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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

For Quarterly Period Ended March 31, 2004

OR

For the Transition Period from              to             

Commission file number 0-18298

Unitrin, Inc.

(Exact name of registrant as specified in its charter)

(312) 661-4600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

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

68,291,332 shares of common stock, $0.10 par value, were outstanding as of April 20, 2004.

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UNITRIN, INC.

INDEX

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UNITRIN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in millions, except per share amounts)

(Unaudited)

The Notes to the Condensed Consolidated Financial Statements are an integral part of these financial statements.

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UNITRIN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in millions, except per share amounts)

The Notes to the Condensed Consolidated Financial Statements are an integral part of these financial statements.

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UNITRIN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in millions)

(Unaudited)

The Notes to the Condensed Consolidated Financial Statements are an integral part of these financial statements.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

The unaudited Condensed Consolidated Financial Statements included herein have been prepared by Unitrin, Inc. (“Unitrin” or the “Company”) pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) but do not include all information and footnotes required by accounting principles generally accepted in the United States of America. In the opinion of the Company’s management, the unaudited Condensed Consolidated Financial Statements include all adjustments necessary for a fair presentation. The preparation of interim financial statements relies heavily on estimates. This factor and certain other factors, such as the seasonal nature of some portions of the insurance business, as well as market conditions, call for caution in drawing specific conclusions from interim results. The accompanying unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K, filed with the SEC for the year ended December 31, 2003.

Stock-Based Compensation

Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” prospectively to all awards granted, modified or settled on or after January 1, 2003.

The effects on Net Income, Net Income Per Share and Net Income Per Share Assuming Dilution if the fair value based method had been applied to all awards since the effective date of SFAS No. 123 for the periods presented below were:

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 2 - Acquisition of Businesses

In June 2002, the Company acquired the personal lines property and casualty insurance business of the Kemper Insurance Companies (“KIC”). KIC retained all liabilities for policies issued by Kemper Auto and Home (“KAH”) prior to the closing, while Trinity Universal Insurance Company (“Trinity”), a subsidiary of Unitrin, is entitled to premiums written for substantially all policies issued or renewed by the Kemper Auto and Home segment after the closing and is liable for losses and expenses incurred thereon. At the acquisition date, Unitrin’s property and casualty insurance subsidiaries were not licensed in all the states where the KAH business is written nor were certain computer and data processing modifications completed to allow for the migration of the KAH business to the Company’s property and casualty insurance subsidiaries. Accordingly, to facilitate the transition of such business to Unitrin’s property and casualty insurance subsidiaries, KIC and Trinity entered into a quota share reinsurance agreement whereby Trinity reinsured, on a 100% indemnity basis, substantially all of the KAH business written or renewed by KIC after the acquisition date. KIC’s financial condition deteriorated rapidly after the acquisition, and accordingly, Unitrin accelerated its plans to transition the business directly to its property and casualty insurance subsidiaries. As of March 31, 2004, Unitrin’s property and casualty insurance subsidiaries have obtained all necessary licenses, have completed all computer and data processing modifications and approximately 75% of the in-force KIC personal lines policies had been renewed directly by Unitrin’s property and casualty insurance subsidiaries and renewal notices for an additional 10% had been sent to policyholders. Unitrin expects that approximately 92% of the in-force KIC personal lines policies at the end of the second quarter of 2004 will have been renewed directly by Unitrin’s property and casualty insurance subsidiaries and renewal notices will have been sent to an additional 5% of policyholders.

Note 3 - Investment in Investee

Equity in Net Income (Loss) of Investee was a loss of $0.1 million and income of $0.4 million for the three months ended March 31, 2004 and 2003, respectively. Unitrin accounts for its investment in its investee, UNOVA, Inc. (“UNOVA”), under the equity method of accounting using the most recent and sufficiently timely publicly-available financial reports and other publicly-available information, which generally results in a three month delay in the inclusion of UNOVA’s results in Unitrin’s consolidated financial statements. Prior to the periods presented in the Condensed Consolidated Financial Statements, Unitrin determined that a decline in the fair value of its investment in UNOVA was other than temporary under applicable accounting standards. Accordingly, Unitrin reduced the carrying value of its investment in UNOVA to its then current estimated realizable value and allocated the reduction to Unitrin’s proportionate share of UNOVA’s non-current assets. Accordingly, Unitrin’s reported equity in the net income of UNOVA differs from Unitrin’s proportionate share of UNOVA’s reported results to the extent that such results include depreciation, amortization or other charges related to such non-current assets. The fair value of Unitrin’s investment in UNOVA subsequently recovered such that the fair value exceeded the carrying value of Unitrin’s investment in UNOVA by $207.6 million and $225.8 million at March 31, 2004 and December 31, 2003, respectively. In accordance with applicable accounting standards, such excess is not included in the Condensed Consolidated Financial Statements.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 4 - Other Receivables

Under the agreement governing the 1999 acquisition of Valley Group, Inc. (“VGI”), the Company is entitled to recover 90% of unfavorable development on VGI’s pre-acquisition loss and loss adjustment expense reserves from the seller, White Mountains Insurance Group, Ltd. (“White Mountains”) (formerly Fund American Enterprise Holdings, Inc.). Recovery is subject to a maximum limit of $50 million. Such reserves have experienced unfavorable development, 90% of the amount of which exceeded the maximum recovery under the agreement. Accordingly, the recoverable at March 31, 2004 is recorded at the maximum limit. The Company delivered a final reserve report to White Mountains on March 7, 2003. On April 4, 2003, White Mountains responded to the Company and indicated, among other things, that it believes that “the final reserve report does not constitute an appropriate calculation of the [unfavorable development] and we will not pay Unitrin the amount indicated.” An exchange of information between the parties ensued. The Company believes it has accurately calculated the reserve amount in question and is pursuing resolution of the matter in accordance with the dispute resolution process provided in the agreement.

On December 31, 2002, Unitrin completed the acquisition of two insurance companies, General Security Insurance Company and General Security Property and Casualty Company (the “SCOR Companies”), from SCOR Reinsurance Company (“SCOR”). Other Receivables at March 31, 2004 and December 31, 2003 included reinsurance recoverables of $218.4 million and $234.4 million, respectively, from General Security National Insurance Company (“GSNIC”), a subsidiary of SCOR. Under the agreement governing the acquisition of the SCOR Companies, SCOR and/or GSNIC are responsible for all liabilities of the SCOR Companies incurred prior to the acquisition. Accordingly, in connection with the sale, GSNIC entered into a reinsurance agreement with the SCOR Companies whereby GSNIC reinsured all of the business written by the seller using the SCOR Companies. To the extent the SCOR Companies are not fully relieved of their legal obligations to policyholders under the reinsurance agreement, Unitrin reports an obligation to policyholders as a liability of the SCOR Companies, with an offsetting and corresponding reinsurance recoverable from GSNIC. The ceding of the SCOR Companies’ insurance liabilities does not discharge the primary liability of the SCOR Companies; therefore, the SCOR Companies remain contingently liable should GSNIC not be financially able to meet the obligations. Pursuant to the reinsurance agreement, should GSNIC become unauthorized in any jurisdiction where authorization or licensure by governmental authorities is required in order for the SCOR Companies to take full credit on their statutory financial statements for reinsurance ceded to GSNIC, or should GSNIC be notified that it is required to file a risk-based capital (“RBC”) plan as a result of its RBC falling below required levels, certain remedies are available. In either case, the reinsurance agreement requires GSNIC to collateralize its outstanding reinsured obligation. On April 1, 2004, A.M. Best Co., Inc., the principal insurance company rating agency, reaffirmed the “B++” rating of GSNIC, assigned the rating an outlook of “stable” and removed the “under review” status of the rating. The Company believes that its reinsurance recoverable from GSNIC continues to be fully collectable at March 31, 2004.

Note 5 - Income Taxes

During the first quarter of 2003, Fireside Securities Corporation (“Fireside”) a subsidiary of Unitrin, was officially notified that its California franchise tax returns for 1998, 1999 and 2000 would be examined by the California Franchise Tax Board (the “FTB”). During the first quarter of 2004, the FTB and Fireside reached agreement on adjustments to these tax returns. The impact of these adjustments was not material to the Company’s consolidated financial statements.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 6 - Notes Payable

Total Debt Outstanding at March 31, 2004 and December 31, 2003 was:

The Company had no outstanding advances under its unsecured revolving credit agreement at March 31, 2004 and December 31, 2003.

Interest Paid, including facility fees, for the three months ended March 31, 2004 and 2003 was:

Interest Expense, including facility fees, for the three months ended March 31, 2004 and 2003 was:

Note 7 - Securities Lending

Some of the Company’s subsidiaries are parties to securities lending agreements whereby unrelated parties, primarily large brokerage firms, borrow securities from the subsidiaries’ accounts. Borrowers of these securities must deposit cash collateral with the subsidiaries equal to 102% of the fair value of the securities loaned. The subsidiaries continue to receive the interest on loaned securities as beneficial owners, and accordingly, the loaned securities are included in Fixed Maturities. The amount of collateral received is invested in short-term securities and is included in these financial statements as Short-term Investments with a corresponding Liability for Funds Held for Securities on Loan included in Accrued Expenses and Other Liabilities. The fair value of collateral held was $132.3 million at March 31, 2004. No securities were on loan at December 31, 2003.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 8 - Net Income Per Share

Net Income Per Share and Net Income Per Share Assuming Dilution for the three months ended March 31, 2004 and 2003 were as follows:

Options outstanding at March 31, 2004 and 2003 to purchase 0.9 million shares and 6.1 million shares, respectively, of Unitrin common stock were excluded from the computation of Net Income Per Share Assuming Dilution for the three months ended March 31, 2004 and 2003, respectively, because the exercise price exceeded the average market price.

Note 9 - Other Comprehensive Income (Loss)

Other Comprehensive Income (Loss) for the three months ended March 31, 2004 and 2003 was:

The Company’s Investment in Investee is accounted for under the equity method of accounting and, accordingly, changes in its fair value are excluded from the determination of Total Comprehensive Income and Other Comprehensive Income (Loss). Total Comprehensive Income for the three months ended March 31, 2004 was $101.6 million. Total Comprehensive Loss for the three months ended March 31, 2003 was $57.5 million.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 10 - Income from Investments

Net Investment Income for the three months ended March 31, 2004 and 2003 was:

Dividends on Northrop Preferred Stock increased for the three months ended March 31, 2004, compared to the same period in 2003, due to the timing of the ex-dividend date.

The components of Net Realized Investment Gains for the three months ended March 31, 2004 and 2003 were:

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 10 - Income from Investments (continued)

Net Realized Investment Gains was $18.5 million for the three months ended March 31, 2004, compared to $5.9 million for the same period in 2003. Net Realized Investment Gains for the three months ended March 31, 2004 includes pre-tax gains of $8.3 million from sales of a portion of the Company’s investment in Northrop Grumman Corporation (“Northrop”) common stock, pre-tax gains of $4.1 million from sales of a portion of the Company’s investment in Baker Hughes, Inc. (“Baker Hughes”) common stock and pre-tax gains of $3.2 million resulting from sales of a portion of the Company’s investment in Hartford Financial Services Group, Inc. (“Hartford”) common stock. The fair value of the Company’s remaining investments in Northrop common stock, Baker Hughes common stock and Hartford common stock was $591.3 million, $84.1 million and $19.7 million, respectively, at March 31, 2004. The Company cannot anticipate when or if similar investment gains may occur in the future.

Net Realized Investment Gains for the three months ended March 31, 2003 includes pre-tax gains of $11.9 million from sales of a portion of the Company’s investment in ITT Industries, Inc. common stock and pre-tax gains of $4.4 million resulting from sales of a portion of the Company’s investment in Baker Hughes common stock. The Company cannot anticipate when or if similar investment gains may occur in the future.

The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Some factors considered in evaluating whether or not a decline in fair value is other than temporary include: 1) the Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value; 2) the duration and extent to which the fair value has been less than cost; and 3) the financial condition and prospects of the issuer. Net Realized Investment Gains for the three months ended March 31, 2004 and 2003 includes pre-tax losses of $0.7 million and $13.1 million, respectively, resulting from other than temporary declines in the fair value of investments. The Company cannot anticipate when or if similar other than temporary declines in the fair value of investments may occur in the future.

Note 11 – Pension Benefits and Postretirement Benefits Other Than Pensions

The components of Pension Expense for the three months ended March 31, 2004 and 2003 were:

The components of Postretirement Benefits Other than Pensions Expense for the three months ended March 31, 2004 and 2003 were:

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 12 - Business Segments

The Company is engaged, through its subsidiaries, in the property and casualty insurance, life and health insurance and consumer finance businesses. The Company conducts its operations through six operating segments: Multi Lines Insurance, Specialty Lines Insurance, Kemper Auto and Home, Unitrin Direct, Life and Health Insurance and Consumer Finance.

Insurance provided by the Multi Lines Insurance segment consists of preferred and standard risk automobile, homeowners, fire, commercial liability and workers compensation and other related lines. Multi Lines Insurance products are marketed to individuals and businesses with favorable risk characteristics and loss histories and are sold by independent agents.

The Specialty Lines Insurance segment primarily consists of automobile and motorcycle insurance sold to individuals and businesses in the non-standard and specialty market through independent agents. The non-standard automobile insurance market consists of individuals and companies that have difficulty obtaining standard or preferred risk insurance, usually because of their driving records.

Kemper Auto and Home provides preferred and standard risk personal automobile and homeowners insurance through independent agents.

Unitrin Direct markets personal automobile insurance through direct mail and the Internet through web insurance portals, click-thrus and its own website. Unitrin Direct, as a direct marketer, typically incurs higher up-front acquisition costs associated with marketing products and acquiring new policies but is expected to experience lower renewal costs than traditional insurance providers.

The Life and Health Insurance segment includes individual life, accident, health and hospitalization insurance. The Company’s Life and Health Insurance employee-agents also market property insurance products under common management.

The Consumer Finance segment makes consumer loans primarily for the purchase of pre-owned automobiles and offers savings products in the form of investment certificates and savings accounts.

It is the Company’s management practice to allocate certain corporate expenses to its operating units. The Company considers the management of certain investments, including Northrop common and preferred stock, Baker Hughes common stock and UNOVA common stock, to be a corporate responsibility. Accordingly, the Company does not allocate dividend income from these investments to its operating segments. The Company does not allocate Net Realized Investment Gains to its operating segments. In the first quarter of 2004, the Company began allocating income taxes to its operating segments. Income taxes for prior periods have been allocated to conform to the current presentation.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 12 - Business Segments (continued)

Segment Revenues for the three months ended March 31, 2004 and 2003 were:

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 12 - Business Segments (continued)

Segment Operating Profit for the three months ended March 31, 2004 and 2003 was:

Segment Net Income for the three months ended March 31, 2004 and 2003 was:

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 13 - Related Party Transactions

One of Unitrin’s directors, Mr. Fayez Sarofim, is the Chairman of the Board, President and the majority shareholder of Fayez Sarofim & Co. (“FS&C”), a registered investment advisory firm. Certain of the Company’s insurance company subsidiaries and FS&C are parties to agreements under which FS&C provides investment management services. In addition, FS&C provides investment management services with respect to certain funds of the Company’s pension plan. The agreements governing these arrangements are terminable by either party at any time upon 30 days advance written notice.

Under these investment advisory arrangements, FS&C is entitled to a fee calculated and payable quarterly based upon the fair market value of the assets under management. At March 31, 2004, the Company’s subsidiaries and the Company’s pension plan had approximately $162.0 million and $71.2 million, respectively, in investments managed by FS&C. During the first three months of 2004, the Company’s subsidiaries and the Company’s pension plan paid $0.1 million in the aggregate to FS&C. During the first three months of 2003, the Company’s subsidiaries and the Company’s pension plan paid $0.1 million in the aggregate to FS&C.

With respect to the Company’s 401(k) Savings Plan, one of the alternative investment choices afforded to participating employees is the Dreyfus Appreciation Fund, an open-end, diversified managed investment fund. FS&C provides investment management services to the Dreyfus Appreciation Fund as a sub-investment advisor. According to published reports filed by FS&C with the SEC, the Dreyfus Appreciation Fund pays monthly fees to FS&C according to a graduated schedule computed at an annual rate based on the value of the Dreyfus Appreciation Fund’s average daily net assets. The Company does not compensate FS&C for services provided to the Dreyfus Appreciation Fund. As of March 31, 2004, employees participating in the Company’s 401(k) Savings Plan had allocated approximately $24.9 million for investment in the Dreyfus Appreciation Fund, representing approximately 12% of the total amount invested in the Company’s 401(k) Savings Plan.

The Company believes that the transactions described above have been entered into on terms no less favorable than could have been negotiated with non-affiliated third parties.

As described in Note 15, the Company also has certain relationships with mutual insurance holding companies and mutual insurance companies. Such companies are owned by the policyholders of such companies or their insurance subsidiaries.

Note 14 - Legal Proceedings

The Company and its subsidiaries are defendants in various legal actions incidental to their businesses. Many of these actions are pending in jurisdictions that permit damages, including punitive damages, that are disproportionate to the actual economic damages alleged to have been incurred. The plaintiffs in certain of these suits seek class action status that, if granted, could expose the Company and its subsidiaries to potentially significant liability by virtue of the size of the purported classes. The State of Mississippi, where the Company and some of its subsidiaries are defendants in a number of lawsuits, has received national attention for a large number of multi-million dollar jury verdicts and settlements against corporations in a variety of industries. Although Mississippi law does not permit class actions, case law there allows for virtually unlimited joinder of plaintiffs in a single action, thereby simulating a class action lawsuit, and the Company and some of its subsidiaries are defendants in such quasi-class action lawsuits. The Company and its subsidiaries believe that there are meritorious defenses to the cases referenced in this paragraph and are defending them vigorously. Although the Company believes that resolution of these cases will not have a material adverse effect on the Company’s financial position, the frequency of large damage awards, including punitive damage awards having little or no relationship to the actual economic damages allegedly incurred, means that there can be no assurance that one or more of these cases will not produce a damage award which could have a material adverse effect on the Company’s financial results for any given period.

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UNITRIN, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 15 – Relationships with Mutual Holding Companies and Mutual Insurance Companies

Trinity and Milwaukee Insurance Company (“MIC”) are parties to a quota share reinsurance agreement whereby Trinity assumes 95% of the business written or assumed by MIC. MIC is owned by Mutual Insurers Holding Company (“MIHC”), which in turn is owned by MIC’s policyholders. Effective July 1, 2001, MIC and First Nonprofit Insurance Company (through its predecessor, First Nonprofit Mutual Insurance Company) (“FNP”) are parties to a quota share reinsurance agreement whereby MIC assumes 80% of the business written or assumed by FNP. Pursuant to an amendment to the MIC/FNP reinsurance agreement, which became effective January 15, 2003, FNP agrees to arrange for its parent company, First Nonprofit Mutual Holding Company (“FNMHC”), to nominate a simple majority to the FNMHC Board of Directors selected by MIC. On January 15, 2003, FNMHC elected five employees of the Company, as selected by MIC, to the FNMHC Board of Directors pursuant to the terms of the amendment. FNP is owned by FNMHC, which in turn is owned by FNP’s policyholders. Five employees of the Company also serve as directors of MIHC’s nine member Board of Directors. Two employees of the Company also serve as directors of MIC, but together do not constitute a majority of MIC’s Board of Directors. The quota share agreements above can be terminated at anytime by each of the parties to the respective agreements, subject to the notice requirements in such agreements.

Trinity and Capitol County Mutual Fire Insurance Company (“Capitol”) are parties to a quota share reinsurance agreement whereby Trinity assumes 95% of the business written by Capitol. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. The Reliable Life Insurance Company (“Reliable”), a wholly-owned subsidiary of Unitrin, provides certain administrative services to Capitol and its subsidiary, Old Reliable Casualty Company (“ORCC”). In addition, agents employed by Reliable are also appointed by Capitol and ORCC to sell property insurance products. Union National Life Insurance Company, a wholly-owned subsidiary of Unitrin, also provides claims administration services to Capitol and ORCC.

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

Summary of Results

Net Income was $48.0 million ($0.71 per common share) for the three months ended March 31, 2004, compared to $13.4 million ($0.20 per common share) for the same period in 2003. Net Income increased for the three months ended March 31, 2004, due primarily to higher segment operating profit and higher net realized investment gains as discussed throughout this Management’s Discussion and Analysis of Results of Operations and Financial Condition.

Earned Premiums for the three months ended March 31, 2004 increased by $33.1 million, compared to the same period in 2003, due primarily to a $46.8 million increase in earned premiums in the Kemper Auto and Home segment and a $8.6 million increase in earned premiums in the Unitrin Direct segment, partially offset by a $23.0 million decrease in earned premiums in the Multi Lines Insurance segment.

Consumer Finance Revenues increased by $3.0 million for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to a higher level of loans outstanding.

Net Investment Income increased by $8.5 million for the three months ended March 31, 2004, compared to the same period in 2003, due to higher levels of investments and the timing of dividends on Northrop Grumman Corporation (“Northrop”) preferred stock, partially offset by lower yields on investments. Other Income decreased by $7.5 million for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to lower administration fees earned to administer run-off business excluded from the acquisition of the personal lines business of the Kemper Insurance Companies (“KIC”).

Net Realized Investment Gains was a pre-tax gain of $18.5 million for the three months ended March 31, 2004, compared to a pre-tax gain of $5.9 million for the same period in 2003. Net Realized Investment Gains for the three months ended March 31, 2004 primarily consisted of pre-tax gains of $8.3 million from sales of Northrop common stock and pre-tax gains of $10.0 million from sales of Other Equity Securities. Net Realized Investment Gains for the three months ended March 31, 2003 primarily consisted of pre-tax gains of $17.9 million from sales of Other Equity Securities, partially offset by pre-tax losses of $13.1 million to write down certain securities. The Company cannot anticipate when or if similar investment gains and losses may occur in the future.

Critical Accounting Policies

The Company’s subsidiaries conduct their businesses in three industries: property and casualty insurance, life and health insurance and consumer finance. Accordingly, the Company is subject to several industry-specific accounting principles under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The process of estimation is inherently uncertain. Accordingly, actual results could ultimately differ materially from the estimated amounts reported in the Company’s financial statements. Different assumptions are likely to result in different estimates of reported amounts. The Company’s critical accounting policies most sensitive to estimates include the valuation of investments, the valuation of property and casualty insurance reserves, the valuation of life insurance reserves, the valuation of the reserve for loan losses, the assessment of recoverability of goodwill, and the valuation of postretirement benefit obligations. These critical accounting policies are more fully described in the Company’s Management’s Discussion and Analysis of Results of Operations and Financial Condition presented in its Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) for the year ended December 31, 2003.

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Multi Lines Insurance

Earned Premiums in the Multi Lines Insurance segment decreased by $23.0 million for the three months ended March 31, 2004, compared to the same period in 2003. Personal lines earned premiums in the Multi Lines Insurance segment decreased by $1.7 million for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to lower premium volume, partially offset by higher premium rates. Commercial lines earned premiums in the Multi Lines Insurance segment decreased by $21.3 million for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to lower premium volume, partially offset by higher premium rates. The Company attributes the lower commercial lines volume largely to its efforts to re-underwrite that book of business which resulted in a significant reduction in policies in force. The Company has substantially completed such re-underwriting activities. The Company anticipates that commercial lines earned premiums in the Multi Lines Insurance segment will continue to decline in 2004 compared to 2003, due primarily to the extensive re-underwriting.

Net Investment Income in the Multi Lines Insurance segment increased by $1.3 million for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to higher levels of investments.

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Multi Lines Insurance (continued)

Operating Profit in the Multi Lines Insurance segment increased by $7.6 million before-tax for the three months ended March 31, 2004, compared to the same period in 2003, due primarily to improved premium rate adequacy in both personal lines and commercial lines, partially offset by higher commercial lines expenses as a percentage of earned premiums. Although the Company has substantially completed its extensive re-underwriting of its commercial lines business, the Company anticipates that commercial lines expenses as a percentage of earned premiums in the Multi Lines Insurance segment will be higher in 2004 due to the lower expected volume due to the re-underwriting. Catastrophe losses in the Multi Lines Insurance segment were $1.3 million for the three months ended March 31, 2004, an increase of $0.5 million compared to the same period in 2003.

Net Income in the Multi Lines Insurance segment increased by $5.1 million after-tax due to the higher operating profit. The Multi Lines Insurance segment’s effective income tax rate increased from 10.5% for the three months ended March 31, 2003, to 23.7% for the three months ended March 31, 2004, due primarily to higher pre-tax operating profit which results in lower levels of tax-exempt investment income as a percentage of pre-tax operating profit.

Specialty Lines Insurance