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

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

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 /  /

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 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 July 31, 2003.

INDEX

Part I. Financial Information
Item 1. Financial Statements

PMA Capital Corporation
Consolidated Balance Sheets
(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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PMA Capital Corporation
Consolidated Statement of Operations
(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

2

PMA Capital Corporation
Consolidated Statements of Cash Flows
(Unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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

See accompanying notes to the unaudited consolidated financial statements.

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PMA Capital Corporation

Notes to the Unaudited 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. Approximately 90% of The PMA Insurance Group’s business is produced through independent agents and brokers.

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. See Note 9 for additional information.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. Basis of Presentation – The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“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 2003 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 six months ended June 30, 2003 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 2002 Annual Report to Shareholders and incorporated by reference in its Form 10-K for the year ended December 31, 2002.

B. Recent Accounting Pronouncements – Effective December 31, 2002, the Company adopted the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock-based employee compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, the Company has applied the disclosure provisions of SFAS No. 148.

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The following table illustrates the effect on net income (loss) if the fair value based method had been applied:

Effective January 1, 2003, the Company adopted the recognition provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). The Company had previously applied the disclosure provisions of FIN 45 to its year end 2002 financial statements. FIN 45 requires certain guarantees to be recorded at fair value and also requires a guarantor to make certain disclosures, even when the likelihood of making payments under the guarantee is remote. Generally, FIN 45 applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party. Adoption of FIN 45 did not have a material effect on the Company’s consolidated financial condition, results of operations or liquidity.

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 SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which were 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.

In January 2003, the Company sold the capital stock of Caliber One Indemnity Company. Pursuant to the agreement of sale, the Company has retained all assets and liabilities related to in-force policies and outstanding claim obligations and is running 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 satisfied, at which point the Company will report the results of the Run-off segment as discontinued operations. The long-lived assets of this segment have been tested for impairment in accordance with the provisions of SFAS No. 144. See Note 9 for additional information.

In July 2002, the FASB 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 the Company announced in May 2002.

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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. During the second quarter of 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. As of June 30, 2003, the Company had no goodwill which is subject to the provisions of SFAS No. 142. The Company has approximately $3.0 million of equity method goodwill (included in other assets on the Balance Sheet), which is accounted for under the provisions of APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires a company to assess if consolidation of an entity is appropriate based upon its variable economic interests in a variable interest entity (“VIE”). The initial determination of whether an entity is a VIE is required to be made on the date at which a company becomes involved with the entity. A VIE is an entity in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A company must consolidate a VIE if the company has a variable interest that will absorb a majority of the VIEs expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur or both. FIN 46 also requires the disclosure of certain information related to VIEs in which a company holds a significant variable interest. FIN 46 is effective for new VIEs established subsequent to January 31, 2003, and for existing VIEs as of July 1, 2003.

The Company is currently assessing the impact that implementing FIN 46 may have on its consolidated financial statements. In this regard, the Company is currently evaluating whether Trabaja Reinsurance Company (“Trabaja”) is a variable interest entity as defined in FIN 46 and, if so, whether the Company’s business activities with Trabaja would warrant consolidation and/or disclosure in the Company’s future financial statements. If the Company were to conclude that it must consolidate Trabaja into its financial statements in accordance with FIN 46, the Company currently estimates that this would result in an increase in investments of approximately $280 million and a decrease in reinsurance receivables of approximately $370 million on the Balance Sheet, and the Company currently estimates that any impact from the initial adoption of FIN 46 would be a non-cash cumulative effect adjustment of no more than approximately $60 million after-tax. Any impact resulting from the implementation of FIN 46 would be subsequently reflected as earnings in future periods for the Company. In addition, the Company is currently evaluating the impact, if any, of FIN 46 on its reporting for two of its wholly owned statutory trusts, which issued $32.5 million of trust preferred securities that are included on the Company’s Balance Sheet at June 30, 2003. See Note 5 for additional information about the trust preferred debt. The Company currently does not expect the application of FIN 46 to these wholly owned statutory trusts to be material to the Company’s financial condition, results of operations or liquidity. The Company is required to adopt FIN 46 in the third quarter of 2003. FIN 46 will have no effect on the statutory capital or results of operations of the Company’s insurance subsidiaries.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003. The Company does not expect adoption of this statement to have a material impact on its financial condition, results of operations or liquidity.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for instruments entered into or modified after May 31, 2003 and the disclosure requirements are effective for the third quarter of 2003. Adoption of this statement did not have an impact on the Company’s financial statements.

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3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

At June 30, 2003, the Company estimated that under all insurance policies and reinsurance contracts issued by its insurance businesses the Company’s liability for unpaid losses and loss adjustment expenses (“LAE”) for all events that occurred as of June 30, 2003 was $2,430.3 million. This amount includes estimated losses from claims plus estimated expenses to settle claims. This estimate includes amounts for losses occurring prior to June 30, 2003 whether or not these claims have been reported to the Company.

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 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, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

PMA Re increased net loss reserves for prior accident years by $10.0 million and $19.5 million for the three and six months ended June 30, 2003, respectively. Each quarter, company actuaries conduct their quarterly reserve reviews to determine the impact of any emerging data on loss development trends and recorded unpaid losses and LAE reserves. During the first quarter of 2003, company actuaries identified higher than expected reported losses and, to a lesser extent, higher than expected paid losses arising from a limited number of ceding company clients who had recently reported loss development in their general liability line of business. This loss emergence occurred mainly in pro rata business written in 1998 to 2000. PMA Re increased its net loss reserves for prior accident years related to this business based on the information available at that time. During the second quarter of 2003, company actuaries continued to monitor this business and based on new information received and analyzed by the actuaries, observed that reported and incurred claims activity during the second quarter was higher than previously expected. Based on this new information, loss reserves for prior accident years were increased in the second quarter of 2003.

During the first quarter of 2002, company actuaries conducted a quarterly reserve review to determine the impact of any emerging data on 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 Caliber One. Management’s selection of the ultimate losses resulting from this review indicated that net loss reserves needed to be increased by $40 million. This unfavorable prior year development reflected 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 1999 and 2000.

Management believes that its unpaid losses and LAE are fairly stated at June 30, 2003. 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, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in 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 June 30, 2003, the related adjustments could have a material adverse impact on the Company’s financial condition, results of operations and liquidity.

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4. REINSURANCE

The Company follows the customary insurance practice of reinsuring with other insurance companies a portion of the risks under the policies written by its insurance subsidiaries. The Company’s insurance and reinsurance subsidiaries maintain reinsurance to protect themselves against the severity of losses on individual claims and unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss. Although reinsurance does not discharge the insurance subsidiaries from their primary liabilities to their policyholders for losses insured under the insurance policies, it does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk.

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

5. DEBT

At December 31, 2002, the Company had $65 million of short-term debt under its bank credit facility (“Credit Facility”) and $86.25 million aggregate principal amount of 4.25% convertible senior debentures (“Convertible Debt”). In March 2003, the Company repaid $20 million of the Credit Facility and amended the Credit Facility to reduce it to $45 million in borrowing capacity. In the second quarter of 2003, the Company repaid the remaining $45 million outstanding and retired the Credit Facility.

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During May 2003, the Company privately placed $17.5 million (“Trust Preferred 1”) and $15.0 million (“Trust Preferred 2”) of 30-year floating rate trust preferred securities through two wholly owned statutory trust subsidiaries The Company used all of the approximately $31.5 million of net proceeds from the sales of these securities to pay down a portion of its Credit Facility. These securities have a 30-year maturity and are redeemable by the Company in whole, or in part, after five years from issuance at their stated liquidation amount plus accrued and unpaid interest. The interest rates on Trust Preferred 1 and 2 will equal the three-month London InterBank Offered Rate (“LIBOR”) plus 4.10% and three-month LIBOR plus 4.20%, respectively. Trust Preferred 1 and 2 will bear interest at the rate of 5.41% and 5.48% per annum through the initial interest payment dates of August 15, 2003 and August 23, 2003, respectively. The Company has entered into interest rate swaps that will become effective in August 2003 and will mature in May 2008. The Company has designated the interest rate swaps as cash flow hedges to manage interest costs and cash flows associated with the variable interest rates associated with Trust Preferred 1 and 2. The interest rate swaps have notional amounts of $17.5 million and $15.0 million, and will effectively convert Trust Preferred 1 and 2 floating-rate securities to fixed rate debt with interest rates of 6.70% and 6.80%, respectively. The Company has the right to defer interest payments on Trust Preferred 1 and 2 for up to twenty consecutive quarters but, if so deferred, the Company may not declare or pay cash dividends or distributions on its Class A common stock. The obligations of the statutory trust subsidiaries are guaranteed by PMA Capital with respect to distributions and payments of Trust Preferred 1 and 2, and the Company issued junior subordinated debentures to the statutory trust subsidiaries which have substantially the same terms as Trust Preferred 1 and 2.

In June 2003, the Company issued $57.5 million of 8.50% monthly income senior notes due June 15, 2018, from which it realized net proceeds of approximately $55 million. The Company used the proceeds from the offering to repay the remaining balance outstanding under the Credit Facility, to increase the statutory capital and surplus of its insurance subsidiaries, and for general corporate purposes. The Company has the right to call these securities beginning in June 2008.

In October 2002, the Company issued $86.25 million aggregate principal amount of 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 on March 30 and September 30. 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 under certain events specified in the indenture, including once the stock price reaches $19.64 for a specified period of time or if the Company’s senior debt rating is below Ba3 or BB-. 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.

The Company has a letter of credit facility (the “Letter of Credit Facility”) which provides for up to $50.0 million in letter of credit capacity. At June 30, 2003, the aggregate outstanding face value amount of letters of credit issued was $15.0 million. The Letter of Credit Facility is utilized primarily for collateralizing reinsurance obligations of the insurance subsidiaries of the Company. At June 30, 2003, fees for the Letter of Credit Facility were 0.45% per annum on the utilized portion and 0.15% on the unutilized portion. The Letter of Credit Facility is collateralized by securities with a total amortized cost of $21.8 million and a fair value of $22.3 million at June 30, 2003. The securities pledged as collateral are included in fixed maturities on the Balance Sheet.

The covenants supporting the Company’s outstanding debt and the Letter of Credit Facility contain provisions that, among other matters, limit the Company’s ability to incur additional indebtedness, merge, consolidate and acquire or sell assets. The covenants of the Company’s Letter of Credit Facility also require the Company to satisfy certain ratios related to statutory surplus, debt-to-capitalization, cash coverage, risk-based capital and reinsurance recoverables to equity. Additionally, the covenants of the Letter of Credit Facility place restrictions on dividends to shareholders. Under the most restrictive covenant, the Company would be able to pay dividends of approximately $25 million in 2003.

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6. COMMITMENTS AND CONTINGENCIES

The Company’s 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 the Company. The eventual effect on the Company of the changing environment in which it operates remains uncertain.

In the event a property and casualty insurer operating in a jurisdiction where the Company’s insurance subsidiaries also operate becomes or is declared insolvent, state insurance regulations provide for the assessment of other 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. As of June 30, 2003, the Company had recorded a liability of $6.7 million for these assessments, which is included in accounts payable, accrued expenses and other liabilities on the Balance Sheet.

The Company has provided a guaranty of $7.0 million related to loans on properties in which the Company has an interest. This guarantee shall continue to be in force until the related loan has been satisfied. The loan is scheduled to be repaid on November 1, 2004. The Company has also provided guarantees of $2.2 million related to an executive loan program for officers of the Company with a financial institution. This program expires on December 31, 2003.

Under the terms of the sale of one of the Company’s insurance subsidiaries in 1998, the Company has agreed to indemnify the buyer, up to a maximum of $15.0 million if the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves of the former subsidiary were established. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, the Company will participate in such favorable loss reserve development.

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. SHAREHOLDERS’ EQUITY

In May 2003, shareholders approved an increase in the authorized shares of PMA Capital’s Class A common stock, which has a $5 par value, from 40 million shares to 60 million shares.

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8. EARNINGS PER SHARE

Shares used as the denominator of the basic and diluted earnings per share were computed as follows:

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 2.6 million stock options were excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2003, and the effect of 3.4 million stock options were excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2002, because they would have been anti-dilutive.

The 2003 diluted shares do not assume the conversion of the Company’s 4.25% convertible debentures into 5.3 million shares of Class A common stock because under the terms of the Convertible Debt agreement they did not meet the required conditions for holders to be able to convert the debentures.

9. RUN-OFF OPERATIONS

In May, 2002, the Company announced its decision to withdraw from the excess and surplus lines marketplace previously served by the Caliber One operating segment. On January 2, 2003, the Company closed on the sale of the capital stock of Caliber One Indemnity Company. The sale generated gross proceeds of approximately $31 million and resulted in a pre-tax gain of $2.5 million, which is included in other revenues in the Statement of Operations for the six months ended June 30, 2003. During the first quarter of 2003, the Company recognized an additional $2.5 million writedown of assets, including approximately $2 million for reinsurance receivables and $500,000 for premiums receivable, reflecting an assessment of their estimated net realizable value. The writedown is included in operating expenses in the Statement of Operations for the six months ended June 30, 2003.

Pursuant to the agreement of sale, the Company has retained all assets and liabilities related to the in-force policies and outstanding claim obligations relating to Caliber One’s business written prior to closing on the sale. As a result of the Company’s decision to exit from and run off this business, the results of this segment are reported as Run-off Operations.

As a result of the decision to exit from and run off this business, results for the Run-off Operations for the quarter ended June 30, 2002 included a charge of $43 million pre-tax ($28 million after-tax). Components of the pre-tax charge include approximately $16 million to write-down assets to their estimated net realizable value, including a non-cash charge of approximately $6 million for leasehold improvements and other fixed assets and $1.3 million for goodwill.

In addition, the $43 million pre-tax charge includes expenses associated with the recognition of liabilities of approximately $27 million, including reinsurance costs of approximately $19 million, long-term lease costs of approximately $4 million and involuntary employee termination benefits of approximately $3 million. At June 30, 2003, the Company has a remaining obligation of approximately $1.8 million for net lease costs, the majority of which will be paid through 2004, and approximately $270,000 for severance, which will be paid through 2004.

During 2002, approximately 80 Caliber One employees, primarily in the underwriting area, were terminated in accordance with the Company’s exit plan. Approximately 14 positions, primarily claims, remain after the terminations. Involuntary employee termination benefits of approximately $2.6 million have been paid through June 30, 2003, including approximately $600,000 during the first six months of 2003.

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10. 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 are presented in the table below. Operating income (loss), which is GAAP net income (loss) excluding net realized investment gains and losses, is the financial performance measure used by the Company’s management and Board of Directors to evaluate and assess the results of the Company’s insurance businesses. Accordingly, the Company reports operating income by segment in this footnote as required by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” The Company’s management and Board of Directors use operating income as the measure of financial performance for our business segments because (i) net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments 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 and losses that do not relate to the operations of the individual segments. Operating income (loss) does not replace net income (loss) as the GAAP measure of our consolidated results of operations.

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Net premiums earned by business segment 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 June 30, 2003, compared with December 31, 2002, and our results of operations for the three and six months ended June 30, 2003, compared with the same periods last year. This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) included in our Form 10-K for the year ended December 31, 2002 (“2002 Form 10-K”), to which the reader is directed for additional information. The term “GAAP” refers to accounting principles generally accepted in the United States of America.

This MD&A contains forward-looking statements, including those made in the Business Outlook section, which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based upon current estimates, assumptions and projections. Actual results may differ materially from those projected in such forward-looking statements, and therefore, you should not place undue reliance on them. See the Cautionary Statements on page 32 for a list of factors that could cause our actual results to differ materially from those contained in any forward-looking statement. Also, see Business – Risk Factors in our 2002 Form 10-K for a further discussion of risks that could materially affect our business.

RESULTS OF OPERATIONS

Consolidated Results

We recorded net income of $12.2 million and $22.9 million for the three and six months ended June 30, 2003, respectively, compared to net losses of $29.7 million and $47.0 million for the same periods last year.

Included in net income (loss) are after-tax net realized investment gains of $2.9 million and $5.7 million for the three and six months ended June 30, 2003, respectively, compared to after-tax net realized losses of $11.4 million and $10.5 million for the same periods last year. The net realized losses in 2002 include impairment losses of $10.3 million after-tax on fixed income securities, including $9.2 million for WorldCom.

Also included in the net loss for the second quarter of 2002 was a charge of approximately $28 million after-tax ($43 million pre-tax) for costs to exit from and run off business written by the Run-off Operations (formerly known as the Caliber One operating segment), which we exited in May 2002. The net loss for the first six months of 2002 also included prior year loss development of approximately $26 million after-tax ($40 million pre-tax) at the Run-off Operations in the first quarter of 2002.

In addition to the changes in realized investment results and the losses for the Run-off Operations in 2002 noted above, results for the second quarter and first six months of 2003 reflect improved underwriting results, partially offset by lower net investment income and higher interest expense.

Consolidated revenues increased to $312.6 million and $615.7 million for the three and six months ended June 30, 2003, respectively, compared to $284.1 million and $511.5 million for the same periods last year. The increases in revenues reflect higher net premiums earned by PMA Re and The PMA Insurance Group due to rate increases over the past few years. Additionally, pre-tax net realized investment gains were $4.5 million and $8.8 million for the second quarter and first six months of 2003, compared to pre-tax net realized investment losses of $17.6 million and $16.2 million for the same periods last year.

In this MD&A, in addition to providing consolidated net income (loss), we also provide segment operating income (loss) because we believe that it is a meaningful measure of the profit or loss generated by our operating segments. Operating income (loss), which is GAAP net income (loss) excluding net realized investment gains and losses, is the financial performance measure used by our management and Board of Directors to evaluate and assess the results of our insurance businesses. Accordingly, we report operating income by segment in Note 10 to our Unaudited Consolidated Financial Statements as required by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” Our management and Board of Directors use operating income as the measure of financial performance because (i) net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments 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 and losses that do not relate to the operations of the

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individual segments. Operating income (loss) does not replace net income (loss) as the GAAP measure of our consolidated results of operations.

Following is a reconciliation of our segment operating results to GAAP net income (loss). Please see Note 10 to our Unaudited Consolidated Financial Statements for further information.

We also provide combined ratios and operating ratios for our insurance segments on pages 18 and 22. The “combined ratio “ is a measure of property and casualty underwriting performance. The combined ratio computed using GAAP-basis numbers is equal to losses and loss adjustment expenses (“LAE”), plus acquisition expenses, insurance-related operating expenses and policyholders’ dividends, where applicable, all divided by net premiums earned. A combined ratio of less than 100% reflects an underwriting profit. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, we invest the available premiums. Underwriting results do not include investment income from these funds. Given the long-tail nature of our liabilities, we believe that the operating ratios are also important in evaluating our business. The operating ratio is the combined ratio less the net investment income ratio, which is net investment income divided by premiums earned.

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Business Outlook

Our current expectation is that full year 2003 consolidated premiums for PMA Re and The PMA Insurance Group will increase by approximately 10-15% over 2002 levels. In addition, we expect that the consolidated combined ratio for full year 2003 at PMA Re and The PMA Insurance Group will be approximately equal to the combined ratio achieved in the first half of 2003. This reflects our expectation for continued strong results from the 2001, 2002 and 2003 underwriting years and our current view of the 1998 to 2000 business.

As we have experienced through the first six months of 2003, our invested asset base has grown as underwriting year premiums have been earned and collected. However, investment income is expected to be constrained in 2003 due to the low interest rate environment and the likelihood that interest rates will remain at these low levels through the end of 2003. We do not anticipate changing our current investment strategies due to the present interest rate environment.

Based on management’s current expectations, our estimated range of consolidated after-tax operating income for 2003 is between $1.40 and $1.50 per diluted share. Our range of estimated operating earnings per share for 2003 assumes that rate adequacy will continue; that loss trends run as expected, excluding catastrophes; and that recorded loss reserves for prior accident years are adequate. In addition, our earnings expectations reflect our current view of anticipated investment income in a lower interest rate environment. Our 2003 earnings per share estimate does not reflect any dilution from our 4.25% convertible senior debentures. If you were to assume conversion of this debt, then our earnings per share figures would be lower by about 10%.

We are unable to provide a reasonable estimate of the range of GAAP net income per share because this would require us to forecast net realized investment gains and losses, which are included in GAAP net income but excluded from operating income. Net realized investment gains were 18 cents per diluted share for the first half of 2003. We are unable to reasonably estimate net realized investment gains and losses for any future period, including the next six months, because they are unpredictable and not necessarily indicative of our current operating fundamentals or our future performance. In addition, in many instances, decisions to buy and sell securities are made for reasons unrelated to our operating businesses and are made at the holding company level in part due to credit concerns or overall changes in the fixed income markets.

The statements made in this Business Outlook section are forward-looking. Our actual results may differ materially from our current expectations as a result of the factors described in the cautionary statements accompanying the forward-looking statements and other factors described in the Cautionary Statements on page 32. Also, see Business – Risk Factors described in our 2002 Form 10-K.

Status of Business Outlook

Our corporate representatives authorized to speak on our behalf may meet privately during the quarter with investors, the media, investment analysts and others. At these meetings, our spokespersons may reiterate the foregoing Business Outlook. At the same time, this Business Outlook will remain publicly available. Prior to the start of the Quiet Period (described below), the public can continue to rely on this Business Outlook as still being our current expectation on matters covered, unless we publish a press release stating otherwise.

Beginning on approximately October 16, 2003, PMA Capital will observe a “Quiet Period” during which this Business Outlook no longer constitutes management’s current expectations. During the Quiet Period, this Business Outlook should be considered historical, speaking as of prior to the beginning of the Quiet Period only and should not be relied upon. We expressly disclaim any current intention to update our Business Outlook during the Quiet Period. During the Quiet Period, our spokespersons will not comment on the Business Outlook or our financial results or expectations other than through a press release or other publicly available document. The Quiet Period will last until approximately October 30, 2003, which is when we currently expect to announce our third quarter 2003 results.

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Segment Results

PMA Re

Summarized financial results of PMA Re are as follows:

PMA Re’s pre-tax operating income was $13.1 million and $21.7 million for the three and six months ended June 30, 2003, respectively, compared to $13.8 million and $26.7 million for the same periods in 2002. The declines in pre-tax operating income reflect lower net investment income, partially offset by improved underwriting results.

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Premiums

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

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

Gross premiums written were $227.9 million and $434.0 million for the three and six months ended June 30, 2003, respectively, compared to $252.8 million and $388.5 million for the same periods last year. During the second quarter of 2002, we recorded an additional $58.1 million of gross premiums written ($44.2 million of net premiums written) 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, comparing actual reported premiums to originally estimated premiums based on ceding company estimates, indicated that premiums written in recent years, primarily for 2001 and 2000 in the Traditional– and Specialty–Treaty units, were higher than originally estimated. The increase in net premiums

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earned of $35.5 million caused by this adjustment was offset by losses and LAE and acquisition expenses. In addition to the effects this adjustment had on the year-over-year comparisons, the increase in gross premiums written in the second quarter reflects higher premium writings in the Finite Risk and Financial Products unit, and the increase in gross premiums written year-to-date reflects higher premium volume across all of our business units, due primarily to rate increases. During the first six months of 2003, PMA Re renewed 65-70% of its in-force Traditional– and Specialty–Treaty business. Rate increases on this business averaged approximately 30% in 2003, as measured by the level of premium increase on renewed in-force business.

Ceded premiums were $55.4 million and $102.9 million for the three and six months ended June 30, 2003, respectively, compared to $43.8 million and $89.2 million for the same periods last year. Ceded premiums represented 24% of gross premiums written for both the second quarter and first six months of 2003, compared to 17% and 23% for the same periods last year. Ceded premiums for the second quarter and first six months of 2003 reflect ceded premiums of approximately $34 million and $66 million from our Finite Risk and Financial Products unit due under a quota share retrocessional cover that cedes one-third of this unit’s 2003 premiums and losses. This cover allows us to enhance the gross underwriting capacity of this unit and to better manage the growth in net premiums written. Offsetting these premium cessions for the six month period was approximately $26 million in cessions under two of our retrocessional covers in the first six months of 2002, primarily for the Traditional– and Specialty–Treaty units. Such ceded premiums were not required in 2003.

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 experienced-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:

The loss and LAE ratio was 61.8% and 68.1% for the three and six months ended June 30, 2003, respectively, compared to 71.9% and 71.2% for the same periods in 2002. The improvement in the loss and LAE ratios is due primarily to price increases experienced throughout all of our business units that outpaced loss cost trends. Furthermore, the loss and LAE ratio on our Finite Risk and Financial Products premiums was lower than last year reflecting better loss experience. The improvement in loss experience was offset by an increase in ceding commissions required under the terms of these contracts, which is reflected in the acquisition expense ratio. In addition, the loss and LAE ratio on property business improved over the same periods last year due to lower than expected claims activity in 2003.

Partially offsetting this favorable loss trend was unfavorable prior year loss development. During the three and six months ended June 30, 2003, PMA Re increased its net loss reserves for prior accident years by $10.0 million and $19.5 million, which increased the loss and LAE ratio by 6.6 points and 6.5 points for each respective period. Each quarter, our actuaries conduct their quarterly reserve reviews to determine the impact of any emerging data on loss development trends and recorded unpaid losses and LAE reserves. During the first quarter of 2003, our actuaries identified higher than expected reported losses and, to a lesser extent, higher than expected paid losses arising from a limited number of ceding company clients who had recently reported loss development in their general liability line of business. This loss emergence occurred mainly in pro rata business written in 1998 to 2000. PMA Re increased its net loss reserves for prior accident

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years related to this business based on the information available at that time. During the second quarter of 2003, our actuaries continued to monitor this business and based on new information received and analyzed by the actuaries, observed that reported and incurred claims activity during the second quarter was higher than previously expected. Based on this new information, loss reserves for prior accident years were increased in the second quarter of 2003.

The acquisition expense ratio increased 6.9 points and 2.5 points in the three and six months ended June 30, 2003, respectively, compared to the same periods in 2002. The increases in the acquisition expense ratio primarily reflect the higher ceding commissions required on assumed Finite Risk and Financial Products pro rata contracts due to the lower loss experience on such contracts in 2003.

The operating expense ratio was 2.5% and 2.2% for the three and six months ended June 30, 2003, respectively. Excluding the impact of the premium adjustment described above, the operating expense ratio was 3.3% and 4.1% for the three and six months ended June 30, 2002, respectively. The improvement in the operating expense ratio for the second quarter of 2003, compared to the same period last year, reflects improved results related to our participation in a Lloyd’s of London syndicate and managing general agency. The improvement in the operating expense ratio for the year-to-date period also reflects a benefit of $2.6 million from the sale of an asset in the first quarter of 2003 that is included in operating expenses, and an increase in net premiums earned that outpaced expenses.

Net Investment Income

Net investment income was $8.6 million for the second quarter of 2003, compared to $14.1 million for the same period in 2002, reflecting lower yields on the invested asset portfolio of approximately 160 basis points on an average invested asset base that increased approximately 7%, and lower interest earned of $2.4 million on funds held arrangements, primarily assumed contracts. Net investment income was $17.0 million for the first six months of 2003, compared to $27.9 million for the same period last year, reflecting lower yields on the invested asset portfolio of approximately 130 basis points on an average invested asset base that increased approximately 4%, and lower interest earned of $5.5 million on funds held arrangements. For the three and six months ended June 30, 2003, the reduction in interest earned on funds held arrangements was substantially offset by lower losses on the associated assumed Finite Risk and Financial Products contracts. In a funds held arrangement, the ceding company retains the premiums and losses are offset against these funds in an experience account. Because the reinsurer is not in receipt of the funds, the reinsurer earns interest on the experience fund balance at a predetermined credited interest rate.

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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 $6.8 million and $15.2 million for the three and six months ended June 30, 2003, compared to $6.4 million and $12.8 million for the same periods in 2002. The increases in operating income were primarily due to improved underwriting results, partially offset by lower net investment income.

Premiums

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Direct workers’ compensation and integrated disability premiums written increased by $23.8 million and $44.6 million for the three and six months ended June 30, 2003 primarily due to price increases of approximately 11% 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. Our retention rate on existing accounts was 86% for the six months ended June 30, 2003. 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 $7.8 million and $2.7 million for the three and six months ended June 30, 2003, compared to the same periods in 2002, primarily due to improved pricing that averaged approximately 16% in the first six months of 2003.

Ceded premiums increased $724,000 and $1.2 million for the three and six months ended June 30, 2003, compared to the same periods in 2002. Premiums ceded for workers’ compensation and integrated disability increased by $1.8 million and $5.1 million as a result of the increase in direct premiums written as well as an increase in rates being charged by reinsurers. Premiums ceded for Commercial Lines decreased by $1.1 million and $4.0 million, primarily because we are retaining more of our Commercial Lines’ risks.

Net premiums written increased 43% and 21% while net premiums earned increased 33% and 21% for the three and six months ended June 30, 2003, respectively, compared to the same periods in 2002. 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.

Losses and Expenses

The components of the GAAP combined ratios are as follows:

The loss and LAE ratios improved 0.1 points and 0.8 points for the three and six months ended June 30, 2003, respectively, compared to the same periods in 2002. The improvement in the loss and LAE ratio for the six months ended June 30, 2003, compared to the same period last year, is primarily due to an improved current accident year loss and LAE ratio. The improvement in the current accident year loss and LAE ratio is primarily due to price increases that have outpaced increasing loss costs. We estimate our medical cost inflation to be approximately 11%, which has contributed to increased severity of workers’ compensation losses. As discussed below, lower policyholder dividends are also used as a means to improve a policy’s overall profitability.

Overall, the total expense ratio was essentially flat for the three and six months ended June 30, 2003, compared to the same periods in 2002, as overall expenses increased in line with higher earned premiums.

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The policyholders’ dividend ratio improved by 0.9 points and 1.3 points for the three and six months ended June 30, 2003, respectively, compared to the same periods last year. Under policies that are subject to dividend plans, the customer may receive a dividend based upon loss experience during the policy period. The improvement in the policyholders’ dividend ratio occurred primarily because The PMA Insurance Group sold less business under dividend plans and wrote business under lower paying dividend plans. Lower dividend payments are effectively another form of price increase that contributes to the overall profitability of our workers’ compensation business.

Net Investment Income

Net investment income was $8.2 million and $16.5 million for the three and six months ended June 30, 2003, compared to $9.2 million and $18.0 million for the same periods in 2002. The lower net investment income primarily reflects a reduction in invested asset yields of approximately 110 and 90 basis points during the second quarter and first six months of 2003, compared to the same periods last year, partially offset by a higher invested asset base that increased approximately 11% and 8% for the three and six months ended June 30, 2003.

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. On January 2, 2003, we closed on the sale of the capital stock of Caliber One Indemnity Company. Pursuant to the agreement of sale, we have retained all assets and liabilities related to the in-force policies and outstanding claim obligations relating to Caliber One’s business written prior to closing on the sale. 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 were essentially breakeven for the Run-off Operations for the three and six months ended June 30, 2003. The first quarter 2003 sale of the capital stock of Caliber One Indemnity Company generated gross proceeds of approximately $31 million and resulted in a pre-tax gain of $2.5 million, which is included in other revenues in the Statement of Operations for the six months ended June 30, 2003. During the first quarter of 2003, the Run-off Operations recognized an additional $2.5 million writedown of assets, including approximately $2 million for reinsurance receivables and $500,000 for premiums receivable, reflecting an assessment of their estimated net realizable value. The writedown is included in operating expenses in the Statement of Operations for the six months ended June 30, 2003.

Pre-tax operating losses were $44.4 million and $87.5 million for the three and six months ended June 30, 2002. As a result of the decision to exit from and run off this business, results for the Run-off Operations for the quarter ended June 30, 2002 included a charge of $43 million pre-tax ($28 million after-tax). Components of the pre-tax charge include

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approximately $16 million to write-down assets to their estimated net realizable value, including a non-cash charge of approximately $6 million for leasehold improvements and other fixed assets and $1.3 million for goodwill.

In addition, the $43 million pre-tax charge includes expenses associated with the recognition of liabilities of approximately $27 million, including reinsurance costs of approximately $19 million, long-term lease costs of approximately $4 million and involuntary employee termination benefits of approximately $3 million. At June 30, 2003, we have a remaining obligation of approximately $1.8 million for net lease costs, the majority of which will be paid through 2004, and approximately $270,000 for severance, which will be paid through 2004.

Pre-tax operating results for the first six months of 2002 also included net unfavorable prior year development of $40 million. During the first quarter of 2002, company actuaries conducted a quarterly reserve review to determine the impact of any emerging data on 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 million. This unfavorable prior year development reflected 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 1999 and 2000.

Loss Reserves

At June 30, 2003, we estimated that under all insurance policies and reinsurance contracts issued by our insurance businesses our liability for unpaid losses and LAE for all events that occurred as of June 30, 2003 is $2,430.3 million. This amount includes estimated losses from claims plus estimated expenses to settle claims. Our estimate includes amounts for losses occurring prior to June 30, 2003 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, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in 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 June 30, 2003. 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, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in 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 June 30, 2003, the related adjustments could have a material adverse effect on our financial condition, results of operations and liquidity. See the discussion under PMA Re – Losses and Expenses beginning on page 20 and Run-off Operations beginning on page 24 for additional information regarding increases in loss reserves for prior years.

For additional discussion of loss reserves and reinsurance, see pages 34 to 37 of the MD&A included in our 2002 Form 10-K, as well as pages 13 to 20 of our Form 10-K for the year ended December 31, 2002.

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Corporate and Other

The Corporate and Other segment includes unallocated investment income and expenses, including debt service. Corporate and Other recorded pre-tax operating losses of $5.6 million and $10.2 million for the three and six months ended June 30, 2003, compared to pre-tax operating losses of $3.7 million and $8.0 million for the same periods in 2002, primarily due to higher interest expense. Interest expense increased by $1.7 million and $2.9 million for the three and six months ended June 30, 2003, compared to the same periods in 2002, primarily due to a higher average amount of debt outstanding in 2003, compared with last year.

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 and net tax payments 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 periodically use cash resources to capitalize subsidiaries and to repurchase shares of our common stock.

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 PMA Insurance Group’s Pooled Companies may not be paid directly to PMA Capital. Approximately $58 million of dividends are available to be paid by PMACIC to PMA Capital in 2003 without the prior approval of the Pennsylvania Insurance Commissioner. The PMA Insurance Group’s Pooled Companies can pay up to $27.4 million in dividends to PMACIC during 2003. Dividends received from subsidiaries were $8.0 million and $16.0 million for the three and six months ended June 30, 2003, respectively, and $7.0 million and $14.0 million for the three and six months ended June 30, 2002, respectively.

Net tax payments received from (paid to) subsidiaries were $(27,000) and $2.7 million for the three and six months ended June 30, 2003, compared to $1.6 million and $6.8 million for the same periods in 2002.

In the first quarter of 2003, we repaid $20 million of our bank credit facility (“Credit Facility”), reducing the outstanding balance to $45 million at March 31, 2003, compared to $65 million at December 31, 2002. The remaining $45 million was repaid in the second quarter of 2003 as discussed below.

During May 2003, we privately placed $17.5 million (“Trust Preferred 1”) and $15.0 million (“Trust Preferred 2”) of 30-year floating rate trust preferred securities through two wholly owned statutory trust subsidiaries. We used all of the approximately $31.5 million of net proceeds from the sales of these securities to pay down a portion of our Credit Facility. These securities have a 30-year maturity and are redeemable in whole, or in part, after five years from issuance at their stated liquidation amount plus accrued and unpaid interest. The interest rates on Trust Preferred 1 and 2 will equal the three-month London InterBank Offered Rate (“LIBOR”) plus 4.10% and three-month LIBOR plus 4.20%, respectively. Trust Preferred 1 and 2 will bear interest at the rate of 5.41% and 5.48% per annum, respectively, through the initial interest payment dates of August 15, 2003 and August 23, 2003, respectively. We have entered into interest rate swaps that will become effective in August 2003 and will mature in May 2008. We have designated the interest rate swaps as cash flow hedges to manage interest costs and cash flows associated with the variable interest rates associated with Trust Preferred 1 and 2. The interest rate swaps have notional amounts of $17.5 million and $15.0 million, and will effectively convert Trust Preferred 1 and 2 floating-rate securities to fixed rate debt with interest rates of 6.70% and 6.80%, respectively. We have the right to defer interest payments on Trust Preferred 1 and 2 for up to twenty consecutive quarters but, if so deferred, we may not declare or pay cash dividends or distributions on our Class A common stock. The obligations of the statutory trust subsidiaries are guaranteed by PMA Capital with respect to distributions and payments of Trust Preferred 1 and 2.

In June 2003, we issued $57.5 million of 8.50% monthly income senior notes due June 15, 2018, from which we realized net proceeds of approximately $55 million. We used the proceeds from the offering to repay the remaining balance outstanding under the Credit Facility, to increase the statutory capital and surplus of our insurance subsidiaries, and for general corporate purposes. We have the right to call these securities beginning in June 2008.

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We also had $86.25 million of 4.25% convertible senior debentures outstanding at both June 30, 2003 and December 31, 2002. We incurred interest expense of $2.2 million and $4.0 million for the three and six months ended June 30, 2003, compared to $572,000 and $1.1 million for the same periods last year. We paid interest of $502,000 and $3.0 million for the three and six months ended June 30, 2003, compared to $258,000 and $863,000 for the same periods last year.

We maintain a $50.0 million secured letter of credit facility (the “Letter of Credit Facility”). The Letter of Credit Facility is utilized primarily for securing reinsurance obligations of our insurance subsidiaries. As of June 30, 2003, we had $15.0 million outstanding under the Letter of Credit Facility.

We paid dividends to shareholders of $3.3 million and $6.6 million, respectively, during the three and six months ended June 30, 2003, compared to $3.3 million and $5.5 million for the same periods last year. The increase in dividends paid for the six months ended June 30, 2003, compared to the same period last year, is due to the additional shares outstanding resulting from our December 2001 issuance of 9,775,000 shares of Class A common stock, which occurred subsequent to the record date for the January 2002 dividend payment. Our dividends to shareholders are restricted by our debt agreements. Under the most restrictive covenant supporting our outstanding debt and Letter of Credit Facility, we would be able to pay dividends of approximately $25 million in 2003.

We did not repurchase any shares during the first six months of 2003. During the first six 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 June 30, 2003 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.

We have provided a guaranty of $7.0 million related to a loan on properties in which we have an interest. This guaranty shall continue to be in force until the related loan has been satisfied. The loan is scheduled to be repaid on November 1, 2004. We have also provided guarantees of $2.2 million related to an executive loan program for our officers with a financial institution. The program expires on December 31, 2003.

We believe 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.

In addition, 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 principal 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.

We currently believe that the existing capital structure is adequate for our current and near term needs. We continually monitor the capital structure in light of developments in our businesses, and our present assessment could change as we become aware of new opportunities and challenges in our businesses. Given our debt-to-total capital ratio of 22%, we believe that we have the financial flexibility to take advantage of favorable market conditions.

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INVESTMENTS

At June 30, 2003, our investment assets were carried at a fair value of $2,209.8 million and had an amortized cost of $2,128.0 million. The average credit quality of the portfolio is AA. At June 30, 2003, $17.7 million, or 0.9%, of our total investments were below investment grade, of which $4.1 million of these below investment grade investments were in an unrealized loss position, which totaled approximately $205,000. At June 30, 2003, all of our fixed income investments were publicly traded and all were rated by at least one nationally recognized credit rating agency.

The net unrealized gain on our fixed maturities at June 30, 2003 was $81.8 million, or 4.9% of the amortized cost basis. The net unrealized gain included gross unrealized gains of $91.7 million and gross unrealized losses of $9.9 million. For all but one security, which was carried at its fair value of $15.4 million at June 30, 2003, 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).

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 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 our ability and intent 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 June 30, 2003, our investment asset portfolio had gross unrealized losses of $9.9 million. For securities that were in an unrealized loss position at June 30, 2003, 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 6 securities that have been in an unrealized loss position for more than 12 months, 5 securities have an unrealized loss of less than $1 million each and/or less than 20% of each security’s amortized cost. These 5 securities have an average unrealized loss per security of approximately $149,000. We own one security with an unrealized loss in excess of $1 million and/or less than 20% of its amortized cost at June 30, 2003. This security, a structured security backed by a

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U.S. Treasury Strip, is rated AAA and has a market value of $15.4 million and a cost of $20 million. The security matures in 2011 at a value of $20 million, and we have both the ability and intent to hold it until maturity.

The contractual maturity of securities in an unrealized loss position at June 30, 2003 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.

Based on our evaluation as of June 30, 2003, we determined there were other than temporary declines in market value of securities issued by one company, resulting in an impairment charge of $244,000 pre-tax during the quarter ended June 30, 2003. 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. Impairment charges for the six months ended June 30, 2003 were $1.3 million, related primarily to securities issued by airline companies.

During the three and six months ended June 30, 2002, we determined there were other than temporary declines in market value for 8 securities of 3 issuers, resulting in an impairment charge of $15.8 million pre-tax, including $14.2 million for WorldCom.

During the six months ended June 30, 2003, we had gross realized gains and losses of $10.3 million and $1.5 million, respectively. The gross realized losses were primarily attributable to impairment losses as discussed above.

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.

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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 (collectively “SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners (“NAIC”) 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

Effective December 31, 2002, we adopted the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We account for stock-based employee compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, we have applied the disclosure provisions of SFAS No. 148.

Effective January 1, 2003, we adopted the recognition provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). We have previously applied the disclosure provisions of FIN 45 to our year end 2002 financial statements. FIN 45 requires certain guarantees to be recorded at fair value and also requires a guarantor to make certain disclosures, even when the likelihood of making payments under the guarantee is remote. Generally, FIN 45 applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party. Adoption of FIN 45 did not have a material effect on our consolidated financial condition, results of operations or liquidity.

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 SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which were 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.

In January 2003, we sold the capital stock of Caliber One Indemnity Company. Pursuant to the agreement of sale, we have retained all assets and liabilities related to in-force policies and outstanding claim obligations and is running 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 satisfied, at which point we will report the results of the Run-off segment as discontinued operations. The long-lived assets of this segment have been tested for impairment in accordance with the provisions of SFAS No. 144.

In July 2002, the FASB 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 we announced in May 2002.

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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. During the second quarter of 2002, we recognized an impairment charge of $1.3 million associated with the goodwill of the Run-off Operations, which is included in operating expenses. As of June 30, 2003, we had no goodwill which is subject to the provisions of SFAS No. 142. We have approximately $3.0 million of equity method goodwill (included in other assets on the Balance Sheet), which is accounted for under the provisions of APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires a company to assess if consolidation of an entity is appropriate based upon its variable economic interests in a variable interest entity (“VIE”). The initial determination of whether an entity is a VIE is required to be made on the date at which a company becomes involved with the entity. A VIE is an entity in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A company must consolidate a VIE if the company has a variable interest that will absorb a majority of the VIEs expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur or both. FIN 46 also requires the disclosure of certain information related to VIEs in which a company holds a significant variable interest. FIN 46 is effective for new VIEs established subsequent to January 31, 2003, and for existing VIEs as of July 1, 2003.

We are currently assessing the impact that implementing FIN 46 may have on our consolidated financial statements. In this regard, we are currently evaluating whether Trabaja Reinsurance Company (“Trabaja”) is a variable interest entity as defined in FIN 46 and, if so, whether our business activities with Trabaja would warrant consolidation and/or disclosure in our future financial statements. If we were to conclude that we must consolidate Trabaja into our financial statements in accordance with FIN 46, we currently estimate that this would result in an increase in investments of approximately $280 million and a decrease in reinsurance receivables of approximately $370 million on the Balance Sheet, and we currently estimate that any impact from the initial adoption of FIN 46 would be a non-cash cumulative effect adjustment of no more than approximately $60 million after-tax. Any impact resulting from the implementation of FIN 46 would be subsequently reflected as earnings in future periods. In addition, we are currently evaluating the impact, if any, of FIN 46 on reporting for two of our wholly owned statutory trusts, which issued $32.5 million of trust preferred securities that are included on our Balance Sheet at June 30, 2003. See Note 5 to the Unaudited Consolidated Financial Statements for additional information about the trust preferred debt. We currently do not expect the application of FIN 46 to these wholly owned statutory trusts to be material to our financial condition, results of operations or liquidity. We are required to adopt FIN 46 in the third quarter of 2003. FIN 46 will have no effect on the statutory capital or results of operations of our insurance subsidiaries.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003. We do not expect adoption of this statement to have a material impact on our financial condition, results of operations or liquidity.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for instruments entered into or modified after May 31, 2003 and the disclosure requirements are effective for the third quarter of 2003. Adoption of this statement did not have an impact on our financial statements.

Critical Accounting Estimates

Our critical accounting estimates can be found on pages 45 to 47 of the MD&A included in our 2002 Form 10-K.

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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. Words such as “believes,” “estimates,” “anticipates,” “expects” or similar words are intended to identify forward-looking statements. 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:

You 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 43 of the MD&A included in our 2002 Form 10-K.

Item 4. Controls and Procedures

As of the end of the period covered by this report, we 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-15(e) 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. During the most recent fiscal quarter, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Part II. Other Information

Item 5. Submission of Matters to a Vote of Security Holders

Our 2003 Annual Meeting of Shareholders (“Annual Meeting”) was held on May 21, 2003. At the Annual Meeting, the shareholders acted upon the following matters:

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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 June 30, 2003:

During the quarterly period ended June 30, 2003, 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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Exhibit Index

The registrant will furnish to the Commission, upon request, a copy of any of the registrant’s agreements with respect to its long-term debt not otherwise filed with the Commission.

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