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

FORM 10-K

Commission File Number 000-22761

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES /X/ NO / /

The aggregate market value of the Class A Common Stock held by non-affiliates of the registrant on June 30, 2003, based on the last price at which the Class A Common Stock was sold, was $270,904,652.

There were 31,334,403 shares outstanding of the registrant’s Class A Common stock, $5 par value per share, as of the close of business on March 1, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

PART I

The “Business Section” and other parts of this Form 10-K contain forward-looking statements that involve inherent risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, and containing words such as “believes,” “estimates,” “anticipates,” “expects” or similar words are forward-looking statements. Our actual results may differ materially from the projected results discussed in the forward-looking statements. Factors that could cause such differences include, but are not limited to, those discussed in “Risk Factors” beginning on page 25 and in the “Cautionary Statements” in “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”).

Item 1. Business

COMPANY OVERVIEW

We are an insurance holding company, whose operating subsidiaries provide workers’ compensation, integrated disability and other commercial property and casualty lines of insurance, primarily in the eastern part of the United States, underwritten and marketed under the trade name The PMA Insurance Group. Our primary insurance business has been in operation since 1915. At December 31, 2003, we had total assets of $4.2 billion and shareholders’ equity of $463.7 million.

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

Prior to November 6, 2003, our reinsurance operations, PMA Re, offered excess of loss and pro rata property and casualty reinsurance protection mainly through reinsurance brokers. On November 6, 2003, we announced our decision to withdraw from the reinsurance business previously served by PMA Re, and we are no longer writing new reinsurance business. Beginning in 2004, PMA Re’s results will be included in our Run-off Operations segment. Under our current corporate structure, PMA Capital Insurance Company, which is the insurance company subsidiary through which PMA Re’s business was underwritten, owns the capital stock of the insurance subsidiaries through which The PMA Insurance Group writes its property and casualty business. On December 22, 2003, PMA Capital Insurance Company entered into a voluntary agreement with the Pennsylvania Insurance Department. Pursuant to this agreement, PMA Capital Insurance Company will not, without the prior approval of the Pennsylvania Insurance Department, pay dividends to us subsequent to November 6, 2003; enter into any new reinsurance contracts, treaties or agreements, except as may be required by law; or alter its or its Pennsylvania-domiciled insurance company subsidiaries’ ownership structure. See "Regulatory Matters – General" beginning on page 17 for additional information regarding our agreement with the Pennsylvania Insurance Department.

Prior to May 1, 2002, we 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, we announced our decision to withdraw from the excess and surplus lines marketplace. In January 2003, we sold the capital stock of Caliber One Indemnity Company, which resulted in a pre-tax gain of $2.5 million. 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. As a result of the decision to exit this business, the results of this segment are reported as Run-off Operations.

In addition, we have a Corporate and Other segment, which includes unallocated investment income and expenses, including debt service.

Financial information in the tables that follow is presented in conformity with accounting principles generally accepted in the United States of America (“GAAP”), unless otherwise indicated. Certain reclassifications have been made to prior periods’ financial information to conform to the 2003 presentation. Revenues, pre-tax operating income (loss) and assets attributable to each of our operating segments and our Corporate and Other segment for the last three years are set forth in Note 15 in Item 8 of this Form 10-K.

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Our gross and net premiums written by segment were as follows:

Property and casualty insurance and reinsurance companies provide loss protection to insureds in exchange for premiums. If earned premiums exceed the sum of losses and loss adjustment expenses (which we refer to as LAE), acquisition expenses, operating expenses and policyholders’ dividends, then underwriting profits are realized. When earned premiums do not exceed the sum of these items, the result is an underwriting loss.

The “combined ratio” is a frequently used measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to losses and LAE, plus acquisition expenses, operating expenses and policyholders’ dividends, where applicable, all divided by net premiums earned. Thus, a combined ratio of under 100% reflects an underwriting profit. The combined ratios of The PMA Insurance Group and PMA Re were as follows:

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. The operating ratios of The PMA Insurance Group and PMA Re were as follows:

Because of our decision to withdraw from the reinsurance business, the financial results and related financial matters of PMA Re presented above will not be indicative of future results and ratios.

A glossary of selected insurance terms used in this Form 10-K is included on pages 22 to 24.

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THE PMA INSURANCE GROUP

Background

The PMA Insurance Group emphasizes its traditional core business, workers’ compensation insurance and integrated disability. We also provide a range of other commercial insurance products but generally only if they complement our workers’ compensation products, including commercial automobile and multi-peril coverages, general liability and related services. The PMA Insurance Group focuses primarily on middle-market and large accounts operating in our principal marketing territory concentrated in the eastern part of the United States. Currently, approximately 90% of this business is produced through independent agents and brokers.

The PMA Insurance Group competes on the basis of its ability to offer tailored workplace disability management solutions to its clients, its long-term relationships with its agents and brokers, its localized service and its reputation as a high-quality claims and risk control service provider.

The PMA Insurance Group has the ability to handle multi-state clients based in its operating territory but which have operations in other parts of the U.S. by being authorized to do business in 52 jurisdictions (including Puerto Rico and the District of Columbia) for workers’ compensation, general liability and commercial automobile. The PMA Insurance Group intends to continue writing other lines of property and casualty insurance, but generally only if such writings are supported by its core workers’ compensation business. The PMA Insurance Group is one of the leading providers of integrated disability products with 123 accounts as of December 31, 2003 that generated approximately $46 million in combined workers’ compensation and integrated disability premium in 2003. The PMA Insurance Group’s primary insurance subsidiaries (Pennsylvania Manufacturers’ Association Insurance Company, Manufacturers Alliance Insurance Company and Pennsylvania Manufacturers Indemnity Company) will sometimes be referred to as the Pooled Companies because they share results under an intercompany pooling agreement.

Although we cannot currently predict the ultimate effect of the recent A.M. Best financial strength rating downgrade on The PMA Insurance Group’s business, such downgrade will likely result in lower premiums written. Further, the recent ratings downgrades may make it more difficult to write business at the same rates and favorable terms and conditions as our current businesses. See “Ratings” beginning on page 16 for additional information.

Products

The PMA Insurance Group’s premiums written were as follows:

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Workers’Compensation Insurance

All states require employers to provide workers’ compensation benefits to their employees for injuries and occupational diseases arising out of employment, regardless of whether such injuries result from the employer’s or the employee’s negligence. Employers may insure their workers’ compensation obligations subject to state regulation or, subject to regulatory approval, self-insure their liabilities. Workers’ compensation statutes require that a policy cover three types of benefits: medical expenses, disability (indemnity) benefits and death benefits. The amounts of disability and death benefits payable for various types of claims are set and limited by statute, but no maximum dollar limitation exists for medical benefits. Workers’ compensation benefits vary among states, and the insurance rates we charge to our customers are subject to differing forms of state regulation.

Statutory direct workers’ compensation business written by jurisdiction was as follows:

Based upon direct written premium information published by the A.M. Best Company for the most recently available year (2002), The PMA Insurance Group is the second largest writer of workers’ compensation insurance in Pennsylvania and ranks among the fifteen largest writers of workers’ compensation insurance in Delaware, District of Columbia, New Jersey, Maryland, Virginia, South Carolina and New York. The PMA Insurance Group has focused primarily on the jurisdictions in the table above based upon its knowledge of their workers’ compensation systems and its assessment of each state’s respective business, economic, legal and regulatory climates. We closely monitor and take into consideration rate adequacy, regulatory climate and economic conditions in each state in the underwriting process. The PMA Insurance Group employs similar analyses in determining whether and to what extent it will offer products in additional jurisdictions.

The PMA Insurance Group is focused on expanding its premium base in territories that meet its underwriting and actuarial criteria. In recent years, The PMA Insurance Group increased its writings of workers’ compensation premiums through focused marketing efforts in its principal marketing territories. In addition, The PMA Insurance Group continues to benefit from writing business for insureds mainly operating in The PMA Insurance Group’s principal marketing territory but with some operations in other states.

Workers’ compensation insurers doing business in certain states are required to provide insurance for risks that are not otherwise written on a voluntary basis by the private market (“residual market business”). This system exists in all of The PMA Insurance Group’s marketing jurisdictions, except Pennsylvania, New York and Maryland. In these three states, separate governmental entities write all of the workers’ compensation residual market business. In 2003, The PMA Insurance Group wrote $24.9 million in premiums of residual market business, which constituted less than 5% of its gross workers’ compensation premiums written. Based upon data for policy year 2002 reported by the National Council on Compensation Insurance, the percentage of residual market business for the industry as a whole, in all states, was 11.0% of direct workers’ compensation premiums written.

The PMA Insurance Group offers a variety of workers’ compensation products to its customers. Rate-sensitive products are essentially based on manual rates filed and approved by state insurance departments, while loss-sensitive products are priced to a certain extent on the basis of the insured’s own loss experience. The PMA Insurance Group has also developed and sold alternative market products, such as large deductible products and other programs and services to customers who agree to assume even greater exposure to loss than under more traditional loss-sensitive products. The PMA Insurance Group decides which type of product to offer a customer based upon the customer’s needs, an underwriting review and financial qualification.

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The PMA Insurance Group’s voluntary workers’ compensation direct premiums written by product type were as follows:

The PMA Insurance Group developed a product for group integrated occupational and non-occupational disability coverages, named PMA One^®, which it began marketing in 1998. PMA One leverages what we consider to be one of The PMA Insurance Group’s most important core competencies: managing employee disabilities. PMA One offers employers the benefits of coordinated workers’ compensation and disability administration, reduced costs, programs designed to encourage faster return to work and heightened employee productivity. In 2003, we had 123 PMA One clients, which generated approximately $46 million of combined workers’ compensation and integrated disability written premiums. PMA One clients include health care systems, educational institutions, manufacturers and financial institutions.

Through The PMA Insurance Group’s workers’ compensation product offerings, we provide a comprehensive array of managed care services to control loss costs. These include:

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Commercial Lines

The PMA Insurance Group writes property and liability coverages for larger and middle market accounts that satisfy its underwriting standards. See “Underwriting” on page 7. These coverages feature commercial automobile, commercial multi-peril, general liability and umbrella business. The PMA Insurance Group offers these products, but generally only if they complement the core workers’ compensation business.

Other Products and Services

The PMA Insurance Group offers “rent-a-captive” products for certain insureds and associations. The purpose of a rent-a-captive program is to offer a customer an alternative method of managing its loss exposures by obtaining many of the benefits of a captive insurer without establishing and capitalizing its own captive; in effect, the insured is “renting” a captive facility that we have already established.

Under this arrangement, the client purchases an insurance policy from us and chooses a participation level. We then cede this portion of the premium and loss exposures to either a Bermuda- or Cayman-based subsidiary. The client participates in the loss and investment experience of the portion ceded to the Bermuda- or Cayman-based subsidiary through a dividend mechanism. The client is responsible for any loss that may arise within its participation level, and this potential obligation is typically secured through a letter of credit or similar arrangement. Our principal sources of income from this rent-a-captive program are the premium income on the risk retained by us and captive management fees earned.

Through PMA Management Corp., The PMA Insurance Group provides claims, risk management and related services primarily to self-insureds on an unbundled basis.

Distribution

The PMA Insurance Group distributes its products through multiple channels, including national, regional and local brokers and agents, employee benefits brokers, and direct sales representatives.

As of December 31, 2003, The PMA Insurance Group employed 12 direct sales representatives and had contracts with approximately 335 independent brokers and agents. The direct sales representatives are generally responsible for certain business located in Pennsylvania and Delaware. For the year ended December 31, 2003, these employees produced approximately $52 million in direct premiums written.

The independent brokers and agents solicit business throughout the marketing territory. The current distribution network generally consists of large regional agents and brokers, local agents, and national brokers that specialize in larger to middle market accounts that require the variety of workers’ compensation, commercial lines and alternative market products offered by The PMA Insurance Group. In 2003, independent brokers and agents accounted for approximately 90% of The PMA Insurance Group’s direct written premiums. The top ten independent brokers and agents accounted for approximately 16% of The PMA Insurance Group’s direct written premiums, the largest of which accounted for approximately 3% of its direct written premiums.

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The PMA Insurance Group’s underwriters review all business submissions before it is accepted. The PMA Insurance Group monitors several statistics with respect to its independent brokers and agents, including a complete profile of the broker/agent, the number of years the broker/agent has been associated with The PMA Insurance Group, the percentage of the broker/agent’s business that is underwritten by The PMA Insurance Group, the ranking of The PMA Insurance Group within the broker/agent’s business and the profitability of the broker/agent’s business.

As of December 31, 2003, the field organization consisted of 17 offices throughout The PMA Insurance Group’s principal marketing territory. Branch offices deliver a full range of services directly to customers located in their service territory, while satellite offices primarily offer risk control and claim adjustment services.

Underwriting

The PMA Insurance Group’s underwriters, in consultation with actuaries, determine the general type of business to be written using a number of criteria, including past performance, relative exposure to hazard, premium size, type of business and other indicators of potential loss. Specific types of business are referred to underwriting specialists and actuaries for individual pricing. The underwriting team also establishes classes of business that The PMA Insurance Group generally will not write, such as certain property exposures, certain hazardous products and activities, and certain environmental coverages. Because terrorism exclusions have never been permitted for workers’ compensation business, we refined our workers’ compensation underwriting guidelines to reduce the underwriting exposure from terrorism risks, including the review of aggregation of risks by geographic location, evacuation and security of buildings in which insured employees work, and the type of entities located in the vicinity of the prospective insured. These refined procedures have not materially affected The PMA Insurance Group’s mix of business.

Underwriters and risk-control professionals in the field report functionally to the Chief Underwriting Officer and locally to branch vice presidents who are accountable for territorial operating results. Underwriters also work with the field marketing force to identify business that meets prescribed underwriting standards and to develop specific strategies to write the desired business. In performing this assessment, the field office professionals also consult with actuaries who have been assigned to the specific field office regarding loss trends and pricing and utilize actuarial loss rating models to assess the projected underwriting results of accounts. A formal underwriting quality assurance program is also employed to ensure consistent adherence to underwriting standards and controls.

The PMA Insurance Group also employs credit analysts. These employees review the financial strength and stability of customers who utilize loss-sensitive and alternative market products and specify the type and amount of collateral that customers must provide under these arrangements. Premium auditors perform audits to determine that premiums charged accurately reflect actual exposures.

Claims Administration

Claims services are delivered to customers primarily through employees located in the field offices. Claim handling professionals are assigned to each reported loss based on coverage and jurisdictional expertise. Claims meeting certain criteria are referred to line of business claim specialists. A formal quality assurance program is carried out to ensure the consistency and effectiveness of claims adjustment activities. Claim handlers are also supported by a network of in-house legal counsel and an anti-fraud investigative unit. A special claims unit has also been established in the home office to focus on more complex specialized matters such as asbestos and environmental claims.

The PMA Insurance Group maintains a centralized claim processing center in order to minimize the volume of clerical and repetitive administrative demands on our claims specialists. The center’s ability to handle loss reports, claim set-up, payments and statutory reporting allows the specialists to focus immediate contact and a timely and effective resolution process. A centralized call center is also located in the claim processing center to provide 24 hour coverage for customer requests and inquiries.

In 2002, The PMA Insurance Group expanded its internet-based functionality to include claim reporting capability. Currently, 20% of new losses are reported through PMA Cinch®, our internet risk management information technology.

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Competition

The domestic property and casualty insurance industry is very competitive and consists of many companies, with no one company dominating the market for all products. In addition, the degree and nature of competition varies from state to state for a variety of reasons, including the regulatory climate and other market participants in each state. In addition to competition from other insurance companies, The PMA Insurance Group competes with certain alternative market arrangements, such as captive insurers, risk-sharing pools and associations, risk retention groups, and self-insurance programs. Many of our competitors are larger and have greater financial resources than us.

The main factors upon which entities in our markets compete are price, service, product capabilities and financial security. The PMA Insurance Group attempts to price its products in such a way that the prices charged to their clients are commensurate with the overall marketplace while still meeting our rate of return targets. The PMA Insurance Group has rejected and/or non-renewed certain accounts where we believed the market rates, terms and conditions for such risks did not provide the opportunity to achieve an acceptable rate of return.

We maintain service standards concerning turn-around time for underwriting submissions, information flow, claims handling and the quality of other services. These standards help ensure that clients are satisfied with our products and services. We periodically participate in surveys of intermediaries and clients to gain an understanding of the perceptions of our service as compared to our competitors.

We attempt to design products that meet the needs of clients in our markets. In recent years, The PMA Insurance Group has developed products that reflect the evolving nature of the workers’ compensation market. Specifically, it has developed PMA One, a product that provides for group integrated occupational and non-occupational disability coverages. The PMA Insurance Group has also increased its focus on rehabilitation and managed care to control workers’ compensation costs for the employers. In addition, it also continues to benefit from writing business for insureds mainly operating in The PMA Insurance Group’s principal marketing territory but with some operations in other states. See “The PMA Insurance Group—Products” for additional discussion. We continually evaluate new product opportunities for The PMA Insurance Group.

Industry Trends

During the 1990s and into 2000, the property and casualty insurance industry was characterized by excess capacity, which resulted in highly competitive market conditions evidenced by declining premium rates and, in many cases, policy terms less favorable to the insurers. As a result of this prolonged soft market, beginning in 2000, capacity in the property and casualty market began to contract as companies withdrew from the business or ceased operations. In response to market conditions, many insurance and reinsurance companies, including our companies, independently sought and achieved significant price increases and improved policy terms commencing in the second half of 2000. In 2002 and 2001, we realized price increases at The PMA Insurance Group in excess of 15%. These increases continued in 2003, with The PMA Insurance Group obtaining price increases of 10% for its workers’ compensation business and 17% for its Commercial Lines business.

In addition to these increases, we have achieved generally improved terms in certain of our insurance policies. For example, we have implemented broader coverage exclusions, lower occurrence limits, lower ceding commissions, accelerated payment terms and higher retentions or deductibles for insureds. These improvements in terms and conditions should further enhance the profitability of our business.

Despite current market conditions, there can be no assurance that prices and premiums will increase at a level consistent with these expectations. Even if the industry in general experiences those types of increases, we cannot assure you that we will see similar increases or that we will achieve price increases consistent with 2003. Further, any benefit that we derive from such price increases may be partially or completely offset by increases in ceded reinsurance premiums and unexpected increases in our loss reserves.

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PMA RE

On November 6, 2003, we announced our decision to withdraw from the reinsurance business. We are no longer writing new reinsurance business. The results of this business, which had been offered though our PMA Re business segment, will be included in Run-off Operations effective in 2004. Prior to November 6, 2003, the Company’s reinsurance operations offered excess of loss and pro rata property and casualty reinsurance protection mainly through reinsurance brokers. PMA Re provided treaty reinsurance on both a traditional and finite risk basis as well as facultative reinsurance. PMA Re focused on providing reinsurance to small- to medium-sized insurers, which we define as insurers with less than $500 million of statutory surplus.

Reinsurance is an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, against all or a portion of the insurance risks underwritten by the ceding company under one or more insurance contracts. Reinsurance provides ceding companies with several benefits: reducing exposure on individual risks, protecting against catastrophic losses, stabilizing underwriting results and maintaining acceptable capital ratios.

PMA Re provided reinsurance coverage primarily under two arrangements: treaty and facultative. Typically, in treaty reinsurance, the primary insurer or ceding company is obligated to cede and the reinsurer is obligated to accept a specified portion of all agreed upon types or categories of risks originally written by the primary insurer or ceding company. Facultative reinsurance is a form of reinsurance coverage that is placed on a risk-by-risk basis, and the reinsurer retains the right to accept or reject each individual risk submitted by the ceding company. Of PMA Re’s total net premiums written during 2003, 95% were treaty and 5% were facultative.

Late in 2000, PMA Re invested in a Lloyd’s of London managing general agency, Cathedral Capital PLC, and commencing in 2001, we began participating in the results of Syndicate 2010, which primarily writes property and aviation reinsurance. In the fourth quarter of 2002, we increased our ownership in Cathedral Capital to 29.9% of their outstanding capital stock. In connection with that transaction, we ceased our direct participation in Syndicate 2010 effective December 31, 2002. At December 31, 2003, our interest in Cathedral Capital was approximately $34 million. Cathedral Capital has agreed to indemnify us for losses exceeding £300,000 arising from Syndicate 2010 related to the 2001 and 2002 underwriting years of account in which we participated. In consideration for the indemnification, we have agreed to pay Cathedral Capital 30% of any underwriting profit related to the 2001 and 2002 years of account. Cathedral Capital primarily provides underwriting and management services for various Lloyd’s syndicates providing primarily property and casualty coverages.

PMA Re had five distinct underwriting units, organized by class of business. The Traditional-Treaty, Finite Risk and Financial Products, Specialty-Treaty, and Accident-Treaty units provided treaty reinsurance coverage. The fifth unit, Facultative, provided reinsurance on a facultative basis. The Traditional-Treaty underwriting unit wrote general property and casualty business. The Traditional casualty portfolio included general liability, umbrella, commercial automobile and workers’ compensation.

The Finite Risk and Financial Products underwriting unit provided PMA Re’s clients with creative risk management solutions that complemented their traditional reinsurance program. Under its finite risk covers, PMA Re assumed a measured amount of insurance risk in exchange for a specified margin. Our finite risk reinsurance covers typically included a combination of sub-limits and caps on the maximum gain or loss to PMA Re as the reinsurer. In December 2003, we executed a definitive agreement with Imagine Insurance Company Limited (“Imagine”) selling the renewal rights to PMA Re’s finite business and giving Imagine the exclusive option to assume certain of PMA Re’s finite business currently in force. The amount of business transferred to Imagine will be subject to their underwriting practices and standards. Under the terms of the agreement, Imagine will compensate PMA Re based upon the amount of in-force business either renewed or assumed by Imagine.

The Specialty-Treaty underwriting unit wrote business that fell outside the confines of our traditional property and casualty risks. The Facultative underwriting unit wrote property and casualty reinsurance on an individual risk basis and on a program/semi-automatic basis, in which we agreed to accept risks that fell within certain predetermined parameters. In 2002, the Accident-Treaty unit was created to take advantage of market opportunities and to expand the portfolio of products offered by PMA Re. The Accident-Treaty unit offered a wide variety of accident products to life insurance companies, writers of workers’ compensation insurance and writers of Special Risk insurance. In 2004, we entered into a 100% quota share reinsurance agreement with a third-party reinsurer in which the reinsurer agreed to reinsure all of the liabilities of the Accident-Treaty unit occurring after December 31, 2003, in return for 100% of the Unit’s unearned premium reserve.

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PMA Re’s gross and net premiums written by business unit and major category of business were as follows:

As of December 31, 2003, traditional catastrophe covers accounted for approximately 2% of PMA Re’s gross property premiums written. The per risk property programs written by PMA Re generally contain per occurrence limits and in some instances there is less catastrophe exposure either because of the locations of the insured values or the nature of the underlying exposures. In addition, PMA Re’s gross premiums written include approximately $21 million of funded catastrophe coverages written by the Finite Risk and Financial Products unit. These funded covers contain per occurrence and aggregate limits, as well as loss sensitive additional premium provisions in the event of a loss to mitigate the severity of the catastrophic loss to us. However, as is common in property reinsurance, PMA Re is exposed to the possibility of loss from catastrophes due to the aggregation of losses. PMA Re actively manages this exposure through zonal management, minimizing writings of catastrophe business, and the purchase of retrocessional protection. See “Item 7 - MD&A - Reinsurance” and “Reinsurance and Retrocessional Protection” on page 11 for additional information regarding PMA Re’s catastrophe retrocessional program.

PMA Re’s claims department analyzes reported claims, establishes individual claim reserves, pays claims, provides claims-related services to clients and audits the claims activities of selected clients. The claims department’s evaluation of claims activity includes reviewing loss reports received from ceding companies to confirm that claims are covered under the terms of the relevant reinsurance contract, establishing reserves on an individual case basis and monitoring the adequacy of those reserves. The claims department monitors the progress and ultimate outcome of the claims to determine that subrogation, salvage and other cost recovery opportunities have been adequately explored. The claims department performs these functions in coordination with the actuarial department.

In addition to evaluating and adjusting claims, the claims department conducts claims audits at the offices of selected ceding companies. The claims department also conducts annual claims audits for many current and former client ceding companies.

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PMA Re’s claims department uses electronic data exchange where trading partner capabilities exist to maintain the timeliness of claims remittances and processing efficiency.

RUN-OFF OPERATIONS

Run-off Operations, formerly known as Caliber One, comprise the assets and liabilities relating to the inforce policies of our former excess and surplus lines business written prior to January 2, 2003. Our excess and surplus lines business focused on excess and surplus lines of insurance for low frequency/high severity risks that were declined by the standard market. The Run-off Operations wrote business throughout the United States, generally through surplus lines brokers.

Our Run-off Operations analyze and investigate reported claims, establish individual claim reserves, pay claims and monitor the progress and ultimate outcome of the excess and surplus lines claims. In addition, they determine that subrogation, salvage and other cost recovery opportunities have been adequately explored.

All notices of claims are reported to the Run-off Operations’ centralized claims department. Claims services are delivered to customers through employees and independent adjusters under the direction of internal claims staff. The claims staff actively directs and manages the activities of all outside attorneys utilized in the claims process.

See Note 15 in Item 8 of this Form 10-K for additional information regarding the Run-off Operations.

REINSURANCE AND RETROCESSIONAL PROTECTION

We follow the customary insurance practice of reinsuring with other insurance companies a portion of the risks under the policies written by our insurance subsidiaries. This reinsurance is maintained to protect the insurance subsidiaries 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 ceded reinsurance agreements of our insurance subsidiaries generally may be terminated at their annual anniversary by either party upon 30 to 90 days’ notice. In general, the reinsurance agreements are treaty agreements, which cover all underwritten risks of the types specified in the treaties. Our reinsurance is on a per risk and per occurrence basis. Per risk reinsurance offers reinsurance protection for each risk involved in each occurrence. Per occurrence reinsurance is a form of reinsurance under which the date of the loss event is deemed to be the date of the occurrence regardless of when reported and permits all losses arising out of one event to be aggregated.

See "Item 7 - MD&A - Reinsurance" and Note 6 in Item 8 of this 10-K for additional information.

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LOSS RESERVES

Insurers establish reserves representing estimates of future amounts needed to pay claims with respect to insured events that have occurred, including events that have not been reported to the insurer. Reserves are also established for LAE representing the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process.

After a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. The estimate reflects the informed judgment of management based on reserving practices and management’s experience and knowledge regarding the nature and value of the specific type of claim. Claims personnel review and update their estimates as additional information becomes available and claims proceed towards resolution. In addition, reserves are also established on an aggregate basis:

Reserves are estimated using various generally accepted actuarial methodologies. As part of the reserving process, historical and industry data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments, changes in social attitudes and economic conditions, including the effects of inflation. This process relies on the basic assumption that past experience, adjusted for the effect of current developments and probable trends, provides a reasonable basis for predicting future events. The reserving process provides implicit recognition of the impact of inflation and other factors affecting claims payments by taking into account changes in historic payment patterns and perceived probable trends. There is generally no precise method, however, for subsequently evaluating the adequacy of the consideration given to inflation or to any other specific factor, since the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent.

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 insurer and the insurer’s payment of that loss. In addition, because reinsurers rely on their ceding companies to provide them with information regarding incurred losses, reported claims for reinsurers become known more slowly than for primary insurers and are generally subject to more unforeseen development and uncertainty. Estimating our 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, 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 December 31, 2003, the related adjustments could have a material adverse effect on our financial condition, results of operations and liquidity.

The table on the next page presents the subsequent development of the estimated year-end property and casualty reserves, net of reinsurance (“net reserves”), for the ten years prior to 2003. The first section of the table shows the estimated net reserves that were recorded at the end of each respective year for all current and prior year unpaid losses and LAE. The second section shows the cumulative amounts of such previously recorded net reserves paid in succeeding years. The third section shows the re-estimates of the net reserves made in each succeeding year.

The cumulative deficiency (redundancy) as shown in the table represents the aggregate change in the reserve estimates from the original balance sheet dates through December 31, 2003; an increase in a loss estimate that related to a prior year occurrence generates a deficiency in each intervening year. For example, a deficiency first recognized in 2000 relating to losses incurred in 1993 would be included in the cumulative deficiency amount for each of the years 1993 through 1999. However, the deficiency would be reflected in operating results in 2000 only.

Conditions and trends that have affected the reserve development reflected in the table may change, and care should be exercised in extrapolating future reserve redundancies or deficiencies from such development.

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Consolidated Loss and Loss Adjustment Expense Development

December 31,
(dollar amounts in millions)

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Unpaid losses and LAE on a GAAP basis were $2,541.3 million and $2,449.9 million at December 31, 2003 and 2002, respectively. Unpaid losses and LAE on a statutory basis were $1,080.1 million and $970.9 million at December 31, 2003 and 2002, respectively. The difference between GAAP and statutory loss reserves reflects: 1) reinsurance receivables on unpaid losses and LAE, which are recorded as assets for GAAP but netted against statutory loss reserves, and 2) non-U.S. domiciled insurance companies, whose unpaid losses and LAE are included for GAAP purposes, but not for statutory purposes.

The components of our (favorable) unfavorable development of reserves for losses and LAE for prior accident years, excluding accretion of discount, are as follows:

The PMA Insurance Group recorded unfavorable prior year loss development of $49.7 million, $1.1 million and $2.9 million in 2003, 2002 and 2001, respectively. In the fourth quarter of 2003, our internal actuaries completed a comprehensive year-end actuarial analysis of loss reserves. Based on the actuarial work performed, we noticed higher than expected claims severity in our workers’ compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers’ compensation business. As a result, The PMA Insurance Group increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of The PMA Insurance Group's loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under The PMA Insurance Group’s loss-sensitive rating plans we adjust the amount of the insured’s premiums after the policy period expires based, to a large extent, upon the insured’s actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million.

During 2003, PMA Re increased net loss reserves for prior accident years by $169.1 million, including $150 million during the third quarter. PMA Re’s third quarter 2003 reserve charge related to higher than expected underwriting losses, primarily from casualty business written in accident years 1997 through 2000. Approximately 75% of the charge was related to general liability business written from 1997 to 2000 with substantially all of the remainder from the commercial automobile line written during those same years. During the third quarter, the Company's actuaries conducted their periodic comprehensive reserve review. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by PMA Re. The information derived during this review indicated that a large portion of the change in expected loss development was due to increasing loss trends emerging in calendar year 2003 for prior accident years. This increase in 2003 loss trends caused us to determine that the reserve levels, primarily for accident years 1997 to 2000, needed to be increased by $150 million. An independent actuarial firm also conducted a comprehensive review of PMA Re’s Traditional-Treaty, Specialty-Treaty and Facultative loss reserves, and concluded that those carried loss reserves were reasonable at September 30, 2003.

PMA Re’s analysis was enhanced by an extensive review of specific accounts, comprising about 40% of carried reserves for accident years 1997 to 2000. The Company's actuaries visited a number of former ceding company clients, which collectively comprised about 25% of PMA Re’s total gross loss and LAE reserves from accident years 1997 to 2000, to discuss reserving and reporting experience with these ceding companies. The Company's actuaries separately evaluated an additional number of other ceding companies, representing approximately 15% of PMA Re’s total gross loss and LAE reserves from accident years 1997 to 2000, to understand and examine data trends.

During 2002, PMA Re recorded unfavorable prior year development of $106.9 million. In the fourth quarter, PMA Re’s actuarial department conducted its routine year-end reserve study to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. During the fourth quarter, the Company’s actuaries observed a higher than expected increase in the frequency and, to a lesser extent, severity of reported claims by PMA Re’s ceding companies. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by PMA Re. Management’s selection of the ultimate losses indicated that net loss and LAE reserves for prior accident years needed to be increased by approximately

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$64 million in the fourth quarter of 2002, primarily for excess of loss and pro rata general liability occurrence contracts and, to a lesser extent, excess of loss general liability claims-made contracts, from accident years 1998, 1999 and 2000.

The remaining $43 million of unfavorable prior year development at PMA Re in 2002 primarily reflects the recording of losses and LAE on additional earned premiums recorded during 2002 as a result of a change in our estimate of ultimate premiums written from prior years. Because premiums from ceding companies are typically reported on a delayed basis, we monitor and update as appropriate the estimated ultimate premiums written. PMA Re’s periodic reviews of estimated ultimate premiums written, which compared actual reported premiums and originally estimated premiums based on ceding company estimates, indicated that premiums written in recent years, primarily in the Traditional- and Specialty-Treaty units for 2001 and 2000, were higher than originally estimated. As a result, PMA Re recorded additional net premiums earned during 2002, including $39.9 million in the second quarter, which were completely offset by losses and LAE and acquisition expenses.

During 2002, the Run-off Operations recorded unfavorable prior year development of $51.8 million. During 2002, company actuaries conducted reserve reviews to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection 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 their reviews indicated that net loss reserves for prior accident years, mainly 1999 and 2000, needed to be increased by $51.8 million. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in 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.

As a result of its reserve reviews conducted in 2001, the Run-off Operations revised its estimate of ultimate expected claims activity and, accordingly, increased its estimate of ultimate losses, substantially all for accident years 1999 and 2000. During 2001, the Run-off Operations recorded unfavorable prior year loss development of $22.2 million. These losses primarily reflect higher than expected claim frequency and severity that emerged in 2001 on certain casualty lines of business, primarily professional liability policies for the nursing homes class of business, and, to a lesser extent, property lines of business.

At December 31, 2003 and 2002, our GAAP loss reserves were recorded net of discount of $67.0 million and $97.8 million, respectively, primarily related to workers’ compensation business. Pre-tax income (loss) is negatively impacted by accretion of discount on prior year reserves and favorably impacted by recording of discount for current year reserves. The net of these amounts is referred to as net discount accretion. Net discount accretion benefited pre-tax results by $6.3 million and $6.8 million in 2003 and 2002, respectively.

At December 31, 2003, our loss reserves were stated net of $33.2 million of salvage and subrogation. Our policy with respect to estimating the amounts and realizability of salvage and subrogation is to develop accident year schedules of historic paid salvage and subrogation by line of business, which are then projected to an ultimate basis using actuarial projection techniques. The anticipated salvage and subrogation is the estimated ultimate salvage and subrogation less any amounts received by us. The realizability of anticipated salvage and subrogation is reflected in the historical data that is used to complete the projection, as historical paid data implicitly considers realization and collectibility.

Asbestos and Environmental Reserves

At December 31, 2003, 2002 and 2001, gross reserves for asbestos-related losses were $37.8 million, $42.1 million and $59.9 million, respectively ($17.8 million, $25.8 million and $28.6 million, net of reinsurance, respectively). Of the net asbestos reserves, approximately $14.9 million, $22.9 million, and $26.6 million related to IBNR losses at December 31, 2003, 2002 and 2001, respectively. At December 31, 2003, 2002 and 2001 gross reserves for environmental-related losses were $14.2 million, $18.2 million and $29.6 million, respectively ($8.8 million, $14.3 million and $16.0 million, net of reinsurance, respectively). Of the net environmental reserves, approximately $3.7 million, $7.9 million and $9.2 million related to IBNR losses at December 31, 2003, 2002 and 2001, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards and regulations. We believe that our reserves for

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asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, our ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to our financial condition and results of operations.

INVESTMENTS

An important component of our financial results is the return on invested assets. Our investment objectives are to (i) seek competitive after-tax income and total return as appropriate, (ii) maintain medium to high investment grade asset quality and high marketability, (iii) maintain maturity distribution commensurate with our business objectives, (iv) provide portfolio flexibility for changing business and investment climates and (v) provide liquidity to meet operating objectives. Our investment strategy includes guidelines for asset quality standards, asset allocations among investment types and issuers, and other relevant criteria for our portfolio. In addition, invested asset cash flows, both current income and investment maturities, are structured after considering projected liability cash flows of loss reserve payouts using actuarial models. Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets, which are structured to emphasize current investment income to the extent consistent with maintaining appropriate portfolio quality and diversity. The liquidity requirements are met primarily through publicly traded fixed maturities as well as operating cash flows and short-term investments.

The executive committee of our board of directors is responsible for reviewing our investment objectives. We retain outside investment advisers to provide investment advice and guidance, supervise our portfolio and arrange securities transactions through brokers and dealers. Investments by the Pooled Companies and PMA Capital Insurance Company must comply with the insurance laws and regulations of the Commonwealth of Pennsylvania.

We do not currently own any derivative financial instruments. We do not use derivatives for speculative purposes. Our investment portfolio does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, we do not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 14% of invested assets at December 31, 2003. Included in this industry segment are diverse financial institutions, including financing subsidiaries of automotive manufacturers.

For additional information on our investments, including carrying values by category, quality ratings and net investment income, see "Item 7 - MD&A - Investments" as well as Notes 2-B and 4 in Item 8 of this Form 10-K.

RATINGS

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

Rating agencies rate insurance companies based on financial strength and the ability to pay claims, factors more relevant to policyholders than investors. We believe that the ratings assigned by nationally recognized, independent rating agencies, particularly A.M. Best, are material to our operations. We currently participate in the ratings process of A.M. Best and Moody’s Investor Services. Other rating agencies also rate our securities, which we do not disclose in our reports.

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

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As of February 29, 2004, the financial strength ratings of our principal insurance subsidiaries and the debt ratings of PMA Capital Corporation, as published by the principal rating agencies, are as follows:

A downgrade in the A.M. Best financial strength rating of the Pooled Companies would result in a material loss of business as policyholders move to other companies with higher financial strength ratings. Accordingly, such a downgrade to our A.M. Best insurer financial strength rating would have a material adverse effect on our results of operations, liquidity and capital resources.

A downgrade in our debt ratings will affect our ability to raise additional debt with terms and conditions similar to our current debt, and, accordingly, will increase our cost of capital. In addition, a downgrade of our debt ratings will make it more difficult to raise capital to refinance any maturing debt obligations and to maintain or improve the current financial strength ratings of our principal insurance subsidiaries.

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

See "Risk Factors" beginning on page 25 and "Item 7 - MD&A - Recent Developments" for additional information regarding our ratings.

REGULATORY MATTERS

General

One or more of The PMA Insurance Group’s Pooled Companies are licensed to transact insurance business in, and are subject to regulation and supervision by, 52 jurisdictions (including Puerto Rico and the District of Columbia). PMA Capital Insurance Company is licensed or accredited to transact business in, and is subject to regulation and supervision by, 50 states and the District of Columbia. Our insurance subsidiaries are authorized and regulated in all jurisdictions where they conduct insurance business.

In supervising and regulating insurance and reinsurance companies, state insurance departments, charged primarily with protecting policyholders and the public rather than investors, enjoy broad authority and discretion in applying applicable insurance laws and regulations for that purpose. The Pooled Companies and PMA Capital Insurance Company are domiciled in Pennsylvania, and the Pennsylvania Insurance Department exercises principal regulatory jurisdiction over them. The extent of regulation by the states varies, but in general, most jurisdictions have laws and regulations governing standards of solvency, adequacy of reserves, reinsurance, capital adequacy and standards of business conduct.

In addition, statutes and regulations usually require the licensing of insurers and their agents, the approval of policy forms and related material and, for certain lines of insurance, including rate-sensitive workers’ compensation, the approval of rates. Property and casualty reinsurers are generally not subject to filing or other regulatory requirements applicable to primary standard lines insurers with respect to rates, underwriting rules and policy forms. The form and content of statutory financial statements are regulated.

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The U.S. federal government does not directly regulate the insurance industry; however, federal initiatives from time to time can impact the insurance industry. In November 2002, the Terrorism Risk Insurance Act of 2002 (“TRIA”) became effective. TRIA provides federal reinsurance protection for property and casualty losses in the United States or to United States aircraft or vessels arising from certified terrorist acts through the end of 2005. For terrorist acts to be covered under TRIA, they must be certified as such by the United States Government and must be committed by individuals acting on behalf of a foreign person or interest. TRIA contains a “make available” provision, which requires insurers subject to the Act, to offer coverage for acts of terrorism that does not differ materially from the terms (other than price), amounts and other coverage limitations offered to the policyholder for losses from events other than acts of terrorism. The “make available” provision permits exclusions for certain types of losses, if a state permits exclusions for such losses. TRIA requires insurers to retain losses based on a percentage of their commercial lines direct earned premiums for the prior year equal to a 7% deductible for 2003, 10% for 2004 and 15% for 2005. The federal government covers 90% of the losses above the deductible, while a company retains 10% of the losses. TRIA contains an annual limit of $100 billion of covered industry-wide losses. TRIA applies to commercial lines of property and casualty insurance, including workers’ compensation insurance, offered by The PMA Insurance Group, but does not apply to reinsurance. The PMA Insurance Group would have a deductible of approximately $43 million in 2004 if a covered terrorist act were to occur.

Workers’ compensation insurers were not permitted to exclude terrorism from coverage prior to the enactment of TRIA, and continue to be subject to this prohibition. When underwriting existing and new commercial insurance business, The PMA Insurance Group considers the added potential risk of loss due to terrorist activity, and this may lead it to decline to write or non-renew certain business. Appropriate rates may be charged for terrorism coverage, and as of January 1, 2004, The PMA Insurance Group had adopted premium charges for workers’ compensation insurance in all states. The PMA Insurance Group has refined its underwriting procedures to take into account terrorism risks.

As discussed above, we have refined our underwriting processes to account for terrorism risks and TRIA may mitigate the potential impact of terrorism losses on our results. However, because of TRIA’s uncertain application, the amount of terrorism losses that The PMA Insurance Group must retain under TRIA and the fact that TRIA does not apply to, and we do not have terrorism exclusions in all of, our reinsurance business, future terrorist attacks may result in losses that could have a material adverse effect on our financial condition, results of operations and liquidity. For additional information regarding the underwriting criteria of our operating segments, see Business – The PMA Insurance Group, Underwriting on page 7 of this Form 10-K.

Further, although we do not write health insurance, federal and state rules and regulations affecting health care services can affect the workers’ compensation and integrated disability services we provide. Pending initiatives to increase health care regulation at the federal and state level include managed care reform and a patient’s bill of rights. We cannot predict what health care reform legislation will be adopted by Congress or by state legislatures where we do business or the effect, if any, that the adoption of health care legislation or regulations at the federal or state level will have on our results of operations.

State insurance departments in jurisdictions in which our insurance subsidiaries do business also conduct periodic examinations of their respective operations and accounts and require the filing of annual and other reports relating to their financial condition. The Pennsylvania Department of Insurance is currently conducting examinations of PMA Capital Insurance Company and the Pooled Companies as of December 31, 2002. Although we have not received the final report of the Department, we do not expect any material adjustments to previously filed statutory financial statements as a result of such examinations. In addition, we do not expect any material qualitative matters to be raised as a result of the examination.

Insurance Holding Company Regulation

The Company and its insurance subsidiaries are subject to regulation pursuant to the insurance holding company laws of the Commonwealth of Pennsylvania. Pennsylvania’s state insurance holding company laws generally require an insurance holding company and insurers and reinsurers that are members of such insurance holding company’s system to register with the insurance department authorities, to file with it certain reports disclosing information including their capital structure, ownership, management, financial condition, certain intercompany transactions, including material transfers of assets and intercompany business agreements, and to report material changes in that information. These laws also require that intercompany transactions be fair and reasonable and, under certain circumstances, prior approval of the Pennsylvania insurance department must be received before entering into an intercompany transaction. Further, these laws require that an insurer’s policyholders’ surplus following any dividends or distributions to shareholder affiliates be reasonable in relation to the insurer’s outstanding liabilities and adequate for its financial needs.

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As a result of discussions with the Pennsylvania Insurance Department, PMA Capital Insurance Company entered into a letter agreement with the Department, dated December 22, 2003. Pursuant to the agreement, PMA Capital Insurance Company has agreed to request the Department’s prior approval of certain additional actions, including: entering into any new reinsurance contracts, treaties or agreements, except as may be required by law; making any payments, dividends or other distributions to, or engaging in any transactions with, any of PMA Capital Insurance Company’s affiliates; making any withdrawal of monies from PMA Capital Insurance Company’s bank accounts or making any disbursements, payments or transfers of assets in an amount exceeding five percent (which equaled $57.1 million as of December 31, 2003) of the fair market value of PMA Capital Insurance Company’s then aggregate cash and investments; incurring any debt, obligation or liability for borrowed money, pledging its assets or loaning monies to any person or entity (whether or not affiliated); appointing any new director or executive officer; or altering its or its Pennsylvania-domiciled insurance company subsidiaries’ ownership structure. The letter agreement shall remain in effect until the Commissioner, or PMA Capital Insurance Company and the Commissioner, determine it is no longer necessary, or until and unless it is superseded by a regulatory order.

In addition, PMA Capital Insurance Company has agreed to engage an independent actuary, approved by the Department, to conduct actuarial assessments of it and its Pennsylvania-domiciled insurance subsidiaries’ (The PMA Insurance Group companies) loss reserves for 2003 and, as the Department deems necessary, each year thereafter. PMA Capital Insurance Company has also agreed to provide the Department with certain financial and operating information, including: a monthly summary statutory financial report of its results of operations and the financial position; a plan for the satisfaction of its reinsurance liabilities that will contain projections for funding each year’s liabilities and that will be regularly reviewed and revised as necessary; a list of commutations of existing reinsurance contracts or treaties and their financial impact. This is a summary of certain terms of the letter agreement and is qualified in its entirety by the full text of the letter agreement, which is filed as Exhibit 99.1 hereto and incorporated herein by reference.

Under Pennsylvania law, no person may acquire, directly or indirectly, a controlling interest in our capital stock unless such person, corporation or other entity has obtained prior approval from the Commissioner for such acquisition of control. Pursuant to the Pennsylvania law, any person acquiring, controlling or holding the power to vote, directly or indirectly, ten percent or more of the voting securities of an insurance company, is presumed to have “control” of such company. This presumption may be rebutted by a showing that control does not exist in fact. The Commissioner, however, may find that “control” exists in circumstances in which a person owns or controls a smaller amount of voting securities. To obtain approval from the Commissioner of any acquisition of control of an insurance company, the proposed acquirer must file with the Commissioner an application containing information regarding: the identity and background of the acquirer and its affiliates; the nature, source and amount of funds to be used to carry out the acquisition; the financial statements of the acquirer and its affiliates; any potential plans for disposition of the securities or business of the insurer; the number and type of securities to be acquired; any contracts with respect to the securities to be acquired; any agreements with broker-dealers; and other matters.

Other jurisdictions in which our insurance subsidiaries are licensed to transact business may have requirements for prior approval of any acquisition of control of an insurance or reinsurance company licensed or authorized to transact business in those jurisdictions. Additional requirements in those jurisdictions may include re-licensing or subsequent approval for renewal of existing licenses upon an acquisition of control. As further described below, laws that govern the holding company structure also govern payment of dividends to us by our insurance subsidiaries.

Restrictions on Subsidiaries' Dividends and Other Payments

We are a holding company that transacts substantially all of our business directly and indirectly through subsidiaries. Our primary assets are the stock of our operating subsidiaries. Our ability to meet our obligations on our outstanding debt and to pay dividends and our general and administrative expenses depends on the surplus and earnings of our subsidiaries and the ability of our subsidiaries to pay dividends or to advance or repay funds to us.

Under Pennsylvania laws and regulations, our insurance subsidiaries may pay dividends only from unassigned surplus and future earnings arising from their businesses and must receive prior approval of the Pennsylvania Insurance Commissioner to pay a dividend if such dividend would exceed the statutory limitation. The current statutory limitation is the greater of (i) 10% of the insurer’s policyholders’ surplus, as shown on its last annual statement on file with the Pennsylvania Insurance Commissioner or (ii) the insurer’s statutory net income for the previous calendar year, but in no event to exceed statutory unassigned surplus. Pennsylvania law gives the Pennsylvania Insurance Commissioner broad discretion to disapprove requests for dividends in excess of these limits. Pennsylvania law also provides that following the payment of any dividend, the insurer’s policyholders’ surplus must be reasonable in relation to its outstanding liabilities and adequate for its financial needs, and permits the Pennsylvania Insurance Commissioner to bring an action to rescind a dividend which violates these standards. In the event that the Pennsylvania Insurance Commissioner determines that the policyholders’ surplus of one subsidiary

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is inadequate, the Commissioner could use his or her broad discretionary authority to seek to require us to apply payments received from another subsidiary for the benefit of that insurance subsidiary.

All of our domestic insurance entities are owned by PMA Capital Insurance Company. Only PMA Capital Insurance Company, a Pennsylvania domiciled company, may pay dividends directly to us. During 2003, we received $24 million in dividends from PMA Capital Insurance Company. Under Pennsylvania law, approximately $17 million of dividends would have been available to be paid by PMA Capital Insurance Company to us in 2004 without the prior approval of the Pennsylvania Insurance Department as of December 31, 2003. However, under the letter agreement dated December 22, 2003, PMA Capital Insurance Company has agreed with the Pennsylvania Insurance Department that PMA Capital Insurance Company will not pay dividends to us without the prior approval of the Pennsylvania Insurance Department. As of December 31, 2003, The PMA Insurance Group’s Pooled Companies can pay up to $23.2 million in dividends to PMA Capital Insurance Company during 2004.

In addition to the regulatory restrictions, we may not declare or pay cash dividends or distributions on our Class A Common stock if we elect to exercise our right to defer interest payments on our $43.8 million of trust preferred debt outstanding.

Risk-Based Capital

The National Association of Insurance Commissioners has adopted risk-based capital requirements for property/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. Under risk-based capital ("RBC") requirements, regulatory compliance is determined by the ratio of a company’s total adjusted capital, as defined by the NAIC, to its authorized control level of RBC (known as the RBC ratio), also as defined by the NAIC.

Four levels of regulatory attention may be triggered if the RBC ratio is insufficient:

At December 31, 2003, the RBC ratios of the Pooled Companies ranged from 398% to 705% and PMA Capital Insurance Company’s RBC ratio was 262%.

We believe that we will be able to maintain the RBC ratios of our insurance subsidiaries in excess of “Company action level” through prudent underwriting, claims handling, investing and capital management. However, no assurances can be given that developments affecting the insurance subsidiaries, many of which could be outside of our control, including but not limited to changes in the regulatory environment, economic conditions and competitive conditions in the jurisdictions in which we write business, will not cause the RBC ratios to fall below required levels resulting in a corresponding regulatory response.

The NAIC has also developed a series of twelve ratios (known as the IRIS ratios) designed to further assist regulators in assessing the financial condition of insurers. These ratio results are computed annually and reported to the NAIC and the insurer’s state of domicile. In 2003, each of the Pooled Companies reported an unusual value in one ratio, relating to reserve development due to the paydown of loss reserves. In addition, one of the Pooled Companies reported an unusual value in a second ratio, due to low investment yield.

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In 2003, PMA Capital Insurance Company reported six unusual values, relating to: (1) liabilities to liquid assets ratio, (2) investment yield, (3) change in policyholder’s surplus, (4) the two-year overall operating ratio, (5) two-year development to policyholder’s surplus ratio and (6) estimated current reserve deficiency to policyholder surplus. The unusual value relating to the liabilities to liquid assets ratio is due largely to investments in PMA Capital Insurance Company’s insurance subsidiaries. These investments are not considered liquid assets, and therefore caused the ratio to increase. The unusual value related to investment yield relates primarily to a decrease in yield on our bond portfolio. The unusual values relating to the remaining ratios are due primarily to the unfavorable prior year loss development recorded in 2003 and 2002.

EMPLOYEES

As of February 29, 2004, we had approximately 1,250 full-time employees. None of our employees are represented by a labor union and we are not a party to any collective bargaining agreements. We consider our employee relations to be good.

AVAILABLE INFORMATION

The address for our internet website is www.pmacapital.com. We make available, free of charge, through our internet website, our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

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GLOSSARY OF SELECTED INSURANCE TERMS

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RISK FACTORS

Our business faces significant risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, results of operations or prospects could be affected materially.

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

Nationally recognized ratings agencies rate the financial strength of our principal insurance subsidiaries and the debt of PMA Capital Corporation. Ratings are not recommendations to buy our securities. Please see “Ratings” beginning on page 16 for a complete description of our ratings.

Although we cannot currently predict the ultimate effect of our B++ (5^th of 16) A.M. Best Rating on The PMA Insurance Group’s business, certain large account clients and clients in certain industries will not purchase property and casualty insurance from insurers with less than an A- (4^th of 16) A.M. Best rating. Therefore, we believe that a continuation of our B++ A.M. Best rating will likely result in lower premiums written. A further downgrade in our A.M. Best ratings would result in a material loss of business as policyholders move to other companies with higher financial strength ratings. Accordingly, such a downgrade to our insurer financial strength ratings would have a material adverse effect on our results of operations, liquidity and capital resources.

A downgrade in our debt ratings will affect our ability to raise additional debt with terms and conditions similar to our current debt, and, accordingly, will increase our cost of capital. In addition, a downgrade of our debt ratings will make it more difficult to raise capital to refinance any maturing debt obligations and to maintain or improve the current financial strength ratings of our principal insurance subsidiaries.

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

If our actual losses from insureds exceed our loss reserves, our financial results would be adversely affected.

Like all insurers and reinsurers, we establish reserves representing estimates of future amounts needed to pay claims with respect to insured events that have occurred, including events that have not been reported to us. We also establish reserves for loss adjustment expenses, which represent the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. Reserves are merely estimates and do not and cannot represent an exact measure of liability. The reserving process involves actuarial models, which rely on the basic assumption that past experience, adjusted for the effect of current developments and likely trends in claims severity, frequency, judicial theories of liability and other factors, is an appropriate basis for predicting future events. However, 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 insurer and the insurer’s payment of that loss. Further, because reinsurers rely on their ceding companies to provide them with information regarding incurred losses, reported claims for reinsurers generally become known more slowly than for primary insurers and are generally subject to more unforeseen development.

If, during that time, actual losses and loss adjustment expenses develop faster or are larger than our loss reserve estimates, which may be due to a wide range of factors, including inflation, changes in claims and litigation trends and legislative or regulatory changes, we would have to increase reserves. As a result, we would incur a charge to earnings in the period the reserves are increased. For example, in the third quarter of 2003, we recorded a charge of $150 million pre-tax related to higher than expected underwriting losses, primarily from casualty business written in accident years 1997 through 2000.

Reserve estimates are continually refined through an ongoing process as further claims are reported and settled and additional information concerning loss experience becomes known. Because setting reserves is inherently uncertain, our current reserves may prove inadequate in light of subsequent developments. As stated in the preceding paragraph, if we increase our reserves, our earnings for the period will generally decrease by a corresponding amount. Therefore, future reserve increases could have a material adverse effect on our results of operations and financial condition.

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We face a risk of non-collectibility of reinsurance, which could materially affect our results of operations.

We follow the customary insurance practice of reinsuring with other insurance and reinsurance companies a portion of the risks under the policies written by our insurance and reinsurance subsidiaries. During 2003, we had approximately $1.4 billion of gross written premiums of which we ceded $237.4 million, or 17% of gross written premiums, to reinsurers for reinsurance protection. This reinsurance is maintained to protect our insurance and reinsurance subsidiaries 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 our subsidiaries from their primary obligation to pay policyholders for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. As of December 31, 2003, we had $1.2 billion of reinsurance receivables from reinsurers for paid and unpaid losses, for which they are obligated to reimburse us under our reinsurance contracts. The collectibility of reinsurance is largely a function of the solvency of reinsurers. We perform annual credit reviews on our reinsurers, focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. We also require assets in trust, letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. Despite these measures, a reinsurer’s insolvency or inability to make payments under the terms of a reinsurance contract could have a material adverse effect on our results of operations and financial condition.

Because we are heavily regulated by the states in which we do business, we may be limited in the way we operate.

We are subject to extensive supervision and regulation in the states in which we do business. The supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of the supervision and regulation is the protection of our insurance policyholders, and not our investors. The extent of regulation varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to state insurance departments. This system of supervision and regulation covers, among other things:

Further, as described above in “Item 1—Regulatory Matters—Insurance Holding Company Regulation,” on December 22, 2003, PMA Capital Insurance Company entered into a voluntary agreement with the Pennsylvania Insurance Department. Pursuant to the agreement, PMA Capital Insurance Company has agreed to request the Department’s prior approval of certain actions, including: entering into any new reinsurance contracts, treaties or agreements, except as may be required by law; making any payments, dividends or other distributions to, or engaging in any transactions with, any of PMA Capital Insurance Company’s affiliates; making any withdrawal of monies from PMA Capital Insurance Company’s bank accounts or making any disbursements, payments or transfers of assets in an amount exceeding five percent of the fair market value of PMA Capital Insurance Company’s then aggregate cash and investments; incurring any debt, obligation or liability for borrowed money, pledging its assets or loaning monies to any person or entity (whether or not affiliated); appointing any new director or executive officer; or altering its or its Pennsylvania-domiciled insurance company subsidiaries’ ownership structure. Finally, the Department may impose additional operational or administrative restrictions deemed necessary by the Pennsylvania

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Insurance Commissioner for implementation of the agreement. These restrictions as well as any further restrictions on the conduct of PMA Capital Insurance Company’s business may adversely affect its ability to efficiently conduct the run-off of its insurance liabilities.

The regulations of the state insurance departments may affect the cost or demand for our products and may impede us from obtaining rate increases on insurance policies offered by our primary insurance operations or taking other actions we might wish to take to increase our profitability. Further, we may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit such authorities to supervise the business and operations of an insurance company. As of December 31, 2003, no state insurance regulatory authority had imposed on us any substantial fines or revoked or suspended any of our licenses to conduct insurance business in any state or issued an order of supervision with respect to our insurance subsidiaries, which would have a material adverse effect on our results of operations or financial condition. In light of recent insolvencies of large property and casualty insurers, it is possible that the regulations governing the level of the guaranty fund or association assessments against us may change, requiring us to increase our level of payments.

Our status as an insurance holding company with no direct operations and our agreement with the Pennsylvania Department of Insurance to restrict dividends from our insurance subsidiaries could adversely affect our ability to meet our obligations and pay dividends.

We are a holding company that transacts substantially all of our business directly and indirectly through subsidiaries. Our primary assets are the stock of our operating subsidiaries. Our ability to meet our obligations on our outstanding debt and to pay dividends and our general and administrative expenses depends on the surplus and earnings of our subsidiaries and the ability of our subsidiaries to pay dividends or to advance or repay funds to us. Payments of dividends and advances and repayments by our insurance operating subsidiaries are restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. Further, we have agreed with the Pennsylvania Insurance Department that PMA Capital Insurance Company, our only direct insurance subsidiary, will not pay dividends to us, without the prior approval of the Pennsylvania Insurance Department. As a result, we may not be able to receive dividends from PMA Capital Insurance Company at times and in amounts necessary to meet our debt obligations and corporate expenses.

We have exposure to unpredictable catastrophes, which can materially affect our financial results.

We are subject to claims arising out of catastrophes that may have a significant effect on our results of operations, liquidity and financial condition. Catastrophes can be caused by various events, including hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Insurance companies are not permitted to reserve for catastrophes until such event takes place. Therefore, although we actively manage our exposure to catastrophes through our underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes could exceed our reinsurance protection and may have a material adverse impact on our financial condition, results of operations and liquidity.

Man-made events, such as terrorism, can also cause catastrophes. For example, the attack on the World Trade Center resulted in approximately $30 million in pre-tax losses to us, after deduction of all reinsurance and retrocessional protection, for 2001. This estimate is based on our analysis of the available facts known by us to date and our examination of known exposures. However, it is difficult to fully estimate our losses from the attack given the uncertain nature of damage theories and loss amounts, and the possible development of additional facts related to the attack. As more information becomes available, we may need to increase our estimate of these losses.

Although the Terrorism Risk Insurance Act of 2002 may mitigate the impact of future terrorism losses in connection with the commercial insurance business offered by The PMA Insurance Group, because of its uncertain application, the amount of losses a company must retain and the fact that it does not apply to reinsurance business, future terrorist attacks may result in losses that have a material adverse effect on our financial condition, results of operations and liquidity.

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We face a risk of non-availability of reinsurance, which could materially affect our ability to write business and our results of operations.

Market conditions beyond our control, such as the amount of surplus in the reinsurance market and natural and man-made catastrophes, determine the availability and cost of the reinsurance protection we purchase. We cannot assure you that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as are currently available. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient, we would either have to be willing to accept an increase in our net exposures or reduce our insurance writings.

Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry.

The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties. The industry’s profitability can be affected significantly by:

The property and casualty insurance industry historically is cyclical in nature. The demand for property and casualty insurance can vary significantly, rising as the overall level of economic activity increases and falling as such activity decreases. The property and casualty insurance industry have been very competitive, although our insurance subsidiaries have experienced more favorable terms and pricing beginning in the second half of 2000 and continuing into early 2004. These fluctuations in demand and competition and the impact on us of other factors identified above could have a negative impact on our results of operations and financial condition.

Because we operate in a highly competitive industry, oversupply may negatively influence the sustainability of adequate rate charges.

The property and casualty insurance and reinsurance industry is highly competitive. The PMA Insurance Group has six major competitors. Its primary competitors are Liberty Mutual Insurance Company, American International Group, Inc., Zurich/Farmers Group, CNA Insurance Companies, Travelers Property & Casualty and The Hartford Insurance Group. Many of our competitors have greater financial, marketing and management resources than we do.

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

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These developments could make the property and casualty insurance marketplace more competitive by increasing the supply of insurance available. The significant amount of capital in the property and casualty marketplace has, until 2001, resulted in the supply of insurance outpacing demand. This oversupply has made it difficult to achieve a level of rate adequacy related to the amount of risk undertaken. Since 2003 prices have increased at a lower rate or have declined in certain lines of business, continued oversupply may negatively influence the adequacy of rate charges, and accordingly, have an adverse effect on our earnings.

Because our investment portfolio is made up primarily of fixed-income securities, the fair value of our investment portfolio and our investment income could suffer as a result of fluctuations in interest rates.

We currently maintain and intend to continue to maintain an investment portfolio made up primarily of fixed-income securities. The fair value of these securities can fluctuate depending on changes in interest rates. Generally, the fair market value of these investments increases or decreases in an inverse relationship with changes in interest rates, while net investment income earned by us from future investments in fixed-income securities will generally increase or decrease with interest rates. Our overall investment strategy is to invest in high quality securities while maintaining diversification to avoid significant concentrations in individual issuers, industry segments and geographic regions. All of our fixed-income securities are classified as available for sale; as a result, changes in the market value of our fixed-income securities are reflected in our balance sheet. Accordingly, changes in interest rates may result in fluctuations in the income from, and the valuation of, our fixed-income investments, which could have an adverse effect on our results of operations and financial condition.

The purported class action lawsuits may result in financial losses and may divert management resources.

We and certain of our directors and key executive officers are defendants in several purported class actions that were filed in 2003 in the United States District Court for the Eastern District of Pennsylvania by alleged purchasers of our Class A Common stock, 4.25% Convertible Debentures and 8.50% Monthly Income Senior Notes. The lawsuits seek damages in an unspecified amount for losses allegedly incurred as a result of materially false and misleading statements and material omissions regarding our loss reserves allegedly contained in our reports filed with the SEC, certain of our press releases, certain prospectuses and prospectus supplements and in other statements made by us. For more information on the lawsuits, see “Item 3—Legal Proceedings.” This litigation may require the dedication of significant management resources. The lawsuits are in their earliest stages. The lawsuits may have a material adverse effect on our financial condition, results of operations and liquidity. We intend to vigorously defend against the claims asserted in these actions.

Our directors and executive officers collectively have significant shareholdings and may influence action requiring stockholder approval and may have interests different than, or adverse to, those of our other security holders.

Our directors and executive officers beneficially owned approximately 13.8% of our Class A common stock at March 1, 2004. As a result, these stockholders, acting alone or together, may be able to influence matters requiring approval by our stockholders and may have interests different than, or adverse to, those of our other security holders, including preventing changes in our board of directors or management that stockholders may desire.

Provisions in our charter documents and the ownership of our shares of Class A common stock by management may impede attempts to replace or remove our board or management with management favored by stockholders.

Our Restated Articles of Incorporation and Amended and Restated Bylaws contain provisions that could delay or prevent changes in our board of directors or management that stockholders may desire. These provisions include:

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Item 2. Properties

PMA Capital Corporation’s and PMA Re’s headquarters are located in approximately 88,000 square feet of leased space in center city Philadelphia, Pennsylvania. The PMA Insurance Group’s headquarters are located in a four story, 110,000 square foot building that we own in Blue Bell, Pennsylvania. We also lease approximately 63,000 square feet of office space in Yardley, Pennsylvania, which previously housed our excess and surplus lines business and now is subleased to an unaffiliated third party. We also own an approximately 16,585 square foot building in Harrisburg, Pennsylvania that we lease to PMA Foundation, which is currently under agreement of sale to PMA Foundation for $1.6 million.

Through various wholly owned subsidiaries, we also own and occupy additional office facilities in three other locations and rent additional office space for our insurance operations in 16 other locations. We believe that such owned and leased properties are suitable and adequate for our current business operations.

Item 3. Legal Proceedings

We are 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 our insureds, or as an insurer defending coverage claims brought against it by our policyholders or other insurers. While the outcome of all litigation involving us, 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 our 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 receivables by amounts that would be material to our financial condition, results of operations or liquidity.

On November 6, 2003, several purported class action lawsuits were filed against PMA Capital Corporation and certain other defendants. A purported class action lawsuit captioned Pitt v. PMA Capital Corporation, John W. Smithson and William E. Hitselberger (initiated November 6, 2003) has been filed in the Eastern District of Pennsylvania by alleged shareholders of PMA Capital who seek to represent a class of purchasers of PMA Capital securities from May 7, 2003 to November 3, 2003. The complaints allege, among other things, that the defendants violated Rule 10b-5 of the Securities Exchange Act of 1934, as amended, by making materially false and misleading public statements and material omissions during the class period regarding the Company’s loss reserves.

Several other purported class action lawsuits, captioned Augenbaum v. PMA Capital Corporation, et. al. (initiated November 6, 2003), Klinghoffer v. PMA Capital Corporation, et. al. (initiated November 10, 2003), and Pollin v. PMA Capital Corporation, John W. Smithson and Frederick W. Anton III (initiated November 11, 2003) were filed in the Eastern District of Pennsylvania by alleged purchasers of the Company’s 4.25% Convertible Debentures and 8.50% Monthly Income Senior Notes. The Klinghoffer and Pollin complaints name PMA Capital Corporation, PMA Capital Trust I, PMA Capital Trust II, certain of the Company’s officers and directors and investment banking firms as defendants. The complaints allege, among other things, that the defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, as amended, by making materially false and misleading statements about its reserves in the registration statement, prospectuses and prospectus supplements in connection with the debt.

Several purported class action lawsuits captioned Newman v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell, (initiated November 7, 2003), Appel v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 10, 2003), Boyd v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 20, 2003), Waller v. PMA Capital Corporation, John W. Smithson, Francis W. McDonnell and William E. Hitselberger (initiated November 12, 2003), Bauer v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 21, 2003), and Frey v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated December 11, 2003) were filed in the Eastern District of Pennsylvania by alleged shareholders of PMA Capital who seek to represent a class of purchasers of PMA Capital securities from November 13, 1998 to November 3, 2003. The complaints allege, among other things, that the defendants violated Rule 10b-5 of the Securities Exchange Act of 1934, as amended, by making materially false and misleading public statements and material omissions during the class period regarding the Company’s loss reserves.

The lawsuits seek unspecified compensatory damages and reasonable costs and expenses. We intend to vigorously defend against the claims asserted in these actions. The lawsuits are in their earliest stages. The lawsuits may have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

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Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of 2003.

Executive Officers of the Registrant

Our executive officers are as follows:

Vincent T. Donnelly was elected as President and Chief Executive Officer in February 2004 and served as head of the interim-Office of the President from November 2003 to February 2004. Prior to that, he served as President and Chief Operating Officer of The PMA Insurance Group since February 1997, and has served as Executive Vice President of PMA Capital Insurance Company since November 2000. Mr. Donnelly served as Senior Vice President — Finance and Chief Actuary of The PMA Insurance Group from 1995 to 1997.

William E. Hitselberger has served as our Senior Vice President, Chief Financial Officer and Treasurer since June 2002. He has also served as Vice President and Chief Financial Officer of The PMA Insurance Group from 1998 to June 2002 and Vice President of The PMA Insurance Group from 1996 to 1998.

Robert L. Pratter has served as our Senior Vice President, General Counsel and Secretary since June 1999, and has served as Vice President and General Counsel of PMA Capital Insurance Company since November 2000. From 1969 to 1999, Mr. Pratter was an attorney and partner in the law firm of Duane Morris LLP.

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PART II

Item 5. Market for the Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Following is information regarding prices for our Class A Common Stock:

There were approximately 9,000 holders of our Class A Common stock at January 31, 2004 based on recordholders and other beneficial owners. We declared quarterly dividends of $0.105 per share for our Class A Common stock in each quarter of 2002 and the first three quarters of 2003. On November 4, 2003, our Board of Directors resolved to suspend the dividends on our Class A Common stock. Our domestic insurance subsidiaries’ ability to pay dividends to us is limited by the insurance laws and regulations of Pennsylvania. Furthermore, our directly owned insurance subsidiary, PMA Capital Insurance Company, has voluntarily agreed not to pay dividends or other distributions to us or other affiliates without the prior approval of the Pennsylvania Insurance Department. For additional information on these restrictions, see "Item 7 - MD&A - Liquidity and Capital Resources."

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Item 6. Selected Financial Data

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the financial condition of PMA Capital Corporation and its consolidated subsidiaries (“PMA Capital” or the “Company” which also may be referred to as “we” or “us”) as of December 31, 2003, compared with December 31, 2002, and the results of operations of PMA Capital for 2003 and 2002, compared with the immediately preceding year. The balance sheet information presented below is as of December 31 for each respective year. The statement of operations information is for the year ended December 31 for each respective year.

This discussion and analysis should be read in conjunction with our audited Consolidated Financial Statements and Notes thereto presented in Item 8 of this Form 10-K ("Consolidated Financial Statements"). You should also read our discussion of Critical Accounting Estimates beginning on page 59 for an explanation of those accounting estimates that we believe are most important to the portrayal of our financial condition and results of operations and that require our most difficult, subjective and complex judgments.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains forward-looking statements, which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, and containing words such as “believes,” “estimates,” “anticipates,” “expects” or similar words, 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 "Cautionary Statements" beginning on page 62 for a list of factors that could cause our actual results to differ materially from those contained in any forward-looking statement. Also, see "Item 1 - Business - Risk Factors" for a further discussion of risks that could materially affect our business.

OVERVIEW

We are a property and casualty insurance holding company, which during the three year period ended December 31, 2003 offered through our subsidiaries standard commercial lines of insurance, excess of loss and pro rata property and casualty reinsurance and excess and surplus lines insurance. In May 2002, we announced our intention to cease writing excess and surplus lines insurance, and since that time, the results of this business have been classified as Run-off Operations. On November 6, 2003, we announced our intention to cease writing excess of loss and pro rata property and casualty reinsurance. The results of this business, which had been offered though our PMA Re business segment, will be included in Run-off Operations effective in 2004. Since November 6, 2003, our subsidiaries offer workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance, primarily in the eastern part of the United States. These products are written through The PMA Insurance Group business segment.

The PMA Insurance Group earns revenue and generates cash primarily by writing insurance policies and collecting insurance premiums. The PMA Insurance Group also earns other revenues by providing risk control and claims adjusting services to customers. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, we invest the available premiums and earn investment income at The PMA Insurance Group and PMA Re. From our revenues are deducted:

These items are further described in the MD&A and in “Item 1–Business”.

Losses and LAE are the most significant expense items affecting our insurance business. Like all insurers, we establish reserves representing estimates of future amounts needed to pay claims with respect to insured events that have occurred, including events that have not been reported to us. We also establish reserves for LAE, which represent the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. Reserves are merely estimates and do not and cannot represent an exact measure of liability. If actual losses and LAE are larger than our loss reserve estimates, or if our actual claims reported to us exceed our estimate of the number of claims to be reported to us, we have to increase reserves for prior years. Changes in reserve estimates may be due to a wide range of factors, including inflation, changes in claims and litigation trends and legislative or regulatory changes. We incur a charge to earnings in the period the

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reserves are increased. In 2003, we recorded a total of $169 million in charges to increase loss reserves for prior years in our PMA Re segment. See "Item 1 - Business - Risk Factors" for additional information.

These charges to increase loss reserves led to the downgrade of the insurer financial strength ratings of PMA Capital Insurance Company, our reinsurance subsidiary, and The PMA Insurance Group (Pennsylvania Manufacturers’ Association Insurance Company, Pennsylvania Manufacturers Indemnity Company and Manufacturers Alliance Insurance Company), or the Pooled Companies, our primary insurance subsidiaries, by the rating agencies that rate the financial strength of our insurance subsidiaries, particularly A.M. Best. The downgrade by A.M. Best of the financial strength rating of PMA Capital Insurance Company from A- (4th of 16) to B++ (5th of 16) was a substantial factor in our decision to withdraw from the reinsurance business. In addition, A.M. Best’s lowering of the financial strength rating of The PMA Insurance Group companies from A- (4th of 16) to B++ (5th of 16) has constrained The PMA Insurance Group’s ability to attract and retain business. Further, the recent ratings downgrades may make it more difficult to write business at the same rates and favorable terms and conditions as our current businesses. We currently believe that one of the most significant challenges that we have in 2004 is restoring the A- A.M. Best rating of The PMA Insurance Group. We believe the restoration of the A- rating is necessary for the growth of our primary insurance operations. We are currently evaluating various alternatives which we believe would allow the rating to be upgraded.

Another significant challenge for 2004 is ensuring that we maintain sufficient cash at the holding company level to pay corporate overhead, including debt service and operating expenses. See "Liquidity and Capital Resources" beginning on page 51 for additional information. In December 2003, we entered into a voluntary agreement with our lead regulator, the Pennsylvania Insurance Department, whereby, among other things, we would seek the Department’s prior approval for any dividends paid from our insurance subsidiaries. See "Item 1 - Business–Regulatory Matters" for additional information about this voluntary agreement. As these dividends are a significant source of cash to the holding company, we will continue to work cooperatively with the Department to demonstrate to them our belief that our insurance subsidiaries have adequate statutory capital to support their expected level of business production, the satisfaction of their existing liabilities and the servicing of the holding company debt and overhead obligations.

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RESULTS OF OPERATIONS

Consolidated Results

We recorded a net loss of $93.6 million in 2003, compared to a net loss of $48.0 million in 2002 and net income of $7.1 million in 2001.

The net loss for 2003 reflects a third quarter after-tax charge of $97.5 million ($150 million pre-tax), to increase loss reserves at PMA Re. On November 6, 2003, we announced our decision to exit from the reinsurance business and we are no longer writing new reinsurance business. See "Recent Developments" beginning on page 38 for additional information. Additionally, we established a valuation allowance of $49 million on our deferred tax asset in 2003.

Results for 2002 were impacted by approximately $42 million after-tax ($64 million pre-tax) due to unfavorable prior year loss development at PMA Re and by approximately $34 million after-tax ($52 million pre-tax) due to unfavorable prior year loss development at the Run-off Operations. Additionally, results for 2002 include a charge of $28 million after-tax ($43 million pre-tax) associated with our decision to exit from and run off our excess and surplus lines business.

Results for 2001 were adversely impacted by approximately $20 million after-tax ($30 million pre-tax) as a result of losses incurred at PMA Re from the September 11th terrorist attack on the World Trade Center and by unfavorable prior year development of $14 million after-tax ($22 million pre-tax) at the Run-off Operations.

Included in net income (loss) are after-tax net realized investment gains of $9.0 million in 2003, compared to after-tax net realized investment losses of $10.5 million for 2002 and gains of $5.2 million for 2001. Net realized investment gains in 2003 were primarily attributable to sales intended to change the duration of our investment portfolio in order to better match our cash flows with our liability payouts. Net realized investment losses for 2002 primarily reflect impairment losses of $15.4 million after-tax ($23.8 million pre-tax) on fixed income securities, primarily corporate bonds issued by telecommunications and energy companies. Net realized investment gains for 2001 reflect the sale of securities because of our decision to shift the mix of our invested asset portfolio from U.S. Treasury and agency securities to corporate bonds and structured securities as a means to enhance our portfolio’s yield. As a result of investment sales pursuant to this strategy and the declining interest rates in 2001, we recorded net realized investment gains in 2001.

Also included in net income for 2001 is a $6.3 million after-tax gain ($9.8 million pre-tax included in other revenues) on the sale of certain real estate properties and a tax benefit of $10.1 million resulting from the completion of an IRS examination of our 1996 tax return.

Consolidated revenues were $1,301.2 million, $1,075.1 million and $850.0 million in 2003, 2002 and 2001. The increases in revenues primarily reflect higher net premiums earned. Since PMA Re is no longer writing new reinsurance business, we do not expect this increasing trend in consolidated revenues to continue.

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 16 to the 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 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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Following is a reconciliation of our segment operating results to GAAP net income (loss). See Note 16 to our Consolidated Financial Statements for additional information.

We also provide combined ratios and operating ratios for our insurance segments on pages 39 and 43. 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 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.

Recent Developments

On November 4, 2003, we announced that we had recorded a pre-tax charge of $150 million at September 30, 2003 to strengthen loss reserves at PMA Re. Since that time, the principal nationally recognized ratings agencies that rate the financial strength of our principal insurance subsidiaries and the debt of PMA Capital Corporation have taken the following actions on our ratings:

On November 24, 2003, we announced that we had voluntarily withdrawn from the Standard & Poor’s rating process.

See "Item 1–Business–Ratings" for additional information regarding our ratings.

On November 4, 2003, our Board of Directors resolved to suspend the dividends on our Class A Common stock.

On November 6, 2003, we announced our decision to withdraw from the reinsurance business previously served by PMA Re, and we are no longer writing new reinsurance business. On December 22, 2003, PMA Capital Insurance Company entered into a voluntary agreement with the Pennsylvania Insurance Department. Pursuant to this agreement, PMA Capital

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Insurance Company agreed, among other things, not to pay dividends to us without the prior approval of the Pennsylvania Insurance Department; enter into any new reinsurance contracts, treaties or agreements, except as may be required by law; alter it or its Pennsylvania-domiciled insurance company subsidiaries’ ownership structure; and agreed to provide the Department with certain financial and operating information. See "Item 1–Business – Regulatory" for additional information regarding our agreement with the Pennsylvania Insurance Department.

Several purported class action lawsuits have been filed against us and certain other defendants. We intend to vigorously defend against the claims asserted in these actions. The lawsuits are in their earliest stages. The lawsuits may have a material adverse effect on our financial condition, results of operations and liquidity. For additional information, see "Item 1 – Legal Proceedings."

Segment Results

The PMA Insurance Group

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

Pre-tax operating income for The PMA Insurance Group was $21.5 million in 2003, compared to $25.3 million in 2002 and $23.1 million in 2001. The lower pre-tax operating income in 2003, compared to 2002, primarily reflects lower underwriting results from accident years 2001 and 2002 in the workers’ compensation lines of business and lower net investment income, partially offset by improved current accident year underwriting results. The increase in operating income for 2002, compared to 2001, was primarily due to improved underwriting results, partially offset by lower net investment income.

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Premiums

The PMA Insurance Group’s premiums written are as follows:

Direct workers’ compensation and integrated disability premiums written increased 37% in 2003 and 26% in 2002, compared to the immediately preceding year, primarily due to an increase in the volume of risks underwritten, and to a lesser extent, pricing increases. In addition, the increase in direct workers’ compensation premiums written for 2003 includes $35 million of retrospectively rated premiums recorded in the fourth quarter under loss-sensitive policies that are attributable to the higher than expected losses from accident years 2001 and 2002. See "Losses and Expenses" beginning on page 41 for additional information. Pricing increased approximately 10% in 2003 and 17% in 2002 on workers’ compensation business. In recent years, The PMA Insurance Group increased its writings of workers’ compensation premiums through focused marketing efforts in its principal marketing territories covering the eastern part of the United States.

For workers’ compensation coverages, the premium charged on fixed-cost policies is primarily based upon the manual rates filed with state insurance departments. Manual rates in The PMA Insurance Group’s principal marketing territories for workers’ compensation increased on average approximately 8% in 2003 and 13% in 2002. These increases in manual rates generally reflect the effects of higher average medical and indemnity costs in recent years. Manual rate changes directly affect the prices that The PMA Insurance Group can charge for its rate sensitive workers’ compensation products, which include fixed cost and dividend policies that comprise approximately 58% of workers’ compensation premiums for 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 $3.5 million and $10.8 million in 2003 and 2002, compared to the immediately preceding year, primarily due to weighted average price increases of approximately 17% in 2003 and 28% in 2002.

Although we cannot currently predict the ultimate effect of the recent A.M. Best financial strength rating downgrade on The PMA Insurance Group’s business, such downgrade will likely result in lower premiums written. Further, the recent ratings downgrades may make it more difficult to write business at the same rates and favorable terms and conditions as our current businesses.

Premiums assumed increased $11.2 million and $5.8 million in 2003 and 2002, respectively, compared to the immediately preceding year, primarily due to an increase in the amount of residual market business in The PMA Insurance Group’s principal marketing territories. Companies which write premiums in certain states generally must share in the risk of insuring entities that cannot obtain insurance in the voluntary market. Typically, an insurer’s share of this residual market business is dependent upon its market share in terms of direct premiums in the voluntary market, and the assignments are accomplished either by direct assignment or by assumption from pools of residual market business.

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Premiums ceded increased $11.8 million in 2003, compared to 2002 and increased $1.9 million in 2002, compared to 2001. Premiums ceded for workers’ compensation and integrated disability increased by $21.1 million in 2003 and $7.9 million in 2002, compared to the immediately preceding year, as a result of the increase in direct premiums written as well as higher rates being charged by reinsurers. Premiums ceded for Commercial Lines were lower by $9.3 million and $5.9 million in 2003 and 2002, respectively, primarily because we have increased our net retentions in Commercial Lines from $250,000 in 2001 to $500,000 in 2002 and $1.5 million in 2003.

Net premiums written increased 33% in 2003 and 27% in 2002, compared to the immediately preceding year, mainly reflecting the trends discussed above for gross premiums written. Net premiums earned increased 39% in 2003 and 18% 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. We made such an adjustment in the fourth quarter of 2003 as described above.

Losses and Expenses

The components of the GAAP combined ratios are as follows:

In the fourth quarter of 2003, our internal actuaries completed a comprehensive year-end actuarial analysis of loss reserves. Based on the actuarial work performed, we noticed higher than expected claims severity in our workers’ compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers’ compensation business. As a result, The PMA Insurance Group increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of The PMA Insurance Group's loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under The PMA Insurance Group’s loss-sensitive rating plans we adjust the amount of the insured’s premiums after the policy period expires based, to a large extent, upon the insured’s actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million.

This unfavorable prior year loss development and resulting premium and policyholders’ dividend adjustments in 2003 increased the loss and LAE ratio by approximately 4 points and decreased the total expense ratio and policyholder’s dividend ratio each by approximately 1.5 points. The total impact to the combined ratio was approximately 1 point. Overall, the loss and LAE ratio increased by 2.6 points in 2003 compared to 2002, reflecting the effects of prior year loss development described above, partially offset by an improved current accident year loss and LAE ratio. Our current accident year loss and LAE ratio improved 5.3 points in 2003, compared to 2002, including 4.5 points due to the premium adjustment of $35 million recorded in the fourth quarter for policies of loss-sensitive plans. The remainder of the improvement is primarily due to price increases that have outpaced increasing loss costs. Medical cost inflation, which has contributed to increased severity of workers’ compensation losses, was the primary reason for the increasing loss costs in 2003. We estimate our medical cost inflation for 2003 to be approximately 11%. We expect medical cost inflation to remain a significant component of loss costs in 2004.

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The loss and LAE ratio increased slightly in 2002, compared to 2001, primarily due to a higher current accident year loss and LAE ratio, partially offset by lower unfavorable prior year development. The current accident year loss and LAE ratio increased by 1.0 point in 2002, compared to 2001, primarily due to increased reinsurance costs and higher workers’ compensation loss trends, partially offset by price increases. The PMA Insurance Group experienced $1.1 million and $2.9 million of unfavorable prior year development in 2002 and 2001, respectively. The lower unfavorable prior year development reduced the loss and LAE ratio by 0.5 points in 2002, compared to 2001. The unfavorable prior year development in 2002 and 2001 primarily reflects higher than expected claims handling costs. For additional information regarding The PMA Insurance Group’s loss reserves, see "Loss Reserves" beginning on page 47.

The expense ratio improved by 0.3 points in 2002, compared to 2001, as premium growth outpaced the increase in expenses. The policyholders’ dividend ratio improved by 2.3 points in 2002, compared to 2001, primarily because we 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 $2.7 million lower in 2003 and $3.8 million lower in 2002, compared to the immediately preceding year. The lower net investment income in 2003, compared to 2002, primarily reflects a reduction in invested asset yields of approximately 90 basis points, partially offset by a higher invested asset base that increased approximately 12%. The decline in 2002, compared to 2001, primarily reflects a reduction in invested asset yields of approximately 50 basis points.

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PMA Re

On November 6, 2003, we announced our decision to withdraw from the reinsurance business. We are no longer writing new reinsurance business. See "Recent Developments" beginning on page 38 for additional information. Because of our decision to withdraw from the reinsurance business, we expect that PMA Re’s premiums written and earned, losses and LAE, and operating expenses will decline materially in 2004. Therefore, PMA Re’s results for 2003 will not be indicative of results for future periods. PMA Re’s results will be included in Run-off Operations beginning in the first quarter of 2004.

Summarized financial results of PMA Re are as follows:

PMA Re recorded a pre-tax operating loss of $79.4 million in 2003, compared to pre-tax operating income of $13.4 million in 2002 and a pre-tax operating loss of $3.1 million in 2001. PMA Re’s results for 2003 reflect the third quarter reserve charge of $150 million associated mainly with accident years 1997 to 2000. Additionally, as a result of the decision to exit from and run off this business, PMA Re’s results for 2003 include exit costs of $2.6 million, mainly related to severance benefits for terminated employees. PMA Re’s 2002 results were impacted by approximately $64 million due to unfavorable prior year loss development. PMA Re’s results for 2001 include a pre-tax charge of approximately $30 million relating to the effects of the losses caused by the terrorist attack on the World Trade Center. See "Losses and Expenses" beginning on page 45 for additional information.

Premiums

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

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

Gross premiums written were $750.9 million for 2003, compared to $776.8 million for 2002, primarily reflecting lower premiums from our Traditional-Treaty unit, partially offset by higher premiums from our Finite Risk and Financial Products unit. In addition, gross premiums written for 2002 included an additional $58.1 million of gross premiums written ($44.2 million of net premiums written) recorded in the second quarter of 2002 as a result of a change in our estimate of ultimate premiums written. Because premiums from ceding companies are typically reported on a delayed basis, we monitor and update, as appropriate, the estimated ultimate premiums written. Our periodic review of estimated ultimate premiums written, 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 earned of $39.9 million in 2002 caused by this adjustment was offset by corresponding losses and LAE and acquisition expenses.

Gross premiums written increased $300.2 million for 2002, compared to 2001, reflecting higher premiums in all of our business units. Additionally, gross premiums written increased in 2002, compared to 2001, due to PMA Re’s increased participation in aviation, ocean marine and accident reinsurance business (included in Other in the tables on pages 43 and 44) due to significantly improved market conditions in these lines.

In 2001, gross and net premiums written included approximately $25 million of premiums (mainly property premiums in the Finite Risk and Financial Products unit) due under contractual provisions of certain of PMA Re’s assumed business where additional premiums were due to us because of the cession of World Trade Center losses to us by our reinsureds. These additional premiums were more than offset by approximately $30 million of ceded premiums payable by PMA Re to its retrocessionaires because PMA Re ceded a portion of its World Trade Center gross losses to these retrocessionaires.

Ceded premiums were $155.8 million, $137.7 million and $116.0 million in 2003, 2002 and 2001, respectively. Ceded premiums for 2003 include approximately $103.6 million from our Finite Risk and Financial Products unit that were due under a quota share retrocessional cover that ceded one-third of this unit’s 2003 premiums and losses. Ceded premiums increased by $21.7 million in 2002, compared to 2001, reflecting the increase in gross premiums written and an increase in premiums charged by retrocessionaires, partially offset by the additional ceded premiums in 2001 resulting from the terrorist attack on the World Trade Center.

Net premiums written decreased approximately 7% and net premiums earned increased by approximately 13% in 2003. In 2002, net premiums written and earned increased approximately 77% and 62%, respectively, compared to the immediately preceding year. Traditionally, trends in net premiums earned follow patterns similar to net premiums written. Generally, in periods of decreasing premium writings, the decrease in net premiums written will be greater than the decrease in net premiums earned, as was the case in 2003. Generally, in periods of premium growth, the increase in net premiums written will be greater than the increase in net premiums earned, as was the case in 2002. Premiums are earned principally on a pro rata basis over the coverage periods of the underlying policies. However, with respect to

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policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustments may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premium in the period in which the adjustment is made.

We expect PMA Re to continue to have gross and net premiums written in 2004 as certain contracts written in 2003 and prior years will continue to generate premiums in 2004. Similarly, because premiums are earned principally on a pro rata basis over the coverage periods of the underlying policies, PMA Re will earn premiums in 2004.

Losses and Expenses

The components of the GAAP combined ratios are as follows:

The loss and LAE ratio was 88.0% for 2003, compared to 79.6% in 2002 and 87.4% in 2001. During 2003, PMA Re increased its net loss reserves for prior accident years by $169.1 million, including $150 million during the third quarter. PMA Re’s third quarter 2003 reserve charge related to higher than expected underwriting losses, primarily from casualty business written in accident years 1997 through 2000. Approximately 75% of the charge was related to general liability business written from 1997 to 2000 with substantially all of the remainder from the commercial automobile line written during those same years. During the third quarter, our actuaries conducted their periodic comprehensive reserve review. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by PMA Re. The information derived during this review indicated that a large portion of the change in expected loss development was due to increasing loss trends emerging in calendar year 2003 for prior accident years. This increase in 2003 loss trends caused us to determine that the reserve levels, primarily for accident years 1997 to 2000, needed to be increased by $150 million. An independent actuarial firm also conducted a comprehensive review of PMA Re’s Traditional-Treaty, Specialty-Treaty and Facultative loss reserves, and concluded that those carried loss reserves were reasonable at September 30, 2003.

PMA Re’s analysis was enhanced by an extensive review of specific accounts, comprising about 40% of carried reserves for accident years 1997 to 2000. Our actuaries visited a number of former ceding company clients, which collectively comprised about 25% of PMA Re’s total gross loss and LAE reserves from accident years 1997 to 2000, to discuss reserving and reporting experience with these ceding companies. Our actuaries separately evaluated an additional number of other ceding companies, representing approximately 15% of PMA Re’s total gross loss and LAE reserves from accident years 1997 to 2000, to understand and examine data trends.

PMA Re’s loss and LAE ratio for 2002 reflects a $64 million increase in net loss reserves for prior accident years in the fourth quarter of 2002. In the fourth quarter, PMA Re’s actuarial department conducted its routine year-end reserve study to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. During the fourth quarter, our actuaries observed a higher than expected increase in the frequency and, to a lesser extent, severity of reported claims by our ceding companies. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business written by PMA Re. Management’s selection of the ultimate losses indicated that net loss and LAE reserves for prior accident years needed to be increased by approximately $64 million in the fourth quarter of 2002, primarily for excess of loss and pro rata general liability occurrence contracts and, to a lesser extent, excess of loss general liability claims-made contracts, from accident years 1998, 1999 and 2000.

For 2001, PMA Re’s loss and LAE ratio reflects the impact on losses and LAE and earned premium of the terrorist attack on the World Trade Center, which increased net losses and LAE by $25 million and decreased net premiums earned by $5 million.

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As a result of the decision to exit from and run off this business, PMA Re’s operating expenses for 2003 include exit costs of $2.6 million, mainly employee termination benefits, the majority of which were paid during the first quarter of 2004.

Approximately 75 employees at PMA Re were terminated in accordance with our exit plan. Approximately 90 positions, primarily claims and financial, remain at PMA Re after the terminations. We have established an employee retention arrangement for these remaining employees. Under this arrangement, PMA Re expects to record expenses of approximately $2 million in 2004, which includes retention bonuses and severance. We expect to pay the majority of these costs in 2004 and 2005.

Net Investment Income

Net investment income was $32.5 million, $48.7 million and $45.4 million in 2003, 2002 and 2001, respectively. The decline in 2003, compared to 2002, reflects lower yields on the invested asset portfolio of approximately 110 basis points on an average invested asset base that increased approximately 10%, and lower interest earned of $9.0 million on funds held arrangements. For 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. The increase in net investment income in 2002, compared to 2001, reflects higher interest earned of $9.7 million on funds held arrangements, partially offset by lower investment earnings of $6.4 million on the invested asset portfolio. The lower investment earnings resulted from a drop in yields of approximately 100 basis points on an average invested asset base that increased approximately 5% during 2002.

Run-off Operations

Summarized financial results of the Run-off Operations, formerly known as Caliber One, 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. In January 2003, we closed on the sale of the capital stock of Caliber One Indemnity Company. Pursuant to the agreement of sale, we 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.

The Run-off Operations recorded a pre-tax operating loss of $818,000 for 2003. The 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 2003. During 2003, the Run-off Operations recognized an additional $2.5 million writedown of assets, made up of 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 2003.

In 2002, the Run-off Operations recorded a pre-tax operating loss of $87.5 million. As a result of our decision to exit from and run off this business, the Run-off Operations recorded a charge of $43 million pre-tax. Components of the pre-tax charge include approximately $16 million to write-down assets to their estimated net realizable value, including non-cash charges 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

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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 December 31, 2003, the Company has a remaining obligation of approximately $859,000 for net lease costs and approximately $152,000 for severance.

Pre-tax operating results for 2002 also include net unfavorable prior year loss development of $51.8 million. During 2002, company actuaries conducted reserve reviews to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection 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 their reviews indicated that net loss reserves for prior accident years, mainly 1999 and 2000, needed to be increased by $51.8 million. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in 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.

The Run-off Operations recorded a pre-tax operating loss of $26.2 million for 2001. The results for 2001 include net unfavorable prior year loss development of $22.2 million, reflecting higher than expected claim frequency and severity that emerged in 2001 on certain casualty lines of business, primarily professional liability policies for the nursing homes class of business and, to a lesser extent, property lines of business.

Corporate and Other

The Corporate and Other segment includes unallocated investment income and expenses, including debt service. This segment recorded pre-tax operating losses of $22.8 million, $14.3 million and $6.3 million in 2003, 2002 and 2001, respectively. Included in results for 2003 are approximately $3 million of accrued costs associated primarily with the remaining salary obligations under employment contracts with our former executive officers. Interest expense increased by $6.6 million in 2003, compared to 2002, primarily due to a higher average amount of debt outstanding. Interest expense declined $3.3 million during 2002, compared to 2001, reflecting a lower average amount of debt outstanding and lower interest rates throughout the year. During 2001, we sold certain real estate properties for net proceeds totaling $14.4 million, resulting in a pre-tax gain of $9.8 million, which is recorded in other revenues.

Loss Reserves and Reinsurance

Loss Reserves

Our consolidated unpaid losses and LAE, net of reinsurance, at December 31, 2003 and 2002 were $1,346.3 million and $1,184.3 million, net of discount of $67.0 million and $97.8 million, respectively. Included in the consolidated unpaid losses and LAE are amounts related to our workers’ compensation claims of $433.8 million and $326.7 million, net of discount of $54.6 million and $76.7 million at December 31, 2003 and 2002, respectively. The discount rate used was approximately 5% at December 31, 2003 and 2002.

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 addition, because reinsurers rely on their ceding companies to provide them with information regarding incurred losses, reported claims 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 December 31, 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

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to differ substantially from the amounts recorded at December 31, 2003, the related adjustments could have a material adverse effect on our financial condition, results of operations and liquidity. See the discussion under Losses and Expenses beginning on pages 41 and 45, and Run-off Operations beginning on page 46 for additional information regarding increases in loss reserves for prior years.

At December 31, 2003, 2002 and 2001, our gross reserves for asbestos-related losses were $37.8 million, $42.1 million and $59.9 million, respectively ($17.8 million, $25.8 million and $28.6 million, net of reinsurance, respectively). At December 31, 2003, 2002 and 2001, our gross reserves for environmental-related losses were $14.2 million, $18.2 million and $29.6 million, respectively ($8.8 million, $14.3 million and $16.0 million, net of reinsurance, respectively).

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, our ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to our financial condition and results of operations.

See "Critical Accounting Estimates — Unpaid Losses and Loss Adjustment Expenses" beginning on page 59 for additional information. In addition, see "Cautionary Statements" beginning on page 62 and "Item 1 - Business - Risk Factors" for a discussion of factors that may adversely impact our losses and LAE in the future.

Reinsurance

Under our reinsurance and retrocessional coverages in place during 2003, 2002 and 2001, we ceded premiums totaling $228.6 million, $300.6 million and $243.4 million, and we ceded losses and LAE of $243.1 million, $223.2 million and $359.6 million to reinsurers and retrocessionaires. Ceded losses for 2001 include approximately $110 million resulting from the September 11th terrorist attack on the World Trade Center.

At December 31, 2003 and 2002, we had amounts receivable from our reinsurers and retrocessionaires totaling $1,220.3 million and $1,295.1 million, respectively. Approximately $39 million and $37 million, or 3%, of these amounts are due to us on losses we have already paid at December 31, 2003 and 2002. The remainder of the reinsurance receivables relate to unpaid claims.

At December 31, 2003, we had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of our shareholders’ equity: