Dividends received from subsidiaries were $7.0 million and $21.0 million for the three and nine months ended September 30, 2002 and 2001.

Net tax payments received from subsidiaries were $11.6 million and $18.4 million for the three and nine months ended September 30, 2002, compared to $787,000 and $7.0 million for the same periods in 2001.

At September 30, 2002, we had $55 million of outstanding debt representing borrowings under our new credit facility (“Credit Facility”), which was executed in September and replaced our existing bank facility that was scheduled to mature at December 31, 2002. On October 23, 2002, we increased our borrowing capacity under the Credit Facility to $65 million by adding a lender. The proceeds from the Credit Facility were used to repay the existing bank facility, which had $62.5 million outstanding. Under the terms of the Credit Facility, the aggregate commitments under the Credit Facility may be increased to $75 million upon securing commitments from additional lenders. The Credit Facility will mature in September 2003, or we may convert the outstanding principal amount into a one-year term loan next September, if we meet certain financial performance targets in 2003. At September 30, 2002, the interest rate on the utilized portion of the Credit Facility was 3.6%, which equals the London InterBank Offered Rate (“LIBOR”) plus 1.8%. The Credit Facility carries a facility fee on the unutilized portion of 0.375% per annum.

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In addition to the Credit Facility, we maintain a committed facility of $50.0 million for letters of credit (the “Letter of Credit Facility”). The Letter of Credit Facility is utilized primarily for securing reinsurance obligations of our insurance subsidiaries. As of September 30, 2002, we had $23.8 million outstanding under the Letter of Credit Facility, compared to $27.9 million at December 31, 2001.

In October 2002, we issued $86.25 million aggregate principal amount of 4.25% convertible senior debentures (“Convertible Debt”) due September 30, 2022 from which we received net proceeds of approximately $83.7 million. The Convertible Debt bears interest at a rate of 4.25% per annum, payable semi-annually, beginning on March 30, 2003. In addition, contingent interest may be payable by us to the holders of the Convertible Debt commencing September 30, 2006, under certain circumstances. Each $1,000 principal amount of the Convertible Debt is convertible into 61.0948 shares of the Company’s Class A common stock from and after certain events specified in the indenture under which the Convertible Debt was issued. Further, holders of the Convertible Debt, at their option, may require us to repurchase all or a portion of their debentures on September 30, 2006, 2008, 2010, 2012 and 2017, or subject to specified exceptions, upon a change in control. We may choose to pay the repurchase price in cash or shares of Class A common stock. The Convertible Debt is redeemable in cash, in whole or in part, at our option at any time on or after September 30, 2006.

We paid dividends to shareholders of $3.3 million and $8.8 million, respectively, during the three and nine months ended September 30, 2002, compared to $2.3 million and $6.8 million for the same periods last year. The increase in dividends paid is due to the additional shares outstanding resulting from our December 2001 issuance of 9,775,000 shares of Class A Common stock. Our dividends to shareholders are restricted by our Credit and Letters of Credit facilities. Based upon the terms of our debt agreements, under the most restrictive debt covenant, we would be able to pay dividends of approximately $15.0 million in 2002.

During the first nine months of 2002, we repurchased 90,000 shares at a total cost of $1.7 million. Since the inception of our share repurchase program in 1998, we have repurchased a total of approximately 3.9 million shares at a cost of $74.6 million. Our remaining share repurchase authorization at September 30, 2002 is $15.4 million. Decisions regarding share repurchases are subject to prevailing market conditions and an evaluation of the costs and benefits associated with alternative uses of capital.

Management believes that our available sources of funds will provide sufficient liquidity to meet our short-term and long-term obligations. However, because we depend primarily upon dividends from our operating subsidiaries to meet our short-term and long-term obligations, any event that has a material adverse effect on the results of operations of our insurance subsidiaries could affect our liquidity and ability to meet our contractual obligations and operating needs.

Additionally, our ability to refinance our existing debt obligations or raise additional capital is dependent upon several factors, including conditions with respect to both the equity and debt markets and the ratings of any securities that we may issue as established by the rating agencies. Our ability to refinance our outstanding debt obligations, as well as the cost of such borrowings, could be adversely affected by any future ratings downgrade.

Management currently believes that the existing capital structure is adequate, but believes additional capital and longer-term capital would provide better support for our growth objectives. Management continually monitors the capital structure in light of developments in our businesses, and the present assessment could change as management becomes aware of new opportunities and challenges in our business.

Investments

At September 30, 2002, our investment assets, including short-term investments, were carried at a fair value of $1,924.4 million and had an amortized cost of $1,873.9 million. The average credit quality on the portfolio is AA. The net unrealized gain on our investment assets at September 30, 2002 was $50.4 million, or 2.7% of the amortized cost basis. The net unrealized gain included gross unrealized gains of $70.2 million and gross unrealized losses of $19.8 million.

We review the securities in our fixed income portfolio on a periodic basis to specifically review individual securities for any meaningful decline in market value below amortized cost. Our analysis addresses all securities whose fair value is significantly below amortized cost at the time of the analysis, with additional emphasis placed on securities whose fair

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value has been below amortized cost for an extended period of time. As part of our periodic review process, we utilize the expertise of our outside professional asset managers who provide us with an updated assessment of each issuer’s current credit situation based on recent issuer activities, such as quarterly earnings announcements or other pertinent financial news for the company, recent developments in a particular industry, economic outlook for a particular industry and rating agency actions.

In addition to company-specific financial information and general economic data, we also consider the ability and intent of our insurance operations to hold a particular security to maturity or until the market value of the bond recovers to a level in excess of the carrying value. Our ability and intent to hold securities to such time is evidenced by our strategy and process to match the cash flow characteristics of the invested asset portfolio, both interest income and principal repayment, to the actuarially determined estimated liability pay-out patterns of each insurance company’s claims liabilities. As a result of this periodic review process, we have determined that there currently is no need to sell any of the fixed maturity investments prior to their scheduled/expected maturity to fund anticipated claim payments.

As of September 30, 2002, our investment asset portfolio had gross unrealized losses of $19.8 million. For securities that were in an unrealized loss position at September 30, 2002, the length of time that such securities have been in an unrealized loss position, as measured by their month-end market values, is as follows:

Of the 20 securities that have been in an unrealized loss position for more than 12 months, 19 securities have an unrealized loss of less than $1 million and/or less than 20% of their amortized cost. These 19 securities have an average unrealized loss per security of approximately $238,000. In addition, 7 of these securities have fair values at September 30, 2002 that are 90% or more of the amortized cost basis. There is only one security with an unrealized loss in excess of $1 million at September 30, 2002, with a market value of $14.4 million and a cost of $20 million. The security is a structured security backed by a U.S. Treasury Strip and is rated AAA. This security matures in 2011 at a value of $20 million, and we have both the ability and intent to hold this security until it matures.

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The contractual maturity of securities in an unrealized loss position at September 30, 2002 was as follows:

For all securities that are in an unrealized loss position for an extended period of time, we perform an evaluation of the specific events attributable to the market decline of the security. We consider the length of time and extent to which the security’s market value has been below cost as well as the general market conditions, industry characteristics and the fundamental operating results of the issuer to determine if the decline is due to changes in interest rates, changes relating to a decline in credit quality of the issuer, or general market conditions. We also consider as part of the evaluation our intent and ability to hold the security until its market value has recovered to a level at least equal to the amortized cost. Where we determine that a security’s unrealized loss is other than temporary, a realized loss is recognized in the period in which the decline in value is determined to be other than temporary.

At September 30, 2002, all of our fixed income investments were publicly traded and all were rated by at least one nationally recognized credit rating agency, typically Standard and Poor’s Rating Services and/or Moody’s Investor Services. In addition, at September 30, 2002, $18.1 million, or 0.9%, of our total investments were below investment grade, of which $8.6 million of these below investment grade investments were in an unrealized loss position, which totaled $1.3 million.

Based on our evaluation as of September 30, 2002, we determined there were other than temporary declines in market value of securities issued by 8 companies, resulting in an impairment charge of $22.2 million pre-tax during the nine months ended September 30, 2002 including $14.2 million for WorldCom. Included in the year to date impairment charge of $22.2 million were $6.4 million of charges related to other than temporary impairments recognized in the third quarter, primarily on securities issued by energy companies. The write-downs were measured based on public market prices and our expectation of the future realizable value for the security at the time we determined the decline in value was other than temporary.

In the first nine months of 2001, we recognized an impairment loss of $1.6 million pre-tax resulting from the issuer filing for bankruptcy. There were no impairment losses in the third quarter of 2001.

For all but one security, which was carried at its fair value of $14.4 million at September 30, 2002, we determine the market value of each fixed income security using prices obtained in the public markets. For this security, whose fair value is not reliably determined from these public market sources, we utilized the services of our outside professional investment asset manager to determine the fair value. The asset manager determines the fair value of the security by using a discounted present value of the estimated future cash flows (interest and principal repayment).

During the three months ended September 30, 2002, there were gross realized gains and losses of $7.3 million and $11.2 million, respectively. Included in the gross losses of $11.2 million were $6.4 million of impairment losses and $4.8 million of realized losses on sales of securities where we reduced and/or eliminated our positions in certain issuers due to credit concerns and to a lesser extent, sales reducing our per issuer exposure and general duration management trades.

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Other Matters

Environmental Factors

Our businesses are subject to a changing social, economic, legal, legislative and regulatory environment that could affect them. Some of the changes include initiatives to restrict insurance pricing and the application of underwriting standards and reinterpretations of insurance contracts long after the policies were written in an effort to provide coverage unanticipated by us. The eventual effect on us of the changing environment in which we operate remains uncertain.

Comparison of SAP and GAAP Results

Results presented in accordance with GAAP vary in certain respects from results presented in accordance with statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department, (collectively “SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners publications. Permitted SAP encompasses all accounting practices that are not prescribed. Our domestic insurance subsidiaries use SAP to prepare various financial reports for use by insurance regulators.

Recent Accounting Pronouncements

In May 2002, we announced our decision to withdraw from the excess and surplus lines marketplace previously served by our Caliber One operating segment. We accounted for the discontinuation of this business under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which are effective January 1, 2002. SFAS No. 144 supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” and establishes a single accounting model for the disposal of long-lived assets and asset groups.

We have entered into a definitive agreement to sell the capital stock of Caliber One Indemnity Company. Pursuant to the agreement, we will retain all assets and liabilities related to in-force policies and outstanding claim obligations and will run-off such in-force policies and claim obligations. Accordingly, under SFAS No. 144, the results of operations of this segment are reported in results from continuing operations, and will continue to be reported as such until all in-force policies and outstanding claim obligations are run-off, at which point we will report the results of the Run-off segment as discontinued operations. The long-lived assets of this segment were tested for impairment in the second quarter of 2002 in accordance with the provisions of SFAS No. 144. See Note 8 for additional information.

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Accordingly, this standard does not apply to our exit from the excess and surplus lines business, which was announced in May 2002.

Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” In accordance with SFAS No. 142, we no longer amortize goodwill, but instead test it periodically for impairment. As of September 30, 2002, we had approximately $3.0 million of goodwill, which is included in other assets on the balance sheet. Amortization of goodwill was $240,000 and $720,000 for the three and nine months ended September 30, 2001, respectively, or $0.01 per basic and diluted share and $0.03 per basic and diluted share for the three and nine months ended September 30, 2001, respectively. In the nine months ended September 30, 2002, we recognized an impairment charge of $1.3 million associated with goodwill at the Run-off Operations, which is included in operating expenses.

Effective January 1, 2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments

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embedded in other contracts (collectively referred to as “derivatives”) and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. We do not have any derivative instruments that are impacted by the accounting requirements of SFAS No. 133 and do not currently participate in any hedging activities. Accordingly, the adoption of SFAS No. 133 did not have a material impact on our financial condition, results of operations or liquidity.

Critical Accounting Policies

You can find our critical accounting policies on pages 46 to 48 of our 2001 Annual Report to Shareholders.

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Cautionary Statements

Except for historical information provided in Management’s Discussion and Analysis and otherwise in this report, statements made throughout, including in the Business Outlook section are forward-looking and contain information about financial results, economic conditions, trends and known uncertainties. These forward-looking statements are based on currently available financial, competitive and economic data and our current operating plans based on assumptions regarding future events. Our actual results could differ materially from those expected by our management. The factors that could cause actual results to vary materially, some of which are described with the forward-looking statements, include, but are not limited to:

Investors should not place undue reliance on any such forward-looking statements. Unless otherwise stated, we disclaim any current intention to update forward-looking information and to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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Item 3. Quantitative and Qualitative Disclosure About Market Risk

There has been no material change regarding our market risk position from the information provided under the caption “Market Risk of Financial Instruments” on page 44 of our 2001 Annual Report to Shareholders.

Item 4. Controls and Procedures

Within the 90-day period prior to the date of this report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of John W. Smithson, President and Chief Executive Officer, and William E. Hitselberger, Senior Vice President and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-14(c) of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be disclosed in our periodic filings with the Securities and Exchange Commission. There were no significant changes in our internal controls or other factors that could significantly affect those controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Because of the inherent limitations in all control systems, no evaluation of controls can provide more than reasonable assurance that all control issues and instances of fraud, if any, within the Company have been detected. Further, it should be noted that the design of any systems of controls is based, in part, upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless how remote.

Part II. Other Information

Item 5. Other Information

Risk Factors

Our business faces significant risks. The risks described below update the risk factors described in our Form 10-K for the year ended December 31, 2001 on pages 30 through 34, and should be read in conjunction with those risk factors. The risk factors described in this Form 10-Q and the 2001 Form 10-K may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, results of operations or prospects could be affected materially.

Because insurance and credit ratings are important to our policyholders and creditors, downgrades in our ratings may adversely affect us.

Nationally recognized ratings agencies rate the financial strength of our principal insurance subsidiaries and the debt of PMA Capital Corporation. Ratings are not recommendations to buy our securities.

Rating agencies rate insurance companies based on financial strength and the ability to pay claims, factors more relevant to policyholders than investors. We believe that the ratings assigned by nationally recognized, independent rating agencies, particularly A.M. Best, are material to our operations. A.M. Best, Standard & Poor’s and Moody’s Investor Services currently rate our principal insurance subsidiaries.

The rating scales of A.M. Best, S&P, and Moody’s are characterized as follows:

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As of October 31, 2002, our principal insurance subsidiaries had the following financial strength ratings:

A downgrade in these ratings could affect our competitive position in the insurance industry and make it more difficult for us to market our products. A significant downgrade could result in a material loss of business as policyholders move to other companies with higher financial strength ratings.

Debt ratings are assessments of the likelihood that the we will make timely scheduled payments of principal and interest when due. The principal agencies that rate PMA Capital’s senior debt characterize their rating scales as follows:

As of October 31, 2002, PMA Capital’s senior debt was rated BBB- (“Adequate” —10^th of 22) by S&P and Baa3 (“Medium” —10^th of 21) by Moody’s. These are the lowest investment-grade debt ratings of S&P and Moody’s. A downgrade would affect our ability to raise additional debt with terms and conditions similar to our current debt, and accordingly, likely increase our cost of capital. In addition, a downgrade of these ratings would make it more difficult to raise capital to refinance any maturing debt obligations or support business growth at our insurance subsidiaries and maintain or improve their current financial strength ratings described above. Furthermore, a downgrade of our senior debt by S&P below BBB- would result in an event of default under our Credit Facility, which could have a material adverse effect on our liquidity and capital resources.

These ratings are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that we or our principal insurance subsidiaries can maintain these ratings. Each rating should be evaluated independently of any other rating.

The covenants in our debt agreements could limit our financial and operational flexibility, which could have an adverse effect on our financial condition, and limit the amount of dividends that we can pay on any class of capital stock.

We have incurred indebtedness and may incur additional indebtedness in the future. At October 31, 2002, we had $65 million outstanding under our Credit Facility, and at September 30, 2002, we had $23.8 million outstanding in letters of credit under our secured letter of credit facility. The agreements governing our indebtedness contain numerous covenants that limit, or have the effect of limiting, our ability to, among other things, borrow money, sell assets, merge or consolidate and make investments. These restrictions could limit our ability to take advantage of business and investment opportunities, and therefore, could adversely affect our financial condition, liquidity and results of operations. In addition, these agreements limit our ability to pay dividends on our Class A Common stock. In 2002, under the most restrictive covenants of these agreements, we would be able to pay dividends of approximately $15 million on any class of capital stock.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

The Exhibits are listed in the Exhibit Index on page 36.

(b) Reports on Form 8-K filed during the quarter ended September 30, 2002:

During the quarterly period ended September 30, 2002, we filed the following Reports on Form 8-K:

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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Certification

34

Certification

35

Exhibit Index

36