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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

Or

For the transition period from              to             

Commission file number 022316

PENN-AMERICA GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

420 S. York Road, Hatboro, PA 19040

(Address of Principal Executive Offices) (Zip Code)

Registrant’s telephone number, including area code: (215) 443-3600

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

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  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 voting and non-voting common equity held by non-affiliates of the registrant was $113,374,463 based on the closing price as of June 30, 2003 at 4:00 p.m. reported in the New York Stock Exchange Composite listing.

As of March 1, 2004, the registrant had 14,760,261 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement with respect to the registrant’s 2004 Annual Meeting of Shareholders, to be filed not later than 120 days after the close of the registrant’s fiscal year (the “Proxy Statement”).

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TABLE OF CONTENTS

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PART I

Item 1. Business

General

Penn-America Group, Inc. (“PAGI”) is a specialty property and casualty insurance holding company. PAGI, through its subsidiaries (collectively “Penn-America” or the “Company”), markets and underwrites general liability, commercial property and multi-peril insurance for small businesses. PAGI’s insurance subsidiaries are Penn-America Insurance Company and its subsidiary, Penn-Star Insurance Company. Penn-America writes business in all 50 states and the District of Columbia. PAGI’s business trust subsidiaries are Penn-America Statutory Trust I (“the Trust I”) and Penn-America Statutory Trust II (“the Trust II”), which were formed for the purpose of raising capital to support the Company’s insurance subsidiaries.

Penn-America’s insureds consist primarily of small businesses including restaurants, apartments, retail stores and service contractors with average annual premiums of about $2,000. In addition, the Company has developed customized products and coverages for other small commercial insureds such as day care facilities, fitness centers and special events. The Company attempts to select only insurance lines of business and industry segments for which it reasonably can evaluate the probability of future loss exposure. Therefore, the Company avoids high-hazard risks and high-hazard lines of business such as medical malpractice and environmental liability. The small businesses that the Company insures often cannot obtain insurance because of their rural locations, small premium size or non-standard risk characteristics. As a result, these small businesses must turn to companies like Penn-America, which operate in a small business niche of the secondary or residual market called the “excess and surplus lines” or “E&S” market. The Company believes the benefits of operating in the excess and surplus lines marketplace include:

The Company writes business on both an admitted and non-admitted basis in thirty-seven states, on only an admitted basis in one state and on only a non-admitted basis in twelve states and the District of Columbia. The Company chooses in each state whether to write business on an admitted or non-admitted basis based upon the Company’s analysis of competition in each state. Writing business on an admitted basis is highly regulated. The regulations, which vary by state, generally govern licensing, underwriting rules, rates and policy forms, and require insurance companies to pay premium taxes and guaranty fund assessments. Writing business on a non-admitted basis is significantly less regulated and provides much more freedom in setting rules, rates and policy forms and removes insurance companies from premium taxes and guaranty fund assessment liabilities. Coverage written on a non-admitted basis is less comprehensive than coverage issued on an admitted basis. If the Company chooses non-admitted status, the Company could be at a competitive disadvantage to carriers writing on an admitted basis if those competitors choose to offer coverages which are more comprehensive and attractive to an insured.

The Company maintains an Internet Web site at http://www.penn-america.com. The Company makes available free of charge on its Web site its annual reports on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission.

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Penn-America Insurance Company was formed in 1975 by Irvin Saltzman, Chairman of the Board of Directors, who began working in the insurance industry in 1947 when he founded a general agency. The Company completed an initial public offering (“IPO”) on October 28, 1993, at a price of $4.00 per share, which was followed by additional offerings in July of 1997 and December of 2002, where 4,537,500 and 2,990,000 shares were sold by the Company for net proceeds of approximately $9.67 and $7.99 per share, respectively. Currently, Penn Independent Corporation (“Penn Independent”), which is 100% owned by the Saltzman family, owns approximately 31% of the Company’s common stock. Jon S. Saltzman, Irvin Saltzman’s son, is a Director, President and Chief Executive Officer of the Company and has been employed by the Company since 1986. Prior to 1986, Jon Saltzman was employed by Penn Independent from 1976 to 1986.

Strategy

The Company’s primary strategy is to produce a superior return to stockholders by being the first-choice insurance carrier for a select group of general agents who serve the specialized needs of the small business marketplace. The Company accomplishes this primary strategy by focusing on the following:

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By focusing on these principles, the Company believes it can deliver strong financial results and build shareholder value.

Marketing and Distribution

Penn-America markets its products through sixty-six (66) general agents, who in turn produce business through more than 30,000 retail insurance brokers located throughout the United States. Penn-America believes that its distribution network enables it to effectively access these numerous small business markets at a relatively low fixed-cost through the marketing, underwriting and administrative support of its general agents. These general agents and their retail insurance brokers have local market knowledge and expertise that enable the Company to access these markets more effectively.

Penn-America’s distribution strategy is to maintain strong relationships with a select group of high-quality general agents. The Company has about one-half the number of general agents as its nearest competitor. The Company carefully selects a limited number of general agents based on their experience and reputation and strives to preserve each agent’s franchise value within its marketing territory. The Company seeks to increase its written premiums with these general agents and to develop strong, long-standing relationships by providing a high level of service and support. For example, the Company tries to respond to its general agents’ request for quotes within 24 hours. The Company also supplies Internet and Web site technology support at no cost to the general agents. The Company believes these activities create goodwill with the general agents and strengthen its relationship with them. The Company’s strategy has resulted in strong and consistent growth. From 1992 to 2003, the Company’s commercial gross written premiums grew from $22.6 million to $209.4 million (a 22% annual compounded growth rate). Most of this growth was due to an increase in gross written premiums per agent from $590,000 in 1992 to $3.9 million in 2003.

The following table sets forth the geographic distribution of the Company’s gross written premiums for the years ended December 31, 2003, 2002, and 2001:

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Underwriting

The Company underwrites its business on both a Binding Authority and Submit basis. Binding Authority business represents risks that may be quoted and bound by the Company’s general agents prior to the Company’s underwriting review, whereas Submit business represents risks that must be submitted by the Company’s general agents to the Company prior to quoting or binding the account.

Binding Authority business accounted for approximately 95% of the Company’s gross written premiums in 2003. Of this amount, approximately 85% is bound by general agents in accordance with the Company’s underwriting manual, with the remaining 15% subject to the Company’s approval. The Company provides its general agents with a comprehensive, regularly updated underwriting manual, which also is available online through a private intranet site called PennLINK. This manual clearly outlines the Company’s risk eligibility, pricing, underwriting guidelines and policy issuance instructions. Penn-America closely monitors the underwriting quality of its business through on-line system edits and in-force account reviews. The Company also periodically audits each agent’s office to determine if the Company’s underwriting guidelines are followed in all aspects of risk selection, underwriting compliance, policy issuance and pricing. In addition to standard commissions, the Company provides strong incentives to its general agents to produce profitable business through a contingent profit commission structure that is tied directly to underwriting profitability. Payments of these contingent profit commissions have been through the issuance of shares of PAGI common stock and cash. As of December 31, 2003, the Company has awarded general agents 392,793 shares of PAGI common stock through its contingent profit commission structure since 1996.

The Company began writing business on a Submit basis in 1999 in response to general agents who had risks similar to the Company’s risk profile but were outside of their underwriting authority. One hundred percent of this business is quoted and bound by Penn-America underwriters; general agents have no binding authority for Submit business. This business accounted for approximately 5% of gross written premiums in 2003.

Lines of Business

The following table sets forth an analysis of gross written premiums by line of business for the years ended December 31, 2003, 2002 and 2001:

Core Commercial Lines. The Company’s core commercial lines consist of its commercial property and casualty lines of business excluding its exited commercial automobile lines (see “Exited lines” below). The core commercial lines are written as follows:

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Exited Lines. The Company’s exited lines consist of its personal and commercial automobile lines of business. The Company exited non-standard personal automobile business in 1999 and commercial automobile in late 2000. The exited lines were written as follows:

Financial Information about Business Segments

The Company has one reportable segment that consists of its commercial property and casualty lines of business. The Company exited the non-standard personal automobile business in 1999 and announced that it would run-off its remaining portfolio of such business. For the years ended December 31, 2003, 2002 and 2001, information relating to the non-standard personal automobile business was not material, and therefore, not disclosed separately.

Pricing

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

The Company primarily uses ISO loss cost rates as the foundation for establishing its pricing benchmarks for all lines of business in all 50 states and the District of Columbia. The Company then develops “loss cost multipliers,” or LCMs, which are designed to support its operating expenses, acquisition expenses and targeted return on equity. The multiplication of LCMs by ISO loss cost rates produces the Company’s final benchmark rates. As a general rule, the Company’s final benchmark rates are set at 110% to 200% of the prescribed ISO benchmark rates because of the Company’s strategy of providing

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insurance to underserved markets. The Company’s final benchmark rates are regionalized to incorporate variables such as historical loss experience, the types and lines of business written and state regulatory considerations. For businesses that the Company writes on an admitted basis, it must obtain advance regulatory approval of rates in a number of states. The Company provides its general agents with pricing flexibility on a per-policy basis, with the objective that in the aggregate, the weighted average premium of all new and renewal commercial policies written by a general agent must equal the Company’s final benchmark rates.

Claims Management and Administration

The Company’s approach to claims management is designed to investigate reported incidents at the earliest juncture, to select, manage and supervise all legal and adjustment aspects thereof and to provide a high level of service and support to general agents, retail insurance brokers and insureds throughout the claims process. The Company’s general agents have no authority to settle claims or otherwise exercise control over the claims process. The Company’s claims staff supervises, processes and approves all claims. The Company has a formal claims review process, and all claims greater than $50,000 are reviewed by senior claims management.

Insurance Loss Reserves

Overview. The Company is directly liable for losses and loss adjustment expenses under the terms of the insurance policies that it writes. In many cases, several years may lapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company reflects the liability for the ultimate payment of all incurred losses and loss adjustment expenses by establishing loss and loss adjustment expense reserves as balance sheet liabilities for both reported and unreported claims.

When a claim involving a probable loss is reported, the Company establishes a case reserve for the estimated amount of the Company’s ultimate loss. The estimate of the amount of the ultimate loss is based upon such factors as:

The Company determines loss adjustment expenses as a percentage of expected indemnity losses based on historical patterns adjusted to reflect current experience.

In addition to case reserves, management establishes reserves on an aggregate basis to provide for incurred but not reported losses and loss adjustment expenses, commonly referred to as “IBNR.” To establish reserves for IBNR the Company must estimate the ultimate liability based primarily on past experience. The Company applies a variety of traditional actuarial techniques to determine its estimate of ultimate liability. The techniques recognize, among other factors:

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The Company continually reviews these estimates and, based on new developments and information, the Company includes adjustments of the probable ultimate liability in the operating results for the periods in which the adjustments are made. In general, initial reserves are based upon the actuarial and underwriting data utilized to set pricing levels and are reviewed as additional information, including claims experience, becomes available. The establishment of loss and loss adjustment expense reserves makes no provision for the broadening of coverage by legislative action or judicial interpretation, or the emergence of new types of losses not sufficiently represented in the Company’s historical experience or that cannot yet be quantified. The Company regularly analyzes its reserves and reviews pricing and reserving methodologies so that future adjustments to prior year reserves can be minimized. However, given the complexity of this process, reserves will require continual updates and the ultimate liability may be higher or lower than previously indicated. Change in estimates for loss and loss adjustment expense reserves, as required by Statement of Financial Accounting Standards (“SFAS”) No. 60, Accounting and Reporting by Insurance Enterprises, is recorded in the period that the change in these estimates is made. The Company does not discount its loss reserves.

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

For more information regarding incurred losses and loss adjustment expenses attributable to prior years for 2003, 2002 and 2001, see the section entitled “Critical Accounting Estimates” beginning on page 28 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report on Form 10-K.

Losses and Loss Adjustment Expense Development. The following table presents the development of unpaid losses and loss adjustment expenses during the ten years ended December 31, 2003. The top section of the table shows the reserves for unpaid losses and loss adjustment expenses at the balance sheet date for each of the indicated years. The next section shows the cumulative net paid losses and loss adjustment expenses for each succeeding year with respect to the reserve amounts previously recorded at the respective periods. The next section represents the re-estimated net reserve for unpaid losses and loss adjustment expenses as of the end of each succeeding year for claims arising in all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported.

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The net cumulative deficiency represents the cumulative change in estimates for net losses and loss adjustments expenses as of December 31, 2003 for each respective year. The changes in estimates are recorded as more information becomes available about the frequency and severity of claims.

The bottom of the table summarizes the re-estimated reserves for unpaid losses and loss adjustment expenses at December 31, 2003 for each of the respective years and the gross cumulative deficiency which represents the cumulative change in estimates for gross losses and loss adjustments expenses as of December 31, 2003 for each respective year.

Schedule of Loss and Loss Adjustment Expense Development

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Analysis of Losses and Loss Adjustment Expense Development

The net cumulative deficiency presented in the previous table represents the difference between the unpaid loss and loss adjustment expense reserves recorded as of December 31 of the respective calendar year and the re-estimation of these reserves as of December 31, 2003. While each year of the table reflects a net cumulative deficiency, the majority of each year’s net cumulative deficiency was recognized by the Company in four calendar periods: 1999, 2000, 2002 and 2003.

In 1999, the Company increased incurred losses and loss adjustment expenses attributable to insured events of prior years by $8,419,000. The increase is attributable primarily to changes in estimates for losses and loss adjustment expenses for the non-standard personal automobile line of business. During 1999, the Company received a significant number of claims relating to accidents incurred prior to 1999, resulting in an increase in loss estimates. In 1999, the Company exited the non-standard personal automobile line of business.

In 2000, the Company increased incurred losses and loss adjustment expenses attributable to insured events of prior years by $9,164,000. The increase is attributable primarily to changes in the Company’s estimates for loss and loss adjustment expense reserves of $1,400,000 for commercial automobile, $3,900,000 for commercial multi-peril liability and $3,400,000 for other liability lines of business.

The Company began writing commercial automobile coverage for vehicles and light trucks in 1998. The initial estimates for 1998 and 1999 were based on a relatively low level of claims reported to the Company. As of December 31, 1999, the Company’s expectations of claim reporting patterns were based on industry experience, since limited Company experience was available. In 2000, the Company received more claims than initially expected for accident years 1998 and 1999. Consequently, the Company increased its estimate by $1,400,000 in 2000. In the fourth quarter of 2000, the Company exited the commercial automobile line of business due to unsatisfactory underwriting results.

The change in estimates in 2000 for the commercial multi-peril line of business resulted principally from an unexpected increase in reported liquor liability claims on policies written in 1998 and 1999. In 2000, the Company increased its estimate by $3,900,000. In 2000, the Company revised its underwriting guidelines to reduce significantly its exposure to liquor liability for bars and taverns in certain states. Ultimately, this revision limited liquor liability coverage only to certain states and certain insureds.

The change in estimates in 2000 for the other liability line resulted principally from construction defect claims, which were new types of claims that were not anticipated when the Company wrote these policies between 1991 and 1996. In 2000, the Company received an increased number of construction defect claims predominantly related to insureds that operated as sub-contractors in the state of California. Prior to 2000, most construction defect litigation was targeted at general contractors and housing developers. However, as their policy limits became eroded due to the vast number of litigants, plaintiff attorneys sought additional recoveries from sub-contractors. Consequently, with the increased number of claims reported combined with expected costs to defend these construction defect claims, the Company increased its estimate by $3,400,000.

For more information regarding incurred losses and loss adjustment expenses attributable to insured events of prior years for 2002 and 2003, see the section entitled “Critical Accounting Estimates” beginning on page 28 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report on Form 10-K.

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Reinsurance

To reduce its exposure to liability on individual risks and to protect against catastrophic losses, the Company purchases reinsurance through contracts called “treaties” or on a facultative basis. Reinsurance involves an insurance company transferring or “ceding” a portion of its exposure on a risk to another insurer (the “reinsurer”). The reinsurer assumes the exposure in return for a portion of the premium. The ceding of liability to a reinsurer does not legally discharge the primary insurer from its liability for the full amount of the policies on which it obtains reinsurance. The primary insurer will be required to pay the entire loss if the reinsurer fails to meet its obligations under the reinsurance agreement.

In formulating its reinsurance programs, the Company is selective in its choice of reinsurers and considers numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize its exposure to the insolvency of its reinsurers, the Company evaluates the acceptability and reviews the financial condition of each reinsurer annually. The Company’s policy is to use only reinsurers that have an A.M. Best Company (“A.M. Best”) rating of “A” (Excellent) or better and that have at least $500 million in statutory surplus.

For more information regarding the Company’s reinsurance programs, see the section entitled “Reinsurance” beginning on page 32 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report on Form 10-K.

Investments

The Company’s investment strategy emphasizes quality, liquidity and diversification, as well as total return. With respect to liquidity, the Company considers liability durations, specifically related to loss reserves, when determining desired investment maturities. In addition, maturities have been staggered to produce cash flows for loss payments and reinvestment opportunities. The Company out-sources the management of its investment portfolio to Gen Re New England Asset Management Inc. (“NEAMS”). In accordance with the asset management agreement between the Company and NEAMS, all investment transactions are approved by the Investment Committee of the Company within 60 days of their initiation by NEAMS. As of December 31, 2003, total cash and investments of $345.7 million consisted of $323.5 million in fixed-maturity securities, $10.2 million in equity securities, consisting of preferred stocks and a mutual fund invested in adjustable rate mortgages, and $12.0 million in cash.

For more information regarding the Company’s investment portfolio, see the section entitled “Investments” beginning on page 35 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report on Form 10-K.

Competition

The property and casualty insurance industry is highly competitive and includes several thousand insurers, ranging from large companies offering a wide variety of products worldwide to smaller, specialized companies in a single state or region offering only a single product in some cases. The Company competes with a number of insurers in attracting quality general agents and in selling insurance products. Many of the Company’s existing or potential competitors are larger excess and surplus lines and specialty admitted insurers which have considerably greater financial and other resources, have greater experience in the insurance industry and offer a broader line of insurance products than the Company. The Company believes that in order to be successful in its market, it must be aware of pricing cycles and must be able to minimize the impact of such cycles through tight expense control and superior customer service.

Another competitive factor is the rating assigned by independent rating organizations such as A.M. Best. Penn-America Insurance Company and Penn-Star Insurance Company currently have a

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pooled rating from A.M. Best of “A-” (Excellent). “A-” is the fourth highest of sixteen rating categories. These ratings are based upon factors, such as, capital adequacy, loss reserve adequacy and operating performance, of concern to policyholders and are not directed toward the protection of investors.

The Company believes that its distribution strategy, which is based on building and maintaining strong relationships with a small number of high quality general agents that are enabled with the latest technological innovation, provides a competitive advantage in the markets it targets. See the section entitled “Marketing and Distribution” beginning on page 5, which more fully describes the elements of the strategies which the Company believes provide this competitive advantage.

Regulation

General. The Company is subject to regulation under the insurance statutes and regulations, including insurance holding company statutes, of the various states in which it does business. These statutes are generally designed to protect the interests of insurance policyholders, as opposed to the interests of stockholders, and they relate to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature and limitations of investments; deposits of securities for the benefit of policyholders; approval of policy forms, rules and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. All insurance companies must file annual statements with certain state regulatory agencies and are subject to regular and special financial examinations by those agencies. The last regulatory financial examination of Penn-America Insurance Company was completed by the Pennsylvania Insurance Department in 1999, covering the five-year period ended December 31, 1998, and for Penn-Star Insurance Company, covering a two-year period ended December 31, 1998, since its initial licensing in 1997.

Insurance Holding Company Laws. Pennsylvania, the Company’s state of domicile, has laws governing insurers and insurance holding companies. The Pennsylvania statutes generally require insurers and insurance holding companies to register and to file reports concerning their capital structure, ownership, financial condition and general business operations. Under the statutes, a person must generally obtain the Pennsylvania Insurance Department’s approval to acquire, directly or indirectly, 10% or more of the outstanding voting securities of PAGI or any of its insurance subsidiaries. The insurance department’s determination of whether to approve any such acquisition is based on a variety of factors, including an evaluation of the acquirer’s financial condition, the competence of its management and whether competition would be reduced. All transactions within a holding company’s group affecting an insurer must be fair and reasonable and the insurer’s statutory surplus following any such transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to applicable regulators is required prior to the consummation of certain transactions affecting insurance subsidiaries of the holding company group.

Dividend Restriction. PAGI is a holding company, the principal asset of which is the common stock of Penn-America Insurance Company. PAGI’s principal source of cash to meet short-term and long-term liquidity needs, including the payment of dividends to stockholders, corporate expenses and interest on its junior subordinated debentures, is dividends from Penn-America Insurance Company. PAGI has no planned capital expenditures that could have an impact on its long-term liquidity needs.

Penn-America Insurance Company’s principal sources of funds are underwriting operations, investment income and proceeds from sales and redemptions of investments. Funds are used by Penn-America Insurance Company and Penn-Star Insurance Company principally to pay claims and operating expenses, to purchase investments and to make dividend payments to PAGI. PAGI’s future liquidity is dependent on the ability of Penn-America Insurance Company to pay dividends to PAGI.

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The Company’s insurance subsidiaries are restricted by statute as to the amount of dividends that they may pay without the prior approval of regulatory authorities. Penn-America Insurance Company may pay dividends to PAGI without advance regulatory approval only from unassigned surplus and only to the extent that all dividends in the past twelve months do not exceed the greater of 10% of total statutory surplus or statutory net income for the prior year. Using these criteria, the available ordinary dividend for 2004 is $12,196,000. Ordinary dividends of $2,600,000, $1,100,000 and $1,600,000 were paid to PAGI in 2003, 2002 and 2001, respectively. Penn-America Insurance Company’s ability to pay future dividends to PAGI without advance regulatory approval is dependent upon maintaining a positive level of unassigned and statutory surplus, which in turn, is dependent upon Penn-America Insurance Company and Penn-Star Insurance Company generating net income in excess of dividends to PAGI. As of December 31, 2003, Penn-America Insurance Company’s statutory surplus was $121,960,000, and included unassigned surplus of $36,420,000.

Penn-America Insurance Company and Penn-Star Insurance Company are required by law to maintain a certain minimum level of statutory surplus. Statutory surplus is calculated by subtracting total liabilities from total assets. The National Association of Insurance Commissioners adopted risk-based capital standards designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2003, the statutory surplus of Penn-America Insurance Company and Penn-Star Insurance Company was in excess of the prescribed risk-based capital requirements. Penn-America Insurance Company’s statutory surplus at December 31, 2003 was $121,960,000 and its regulatory action level was $30,034,000. Penn-Star Insurance Company’s statutory surplus at December 31, 2003 was $42,232,000 and its regulatory action level was $11,256,000.

Insurance Guaranty Funds. Under insolvency or guaranty laws in states in which Penn-America is licensed as an admitted insurer (and in New Jersey), organizations have been established (often referred to as guaranty funds) with the authority to assess admitted insurers up to prescribed limits for the claims of policyholders insured by insolvent, admitted insurance companies. Surplus lines insurance companies are generally not subject to such assessments except in New Jersey and their policyholders are not eligible to file claims against the guaranty funds.

Additional Legislation or Regulations. New regulations and legislation are proposed from time to time to limit damage awards, to bring the industry under regulation by the federal government, to control premiums, policy terminations and other policy terms and to impose new taxes and assessments. Difficulties with insurance availability and affordability have increased legislative activity at both the federal and state levels. Some state legislatures and regulatory agencies have enacted measures, particularly in personal lines, to limit midterm cancellations by insurers and to require advance notice of renewal intentions. In addition, Congress is investigating possible avenues for federal regulation of the insurance industry.

Employees

The Company has approximately 120 employees. The Company is not a party to any collective bargaining agreements and believes that its employee relations are good.

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Risk Factors

The provisions of the Private Securities Litigation Reform Act of 1995 (the “Act”) became effective in December 1995. The Act provides a “safe harbor” for companies which make forward-looking statements providing prospective information. The “safe harbor” under the Act relates to protection for companies with respect to litigation filed on the basis of such forward-looking statements. The Company wishes to take advantage of the “safe harbor” provisions of the Act and is therefore including this section in its Annual Report on Form 10-K. The statements contained in this Annual Report, if not historical, are forward-looking statements and involve risks and uncertainties which are described below that could cause actual results to differ materially from the results, financial or otherwise, or other expectations described in such forward-looking statements. These statements are identified with the words “anticipates,” “expects,” “intends,” “seeks” or “plans” or words of similar meaning. Therefore, forward-looking statements should not be relied upon as a prediction of actual future results or occurrences.

The following are certain risk factors that can adversely affect the Company’s business and its results of operations and financial condition. This list is not exhaustive and new risk factors may emerge due to the continually changing business environment. The Company cannot predict new risk factors, nor can it assess the impact, if any, of such new risk factors on its business.

Risks Related to the Company’s Business

A decline in the financial rating of PAGI’s insurance subsidiaries may result in a reduction of new or renewal business.

PAGI’s insurance subsidiaries currently have a pooled “A-” (Excellent) rating from A.M. Best. A.M. Best assigns ratings that are generally based on an insurance company’s ability to pay policyholder obligations (not towards protection of investors) and focus on capital adequacy, loss reserve adequacy and operating performance. A reduction in the Company’s performance in these criteria could result in a downgrade of its rating. A downgrade of this rating could cause the Company’s current and future general agents, retail brokers and insureds to choose other, higher-rated competitors.

The Company’s inability to assess underwriting risk accurately could reduce net income.

The Company’s underwriting success is dependent on its ability to assess accurately the risks associated with the businesses on which the risk is retained. The Company relies on the experience of its underwriting staff in assessing these risks. In addition, the failure to retain or to hire experienced personnel could adversely affect the ability to accurately make those determinations. If the Company fails to assess accurately the risks retained, it could result in the failure to establish appropriate premium rates and the Company’s reserves may be inadequate to cover its losses, which could reduce net income. The underwriting process is further complicated by exposure to unpredictable developments, including weather-related and other natural catastrophes, as well as war and acts of terrorism.

The Company’s general agents may exceed their authority and could bind business outside its underwriting guidelines.

The Company underwrites a substantial majority of its policies on a binding authority basis. Binding authority business represents risks that may be quoted and bound by the Company’s general agents prior to the Company’s underwriting review. An agent’s binding authority is limited, however, by underwriting guidelines that are in place. These guidelines include, but are not limited to, restrictions on authorized lines and classes of business, limits of liability, policy premium, pricing and the total insured value per location. If a general agent exceeds its authority by binding a risk that does not comply with such underwriting guidelines, the Company is at risk on claims that occur from the time the policy was written

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until the policy is received and canceled by the Company. In addition, to cancel the policy for exceeding underwriting authority, the Company must receive and cancel the policy within statutorily prescribed time limits, typically sixty (60) days. As a result, the Company may be bound by a policy that does not comply with its underwriting guidelines, and until the Company can effect a cancellation, the Company may incur losses and loss adjustment expenses related to that policy.

The Company depends on general agents for a significant amount of revenue and the loss of any one of such agents, through sale or otherwise, could adversely affect the Company.

The Company’s marketing and distribution strategy is dependent on relations with its general agents. The Company distributes its products through sixty-six (66) general agents that have limited binding authority. For the year ended December 31, 2003, the Company had one agency that produced approximately 11% of the Company’s gross written premiums. A loss of all or substantially all of the business produced by this general agent, through the sale of such agency to a larger national agency or otherwise, could result in a decline in premium volume and an adverse effect on the business and operations of the Company.

The Company depends on its general agents to collect, retain and remit premiums to the Company on insurance policies that are bound and in-force.

The Company’s general agents collect insurance premiums on policies that are bound and in-force and are required to remit these premiums to the Company within forty-five days after the end of the month in which the policies are effective. While most states require general agents to maintain premium monies in a fiduciary account for the benefit of its insurance companies, general agents could use these monies for unauthorized purposes, exposing the Company to credit risk of its general agents.

The Company enters into transactions with affiliates and insiders who hold a considerable amount of the Company’s common stock on terms that may be less advantageous than those obtained from unrelated third parties.

Penn Independent, PAGI’s controlling stockholder, which is owned 100% by the Saltzman family, owned approximately 31% of PAGI’s outstanding common stock as of December 31, 2003. As a result, Penn Independent may influence the Company’s decisions. Several of Penn Independent’s wholly-owned subsidiaries are insurance agencies that write business with the Company. In addition, the Company leases its headquarters from Mr. Saltzman and it obtains services from Penn Independent. The terms and conditions of these transactions with affiliates could be less advantageous than those obtained from unrelated parties.

Failure to establish adequate loss reserves could have a material adverse effect on the Company’s financial condition.

The Company is directly liable for losses and loss adjustment expenses under the terms of the insurance policies that it writes. In many cases, several years may lapse between the occurrence of an insured loss, the reporting of the loss to the Company and its payment of that loss. The Company reflects its liability for the ultimate payment of all incurred losses and loss adjustment expenses by establishing loss and loss adjustment expense reserves as balance sheet liabilities for both reported and unreported claims. These reserves are based on historical data and estimates of future events and by their nature are imprecise. The Company’s ultimate losses and loss adjustment expenses may vary from established reserves.

Furthermore, factors such as claims inflation, claims settlement patterns, legislative activity, social and economic patterns, and litigation and regulatory trends, all of which are difficult to predict, may have a substantial impact on the Company’s future loss experience. Additionally, the Company has established loss and loss adjustment expense reserves for certain lines of business which were exited by the

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Company, but circumstances could develop that would make these reserves insufficient. If any of the Company’s reserves should prove to be inadequate, the Company will be required to increase reserves resulting in a reduction in net income in the period in which the deficiency is identified. Future loss experience substantially in excess of established reserves could also have a material effect on future earnings and liquidity. As of December 31, 2003, unpaid loss and loss adjustment expense reserves were $174.9 million, consisting of case loss and loss adjustment expense reserves of $43.7 million, and incurred but not reported loss and loss adjustment expense reserves of $131.2 million.

The Company relies on its ability to obtain reinsurance support.

The Company currently purchases excess of loss and catastrophic event reinsurance, which allows it to write greater limits of liability than the Company otherwise could. In addition, the Company may choose in the future to re-evaluate the use of reinsurance to increase, decrease or eliminate the amount of liability it cedes to reinsurers, depending upon its cost and availability.

The maintenance of reinsurance does not legally discharge the Company from its primary liability for the full amount of the risks the Company insures, although it does make the reinsurer liable to the Company. Therefore, the Company is subject to credit risk with respect to its reinsurers. As of December 31, 2003, the Company had $38.0 million of reinsurance recoverable.

Since September 2001, the Company’s multiple-line excess of loss treaty reinsurance is with American Re, part of the Munich Re Group. American Re is rated “A+” (Superior) by A.M. Best. For the three years prior to September 1, 2001, General Reinsurance Corporation, rated “A++” (Superior) by A.M. Best, was the Company’s reinsurer on its multiple-line excess of loss treaty.

For 2004, the Company’s catastrophic loss reinsurance program includes: American Agricultural Insurance Company, Converium Reinsurance (North America) Inc., Converium (UK), Everest Reinsurance Company, Hannover Re (Bermuda) Ltd., PXRE Reinsurance Company, Shelter Reinsurance Company, Sirius International Insurance Corporation and XL Re Ltd. All of these reinsurers have statutory surplus greater than $500 million and an A.M. Best rating of “A” (Excellent) or higher.

The Company’s investment portfolio is subject to economic loss, principally from changes in the market value of financial instruments.

The Company had fixed-maturity and equity investments with a market value of $333.7 million at December 31, 2003 that are subject to:

The Company’s fixed-maturity investment portfolio includes mortgage-backed and other asset-backed securities. As of December 31, 2003, mortgage-backed securities and other asset-backed securities constituted approximately 36.3% of the Company’s fixed-maturity investments. As with other fixed-maturity investments, the fair value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Changes in interest rates can expose the Company to prepayment risks on these investments. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities and other asset-backed securities are paid more quickly, requiring the Company to reinvest the proceeds at the then current market rates.

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The success of any investment activity is affected by general economic conditions, which may adversely affect the markets for common stock, fixed-maturity and equity securities. Unexpected volatility or illiquidity in the markets in which the Company holds positions could reduce liquidity and stockholders’ equity.

Risks Related to the Company’s Industry

The Company’s success is highly dependent on key personnel.

The efforts and abilities of the Company’s present management, particularly that of Jon S. Saltzman, President and Chief Executive Officer, Joseph F. Morris, Senior Vice President, Chief Financial Officer and Treasurer, and J. Ransley Lennon, Vice President-Information Technology, are very important to the Company’s success. If the Company were to lose the services of any of these key personnel, it may find it difficult to find a suitable replacement, which could cause operating results to decline. While the Company does not maintain employment contracts with these personnel, it does maintain key personnel life insurance policies.

Changes in the Company’s operating environment may affect its performance.

The Company may incur significant fluctuations in operating results due to changes in competition, market conditions, catastrophe losses, severe weather conditions and general economic conditions, including interest rate changes, as well as court decisions, legislative initiatives, the frequency of litigation and the size of judgments. The impact of these factors can dramatically affect demand for the Company’s products, insurance capacity, pricing and claims experience and, consequently, the Company’s business, results of operations or financial condition.

The Company is heavily regulated and changes in the regulation of the insurance industry may have an adverse impact.

The Company is subject to regulation, primarily by Pennsylvania, its domiciliary state, and to a lesser degree, the thirty-seven (37) other states in which the Company is an admitted insurer. The regulations are generally designed to protect the interests of insurance policyholders, as opposed to the interests of stockholders. These regulations relate to authorized lines of business, capital and surplus requirements, rules, rates and forms, investment parameters, underwriting limitations, transactions with affiliates, dividend limitations, changes in control and a variety of other financial and non-financial components of the Company’s business. Significant changes in these laws and regulations could further limit the Company’s discretion or make it more expensive to conduct its business.

The National Association of Insurance Commissioners has adopted a system to test the adequacy of statutory capital, known as “risk-based capital,” which applies to PAGI’s insurance subsidiaries. This system establishes the minimum amount of risk-based capital necessary for a company to support its overall business operations. It identifies property and casualty insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision or control. Thus, failure to maintain risk-based capital at the required levels could adversely affect the ability of PAGI’s insurance subsidiaries to maintain regulatory authority to conduct its business. For more information regarding risk-based capital as of December 31, 2003, see the section entitled “Liquidity and Capital Resources” beginning on page 38 of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report on Form 10-K.

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The Company’s business is cyclical in nature which can affect its financial performance.

Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns of soft markets (declining premium rate levels) followed by hard markets (rising premium rate levels). Although an individual insurance company’s financial performance is dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. Since this cyclicality is due in large part to the actions of its competitors and general economic factors, the Company cannot predict with certainty how long soft or hard markets will last.

The Company operates in a highly competitive market.

The property and casualty insurance industry is highly competitive. The Company competes with numerous domestic and international insurers, many of which have greater financial and management resources and experience in the insurance industry. The Company also may compete with new entrants in the future. Competition is based on many factors, including:

Ultimately, this competition could affect the Company’s ability to attract business at premium rates which are likely to generate underwriting profits.

State statutes limit the aggregate amount of dividends the Company’s subsidiaries may pay to the Company in any twelve month period, thereby limiting its funds to pay expenses and dividends.

PAGI is an insurance holding company, the principal asset of which is the common stock of Penn-America Insurance Company. Dividends from Penn-America Insurance Company are PAGI’s primary source of funds to pay expenses and dividends. The payment of dividends by Penn-America Insurance Company to PAGI and the payment of dividends by Penn-Star Insurance Company to Penn-America Insurance Company are limited by statute. In general, these restrictions limit the aggregate amount of dividends or other distributions that Penn-America Insurance Company or Penn-Star Insurance Company may declare or pay within any 12-month period without advance regulatory approval. Generally this limitation is the greater of statutory net income for the preceding calendar year or 10% of the statutory surplus. In addition, insurance regulators have broad powers to prevent reduction of statutory surplus to inadequate levels and could refuse to permit the payment of dividends of the maximum amounts calculated under any applicable formula.

Applicable insurance laws, certain provisions in the Company’s articles of incorporation and agreements with certain key employees make it difficult to effect a change of control and a large shareholder may have significant influence over potential change of control transactions.

Under applicable Pennsylvania insurance laws and regulations, no person may acquire control of PAGI unless that person has filed a statement containing specified information with the Pennsylvania Insurance Commissioner and obtains advance approval for such acquisition. Under applicable laws and regulations, any person acquiring, directly or indirectly (by revocable proxy or otherwise), 10% or more of the voting stock of any other person is presumed to have acquired control of such person, and a person who

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beneficially acquires 10% or more of the Company’s common stock without obtaining advance approval of the Pennsylvania Insurance Commissioner would be in violation of Pennsylvania insurance law and would be subject to injunctive action requiring disposition or seizure of the shares and prohibiting the voting of such shares, as well as other action determined by the Pennsylvania Insurance Commissioner.

In addition, many state insurance laws require prior notification to the state insurance department of a change of control of a non-domiciliary insurance company licensed to transact insurance in that state. While these pre-notification statutes do not authorize the state insurance departments to disapprove the change of control, they authorize regulatory action (including a possible revocation of the Company’s authority to do business) in the affected state if particular conditions exist such as undue market concentration. Any future transactions that would constitute a change of control of the Company may require prior notification in the states that have pre-acquisition notification laws.

The Company’s articles of incorporation contain certain provisions that make more difficult the acquisition of control of PAGI by means of a tender offer, open market purchase, a proxy fight or otherwise. Other provisions in the articles of incorporation that make it difficult to effect a change of control include the authority of the Company’s Board of Directors to issue series of preferred stock with such voting rights and other powers as the Board of Directors may determine, and notice requirements in the bylaws relating to nominations to the Board of Directors and to the raising of business matters at stockholders’ meetings.

Penn Independent currently owns approximately 31% of the Company’s outstanding common stock. Penn Independent’s stock ownership and ability to nominate persons for election to the Company’s Board of Directors provides Penn Independent with significant influence over potential change of control transactions.

Finally, the Board of Directors has approved change in control and severance compensation for certain of the Company’s key employees. In the event of a change in control, as defined in the agreements, these individuals will receive .25 to 2 times their annual base salary to stay through such a change in control, and .25 to 2 times their annual base salary as severance if they are terminated, as defined in the agreements, due to a change in control.

Risks Related to the Company’s Common Stock

Trading in the Company’s common stock is potentially volatile and the Company cannot guarantee that an active trading market or a specific share price will be established.

The stock market has experienced price and volume fluctuations that have been unrelated to the operating performance of particular companies. The market price of the Company’s common stock may be significantly affected by quarterly variations in results of operations, changes in financial estimates by securities analysts or by failure to meet estimates, litigation, general trends in the insurance industry, actions by governmental agencies, national economic and stock market conditions, industry reports and other factors, many of which are beyond the Company’s control. Light trading in the Company’s common stock also has the potential to contribute to the volatility of the stock price. When few shares trade on any given day, any one trade, even if relatively small, may have an impact on the market price, causing the share price of the Company’s common stock to rise or fall.

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The Company may require additional capital in the future that may not be available or only available on unfavorable terms.

The Company’s future capital requirements depend on many factors, including the level of premiums written by the Company’s insurance subsidiaries and the Company’s need to establish adequate loss reserves. The extent that the Company needs to raise additional capital to support its insurance subsidiaries may be on terms that are not favorable to existing shareholders.

The Company has a significant number of shares eligible for future sale.

As of December 31, 2003, Penn Independent held 4,631,250 shares of the Company’s common stock and option holders held options to purchase an aggregate 630,060 shares of the Company’s common stock. The Company cannot predict the effect, if any that future sales of the Company’s common stock by Penn Independent or option holders, or the availability of shares of its common stock for future sale will have on the market price of its common stock prevailing from time to time. Sales of substantial amounts of the Company’s common stock in the public market by insiders or existing shareholders, or the perception that such sales could occur, could adversely affect the market price of its common stock and may make it more difficult for the Company to sell its equity securities in the future at a time and at a price which the Company deems appropriate.

Item 2. Properties.

The Company leases approximately 23,000 square feet in an office building located in Hatboro, Pennsylvania. The office building also houses Penn Independent and certain of its subsidiaries. The Company leases the space from Mr. Irvin Saltzman, Chairman of the Board of Directors of the Company, pursuant to a lease agreement renewed June 30, 2000 that expires on June 30, 2005, and provides for an annual rental payment of $281,000. This amount is considered by the Company to be at fair market value.

Item 3. Legal Proceedings.

The Company’s insurance subsidiaries are subject to routine legal proceedings in connection with their property and casualty business. There are no other legal proceedings that the Company is currently involved.

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

No matter was submitted during the fourth quarter of 2003 to a vote of holders of PAGI’s common stock.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Market, Dividends and Holders. PAGI’s common stock trades on the New York Stock Exchange under the symbol “PNG”. As of January 31, 2004, there were 205 registered holders of record and approximately 1,100 beneficial holders of record of PAGI’s common stock. The high and low sales prices of, and cash dividend per share for, the common stock during each quarter within 2003 and 2002 were as follows:

PAGI’s principal source of cash to pay dividends to stockholders is dividends from Penn-America Insurance Company, which are restricted by statute as to the amount of dividends that may be paid without the prior approval of regulatory authorities. For information that more fully describes dividend restrictions for Penn-America Insurance Company, see the section entitled “Liquidity and Capital Resources” beginning on page 38 of Item 7, “Management’s Discussion and Analysis of Financial Condition”, of this report on Form 10-K.

Equity Compensation Plans. The following table summarizes the Company’s common stock that is authorized for issuance under its equity compensation plans as of December 31, 2003.

The Company’s equity compensation plan approved by security holders is its 2002 Stock Compensation Plan. The Company’s equity compensation plan not required to be approved by security holders is its Agents’ Contingent Profit Commission Plan. For more information about these plans, see Note 15 entitled “Stock Incentive Plans” beginning on page 63 of Item 8, “Financial Statements and Supplementary Data”, of this report on Form 10-K.

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Item 6. Selected Financial Data.