Edgar Filing: PENN AMERICA GROUP INC

As filed with the Securities and Exchange Commission on November 21, 2002

Registration No. 333-91362
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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Amendment No. 3 to

FORM S-2
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933

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PENN-AMERICA GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania 23-2180139
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) I.D. No.)

420 S. York Road
Hatboro, Pennsylvania 19040
(215) 443-3656
(Address, including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)

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Jon S. Saltzman, President and Chief Executive Officer
Penn-America Group, Inc.
420 S. York Road
Hatboro, Pennsylvania, 19040
(215) 443-3656
(Name, Address Including Zip Code and Telephone Number, Including Area Code,
of Agent for Service)

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Copies to:

Michael B. Pollack, Esq. Gary I. Horowitz, Esq.
Reed Smith LLP Simpson Thacher & Bartlett
One Liberty Place, 1650 Market St. 425 Lexington Avenue
Philadelphia, PA 19103 New York, NY 10017
(215) 851-8100 (212) 455-2000

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Approximate date of commencement of proposed sale to the public: As soon as
practicable after this registration statement becomes effective.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [_]
If the registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(1)
of this form, check the following box: [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_] ____________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_] ____________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box: [_]

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The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.

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The information in this prospectus is not complete and may be changed.
Penn-America may not sell nor accept offers to buy these securities until the
registration statement relating to these securities filed with the Securities
and Exchange Commission is effective. This prospectus is not an offer to sell
and it is not seeking an offer to buy these securities in any state where the
offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED , 2002

PROSPECTUS

2,600,000 Shares

[LOGO] Group (R)
Penn-America Group, Inc.

Common Stock

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We are offering 2,600,000 shares of our common stock.

Our common stock is traded on the New York Stock Exchange under the symbol
"PNG." On November 19, 2002, the closing price for our common stock was $9.45
per share.

See "Risk Factors" beginning on page 6 to read about risks you should consider
before buying shares of our common stock.

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.

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Per
Share Total
----- -----

Public offering price................. $ $
Underwriting discounts and commissions $ $
Proceeds, before expenses, to us...... $ $

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The underwriters may exercise an option to purchase up to an additional 390,000
shares of our common stock from us to cover over-allotments from time to time
for a period of 30 days from this offering.

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Bear, Stearns & Co. Inc.

Ferris, Baker Watts
Incorporated

Keefe, Bruyette & Woods, Inc.

The date of this Prospectus is , 2002.

Except where the context otherwise indicates, the terms "Penn-America," "we,"
"us," "ours" and "our" include Penn-America Group, Inc. and our wholly-owned
subsidiary, Penn-America Insurance Company, and its wholly-owned subsidiary,
Penn-Star Insurance Company.

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The "PA Group" logo is the trademark of Penn-America Insurance Company.
"PennLink" and "Penn-Star" are the trademarks of Penn-America Group, Inc.
"PennLink" is also the trademark of Penn-America Insurance Company and
Penn-Star Insurance Company. This prospectus also contains product names, trade
names, trademarks and service marks that belong to other companies.

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UNDER APPLICABLE PENNSYLVANIA INSURANCE LAWS AND REGULATIONS, NO PERSON MAY
ACQUIRE CONTROL OF PENN-AMERICA GROUP, INC. 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
BENEFICIALLY ACQUIRES 10% OR MORE OF OUR 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.

PROSPECTUS SUMMARY

This summary highlights information contained elsewhere is this prospectus.
This summary is not complete and does not contain all of the information that
you should consider before investing in our common stock. You should read the
entire prospectus carefully, especially "Risk Factors" and our consolidated
financial statements and related notes. All per-share numbers in this
prospectus reflect a three-for-two stock split effected on May 9, 2002.

PENN-AMERICA GROUP, INC.

Overview

We are a specialty property and casualty insurance holding company which,
through our subsidiary, Penn-America Insurance Company and its subsidiary,
Penn-Star Insurance Company, markets and underwrites general liability,
commercial property and multi-peril insurance for small businesses located
primarily in small towns and suburban and rural areas. The insurance needs of
this group are serviced by retail insurance brokers who maintain relationships
with the general agents with whom we do business. We write business in all
fifty states and the District of Columbia.

We are rated "A-" by A.M. Best Co., which assigns ratings to each insurance
company transacting business in the United States. "A-" is the fourth highest
of sixteen rating categories, and is considered "excellent" by A.M. Best Co.
These ratings are based upon factors of concern to policyholders and are not
directed toward the protection of investors.

As of September 30, 2002, we had consolidated assets of $298.9 million and
consolidated stockholders' equity of $90.1 million. For the twelve-month period
ended September 30, 2002, we produced gross written premiums of $145.8 million.

Our Business

Our insureds consist primarily of small businesses including restaurants,
mercantiles and non-residential service contractors. In addition, we have
developed customized products and coverages for other small commercial insureds
such as daycare facilities, fitness centers and special events. These small
businesses and their retail brokers have limited access to larger standard
lines insurers. The insurance industry calls this underserved market the
"excess and surplus lines marketplace."

The excess and surplus lines marketplace is a secondary, or residual, market
for businesses that are unable to obtain coverage from standard lines carriers
for a variety of reasons, which include:

. the "non-standard" nature of the insureds are not within the risk-taking
appetite of standard lines carriers;

. the relatively small account size generates insufficient premiums for the
standard lines carriers to cover their overhead expenses;

. the location of the businesses in small towns or rural areas are too
remote to be reached economically by the retail agent system of standard
lines carriers; and

. the lack of sufficient premiums by a retail agent to warrant a direct
appointment from a standard lines carrier.

We believe the challenges in our marketplace described above are balanced by
the benefits of our operating in the excess and surplus lines marketplace,
which include:

. higher prices than the standard lines segment;

. more flexibility in offering coverage forms, particularly in designing
exclusions for specific loss exposures; and

. lower premium taxes and guarantee fund assessments.

In 2001, the excess and surplus lines marketplace represented approximately
$15.7 billion, or 4.4%, of the entire $357 billion domestic property and
casualty industry, as measured by direct premiums written.

We market our products through fifty-seven (57) general agents who, in turn,
produce business through more than 25,000 retail insurance brokers located
throughout the United States. We believe that our distribution network enables
us to efficiently access these numerous small markets at a relatively low
fixed-cost through the marketing, underwriting and administrative support of
our general agents. These general agents and their retail insurance brokers
have local market knowledge and expertise that enable us to more effectively
access these markets.

Our distribution strategy is to maintain strong relationships with a select
group of high-quality general agents. We believe that our network of general
agents is smaller than our competitors because of our detailed selection
process. We carefully select a limited number of general agents based on their
experience and reputation and strive to preserve each general agent's franchise
value with us within that general agent's marketing territory. We seek to
increase our written premiums with these general agents and develop strong,
long-standing relationships by providing a high level of service and support.
Our strategy has resulted in strong and consistent growth from 1992 to 2001 in
commercial gross written premiums from $22.6 million to $98.4 million (an 18%
annualized compound growth rate), with only a modest increase in the number of
general agents from thirty-eight (38) to fifty-seven (57).

We write business on an admitted and non-admitted basis. We choose in each
state whether to write business on an admitted or non-admitted basis based upon
our 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 we choose non-admitted status, we
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. Further, surplus lines agents are prohibited from
writing non-admitted business in states in which they are not resident. Thus,
if we do not have resident surplus lines agents in every state (currently, we
do not in 7 states), we are precluded from writing business on a non-admitted
basis in those states.

Since the middle of 2001, the excess and surplus lines marketplace has
experienced hardening conditions characterized by increased volume and prices.
Standard lines carriers who had previously expanded into this market have
exited this segment to focus on larger accounts and more traditional standard
lines classes of business. Additionally, many of our competitors have
consolidated, have stopped writing business or have imposed unilateral
underwriting restrictions on their agents. These market disruptions have
resulted in an influx of new business and overall price increases averaging 16%
across our book of business since January 1, 2002.

Our Strategy

Our 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. We
accomplish this primary strategy by focusing on the following:

. Serving small businesses in small cities and towns.

. Using a small and selective general agency distribution network.

. Maintaining a disciplined underwriting process.

. Providing innovative technology to our general agents.

. Maintaining an experienced, responsive management team.

. Creating shareholder value through strong financial results.

By focusing on these principles, we believe we can deliver strong financial
results and build shareholder value.

Other Information

Penn-America Insurance Company was formed in 1975 by Irvin Saltzman,
chairman of our board of directors, who began working in the insurance industry
in 1947 when he founded a general agency. Jon S. Saltzman, Irvin Saltzman's
son, is our President and Chief Executive Officer and has been employed by us
since 1986. Prior to 1986, Jon Saltzman was employed by Penn Independent
Corporation from 1976 to 1986. Currently, the Saltzman family, substantially
through their ownership of Penn Independent Corporation, owns approximately 40%
of our common stock. For additional information, please refer to Note 3 of our
audited financial statements on page F-21.

Our executive offices are located at 420 South York Road, Hatboro,
Pennsylvania 19040. Our telephone number is (215) 443-3656. Our web site is
located at http://www.penn-america.com. Information contained on our website
does not constitute part of this prospectus.

The Offering

Shares offered.............. 2,600,000 shares

Total shares outstanding
after this offering....... 14,185,223 shares

Use of proceeds............. We estimate that the net proceeds of the offering
will be $ million, based upon a public
offering price of $ per share ($
million if the underwriters exercise their
over-allotment option in full). We intend to use
the net proceeds of this offering to support our
operations, including contributing capital to our
insurance subsidiaries and capitalizing new
insurance subsidiaries to support growth of our
business, and for working capital and other
general corporate purposes.

New York Stock Exchange
symbol.................... PNG

The number of shares of our common stock to be outstanding after this
offering is based on the number of shares outstanding as of September 30, 2002,
and does not include the following:

. up to 390,000 shares of common stock that the underwriters may purchase
from us if they exercise their over-allotment option;

. 1,386,517 shares of common stock reserved for issuance under our stock
option plans, of which options to purchase 786,950 shares were outstanding
as of September 30, 2002, at a weighted average exercise price of $6.09
per share; and

. 288,014 shares of common stock reserved for issuance under our contingent
profit commission plan payable to our general agents.

Summary Consolidated Financial Data

You should read this summary information with the discussion in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes to
those financial statements included elsewhere in this prospectus. We derived
the summary consolidated financial data as of December 31, 1997, and 1998, and
for the years ended December 31, 1997, and 1998, from our Annual Reports on
Form 10-K as of December 31, 1998 filed with the Securities and Exchange
Commission. We derived the summary consolidated financial data as of and for
the years ended December 31, 1999, 2000, and 2001 from our audited consolidated
financial statements included elsewhere in this prospectus and in our Annual
Report on Form 10-K/A for the period ended December 31, 2001 filed with the
Securities and Exchange Commission. See "Where You Can Find More Information."
We derived the summary consolidated financial data as of September 30, 2002 and
2001, and for the nine months ended September 30, 2002 and 2001, from our
unaudited consolidated financial statements for those periods. The financial
results for the nine months ended September 30, 2002 and 2001 are not
necessarily indicative of the results that may be expected for any other
interim period or for a full year.

Nine months ended
September 30, Year ended December 31,
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2002 2001 2001 2000 1999 1998 1997
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(Unaudited) (Restated) (Restated) (Restated)
(dollars in thousands, except per share data)

Operating Data:
Premiums earned.............................. $ 80,922 $ 66,194 $ 88,934 $ 91,449 $ 85,677 $ 89,493 $ 91,649
Net investment income........................ 8,796 8,516 11,339 10,454 9,537 10,763 9,218
Net realized investment gain (loss).......... (173) (192) (1,178) (2,808) (110) 18 1,314
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Total revenues............................... 89,545 74,518 99,095 99,095 95,104 100,274 102,853
Net income (loss)............................ 6,565 3,512 4,940 (4,831) 1,410 8,881 9,645
Comprehensive income (loss).................. 10,304 6,014 7,254 (343) (5,000) 9,946 10,301
Diluted net income (loss) per share(1)....... 0.56 0.31 0.43 (0.42) 0.11 0.60 0.78

Cash dividends per share(1).................. $0.11583 $ 0.105 $ 0.14 $ 0.14 $ 0.1383 $ 0.1333 $ 0.1067
Cash flow provided by operations(2).......... 35,990 2,803 8,423 14,991 8,602 10,644 24,988

Insurance Performance Data:
Gross written premiums(3).................... $118,370 $ 70,965 $ 98,412 $109,791 $ 95,983 $ 95,097 $104,694
Net written premiums(4)...................... 101,576 62,979 87,123 97,250 87,036 87,829 96,561
GAAP combined ratio:
Loss ratio(5)............................. 66.1 70.6 68.5 82.4 73.8 62.3 63.0
Expense ratio(6).......................... 32.5 33.9 34.6 34.0 34.5 33.9 33.2
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Combined ratio(7)......................... 98.6 104.5 103.1 116.4 108.3 96.2 96.2

Balance Sheet Data (at the end of the
period):
Cash and investments......................... $229,100 $184,329 $188,615 $178,675 $166,227 $182,866 $177,819
Total assets................................. 298,878 242,322 248,115 239,486 217,782 230,504 225,157
Total stockholders' equity................... 90,066 79,286 80,391 74,051 80,618 100,630 97,307
Total stockholders' equity per share(1)...... 7.77 6.93 7.00 6.52 6.67 7.14 6.56

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(1)Adjusted to reflect a three-for-two stock split of our common stock effected
on May 9, 2002.

(2)Cash flow provided by operations differs from net income (loss), due to the
fact that net income (loss) includes accruals for non-cash items as required
by GAAP and net realized investment gain (loss).

(3)The amount received or to be received for insurance policies written by us
during a specific period of time without reduction for acquisition costs,
reinsurance costs or other deductions.
(4)The total of gross written premiums less the portion of such premiums ceded
to (reinsured by) other insurers during a specific period of time.
(5)The ratio of losses and loss adjustment expenses to premiums earned.
(6)The ratio of amortization of deferred policy acquisition costs and other
underwriting expenses to premiums earned.
(7)The addition of the loss ratio and expense ratio.

RISK FACTORS

Investing in shares of our common stock involves a high degree of risk.
Before you invest in shares of our common stock, you should carefully consider
the following risks and cautionary statements. If any of the following risks
actually occur, our business, financial condition or results of operations may
suffer. As a result, the trading price of our common stock could decline, and
you could lose all or a substantial portion of your investment.

Risks Related To Our Business

A decline in our financial rating may result in a reduction of new or renewal
business.

Our insurance subsidiaries currently have a pooled "A-" (excellent) rating
from A.M. Best Co. A.M. Best Co. 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 our performance in these criteria
could result in a downgrade of our rating. A downgrade of this rating could
cause our current and future general agents, retail brokers and insureds to
choose other, higher rated competitors.

We are heavily regulated and changes in the regulation of the insurance
industry may have an adverse impact.

We are subject to regulation, primarily by Pennsylvania, our domiciliary
state, and to a lesser degree, the thirty-seven (37) other states in which we
are 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 our business. Significant changes in these laws and regulations
could further limit our discretion or make it more expensive to conduct our
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 Penn-America Insurance Company and Penn-Star Insurance Company,
Penn-America Insurance Company's wholly-owned subsidiary. 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 our insurance subsidiaries to maintain regulatory
authority to conduct our business. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources"
for a full discussion of our risk-based capital as of December 31, 2001.

Our general agents may exceed their authority and could bind us to business
outside our underwriting guidelines.

We underwrite a substantial majority of our policies on a binding authority
basis. Binding authority business represents risks that may be quoted and bound
by our general agents prior to our underwriting review. An agent's binding
authority is limited, however, by underwriting guidelines we have 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 us on a risk that does not comply with such underwriting guidelines,
we are at risk for that policy on claims that occur during the period from when
the policy was written until we receive the policy and cancel it. In addition,
to cancel the policy for exceeding underwriting authority, we must receive and
cancel the policy within statutorily prescribed time limits, typically sixty
(60) days. As a result, we may be bound by a policy that does not comply with
our underwriting guidelines, and until we can effect a cancellation, we may
incur loss and loss adjustment expenses related to that policy.

We enter into transactions with our affiliates and insiders who hold a
considerable amount of our stock on terms that may be less advantageous to us
than we might obtain from unrelated third parties.

Currently, Mr. Irvin Saltzman and his family and affiliates, substantially
through their ownership of Penn Independent Corporation, our controlling
stockholder, beneficially own approximately 40% of our outstanding common stock
and will own approximately 33% of our outstanding common stock upon completion
of this offering (approximately 32% if the underwriters' over-allotment option
is exercised). As a result, they may influence our decisions. Several of Penn
Independent Corporation's wholly-owned subsidiaries are insurance agencies that
write business with us, we lease our headquarters from Mr. Saltzman and we
obtain services from Penn Independent Corporation. The terms and conditions of
our transactions with affiliates could be less advantageous to us than those we
might obtain from unrelated parties. See "Certain Transactions" elsewhere in
this prospectus for a description of these affiliate transactions.

Our success is highly dependent on key personnel.

The efforts and abilities of our present management, particularly that of
Jon S. Saltzman, our President and Chief Executive Officer, Joseph F. Morris,
our Senior Vice President, Chief Financial Officer and Treasurer, J. Ransley
Lennon, our Vice President--Information Technology, Nancy M. Rankin, our Vice
President--Underwriting and John D. Curry, our Vice President--Marketing and
Agency Relations, are very important to our success. If we were to lose the
services of any of these key personnel, we may find it difficult to find a
suitable replacement, which could cause our operating results to decline. We
maintain a key personnel life insurance policy on all of these personnel.

Our investment portfolio is subject to economic loss, principally from changes
in the market value of financial instruments.

We had fixed-income and preferred stock investments with a market value of
$195.0 million at September 30, 2002 that are subject to:

. market value risk, which is the risk that our invested assets will
decrease in value. This decrease in value may be due to a change in the
prevailing market yields on our investments, an unfavorable change in the
liquidity of an investment or an unfavorable change in the financial
prospects or a downgrade in the credit rating of the issuer of an
investment;

. reinvestment risk, which is the risk that interest rates will decline and
funds reinvested will earn less than expected; and

. liquidity risk, which is the risk that we may have to sell assets at an
undesirable time and/or price to provide for payment of claims.

Our fixed-income investment portfolio includes mortgage-backed and other
asset-backed securities. As of September 30, 2002, mortgage-backed securities
and other asset-backed securities constituted approximately 26.7% of our cash
and invested assets. As with other fixed income 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 us 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
us to reinvest the proceeds at the then current market rates.

Our common stock portfolio of $6.6 million as of September 30, 2002 is
subject to economic loss from the decline in common stock prices. We invest the
equity portion of our portfolio exclusively in exchange-traded funds, known as
"ETFs". ETFs are securities that represent an interest in a trust that owns a
basket of common stocks that replicate a major market index (such as the S&P
500 or the Dow Jones Industrial Average) or a portion of a major market index
(such as the Value Component of the S&P 500). Since these securities represent

an interest in the equity capital markets as a whole, or a sub-sector thereof,
they are a diversified, index-based exposure to common stocks. As such, the
value of these ETFs will be determined by the performance of equity markets in
general or of a particular sub-sector.

The success of any investment activity is affected by general economic
conditions, which may adversely affect the markets for common stock, fixed
income and preferred stock securities. Unexpected volatility or illiquidity in
the markets in which we hold positions could reduce our liquidity and
shareholders' equity.

Risks Related To Our Industry

Failure to establish adequate loss reserves could have a material adverse
effect on our financial condition.

We are liable for loss and loss adjustment expenses under the terms of the
insurance policies we underwrite. In many cases, several years may lapse
between the occurrence of an insured loss, the reporting of the loss to us and
our payment of the loss. We establish loss reserves for the ultimate payment of
all loss and loss adjustment expenses incurred. These reserves are based on
historical data and estimates of future events and by their nature are
imprecise. Our ultimate loss 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 our
future loss experience. Additionally, we have established loss and loss
adjustment expense reserves for certain lines of business we have exited, but
circumstances could develop that would make these reserves insufficient. If any
of our reserves should prove to be inadequate, we will be required to increase
reserves resulting in a reduction in our 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 September 30, 2002, unpaid losses and loss adjustment expense
reserves were $131.8 million, consisting of case loss and loss adjustment
expense reserves of $36.2 million, and incurred but not reported loss and loss
adjustment expense reserves of $95.6 million.

Changes in our operating environment may affect our performance.

We 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 our products, insurance capacity, pricing and claims experience and,
consequently, our business, results of operations or financial condition.

Our business is cyclical in nature which can affect our financial performance.

Historically, the financial performance of the property and casualty
insurance industry has tended to fluctuate in cyclical patterns of soft markets
followed by hard markets. 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 approximately the last half of 2001, the
property and casualty insurance industry appears to be experiencing a hardening
market. Since this cyclicality is due in large part to the actions of our
competitors and general economic factors, we cannot predict with certainty how
long this hardening market will last.

We operate in a highly competitive market.

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

. the perceived market strength of the insurer;

. pricing and other terms and conditions;

. services provided;

. the speed of claims payment;

. the reputation and experience of the insurer; and

. ratings assigned by independent rating organizations such as A.M. Best Co.

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

We rely on our ability to obtain reinsurance support.

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

The events of September 11, 2001 will likely result in reinsurance being
more difficult or more expensive to obtain. To the extent that we are forced to
pay more for reinsurance or retain more liability than we do currently, we may
need to reduce our level of direct insurance.

The maintenance of reinsurance does not legally discharge us from our
primary liability for the full amount of the risks we insure, although it does
make the reinsurer liable to us. Therefore, we are subject to credit risk with
respect to our reinsurers. As of September 30, 2002, we had $27.0 million of
reinsurance recoverable.

Since September 2001, our 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 Co. For the three years prior to September 1, 2001,
General Reinsurance Corporation, rated "A++" (superior) by A.M. Best Co., was
our reinsurer on our multiple-line excess of loss treaty.

As of January 1, 2002, our catastrophic loss reinsurance program includes:
American Agricultural Insurance Company, Converium (North America), Converium
(UK), Everest Reinsurance Company, Hannover Ruckversicherungs, PXRE Reinsurance
Company, Shelter Reinsurance Company, Sirius International Insurance
Corporation and XL Re Ltd. All of these reinsurers are rated "A-" (excellent)
or higher by A.M. Best Co. and have policyholders' surplus greater than $500
million.

Risks Related To This Offering

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

We are an insurance holding company and our principal asset is the stock we
hold in Penn-America Insurance Company. Dividends and other payments from this
company are our primary source of funds to pay expenses and dividends. The
payment of dividends by Penn-America Insurance Company to us 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 our 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 Penn-America Group, Inc. 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
beneficially acquires 10% or more of our 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 our 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 us may require prior
notification in the states that have pre-acquisition notification laws.

Our articles of incorporation contain certain provisions that make more
difficult the acquisition of control of Penn-America Group, Inc. 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 our 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 Corporation currently owns approximately 40% of our
outstanding common stock and after this offering will own approximately 33% of
our outstanding common stock (approximately 32% if the underwriters'
over-allotment option is exercised in full). Penn Independent Corporation's
stock ownership and ability to nominate persons for election to our board of
directors provides Penn Independent Corporation 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 our 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. See "Certain
Transactions".

We have a significant number of shares eligible for future sale.

As of September 30, 2002, Penn Independent Corporation held 4,631,250 shares
of our common stock and option holders held options to purchase an aggregate
786,950 shares of our common stock. We cannot predict the effect, if any, that
future sales of our common stock by Penn Independent Corporation or option
holders, or the availability of shares of our common stock for future sale will
have on the market price of our common stock prevailing from time to time.
Sales of substantial amounts of our common stock in the public market following
the offering, or the perception that such sales could occur, could adversely
affect the market price of our common stock and may make it more difficult for
us to sell our equity securities in the future at a time and at a price which
we deem appropriate.

FORWARD-LOOKING STATEMENTS

This prospectus and the documents incorporated by reference into this
prospectus contain "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. These statements include information with respect to our financial
condition, our results of operations and businesses and the expected impact of
this offering on our financial condition. Words such as "may," "will,"
"should," "could," "would," "predicts," "potential," "continue," "expects,"
"anticipates," "future," "intends," "plans," "believes," "estimates" and
similar expressions, as well as statements in future tense, identify
forward-looking statements.

These forward-looking statements are not guarantees of our future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from the results contemplated by the
forward-looking statements. See "Risk Factors" beginning on page 6.

The effects of these factors are difficult to predict. New factors emerge
from time to time, and we cannot assess the potential impact of any such factor
or the extent to which any factor, or combination of factors, may cause results
to differ materially from those contained in any forward-looking statement. Any
forward-looking statement speaks only as of the date of this prospectus. We do
not undertake any obligation to update any forward-looking statement to reflect
events or circumstances after the date of such statement or to reflect the
occurrence of unanticipated events.

In evaluating a potential investment in shares of our common stock, you
should carefully consider the discussion of these and other factors in the
section entitled "Risk Factors" on page 6.

USE OF PROCEEDS

We estimate that we will receive net proceeds of approximately $
million from our sale of common stock in this offering, or $ million if
the underwriters exercise their over-allotment option in full, assuming a
public offering price of $ per share, after deducting underwriting
discounts and commissions and our share of estimated offering expenses.

We intend to use the net proceeds of this offering to support our
operations, including contributing capital to our insurance subsidiaries and
capitalizing new insurance subsidiaries to support the growth of our business,
and for working capital and other general corporate purposes.

PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY

Our common stock is quoted on the New York Stock Exchange under the symbol
"PNG" and has been traded publicly since our initial public offering in October
1993. The following table sets forth the high and low closing sale prices per
share for our common stock as reported by the New York Stock Exchange and
dividends declared per share for the periods indicated. We have adjusted these
market prices and dividends paid to reflect the three-for-two split of our
common stock effected on May 9, 2002.

Market Price
------------
High Low Dividend
------ ----- --------

Year Ended December 31, 2000
First Quarter....................................... $ 6.00 $4.42 $ .035
Second Quarter...................................... 6.50 4.75 .035
Third Quarter....................................... 5.25 4.59 .035
Fourth Quarter...................................... 6.29 4.59 .035
Year Ended December 31, 2001
First Quarter....................................... $ 6.97 $4.79 $ .035
Second Quarter...................................... 7.00 6.67 .035
Third Quarter....................................... 6.80 6.40 .035
Fourth Quarter...................................... 7.03 6.00 .035
Year Ended December 31, 2002
First Quarter....................................... $10.43 $7.27 $.03833
Second Quarter...................................... 11.40 9.45 .03875
Third Quarter....................................... 10.70 7.80 .03875
Fourth Quarter (through November 19, 2002).......... 9.45 8.60 .03875

On November 19, 2002 the last reported sale price of our common stock on the
New York Stock Exchange was $9.45 per share. As of February 1, 2002, there were
approximately 190 registered holders of record and approximately 1,000
beneficial owners of our common stock.

Our current policy is to pay quarterly cash dividends. The payment of
dividends is subject to the discretion of our board of directors and will
depend upon general business conditions and legal restrictions on payment of
dividends by our subsidiaries to us and other factors that our board of
directors deems relevant. See our risk factor on page 10, which discusses the
limits on our subsidiaries' ability to pay dividends to us, and page 24, which
discusses a potential contractual restriction on our ability to pay dividends.

CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2002:

. on an actual basis; and

. on an as adjusted basis to give effect to our sale of 2,600,000 shares of
common stock in this offering at an assumed public offering price of
$ per share and the application of the net proceeds, after
deducting underwriting discounts and commissions and estimated offering
expenses; and to give effect to the issuance of $15 million of trust
preferred securities issued by Penn-America Statutory Trust I, our
wholly-owned business trust subsidiary. We expect this trust to issue
these securities on or about December 4, 2002. For more information, see
Liquidity and Capital Resources on page 24 and Note 7 to the Unaudited
Consolidated Financial Statements on F-11.

You should read this table in conjunction with our "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our
consolidated financial statements and related notes appearing elsewhere in this
prospectus.

September 30, 2002
------------------
As
Actual Adjusted
-------- --------
(in thousands)

Company obligated mandatorily redeemable preferred securities of subsidiary trust holding
solely junior subordinated debentures.................................................. $ -- $15,000
Stockholders' Equity
Preferred stock, $0.01 par value; 2,000,000 shares authorized, none issued............ -- --
Common stock, $0.01 par value; 20,000,000 shares authorized; 15,335,223 shares
issued; 11,585,223 shares outstanding (15,335,223 shares issued; 14,185,223 shares
outstanding, as adjusted)........................................................... 153
Additional paid in capital............................................................ 71,523
Accumulated other comprehensive income................................................ 6,845
Treasury stock at cost, 3,750,000 shares (1,150,000 shares, as adjusted).............. (24,161)
Officers' stock loans................................................................. (629)
Retained earnings..................................................................... 36,545
Unearned compensation from restricted stock awards.................................... (210)
-------- -------
Total stockholders' equity........................................................ 90,066
-------- -------

Total capitalization........................................................... $ 90,066 $
======== =======

The table above excludes the following shares at September 30, 2002:

. up to 390,000 shares of common stock that the underwriters may purchase
from us if they exercise their over-allotment option;

. 288,014 shares of common stock reserved for issuance under our contingent
profit commission plan payable to our general agents.

SELECTED CONSOLIDATED FINANCIAL DATA

You should read this summary information with the discussion in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes to
those financial statements included elsewhere in this prospectus. We derived
the selected consolidated financial data as of December 31, 1997 and 1998, and
for the years ended December 31, 1997 and 1998, from our Annual Reports on Form
10-K as of December 31, 1998 filed with the Securities and Exchange Commission.
We derived the selected consolidated financial data as of and for the years
ended December 31, 1999, 2000, and 2001 from our audited consolidated financial
statements included elsewhere in this prospectus and in our Annual Report on
Form 10-K/A for the period ended December 31, 2001 filed with the Securities
and Exchange Commission. See "Where You Can Find More Information." We derived
the selected consolidated financial data as of September 30, 2002 and 2001 and
for the nine months ended September 30, 2002 and 2001 from our unaudited
consolidated financial statements for those periods. The financial results for
the nine months ended September 30, 2002 and 2001 are not necessarily
indicative of the results that may be expected for any other interim period or
for a full year.

Operating Data:
Premiums earned........................ $ 80,922 $ 66,194 $ 88,934 $ 91,449 $ 85,677 $ 89,493 $ 91,649
Net investment income.................. 8,796 8,516 11,339 10,454 9,537 10,763 9,218
Net realized investment gain (loss).... (173) (192) (1,178) (2,808) (110) 18 1,314
-------- -------- -------- -------- -------- -------- --------
Total revenues......................... 89,545 74,518 99,095 99,095 95,104 100,274 102,853
Net income (loss)...................... 6,565 3,512 4,940 (4,831) 1,410 8,881 9,645
Comprehensive income (loss)............ 10,304 6,014 7,254 (343) (5,000) 9,946 10,301
Diluted net income (loss) per share(1). 0.56 0.31 0.43 (0.42) 0.11 0.60 0.78

Cash dividends per share(1)............ $0.11583 $ 0.105 $ 0.14 $ 0.14 $ 0.1383 $ 0.1333 $ 0.1067
Cash flow provided by operations(2).... 35,990 2,803 8,423 14,991 8,602 10,644 24,988

Insurance Performance Data:
Gross written premiums(3).............. $118,370 $ 70,965 $ 98,412 $109,791 $ 95,983 $ 95,097 $104,694
Net written premiums(4)................ 101,576 62,979 87,123 97,250 87,036 87,829 96,561
GAAP basis:
Loss ratio(5)....................... 66.1 70.6 68.5 82.4 73.8 62.3 63.0
Expense ratio(6).................... 32.5 33.9 34.6 34.0 34.5 33.9 33.2
-------- -------- -------- -------- -------- -------- --------
Combined ratio(7)................... 98.6 104.5 103.1 116.4 108.3 96.2 96.2

Balance Sheet Data (at the end of the
period):
Cash and investments................... $229,100 $184,329 $188,615 $178,675 $166,227 $182,866 $177,819
Total assets........................... 298,878 242,322 248,115 239,486 217,782 230,504 225,157
Total stockholders' equity............. 90,066 79,286 80,391 74,051 80,618 100,630 97,307
Total stockholders' equity per share(1) 7.77 6.93 7.00 6.52 6.67 7.14 6.56

--------
(1)Adjusted to reflect a three-for-two stock split of our common stock effected
on May 9, 2002.

(3)The amount received or to be received for insurance policies written by us
during a specific period of time without reduction for acquisitions costs,
reinsurance costs or other deductions.
(4)The total of gross written premiums less the portion of such premiums ceded
to (reinsured by) other insurers during a specific period of time.
(5)The ratio of losses and loss adjustment expenses to premiums earned.
(6)The ratio of amortization of deferred policy acquisition costs and other
underwriting expenses to premiums earned.
(7)The addition of the loss ratio and expense ratio.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated
financial statements and related notes included in those financial statements.
All per-share numbers in this prospectus reflect a three-for-two stock split
effected on May 9, 2002.

We recently resolved various accounting and disclosure comments from the
Securities and Exchange Commission ("SEC"). One of the comments addressed
related to the timing of the recording other-than-temporary ("OTT") declines in
the market value of certain equity securities. We agreed to amend our
accounting policy and record OTT write-downs on these securities for the
periods ended December 31, 2001, 2000 and 1999. This restatement affects net
income for each of these periods but has no effect on aggregate stockholders'
equity since the unrealized loss on these securities was already recorded in
Accumulated Other Income (Loss) in the Consolidated Balance Sheets and
Statements of Stockholders' Equity. This restatement resulted in an increase to
accumulated other comprehensive income of $2,014,000 and decrease to retained
earnings of the same amount as of December 31, 2001.

The table below shows a comparison of previously recorded and restated
amounts for total revenues, net income (loss) and net income (loss) per share
(basic and diluted) for the periods affected.

For the years ended
------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
As As As As As As
Reported Restated Reported Restated Reported Restated
-------- -------- -------- -------- -------- --------

Total revenues............. $99,718 $99,095 $100,572 $99,095 $96,055 $95,104
Net income (loss).......... 5,351 4,940 (3,856) (4,831) 2,038 1,410
Net income (loss) per share
Basic................... 0.47 0.43 (0.33) (0.42) 0.16 0.11
Diluted................. 0.47 0.43 (0.33) (0.42) 0.16 0.11

This restatement had no effect on net income for the three and nine months
ended September 30, 2001. The effect of this restatement is reflected in the
Consolidated Balance Sheets and Consolidated Statements of Stockholders' Equity
for balances at December 31, 2001.

Results of Operations

Three Months Ended September 30, 2002 and 2001

Premiums earned were $30.7 million for the three months ended September 30,
2002 compared to $20.9 million for the three months ended September 30, 2001.
We previously announced that we were exiting both commercial automobile and
non-standard personal automobile lines of business. Premiums earned for these
exited lines of business decreased to $13,000 for the three months ended
September 30, 2002 compared to $812,000 for the three months ended September
30, 2001. Our core commercial lines premiums earned (excluding exited lines of
business) increased $10.6 million, or 52.4%, attributable to the increase in
net written premiums for the three months ended September 30, 2002 as compared
to the same period of 2001.

Gross written premiums increased 82.9% for the three months ended September
30, 2002 to $43.1 million compared to $23.6 million for the three months ended
September 30, 2001. This increase was attributable to rate increases, strong
growth in new business and higher average exposures per policy.

Ceded written premiums, the portion of gross written premiums reinsured by
other unaffiliated insurers, increased to $6.6 million for the three months
ended September 30, 2002 compared to $2.5 million for the three months ended
September 30, 2001. The increase in ceded written premiums was primarily due to
growth in gross written premiums, and approximately a 50% increase in
reinsurance rates on our multiple-line excess of loss reinsurance treaty.

Net written premiums, which are gross written premiums less ceded written
premiums, increased 73.3% for the three months ended September 30, 2002 to
$36.5 million compared to $21.1 million for the three months ended September
30, 2001. The increase in net written premiums was consistent with the increase
in gross written premiums, but was partially offset by higher reinsurance costs.

Net investment income increased to $3.0 million for the three months ended
September 30, 2002 compared to $2.9 million for the same period last year,
primarily due to growth in average invested assets, which was partially offset
by a lower average investment yield on our fixed-income investments and lower
interest rates on the our overnight cash balances.

Net realized investment gain was $1.2 million for the three months ended
September 30, 2002 compared to $40,000 from the three months ended September
30, 2001. The net realized investment gain for the three months ended September
30, 2002 consisted of $2.3 million in net realized investment gain recognized
on the sale of certain of our fixed-income investments, partially offset by a
$1.1 million other-than-temporary impairment write-down on certain of our
common stock investments.

Losses and loss adjustment expenses increased 42.9% to $20.8 million for the
three months ended September 30, 2002 from $14.6 million for the three months
ended September 30, 2001. The loss ratio for the three months ended September
30, 2002 was 67.7 compared to 69.5 for the three months ended September 30,
2001. The loss ratio is calculated by dividing losses and loss adjustment
expenses by premiums earned. The improvement in the loss ratio was primarily
attributable to rate increases implemented in 2001 and 2002 and exiting of the
commercial automobile line of business, partially offset by an increase in the
severity of property claims.

Amortization of deferred policy acquisition costs ("ADAC") increased 51.8%
to $7.5 million for the three months ended September 30, 2002 from $5.0 million
for the three months ended September 30, 2001 primarily due to the growth in
premiums earned.

Other underwriting expenses increased 8.9% to $2.2 million for the three
months ended September 30, 2002 from $2.0 million for the three months ended
September 30, 2001. This increase is mainly attributable to increases in salary
and benefit expenses associated with the hiring of additional underwriting and
marketing personnel.

The overall GAAP combined ratio, which is the sum of the loss and expense
ratios, decreased to 99.4 for the three months ended September 30, 2002 from
102.8 for the three months ended September 30, 2001. This improvement was
primarily due to the decrease in the loss ratio to 67.7 in 2002 compared to
69.5 in 2001. The expense ratio decreased to 31.7 for the three months ended
September 30, 2002 from 33.3 for the three months ended September 30, 2001. The
expense ratio is calculated by dividing the sum of ADAC and other underwriting
expenses by premiums earned. The GAAP combined ratio is a standard measure of
underwriting profitability used throughout the property and casualty insurance
industry. A ratio below 100.0 generally indicates profitable underwriting
results.

The factors described above resulted in net income for the three months
ended September 30, 2002 of $2.9 million or $0.25 per share (basic and diluted)
compared to net income of $1.6 million or $0.14 per basic and $0.13 per diluted
share for the three months ended September 30, 2001.

Nine Months Ended September 30, 2002 and 2001

Premiums earned were $80.9 million for the nine months ended September 30,
2002 compared to $66.2 million for the nine months ended September 30, 2001. We
previously announced that we were exiting both commercial automobile and
non-standard personal automobile lines of business. Premiums earned for these
exited lines of business decreased to $26,000 for the nine months ended
September 30, 2002 compared to $4.4 million for the nine months ended September
30, 2001. Our core commercial lines premiums earned (excluding exited lines of
business) increased $19.1 million, or 31.0%, attributable to the increase in
net written premiums for the nine months ended September 30, 2002 as compared
to the same period of 2001.

Gross written premiums increased 66.8% for the nine months ended September
30, 2002 to $118.4 million compared to $71.0 million for the nine months ended
September 30, 2001. This increase was attributable to rate increases, strong
growth in new business and higher average exposures per policy.

Ceded written premiums, the portion of gross written premiums reinsured by
other unaffiliated insurers, increased to $16.8 million for the nine months
ended September 30, 2002 compared to $8.0 million for the nine months ended
September 30, 2001. The increase in ceded written premiums was primarily due to
growth in gross written premiums, and approximately a 42% increase in
reinsurance rates on our multiple-line excess of loss reinsurance treaty.

Net written premiums, which are gross written premiums less ceded premiums,
increased 61.3% for the nine months ended September 30, 2002 to $101.6 million
compared to $63.0 million for the nine months ended September 30, 2001. The
increase in net written premiums was consistent with the increase in gross
written premiums, but was partially offset by higher reinsurance costs.

Net investment income increased to $8.8 million for the nine months ended
September 30, 2002 compared to $8.5 million for the same period last year,
primarily due to growth in the average invested assets, which was partially
offset by a lower average investment yield on our fixed-income securities and
lower interest rates on our overnight cash balances.

Net realized investment loss was $0.2 million for the nine months ended
September 30, 2002 and 2001. The net realized loss for the current period
consisted of a $2.1 million other-than-temporary write-down on certain of our
preferred and common stocks, along with a loss on the sale of certain of our
common stocks of $0.3 million. This loss was partially offset by $2.3 million
in net realized investment gains on the sale of certain of our fixed-income
investments.

Losses and loss adjustment expenses increased 14.4% to $53.4 million for the
nine months ended September 30, 2002 from $46.7 million for the nine months
ended September 30, 2001. The loss ratio for the nine months ended September
30, 2002 was 66.1 compared to 70.6 for the nine months ended September 30,
2001. This improvement is attributable to rate increases implemented in 2001
and 2002 and exiting of the commercial automobile line of business, primarily
offset by an increase in the severity of property claims.

Amortization of deferred policy acquisition costs increased 18.0% to $20.3
million for the nine months ended September 30, 2002 from $17.2 million for the
nine months ended September 30, 2001 primarily due to the growth in premiums
earned. This increase was partially offset by a decline in the ratio of ADAC to
premiums earned of 25.1 for the nine months ended September 30, 2002 compared
to 26.0 for the nine months ended September 30, 2001. The improvement in this
ratio was attributable to us writing a larger portion of our business on a
non-admitted basis, which is not subject to premium tax expense and has a lower
overall commission rate.

Other underwriting expenses increased 15.0% to $6.0 million for the nine
months ended September 30, 2002 from $5.2 million for the nine months ended
September 30, 2001. This increase is mainly attributable to increases in salary
and benefit expenses associated with the hiring of additional underwriting and
marketing personnel.

The overall GAAP combined ratio decreased to 98.6 for the nine months ended
September 30, 2002, from 104.5 for the nine months ended September 30, 2001,
primarily due to the decrease in the loss ratio to 66.1 in 2002 compared to
70.6 in 2001. The expense ratio was 32.5 for the nine months ended September
30, 2002 and 33.9 for the nine months ended September 30, 2001.

The factors described above resulted in net income for the nine months ended
September 30, 2002 of $6.6 million or $0.57 per basic share and $0.56 per
diluted share compared to net income of $3.5 million or $0.31 per share (basic
and diluted) for the nine months ended September 30, 2001.

Year ended December 31, 2001 compared with year ended December 31, 2000

Gross written premiums decreased 10.4% to $98.4 million for the year ended
December 31, 2001 from $109.8 million for the year ended December 31, 2000. The
decrease was due to the decline of $13.2 million in gross written premiums for
the exited commercial and non-standard personal automobile lines. Core
commercial gross written premiums increased 1.9% in 2001 to $97.3 million from
$95.5 million in the prior year. This increase was attributable mainly to rate
increases implemented during the year as well as growth in new business, which
were offset partially by a decline in the renewal ratio due to our decision to
exit the residential contractors industry segment.

Ceded written premiums, the portion of gross premiums reinsured by other
unaffiliated insurers, decreased to $11.3 million for the year ended December
31, 2001 compared to $12.5 million for the year ended December 31, 2000. The
decline is ceded written premiums is primarily due to the decline in gross
written premiums.

Net written premiums decreased 10.4% to $87.1 million for the year ended
December 31, 2001 from $97.3 million for the year ended December 31, 2000. This
decline is consistent with the drop in gross written premiums. Premiums earned
decreased 2.8% to $88.9 million for the year ended December 31, 2001 from
$91.5 million for the year ended December 31, 2000.

Net investment income increased 8.5% to $11.3 million for the year ended
December 31, 2001 from $10.5 million for the year ended December 31, 2000. The
increase resulted principally from an increase in the investment yield of the
fixed-income investment portfolio and the growth in invested assets, partially
offset by a decline in interest rates on overnight cash balances.

Net realized investment loss for the year ended December 31, 2001 was $1.2
million for the year ended December 31, 2001 as compared with $2.8 million for
the year ended December 31, 2000. Net realized investment loss for the years
ended December 31, 2001 and 2000 included other-than-temporary impairment
write-downs on certain of our preferred and common stock investments of $1.2
million and $1.7 million, respectively.

For the year ended December 31, 2001, the other-than-temporary impairment
write-down was primarily due to declines in the market value of two common
stock exchange-traded funds, S & P 500 Depositary Receipts and Biotech Holders
Trust, totaling $1.0 million. For the year ended December 31, 2000, the
other-than-temporary impairment write-downs were due to declines in the market
value of twelve preferred stock securities totaling $1.3 million and one common
stock, AMEX Technology Fund, totaling $0.4 million.

Losses and loss adjustment expenses decreased 19.2% to $60.9 million in 2001
as compared with $75.4 million in 2000. The 2000 operating results included
strengthening of prior year loss reserves of $9.2 million. This prior year
reserve increase related principally to the commercial automobile liability,
commercial multi-peril liability and other liability lines of business.

The September 11, 2001 tragedies in New York, Washington D.C. and
Pennsylvania resulted in no property or casualty losses to us.

Amortization of deferred acquisition costs decreased 9.9% to $22.7 million
for the year ended December 31, 2001 from $25.2 million for the year ended
December 31, 2000. The decrease is due to lower commission rates to general
agents that were implemented in the third quarter of 2000 and lower premium
taxes as a result of our writing a larger portion of our business on a
non-admitted basis. Also contributing to the decrease were lower commissions
related to the exited lines of business. Non-standard personal automobile
commission rates were higher than commercial rates.

Other underwriting and corporate expenses increased 29.2% to $8.6 million
for the year ended December 31, 2001 from $6.6 million for the year ended
December 31, 2000. This increase was due to the recording of additional
expenses related to guarantee fund assessments and an increase in the allowance
for doubtful accounts. Costs related to audits of assureds' records and salary
expenses also were higher in 2001 than in the prior year.

The GAAP combined ratio decreased to 103.1 for the year ended December 31,
2001 compared with 116.4 for the year ended December 31, 2000. The loss ratio
decreased to 68.5 for the year ended December 31, 2001 from 82.4 for the year
ended December 31, 2000. As noted above, 2000 operating results included the
strengthening of prior year loss reserves by $9.2 million. This strengthening
added approximately 10.0 points to the 2000 loss and combined ratios. The
expense ratio for the year ended December 31, 2001, increased slightly to 34.6
from 34.0 for the year ended December 31, 2000.

As a result of the factors described above, net income for the year ended
December 31, 2001 was $4.9 million or $0.43 per share (basic and diluted) as
compared with a net loss of $4.8 million or $0.42 per share (basic and diluted)
for the year ended December 31, 2000.

Year ended December 31, 2000 compared with year ended December 31, 1999

Gross written premiums increased 14.4% to $109.8 million for the year ended
December 31, 2000 from $96.0 million for the year ended December 31, 1999. This
increase resulted from a 26.7% increase in commercial lines gross written
premiums to $107.0 million, partially offset by a 75.8% decline in gross
written premiums for the non-standard personal automobile lines of business to
$2.8 million. We exited the non-standard personal automobile lines of business
in 1999.

Net written premiums increased 11.7% to $97.3 million for the year ended
December 31, 2000 from $87.0 million for the year ended December 31, 1999.
During the same period, net premiums earned increased 6.7% to $91.5 million
from $85.7 million. The increase in net premiums earned corresponds to the
increase in gross and net written premiums.

Net investment income increased 9.6% to $10.5 million for the year ended
December 31, 2000 from $9.5 million for the year ended December 31, 1999. The
increase resulted principally from an increase in yields on fixed-income
investments and an increase in cash flows from operations due principally to
the growth in written premiums and a reduction in paid losses.

Net realized investment loss for the year ended December 31, 2000 was $2.8
million as compared with $0.1 million for the year ended December 31, 1999.
Realized investment losses were generated in 2000 due to our decision to sell
selected securities and reinvest the proceeds into higher-yielding securities,
along with other-than-temporary impairment write-downs due to declines in the
market value of twelve preferred stock securities totaling $1.3 million and one
common stock, AMEX Technology Fund, totaling $0.4 million.

Losses and loss adjustment expenses increased 19.3% to $75.4 million in 2000
as compared with $63.2 million in 1999. The 2000 operating results included
strengthening of prior year loss reserves of $9.2 million relating principally
to our commercial automobile liability, commercial multi-peril liability and
other liability lines of business. Operating results in 1999 included adverse
loss development of $8.4 million in our

discontinued non-standard personal automobile, other liability and property
lines of business. Property results in 1999 also were affected by losses
related to Hurricanes Floyd and Irene and other windstorm damage.

Amortization of deferred acquisition costs increased 1.7% to $25.2 million
for the year ended December 31, 2000 from $24.8 million for the year ended
December 31, 1999. The increase was attributable primarily to the growth in
premiums earned.

Other underwriting and corporate expenses increased 10.0% to $6.6 million
for the year ended December 31, 2000 from $6.0 million for the year ended
December 31, 1999. This increase was mainly attributable to increases in salary
and benefit expenses.

The GAAP combined ratio increased to 116.4 for the year ended December 31,
2000 compared with 108.3 for the year ended December 31, 1999. The loss ratio
increased to 82.4 for the year ended December 31, 2000 from 73.8 for the year
ended December 31, 1999. The expense ratio decreased to 34.0 for the year ended
December 31, 2000 from 34.5 for the year ended December 31, 1999.

As a result of the factors described above, net loss for the year ended
December 31, 2000 was $4.8 million or $0.42 per share (basic and diluted) as
compared with net income of $1.4 million or $0.11 per share (basic and diluted)
for the year ended December 31, 1999.

Critical Accounting Estimates and Policies

We are directly liable for losses and loss adjustment expenses under the
terms of the insurance policies we write. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss and
the payment of that loss. We reflect our 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, we establish a case
reserve for the estimated amount of our ultimate loss. The estimate of the
amount of the ultimate loss is based upon factors such as:

. the type of loss,

. the jurisdiction of the occurrence,

. our knowledge of the circumstances surrounding the claim,

. the severity of injury or damage,

. the potential for ultimate exposure, and

. policy provisions relating to the claim.

We determine loss adjustment expenses via a formula method that estimates
loss adjustment expenses as a percentage of expected indemnity losses based on
historical patterns adjusted to current experience.

In addition to case reserves, we establish 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 INBR, we must
estimate the ultimate liability based primarily on past experience. We apply a
variety of traditional actuarial techniques to estimate our ultimate liability.
The techniques recognize, among other factors:

. our and the industry's experience,

. historical trends in reserving patterns and loss payments,

. the impact of claim inflation,

. the pending level of unpaid claims,

. the cost of claim settlements,

. the line of business mix, and

. the economic environment in which property and casualty insurance
companies operate.

We continually review these estimates and, based on new developments and
information, we include 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 for the
extraordinary future emergence of new types of losses not sufficiently
represented in our historical experience, or which cannot yet be quantified. We
regularly analyze our reserves and review 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. We
do not discount our loss reserves.

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

Year ended December 31,
-------------------------
2001 2000 1999
-------- -------- -------
(in thousands)

Balance, beginning of year........................ $115,314 $ 93,719 $88,937
Less reinsurance recoverable...................... 24,093 18,086 16,502
-------- -------- -------
Net balance, beginning of year.................... 91,221 75,633 72,435
Incurred related to:
Current year................................... 60,885 66,214 54,768
Prior years.................................... 36 9,164 8,419
-------- -------- -------
Total incurred.................................... 60,921 75,378 63,187
Paid related to:
Current year................................... 19,913 26,273 23,540
Prior year..................................... 38,183 33,517 36,449
-------- -------- -------
Total paid........................................ 58,096 59,790 59,989
Net balance, end of year.......................... 94,046 91,221 75,633
Plus reinsurance recoverable...................... 25,552 24,093 18,086
-------- -------- -------
Balance, end of year.............................. $119,598 $115,314 $93,719
======== ======== =======

In 2001, we increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $36,000. This increase related
entirely to the commercial automobile line of business. During 2001, we
increased our estimate for the commercial multi-peril liability line of
business by $1.8 million due to the development of outstanding claim reserves
on claims occurring primarily in 1998 and 1999. This increase was almost
entirely offset by a reduction in our estimate for the non-standard personal
automobile line of business due to favorable settlements on closed claims.

In 2000, we increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $9.2 million. The increase is
primarily attributable to changes in our estimates for losses and loss
adjustment expense reserves of $1.4 million for our commercial automobile, $3.9
million for our commercial multi-peril liability and $3.4 million for our other
liability lines of business.

We began writing commercial automobile coverage for vehicles and light
trucks in 1998. Our initial estimates for 1998 and 1999 were based on a
relatively low level of claims reported to us. In 2000, we received a
significant number of claims relating to accidents incurred in 1998 and 1999,
resulting in an increase in our loss

estimates. In the fourth quarter of 2000, we exited the commercial automobile
line of business due to unsatisfactory underwriting results.

Our change in estimates in 2000 for the commercial multi-peril line of
business resulted principally from our increased exposure to liquor liability
losses for policies primarily written in 1998 and 1999. In 2000, we revised our
underwriting approach significantly to reduce our exposure to liquor liability.

Our 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 by us when we wrote these policies between 1991 and
1996. These claims predominantly related to residential contractors and
sub-contractors in California. In 2000, we completed our withdrawal from the
residential contractors and sub-contractors industry segment.

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

Incurred losses and loss adjustment expenses include estimates, recorded as
loss and loss adjustment expense reserves on the balance sheet, for the
ultimate payment on both reported and unreported claims. We change our
estimates for loss and loss adjustment expenses reserves as new events occur,
as more loss experience is acquired or as additional information is received.
Our estimates for loss and loss adjustment expense reserves result from a
continuous review process and the change in these estimates, as required by
Financial Accounting Standards Board No. 60, Accounting and Reporting by
Insurance Enterprises, paragraph 18, is recorded in the period that the change
in these estimates is made.

We believe that our loss and loss adjustment expense reserves are fairly
stated as of September 30, 2002 due to our exiting of non-standard personal and
commercial automobile lines of business and the reduction in our exposure to
construction defect and liquor liability losses. In addition, we implemented
improvements in our loss reserving process, including the development of
monthly and quarterly loss and loss adjustment expense reserve analyses and the
creation of reserve committee that meets quarterly.

The following table presents our accident year loss and loss adjustment
expense ratios (the sum of losses and loss adjustment expenses divided by
premiums earned) for the ten most recent accident years (the year in which the
loss occurred), as recorded as of December 31, 1999, 2000 and 2001 and
September 30, 2002 after giving effect to the increase in loss and loss
adjustment expenses relating to changes in estimates of insured events of prior
years. These "accident year" loss ratios differ from the loss ratios included
in our financial statements set forth elsewhere in this prospectus in that the
latter loss ratios are based upon the year in which we recognize the loss for
accounting purposes, regardless of when the loss actually occurred or was
reported to us. See the notes to the consolidated financial statements included
elsewhere in this prospectus.

As of December 31, As of
------------------ September 30,
Accident Year 1999 2000 2001 2002
------------- ---- ---- ---- -------------

1992.............................................. 69.6 72.1 72.5 72.5
1993.............................................. 70.9 70.2 71.3 71.3
1994.............................................. 69.1 72.0 71.8 71.8
1995.............................................. 63.9 65.4 65.1 65.3
1996.............................................. 68.1 68.3 69.4 69.4
1997.............................................. 62.4 62.0 62.1 62.3
1998.............................................. 63.6 65.8 65.0 66.2
1999.............................................. 63.8 68.2 70.0 73.5
2000.............................................. 72.4 70.2 70.0
2001.............................................. 68.5 64.6
2002.............................................. 65.1

During the first nine months of 2002, in the aggregate, there have been no
material adjustments to prior year reserves. During the first nine months of
2002, we decreased our estimate for the commercial multi-peril property line of
business by $2.5 million, primarily relating to claims occurring in 2001. This
reduction was offset by an increase in our estimate for commercial multi-peril
liability line of business due to the development of outstanding claim reserves
on claims occurring primarily in 1998 and 1999.

Liquidity and Capital Resources

We are a holding company, the principal asset of which is the common stock
of Penn-America Insurance Company. The principal source of cash to meet our
short-term liquidity needs, including the payment of our dividends to
stockholders and our corporate expenses, is dividends from Penn-America
Insurance Company. As of September 30, 2002, we have no long-term debt
obligations or planned capital expenditures that could impact our long-term
liquidity.

On or about December 4, 2002, we expect that Penn-America Statutory Trust I,
our wholly-owned business trust subsidiary, will issue 15,000 of floating rate
capital securities with a liquidation amount of $1,000 per security. These
securities will have a thirty-year maturity, with a provision that allows us to
call these securities at par after five years from the date of issuance. We
expect cash distributions to be paid quarterly in arrears at a rate of 400
basis points over three-month London Interbank Offered Rates. Distributions on
these securities can be deferred for up to five years, but, if so deferred, we
may not declare or pay cash dividends or distributions on our common stock. We
will guarantee all obligations of Penn-American Statutory Trust I with respect
to distributions and payments of these securities.

Proceeds from the sale of these securities by Penn-America Statutory Trust I
will be used to acquire $15 million of Floating Rate Junior Subordinated
Deferrable Interest Debentures issued by us. These debentures will have the
same exact terms with respect to maturity, payments, and distributions as the
floating rate capital securities issued by Penn-America Statutory Trust I. The
intended use of the proceeds from these debentures are to support our insurance
operations, including contributing capital to support the growth in business,
and for working capital and other general corporate purposes. Neither the
capital securities issued by our subsidiary nor the debentures issued by us
have been or will be registered under the Securities Act, and neither may be
offered or sold in the United States absent registration or an applicable
exemption from registration requirements.

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 us. Our future liquidity is
dependent on the ability of Penn-America Insurance Company to pay dividends to
us.

Our 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 us 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 policyholders' surplus, or statutory net income for the
prior year. Using these criteria, the available ordinary dividend payable by
Penn-America Insurance Company to us for 2002 is $6,473,325. Ordinary dividends
paid by Penn-America Insurance Company to us were $1.1 million in 2002 and $1.6
million in 2001. No ordinary dividends were paid to us in 2000. Rather, after
receiving approval from the Pennsylvania Insurance Department, Penn-America
Insurance Company paid a $6.4 million return of capital to us in 2000, which we
used to repurchase common stock and to pay common stock dividends and our
operating expenses. Penn-America Insurance Company's ability to pay future
dividends to us without advance regulatory approval is dependent upon
maintaining a positive level of unassigned and policyholders' surplus, which in
turn, is dependent upon Penn-America Insurance Company and Penn-Star

Insurance Company generating net income in excess of dividends to us. As of
September 30, 2002, Penn-America Insurance Company's unassigned surplus was
$21.2 million and policyholders' surplus was $69.2 million, both up $4.5
million from December 31, 2001.

Penn-America Insurance 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. Payment of these
contingent profit commissions has been through the issuance of our common stock
and cash. In 2002, we issued 62,836 shares of our common stock at an average
value of $7.79 per share as part of the payment of the 2001 contingent profit
commission due to the general agents of Penn-America Insurance Company.

Penn-America Insurance Company and Penn-Star Insurance Company are required
by law to maintain a certain minimum level of policyholders' surplus on a
statutory basis. Policyholders' 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, 2001, the
policyholders' 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 policyholders' surplus at
December 31, 2001 was $64,733,251 and its regulatory action level was
$17,124,648. Penn-Star Insurance Company's policyholders' surplus at December
31, 2001 was $33,389,965 and its regulatory action level was $5,675,459.

Net cash provided by operating activities decreased to $8.4 million for the
year ended December 31, 2001 from $15.0 million for the year ended December 31,
2000. The decrease in net cash provided by operations resulted principally from
the decrease in net written premiums during 2001, partially offset by a
decrease in paid losses. Net cash used by investing activities was $5.5 million
for the year ended December 31, 2001, compared with $9.1 million for the year
ended December 31, 2000.

Net cash used by financing activities was $1.2 million for the year ended
December 31, 2001 as compared with $6.5 million for the same period in 2000. In
2000, $4.7 million was used by us to repurchase 858,638 shares of our common
stock through a stock buy-back program, which was discontinued in the third
quarter of 2000.

Net cash provided by operating activities was $36.0 million for the nine
months ended September 30, 2002 compared to $2.8 million for the nine months
ended September 30, 2001. This improvement is mostly attributable to the
increase in net written premiums combined with a decrease in paid losses.

Net cash used by investing activities was $20.3 million for the nine months
ended September 30, 2002, compared to $5.4 million for the nine months ended
September 30, 2001. This increase is mostly attributable to the improved
operating cash flows that were primarily used to purchase fixed maturities
available for sale.

Net cash used by financing activities was $1.1 million for the nine months
ended September 30, 2002, compared to $1.0 million for the nine months ended
September 30, 2001.

Investment Portfolio

We seek to maintain sufficient liquidity from operations, investing and
financing activities to meet our anticipated insurance obligations and
operating and capital expenditure needs. Our investment strategy emphasizes
quality, liquidity and diversification, as well as total return. With respect
to liquidity, we consider 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. At September 30, 2002, we held a total of $229.1
million in cash and investments. Of this amount, cash represented $27.6
million, equity securities represented $23.4 million, and fixed-income
securities represented $178.1 million.

Our cash and investments portfolio mix as of September 30, 2002 was as
follows:

Fixed-income:
U.S. Treasury securities and obligations of
U.S. government agencies..................... 8%
Corporate securities........................... 27%
Mortgage-backed securities..................... 6%
Other structured securities.................... 21%
Municipal securities........................... 16%
---
Total fixed income................................ 78%
Cash.............................................. 12%
Preferred stock................................... 7%
Common stock...................................... 3%
---
100%
===

Our fixed-income portfolio of $178.1 million was 78% of the total cash and
investments as of September 30, 2002. Approximately 90% of these securities
were rated "A" or better by Standard & Poor's. Standard & Poor's rates publicly
traded securities in twenty categories ranging from AAA to CC. Securities with
ratings from AAA to BBB- (the top ten categories) are commonly referred to as
having an investment grade rating. Equity securities, which consist of
preferred stocks and common stocks (comprised exclusively of exchange traded
funds), were $23.4 million or 10% of total cash and investments as of September
30, 2002.

As of September 30, 2002, our investment portfolio contained corporate
fixed-income and preferred stock securities with a market value of $79.6
million. A summary of these securities by industry segment is as follows:

Financial institutions............................ 39%
Communications.................................... 15%
Utilities......................................... 15%
Consumer, non-cyclical............................ 8%
Industrial........................................ 6%
Basic materials................................... 6%
Consumer, cyclical................................ 5%
Technology........................................ 3%
Energy............................................ 3%
---
100%
===

As of September 30, 2002, the investment portfolio contained $61.2 million
of mortgage-backed, asset-backed and collateralized mortgage obligations. All
of these securities were rated "A" or better and 78% were rated "AAA" by
Standard & Poor's. These securities are publicly traded, and have market values
obtained from an independent pricing service. Changes in estimated cash flows
due to changes in prepayment assumptions from the original purchase assumptions
are revised based on current interest rates and the economic environment. We
had no derivative financial instruments, real estate or mortgages in the
investment portfolio as of September 30, 2002.

The quality of the fixed-income portfolio as of September 30, 2002 was as
follows:

"AAA"............................................. 49%
"AA".............................................. 22%
"A"............................................... 19%
"BBB"............................................. 8%
Below "BBB"....................................... 2%
---
100%
===

We regularly evaluate our investment portfolio to identify
other-than-temporary impairments of individual securities. We consider many
factors in determining if an other-than-temporary impairment exists, including
the length of time and extent to which the market value of the security has
been less than cost, the financial condition and near-term prospects of the
issuer of the security and our ability and willingness to hold the security
until the market value is expected to recover.

The following table contains an analysis of our securities with gross
unrealized losses, categorized by the period that the securities were in a
continuous unrealized loss position as of September 30, 2002:

Investment Securities with Gross Unrealized Losses, Categorized by Period of
Continuous Unrealized Loss Position
----------------------------------------------------------------------------
Over
Nine
Number Gross Nine Months Over
of Fair Book Unrealized Months to One One
Securities Value Value Losses or Less Year Year
---------- ------ ------ ---------- ------- ------ ----
(in thousands)

Fixed income securities 6 $6,078 $6,462 $384 $ 8 $51 $325
Preferred stock........ 2 1,276 1,289 13 13 -- --
Common stock........... 1 550 602 52 52 -- --
---- --- --- ----
$449 $73 $51 $325
==== === === ====

As of September 30, 2002, our fixed-income investment portfolio had six
securities with $384,000 of gross unrealized losses. No single issuer had an
unrealized loss position of greater than $150,000. The over one year gross
unrealized losses of $325,000 represents two public utility securities and one
other structured security. The two public utility securities had a combined
unrealized loss of $225,000. These securities have maturity dates in 2004, were
upgraded to B- and BB by Standard and Poor's in February 2002 and the
unrealized loss position was 8.9% of original cost. The other structured
security has a maturity date in 2003, a Standard & Poor's rating of AA and the
unrealized loss position was 10% of book value. The over six months to one year
gross unrealized loss for fixed-income securities of $51,000 consists primarily
of one corporate security with a Standard & Poor's rating of BBB and an
unrealized loss position of 3.2% of original cost.

As of September 30, 2002, our preferred stock portfolio has two securities
with a gross unrealized loss of $13,000. Both securities are investment grade
with Standard & Poor's ratings of BBB- and A+.

As of September 30, 2002, our common stock portfolio contains one security,
an exchange-traded fund, with a gross unrealized loss of $52,000. The
unrealized loss position on this security is 8.7% of its book value and has
been in a continuous unrealized loss position for less than three months at
September 30, 2002.

Three-for-Two Stock Split

On April 11, 2002, we announced a three-for-two stock split to be effected
in the form of a 50% stock dividend payable to stockholders of record as of
April 25, 2002. The distribution date was May 9, 2002.

Quantitative and Qualitative Disclosures About Market Risk

Market risk is the potential economic loss principally arising from adverse
changes in the market value of financial instruments. The major components of
market risk affecting us are interest rate risk and equity price risk.

Interest Rate Risk

We had fixed-income and preferred stock investments with a market value of
$195.0 million at September 30, 2002 that are subject to interest rate risk. We
manage our exposure to interest rate risk through a

disciplined asset/liability matching and capital management process. In the
management of this risk, the characteristics of duration, credit and
variability of cash flows are critical elements. These risks constantly are
assessed and balanced within the context of our liability and capital position.

The table below summarizes our interest rate risk. The table illustrates the
sensitivity of the market value of fixed-income and preferred stock investments
to selected hypothetical changes in interest rates as of September 30, 2002.
The selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have on the market value of the
fixed-income and preferred stock portfolio and stockholders' equity.

Estimated Market Hypothetical Percentage
Value of Fixed Increase (Decrease) in
Income and Estimated ------------------------
Preferred Stock Change in Stockholders'
Hypothetical Change in Interest Rates Investments Market Value Market Value Equity
------------------------------------- ---------------- ------------ ------------ -------------
(dollars in thousands)

200 basis point increase....... $180,184 $(14,778) (7.6)% (10.8)%
100 basis point increase....... 187,690 (7,272) (3.7) (5.3)
No change...................... 194,962 -- -- --
100 basis point decrease....... 202,624 7,662 3.9 5.6
200 basis point decrease....... 210,929 15,967 8.2 11.7

Equity Price Risk

Equity price risk is our underlying exposure to an economic loss from the
decline of common stock prices. Our common equity portfolio was $6.6 million at
September 30, 2002.

We attempt to mitigate equity price risk to our common stock portfolio by
investing exclusively in exchange-traded funds, or ETFs. ETFs are securities
that represent an interest in a trust that owns and holds a basket of common
stocks that replicate a major market index (such as the S&P 500 or the Dow
Jones Industrial Average) or a portion of a major market index (such as the
Value Component of the S&P). Since these securities represent an interest in
the equity capital markets as a whole, or a sub-sector thereof, they are a
diversified, index-based exposure to common stocks. As such, the value of these
ETFs will be determined by the performance of the equity capital markets in
general or of a particular sub-sector and reduces equity price risk to a single
issuer of stock.

The table below summarizes our common equity price risk. The table
illustrates the sensitivity of the market value of common stock investments to
selected hypothetical changes in market prices as of September 30, 2002. The
selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have on the fair value of the
common stock investment portfolio and stockholders' equity.

Estimated Hypothetical
Market Percentage
Value of Estimated Increase
Common Change in (Decrease) in
Equity Market Stockholders'
Hypothetical Change in Market Price Investments Value Equity
----------------------------------- ----------- --------- -------------
(dollars in thousands)

20% price increase......... $7,871 $ 1,312 1.0%
10% price increase......... 7,215 656 0.5
No change.................. 6,559 -- --
10% price decrease......... 5,903 (656) (0.5)
20% price decrease......... 5,247 (1,312) (1.0)

OUR BUSINESS

We are a specialty property and casualty insurance holding company which,
through our subsidiary, Penn-America Insurance Company and its subsidiary,
Penn-Star Insurance Company, markets and underwrites general liability,
commercial property and multi-peril insurance for small businesses located
primarily in small towns and suburban and rural areas. We focus on serving the
insurance needs of small businesses, including restaurants, mercantiles and
non-residential service contractors. We have also developed customized products
and coverages for other small insureds such as daycare facilities, fitness
centers and special events.

The excess and surplus lines marketplace is a secondary, or residual, market
for these small businesses, and their retail brokers, who are unable to obtain
coverage from standard lines carriers for a variety of reasons. In 2001, the
excess and surplus lines marketplace represented approximately $15.7 billion,
or 4.4%, of the entire $357 billion domestic property and casualty industry, as
measured by direct premiums written.

We believe we have benefited from insurance industry consolidation,
corporate downsizing and the increased use of communications technology and
personal computers, which, among other factors, have contributed to the high
growth in the number of small businesses in these areas. We select only
insurance lines of business and industry segments for which we reasonably can
evaluate the probability of future loss exposure. Therefore, we avoid
high-hazard risks and high-hazard lines of business such as medical malpractice
and environmental liability.

On November 19, 2002, the United States Senate passed the "Terrorism Risk
Insurance Act of 2002." Since this act had previously been approved by the
House of Representatives, it will become effective immediately when signed by
President Bush. This act creates the Terrorism Insurance Program to be
administered by the Department of the Treasury. We are required to participate
in this program. Currently, losses related to terrorist acts are excluded from
most of our policies. Under the Terrorism Insurance Program, however, we must
offer coverage for losses related to terrorist acts in amounts similar to what
we offer for losses related to other events. Subject to certain deductibles, we
will be reimbursed by the federal government for 90% of the amount we pay for
claims related to terrorist acts. The program is scheduled to terminate on
December 31, 2005. Although there can be no assurances, given our focus on
small businesses located primarily in small towns and suburban and rural areas,
we do not believe this act would have a material adverse effect on us.

Our Strategy

. Serving small businesses in small cities and towns. This market is
traditionally underserved by standard lines carriers who avoid writing
this business for a variety of reasons. As a result, we generally command
higher premiums and generally have more coverage form flexibility than
standard lines carriers.

. Using a small and selective general agency distribution network. We
currently have fifty-seven (57) general agents who, in turn, produce
business through more than 25,000 retail insurance brokers. This small
number of general agents allows for relative market exclusivity and
affords ready access to our senior management. Our average general agency
tenure of ten years gives us the opportunity to achieve our long-term
revenue goals through "same store sales" growth. Our network allows us to
maintain a low fixed cost distribution system with a national reach.

. Maintaining a disciplined underwriting process. We are selective in
establishing relationships with general agents and engage in a
comprehensive review process before appointing a general agent. We extend
only limited underwriting authority to each general agent. We monitor and
control the underwriting process of the general agents and audit each
general agent both remotely and on-site on a regular basis.

. Providing innovative technology to our general agents. Our technology
helps us to build strong relationships with our general agents and improve
the quality of our underwriting results. We enhance our franchise value by
acting as consultants to our general agents' information technology
function. We use automation to improve operating efficiency, providing
automated forms and manuals and policy submission and issuance systems.
This technology expedites access to information and allows our general
agents to react quickly in addressing underwriting issues and concerns.

. Maintaining an experienced, responsive management team. Our management
team is experienced in the insurance industry and the excess and surplus
lines marketplace and has long-standing relationships in the industry. We
maintain a flat organizational structure which allows us to be highly
responsive and flexible in interactions with general agents. Operating in
a small town ourselves, we can directly relate to the business needs and
challenges of our general agents and insureds.

. Creating shareholder value through strong financial results. The
underpinnings of our strong financial results include:

. a conservative investment strategy, focused largely on investment grade
fixed income securities;

. a conservative reserving philosophy designed to establish adequate
reserves as soon as a loss is known;

. a reinsurance program with financially sound and reputable reinsurers;
and

. a discipline of underwriting only risks on which we can reasonably
expect to generate an underwriting profit.

By focusing on these principles, we believe we can deliver strong financial
results and build shareholder value.

Lines of Business

The following table sets forth an analysis of gross written premiums by
specific product lines during the periods indicated:

Year ended December 31,
-----------------------------------------------
2001 2000 1999
-------------- --------------- --------------
Amount Percent Amount Percent Amount Percent
------- ------- -------- ------- ------- -------
(dollars in thousands)

Core commercial lines
Special property................. $10,118 10.3% $ 5,930 5.4% $ 5,374 5.6%
Commercial multi-peril--property. 36,381 37.0 32,677 29.8 25,418 26.5
Commercial multi-peril--liability 27,348 27.8 27,660 25.2 21,649 22.6
Other liability.................. 23,483 23.8 29,268 26.6 24,966 26.0
------- ----- -------- ----- ------- -----
Total core commercial......... 97,330 98.9 95,535 87.0 77,407 80.7
Exited lines
Commercial auto liability........ 874 0.9 8,779 8.0 5,477 5.7
Commercial auto physical damage.. 206 0.2 2,690 2.5 1,569 1.6
Personal lines................... 2 -- 2,787 2.5 11,530 12.0
------- ----- -------- ----- ------- -----
Total exited lines............ 1,082 1.1 14,256 13.0 18,576 19.3
------- ----- -------- ----- ------- -----

Total gross written premiums..... $98,412 100.0% $109,791 100.0% $95,983 100.0%
======= ===== ======== ===== ======= =====

. Our Commercial General Liability insurance is written on an occurrence
policy form, which generally provides coverage for bodily injury or
property damage that arises during the policy period, even though a claim
is made after the policy expires, as opposed to a claims-made policy form,
which generally provides coverage for claims made against an insured
during the policy period, irrespective of when the bodily injury or
property damage occurred. Our insurance coverage provides limits generally
ranging

from $25,000 to $3 million per occurrence, with the majority of policies
having limits between $500,000 and $1 million. Our general liability
policies provide for defense and related expenses in addition to per
occurrence and aggregate policy limits.

. Our Commercial Property lines provide limits usually no higher than $2
million per risk, with almost all of the policies being written at limits
of $1 million per risk or less.

. We write Commercial Multi-Peril policies that provide the same commercial
property and general liability coverages bundled together as a "package"
for our insureds. The limits on these policies are the same as if written
separately.

. We also offer Commercial Umbrella policies to enhance our commercial
multi-peril and commercial general liability writings. Commercial umbrella
insurance is written for limits up to $5 million per occurrence. For
commercial umbrella coverage, we usually write the primary $1 million
liability limit.

. Commercial Automobile policies were written with liability limits up to $1
million per occurrence.

. Non-Standard Personal Automobile policies were written with liability
limits up to $100,000 per person and $300,000 per occurrence.

Marketing and Distribution

We market our products through fifty-seven (57) general agents, who in turn
produce business through more than 25,000 retail insurance brokers located
throughout the United States. We believe that our distribution network enables
us to efficiently access these numerous small markets at a relatively low fixed
cost through the marketing, underwriting and administrative support of our
general agents. These general agents and their retail insurance brokers have
local market knowledge and expertise that enable us to more effectively access
these markets.

Our distribution strategy is to maintain strong relationships with a select
group of high-quality general agents. We believe that our network of general
agents is smaller than our competitors because of our detailed selection
process. We carefully select a limited number of general agents based on their
experience and reputation and strive to preserve each general agent's franchise
value with us within that general agent's marketing territory. We seek to
increase our written premiums with these general agents and develop strong,
long-standing relationships by providing a high level of service and support.
For example, we try to respond to our general agents' requests for quotes
within 24 hours. We also supply internet and web site technology support at no
cost to the general agent. We believe these activities create goodwill with the
general agents and strengthen our relationships with them. Our strategy has
resulted in strong and consistent growth from 1992 to 2001 in commercial gross
written premiums from $22.6 million to $98.4 million (an 18% annualized
compound growth rate), with only a modest increase in the number of general
agents from thirty-eight (38) to fifty-seven (57).

The following table sets forth the geographic distribution of our gross
written premiums for the periods indicated:

Pacific........... $15,613 15.9% $ 19,961 18.2% $21,404 22.3%
Midwest........... 17,338 17.6 21,768 19.8 17,516 18.2
South............. 17,021 17.3 16,539 15.1 13,812 14.4
Southwest......... 12,306 12.5 15,532 14.1 13,971 14.6
Mid-Atlantic...... 17,633 17.9 17,253 15.7 12,496 13.0
Mountain/Northwest 8,088 8.2 10,457 9.5 10,849 11.3
New England....... 10,413 10.6 8,281 7.6 5,935 6.2
------- ----- -------- ----- ------- -----
$98,412 100.0% $109,791 100.0% $95,983 100.0%
======= ===== ======== ===== ======= =====

Underwriting

Core Commercial Business

We underwrite our core commercial business, which excludes the exited
commercial automobile business (see "Exited Lines" below), on a binding
authority, submit and specialty lines basis.

. Binding authority business represents risks that may be quoted and bound
by our general agents prior to our underwriting review.

. Submit business represents risks that must be submitted by our general
agents to us prior to quoting or binding the account.

. Specialty lines business represents risks that meet specific,
pre-determined industry-segment and territorial parameters and may be
quoted or bound by our general agents prior to our underwriting review.

Binding authority business accounted for approximately 88% of our core
commercial gross written premiums in 2001. Of this amount, approximately 85% is
bound by general agents in accordance with our underwriting manual, with the
remaining 15% subject to our approval. We provide our 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 our risk eligibility, pricing, underwriting guidelines and policy
issuance instructions. We closely monitor the underwriting quality of our
business through online system edits and in-force account reviews. We also
periodically audit each general agent's office to determine if our underwriting
guidelines are followed in all aspects of risk selection, underwriting
compliance, policy issuance and pricing. In addition to standard commissions,
we provide strong incentives to our 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 our common stock and cash. Since 1996, we
have awarded general agents approximately 360,000 shares of common stock
through the contingent profit commission structure.

We began writing business on a submit basis in 1999 in response to general
agents who had risks similar to our risk profile but were outside of their
underwriting authority. This provides a market to our general agents for
approximately fifty classes of business. One hundred percent of the business is
quoted and bound by our underwriters; general agents have no binding authority.
This business accounted for approximately 5% of our core commercial gross
written premiums in 2001.

Specialty lines business, which accounted for 7% of our core commercial
gross written premiums in 2001, represents specialized underwriting and
marketing programs for individual general agents based upon specific
territorial needs and opportunities. An individual general agent typically is
given exclusive marketing authority for a special program subject to
territorial limitations. We are continuously developing specialized programs
for certain industry segments to meet the needs of insureds in these segments.
For example, we have developed programs for cargo and Alaskan dwellings.
Collectively, these programs are a significant benefit to our marketing efforts.

Exited Lines

We exited the non-standard personal automobile business in 1999 and, as a
result, gross written premiums declined to $2,000 in 2001 from $2.8 million in
2000 and $11.5 million in 1999.

We offered commercial automobile coverage from 1998 through the first
quarter of 2001. In late 2000, we announced that we were exiting this line of
business due to unsatisfactory underwriting results. No new policies have been
written since the first quarter of 2001 and no policies are being renewed.
Gross written premiums for commercial automobile business decreased to $1.1
million in 2001 from $11.5 million in 2000 and $7.0 million in 1999.

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,
known as "ISO". ISO makes available to its members advisory rating, statistical
and actuarial services, policy language and other related services. ISO
currently provides these 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.

We primarily use ISO loss cost rates as the foundation for establishing our
pricing benchmarks for all lines of business in all 50 states. We then develop
"loss cost multipliers," or LCMs, which are designed to support our operating
expenses, acquisition expenses and targeted return on equity. The
multiplication of our LCMs by ISO loss cost rates produces our final benchmark
rates. As a general rule, our final benchmark rates are set at 110% to 150% of
the prescribed ISO benchmark rates because of our strategy of providing
insurance to underserved markets. Our 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 business that we
write on an admitted basis, we must obtain advance regulatory approval of rates
in a number of states. We provide our 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 our final benchmark rates.

Claims Management and Administration

Our approach to claims management is 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.
Our general agents have no authority to settle claims or otherwise exercise
control over the claims process. Our claims management staff supervises and
processes all claims. We have a formal claims review process, and all claims
greater than $25,000 are reviewed by senior claims management.

Insurance Loss Reserves

We are directly liable for losses and loss adjustment expenses under the
terms of the insurance policies that we write. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss to
us and our payment of that loss. We reflect our 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.

. the type of loss;

. the jurisdiction of the occurrence;

. our knowledge of the circumstances surrounding the claim;

. the severity of injury or damage;

. the potential for ultimate exposure; and

. policy provisions relating to the claim.

We determine loss adjustment expenses via a formula method that estimates loss
adjustment expenses as a percentage of expected indemnity losses based on
historical patterns adjusted to current experience.

In addition to case reserves, we establish 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, we must
estimate the ultimate liability based primarily on past experience. We apply a
variety of traditional actuarial techniques to estimate our ultimate liability.
The techniques recognize, among other factors:

. our and the industry's experience;

. historical trends in reserving patterns and loss payments;

. the impact of claim inflation;

. the pending level of unpaid claims;

. the cost of claim settlements;

. the line of business mix; and

. the economic environment in which property and casualty insurance
companies operate.

We continually review these estimates and, based on new developments and
information, we include adjustments of the probable ultimate liability in
operating results for the periods in which the adjustments are made. In
general, our 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 for the
extraordinary future emergence of new types of losses not sufficiently
represented in our historical experience, or which cannot yet be quantified. We
regularly analyze our reserves and review our 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. We do not discount our loss reserves.

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

Year ended December 31,
-------------------------
2001 2000 1999
-------- -------- -------
(in thousands)

Balance, beginning of year........................... $115,314 $ 93,719 $88,937
Less reinsurance recoverable......................... 24,093 18,086 16,502
-------- -------- -------
Net balance, beginning of year....................... 91,221 75,633 72,435
Incurred related to:
Current year...................................... 60,885 66,214 54,768
Prior Years....................................... 36 9,164 8,419
-------- -------- -------
Total incurred....................................... 60,921 75,378 63,187
Paid related to:
Current Year...................................... 19,913 26,273 23,540
Prior Years....................................... 38,183 33,517 36,449
-------- -------- -------
Total paid........................................... 58,096 59,790 59,989
Net balance, end of year............................. 94,046 91,221 75,633
Plus reinsurance recoverable......................... 25,552 24,093 18,086
-------- -------- -------
Balance, end of year................................. $119,598 $115,314 $93,719
======== ======== =======

In 2000, we increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $9.2 million. The increase is
primarily attributable to changes in our estimates for losses and loss
adjustment expense reserves of $1.4 million for our commercial automobile, of
$3.9 million for our commercial multi-peril liability and $3.4 million for our
other liability lines of business.

Our change in estimates in 2000 for the other liability line resulted
principally from construction defect claims, which were new claims that were
not anticipated by us when we wrote these policies between 1991 and 1996. These
claims predominantly related to residential contractors and sub-contractors in
California. In 2000, we completed our withdrawal from the residential
contractors and sub-contractors industry segment.

Incurred losses and loss adjustment expenses include estimates, recorded as
loss and loss adjustment expense reserves on the balance sheet, for the
ultimate payment on both reported and unreported claims. We change our
estimates for loss and loss adjustment expenses reserves as new events occur,
as more loss experience is acquired, or as additional information is received.
Our estimates for loss and loss adjustment expense reserves result from a
continuous review process and the change in these estimates, as required by
Financial Accounting Standards Board No. 60, Accounting and Reporting for
Insurance Enterprises, paragraph 18, is recorded in the period that the change
in these estimates is made.

We believe that our loss and loss adjustment expense reserves are fairly
stated as of September 30, 2002 due to our exiting of non-standard personal and
commercial automobile lines of business, and the reduction in our exposure to
construction defect and liquor liability losses. In addition, we implemented
improvements in our loss reserving process, including the development of
monthly and quarterly loss and loss adjustment expense reserve analyses and the
creation of reserve committee that meets quarterly.

The following table presents our accident year loss and loss adjustment
expense ratios (the sum of losses and loss adjustment expenses divided by
premiums earned) for the ten most recent accident years (the year in which the
loss occurred), as recorded as of December 31, 1999, 2000 and 2001, and
September 30, 2002, after giving effect to the increase in loss and loss
adjustment expenses relating to changes in estimates of insured events of prior
years. These "accident year" loss ratios differ from the loss ratios included
in our financial statements set forth elsewhere in this prospectus in that the
latter loss ratios are based upon the year in which we recognize the loss for
accounting purposes, regardless of when the loss actually occurred or was
reported to us. See the notes to the consolidated financial statements included
elsewhere in this prospectus.

As of December 31, As of September 30,
------------------ -------------------
Accident Year 1999 2000 2001 2002
------------- ---- ---- ---- ----

1992......................................... 69.6 72.1 72.5 72.5
1993......................................... 70.9 70.2 71.3 71.3
1994......................................... 69.1 72.0 71.8 71.8
1995......................................... 63.9 65.4 65.1 65.3
1996......................................... 68.1 68.3 69.4 69.4
1997......................................... 62.4 62.0 62.1 62.3
1998......................................... 63.6 65.8 65.0 66.2
1999......................................... 63.8 68.2 70.0 73.5
2000......................................... 72.4 70.2 70.0
2001......................................... 68.5 64.6
2002......................................... 65.1

The following table represents the development of unpaid loss and loss
adjustment expense reserves during the ten years ended December 31, 2001. The
top of the table reflects the ten-year development of our reserves, net of
reinsurance. The bottom of the table reconciles 1992 through 2001 ending
reserves to the gross reserves in our consolidated financial statements. Prior
to 1992, we developed our reserves on a net of reinsurance basis and
restatement for those prior years is not presented. The top line of the table
shows the estimated reserve for unpaid loss and loss adjustment expenses at the
balance sheet date for each of the indicated years. These figures represent the
estimated amount of unpaid loss and loss adjustment expenses 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. The table also shows the
re-estimated amount of the previously recorded reserve based on experience as
of the end of each succeeding year. The estimate changes as more information
becomes available about the frequency and severity of claims. The cumulative
redundancy or deficiency represents the aggregate change in the reserve
estimates over all prior years.

1991 1992 1993 1994 1995 1996 1997 1998
------- -------- -------- -------- -------- -------- -------- --------
(in thousands)

Reserves for unpaid losses and loss
adjustment expenses, as stated............ $25,681 $ 26,110 $ 26,830 $ 35,307 $ 46,512 $ 55,656 $ 68,863 $ 72,435
a. Net cumulative paid as of
1 year later.............................. $ 6,605 $ 7,381 $ 6,852 $ 12,383 $ 17,208 $ 23,660 $ 30,236 $ 36,449
2 years later............................. 10,988 11,127 13,127 20,617 29,612 38,819 51,141 55,718
3 years later............................. 13,325 15,546 18,656 27,266 38,091 50,982 63,470 70,370
4 years later............................. 16,417 19,253 22,254 32,119 44,016 57,613 72,651
5 years later............................. 19,283 21,503 24,303 34,883 48,236 62,724
6 years later............................. 20,872 22,796 25,642 37,687 51,485
7 years later............................. 21,881 23,714 27,121 39,863
8 years later............................. 22,452 24,959 28,449
9 years later............................. 23,303 25,979
10 years later............................ 24,006
b. Reserves re-estimated as of end of year
1 year later.............................. $23,228 $ 24,478 $ 23,897 $ 33,601 $ 45,708 $ 55,997 $ 68,946 $ 80,855
2 years later............................. 22,383 21,945 23,489 34,281 47,225 57,913 76,217 86,351
3 years later............................. 20,471 22,032 24,558 36,453 47,378 63,575 79,881 86,899
4 years later............................. 20,819 22,767 26,335 36,359 50,704 67,310 81,226
5 years later............................. 21,726 23,935 26,380 38,768 54,245 68,567
6 years later............................. 22,550 24,143 27,532 41,425 54,740
7 years later............................. 22,761 24,776 29,050 42,095
8 years later............................. 23,117 26,485 29,804
9 years later............................. 24,280 26,948
10 years later............................ 24,644
Net cumulative redundancy (deficiency)..... $ 1,037 $ (839) $ (2,974) $ (6,788) $ (8,228) $(12,911) $(12,363) $(14,463)
Gross liability for unpaid losses and loss
adjustment expenses, as stated............ $ 31,703 $ 33,314 $ 44,796 $ 60,139 $ 70,728 $ 84,566 $ 88,937
Reinsurance recoverable.................... 5,593 6,484 9,489 13,627 15,072 15,703 16,502
Net liability for unpaid losses and loss
adjustment expenses, as stated............ 26,110 26,830 35,307 46,512 55,656 68,863 72,435
-------- -------- -------- -------- -------- -------- --------
Gross liability re-estimated--1 year later. 30,609 32,796 48,173 63,884 71,644 85,640 98,395
Reinsurance recoverable re-estimated....... 6,131 8,899 14,572 18,176 15,647 16,694 17,540
Net liability re-estimated--1 year later... 24,478 23,897 33,601 45,708 55,997 68,946 80,855
-------- -------- -------- -------- -------- -------- --------
Gross liability re-estimated--2 years later 30,390 36,243 53,009 66,405 74,312 92,832 104,664
Reinsurance recoverable re-estimated....... 8,445 12,754 18,728 19,180 16,399 16,615 18,313
Net liability re-estimated--2 years later.. 21,945 23,669 34,281 47,225 57,913 76,217 86,351
-------- -------- -------- -------- -------- -------- --------
Gross liability re-estimated--3 years later 33,992 41,600 56,042 66,891 80,574 97,786 105,248
Reinsurance recoverable re-estimated....... 11,960 17,042 19,589 19,513 16,999 17,905 18,349
Net liability re-estimated--3 years later.. 22,032 24,558 36,453 47,378 63,575 79,881 86,899
-------- -------- -------- -------- -------- -------- --------
Gross liability re-estimated--4 years later 38,165 43,824 56,167 68,927 84,831 98,244
Reinsurance recoverable re-estimated....... 15,398 17,489 19,808 18,223 17,521 17,018
Net liability re-estimated--4 years later.. 22,767 26,335 36,359 50,704 67,310 81,226
-------- -------- -------- -------- -------- --------
Gross liability re-estimated--5 years later 39,956 44,466 58,272 73,042 85,221
Reinsurance recoverable re-estimated....... 16,021 18,086 19,504 18,797 16,654
Net liability re-estimated--5 years later.. 23,935 26,380 38,768 54,245 68,567
-------- -------- -------- -------- --------
Gross liability re-estimated--6 years later 40,670 45,595 61,814 72,978
Reinsurance recoverable re-estimated....... 16,527 18,063 20,389 18,238
Net liability re-estimated--6 years later.. 24,143 27,532 41,425 54,740
-------- -------- -------- --------
Gross liability re-estimated--7 years later 41,679 47,955 61,766
Reinsurance recoverable re-estimated....... 16,903 18,905 19,671
Net liability re-estimated--7 years later.. 24,776 29,050 42,095
-------- -------- --------
Gross liability re-estimated--8 years later 43,958 48,032
Reinsurance recoverable re-estimated....... 17,473 18,228
Net liability re-estimated--8 years later.. 26,485 29,804
-------- --------
Gross liability re-estimated--9 years later 44,248
Reinsurance recoverable re-estimated....... 17,300
Net liability re-estimated--9 years later.. 26,948
Gross cumulative deficiency................ $(12,545) $(14,718) $(16,970) $(12,838) $(14,493) $(13,678) $(16,311)

1999 2000 2001
-------- -------- --------

Reserves for unpaid losses and loss
adjustment expenses, as stated............ $ 75,633 $ 91,221 $ 94,046
a. Net cumulative paid as of
1 year later.............................. $ 34,626 38,183
2 years later............................. 57,415
3 years later.............................
4 years later.............................
5 years later.............................
6 years later.............................
7 years later.............................
8 years later.............................
9 years later.............................
10 years later............................
b. Reserves re-estimated as of end of year
1 year later.............................. $ 84,797 $ 91,257
2 years later............................. 86,863
3 years later.............................
4 years later.............................
5 years later.............................
6 years later.............................
7 years later.............................
8 years later.............................
9 years later.............................
10 years later............................
Net cumulative redundancy (deficiency)..... $(11,230) $ (36)
Gross liability for unpaid losses and loss
adjustment expenses, as stated............ $ 93,719 $115,314 $119,598
Reinsurance recoverable.................... 18,086 24,093 25,552
Net liability for unpaid losses and loss
adjustment expenses, as stated............ 75,633 91,221 94,046
-------- -------- --------
Gross liability re-estimated--1 year later. 101,597 115,350
Reinsurance recoverable re-estimated....... 16,800 24,093
Net liability re-estimated--1 year later... 84,797 91,257
-------- --------
Gross liability re-estimated--2 years later 104,137
Reinsurance recoverable re-estimated....... 17,274
Net liability re-estimated--2 years later.. 86,863
--------
Gross liability re-estimated--3 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--3 years later..

Gross liability re-estimated--4 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--4 years later..

Gross liability re-estimated--5 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--5 years later..

Gross liability re-estimated--6 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--6 years later..

Gross liability re-estimated--7 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--7 years later..

Gross liability re-estimated--8 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--8 years later..

Gross liability re-estimated--9 years later
Reinsurance recoverable re-estimated.......
Net liability re-estimated--9 years later..
Gross cumulative deficiency................ $(10,418) $ (36)

The table below illustrates the sensitivity to a hypothetical change in our
net loss and loss adjustment expense reserves as of December 31, 2001. The
selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have on stockholders' equity.

Hypothetical
Percentage
Balance of Net Change in Net Increase
Loss and Loss Loss and Loss (Decrease) in
Adjustment Adjustment Stockholders'
Hypothetical Change in Net Loss and Loss Adjustment Expense Reserve Expense Reserves Expense Reserve Equity
------------------------------------------------------------------- ---------------- --------------- -------------
(dollars in thousands)

3% increase............................ $96,867 $ 2,821 (2.3)%
2% increase............................ 95,927 1,881 (1.5)
1% increase............................ 94,986 940 (0.8)
No change.............................. 94,046 -- --
1% decrease............................ 93,106 (940) 0.8
2% decrease............................ 92,165 (1,881) 1.5
3% decrease............................ 91,225 (2,821) 2.3

Reinsurance

We purchase reinsurance through contracts called "treaties" to reduce our
exposure to liability on individual risks and to protect against catastrophic
losses. 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 our reinsurance programs, we are selective in our choice of
reinsurers and consider 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 our exposure to the insolvency
of our reinsurers, we evaluate the acceptability and review the financial
condition of each reinsurer annually. Our policy is to use only reinsurers that
have an A.M. Best Co. rating of "A-" (excellent) or better and that have at
least $500 million in policyholders' surplus.

Line of Business Company Policy Limit Reinsurance Coverage/Company Retention
---------------- -------------------- --------------------------------------

Property $2.0 million per risk $1.7 million per risk in excess
of $300,000 per risk
Commercial Automobile $1.0 million per occurrence $750,000 per occurrence in
excess of $250,000 per
occurrence
General Liability $3.0 million per occurrence $2.5 million per occurrence
in excess of $500,000
per occurrence

Our combined retention for any one loss resulting from a common occurrence
involving both the property and general liability coverage on a single risk is
$500,000. We also maintain casualty contingent excess coverage with American
Re, which covers exposures such as punitive damages and other extra-contractual
obligations,

losses in excess of policy limits (such as bad faith and errors and omissions)
and liability actions brought by two or more of our insureds against each other
resulting from the same occurrence.

We offer umbrella liability policies up to $5.0 million per occurrence.
These policies are reinsured with American Re for 90% of policy limits up to
$1.0 million per occurrence and 100% of policy limits to $4.0 million in excess
of $1.0 million per occurrence.

We maintain a catastrophic loss reinsurance program, the terms of which
provide for 100% retention of the first $1.0 million per occurrence,
reinsurance of 90% of $1.0 million per occurrence in excess of $1.0 million per
occurrence and reinsurance of 100% of $23.0 million per occurrence in excess of
$2.0 million per occurrence.

We may write individual policies with limits of liability greater than the
aforementioned policy limits. These limits of liability are 100% reinsured on a
facultative reinsurance basis.

Competition

The property and casualty insurance industry is highly competitive. We
compete with domestic and international insurers, some of which have greater
financial, marketing and management resources and experience than we do. We
also may compete with new market entrants in the future. Competition is based
on many factors, including the perceived market strength of the insurer,
pricing and other terms and conditions, services provided, the speed of claims
payment, the reputation and experience of the insurer and ratings assigned by
independent rating organizations such as A.M. Best Co. Penn-America Insurance
Company and Penn-Star Insurance Company currently have a pooled rating from
A.M. Best Co. of "A-" (excellent). Ratings for an insurance company are based
on its ability to pay policyholder obligations and are not directed toward the
protection of investors.

CERTAIN TRANSACTIONS

Headquarters Lease

Our headquarters in Hatboro, Pennsylvania is occupied pursuant to a lease,
effective July 1, 2000, with Mr. Irvin Saltzman, Chairman of our Board of
Directors. The lease is for an initial term of five years and we have one
five-year renewal option thereafter. The current rent is $357,247 per year,
based on a price of $15.25 per square foot. Included in the square footage
charge is our share of costs for insurance, real estate taxes, housekeeping,
HVAC, energy management, snow removal/landscaping, utilities, pest control,
transformer maintenance, bathroom maintenance, plant maintenance, phone/voice
mail system maintenance and smoke/fire monitoring. We are required to pay our
pro rata share of all increases in the base year of taxes, fees, assessments
and expenses on the entire office facility. As of March 28, 2002, there was no
pro rata share charge. We believe that the amount being paid by us under the
lease represents a fair market value annual rental charge and that the terms of
the lease are as favorable to us as we might have obtained from unaffiliated
third parties.

Affiliated Insurance Entities

Several of Penn Independent Corporation's wholly-owned subsidiaries are
insurance agencies that write business with us. During the year ended December
31, 2001, the premiums written by these agencies for us represented 3.95%
($3,888,000) of our total premiums. Total commissions paid to these agencies
were $855,000. Premiums receivable from these agencies were $454,000 as of
December 31, 2001. The commissions paid were on terms as favorable to us as we
might have obtained from unaffiliated third parties. One of the subsidiaries,
Delaware Valley Underwriting Agency, Inc., wrote 2.74% ($2,700,000) of our
total premiums; and Mr. E. Anthony Saltzman, Vice President of that company, is
currently one of our directors. Because the insurance agencies are compensated
on commissions received, while we are compensated on the underwriting
profitability of the policies written, it is possible our affiliate could bind
us to unprofitable policies.

Executive Loans

In 2000 and in 2001, our board of directors and the board of directors of
Penn-America Insurance Company authorized the issuance of several executive
loans to purchase our common stock. Under the terms of the loans, the
executives are required to repay principal, brokerage commissions, transaction
costs and interest, calculated semi-annually, within five years from the date
of the loan. On default, the Penn-America Insurance Company has recourse
against the defaulting executive. However, Penn-America Insurance Company has
agreed to forgive the repayment of these loans upon a change of control, as
that term is defined in the loan documents. No executive officer entered into
any loan(s) with Penn-America Insurance Company in 2001 in excess of $60,000.
At a meeting of our board of directors in August 2002, the board withdrew its
authorization to extend executive loans.

The following table shows the outstanding principal amount of loans to our
officers and the aggregate number of shares of our common stock acquired with
the proceeds of the loans.

Original Loan and
Outstanding Balance as of Weighted Average
Name September 30, 2002 Interest Rate Number of Shares Acquired
---- ------------------------- ---------------- -------------------------

Jon S. Saltzman.......... $359,072 6.16% 71,250
Thomas P. Bowie(1)....... 46,139 5.07% 7,500
Joseph F. Morris......... 55,845 5.07% 9,000
J. Ransley Lennon........ 97,943 6.20% 16,500
Garland P. Pezzuolo...... 35,511 5.61% 6,000
-------- ---- -------
Total.................... $594,510 5.95% 110,250
======== ==== =======

--------

(1)As of October 31, 2002, Thomas P. Bowie was no longer employed with us.

Change in Control Agreements

On November 12, 2002, our board of directors approved certain change in
control compensation, equaling .25 to 2 times certain of our key employees'
annual base salaries in the event of a change in control, and additional
severance compensation equaling .25 to 2 times certain of our key employee's
annual base salaries if the key employee is terminated within 12 months of a
change in control.

Under the agreements, "change in control" is defined to mean any transaction
or series of transactions where:

(1)any person becomes the beneficial owner of a percentage ownership in us
that is greater than the beneficial ownership of our controlling
shareholder, Penn Independent Corporation;

(2)any person becomes the beneficial owner of 30% or more of our common
stock and there is a corresponding change in 25% or more of the
composition of the board within 2 years, which change was not authorized
by a majority of the then current board;

(3)any person becomes the beneficial owner of greater than 50% of our
controlling shareholder, Penn Independent Corporation;

(4)there is a change in 25% or more of the composition of the board within
2 years, which change was not authorized by a majority of the then
current board;

(5)80% or more of our assets are sold or transferred; or

(6)the board determines that such transaction or transactions constitute a
change of control.

The agreements further define "termination upon a change of control" as
termination of employment either: (1) within 12 months immediately following a
change of control or (2) after a potential change of control and prior to a
change of control if a change of control occurs within 12 months of such
termination of employment, that is either:

(a) initiated by us for any reason other than the employee's death or
disability or for cause; or

(b) initiated by the employee following one or more of the following
occurrences:

(1) an assignment to the employee of duties inconsistent with, or
a significant reduction or change by us in the nature or scope of the
authority, duties or responsibilities of the employee from those
assigned to or held by the employee immediately prior to the change
of control or potential change of control, as the case may be;

(2) any removal of the employee from the officer positions with us
held immediately prior to the change of control or potential change
of control, as the case may be, (if any), except in connection with
promotions to positions of greater responsibility and higher prestige;

(3) a reduction by us in the employee's base salary in effect
immediately prior to the change of control or potential change of
control, as the case may be, or as of the same may be increased
thereafter;

(4) a transfer or relocation of the site of employment of the
employee, without his express written consent, to a location more
than 50 miles from the general area in which his principal place of
business was located;

(5) any failure by us to comply with and satisfy its obligations
to ensure that a successor corporation complies with the agreement.

Agreements with Penn Independent Corporation

We receive services from executives (including Mr. Irvin Saltzman), staff
and administrative personnel of Penn Independent Corporation, including
services in connection with our investment portfolio, human resource

administration and related services. We have historically been charged a
portion of the amounts paid by Penn Independent Corporation for services such
as insurance, telecommunications, postage and office supplies (based on actual
costs incurred). In 2001, we were charged $212,000 for these services, the
majority of which fees represented payments for the services of Penn
Independent Corporation personnel for executive, human resource administration,
investment advisory (Mr. Irvin Saltzman) and other related support services
(based upon the number of our employees in proportion to the total number of
Penn Independent employees for which these services are provided).

We believe that the terms of the transactions described above are at least
as favorable as those that might have been obtained from unaffiliated third
parties.

DESCRIPTION OF CAPITAL STOCK

We have authorized 20,000,000 shares of our common stock, par value $.01 per
share, and 2,000,000 shares of preferred stock, par value $.01 per share. As of
September 30, 2002, 11,585,223 shares of our common stock and no shares of our
preferred stock are outstanding.

Common Stock

Holders of our common stock are entitled to one vote for each share held on
all matters submitted to vote of stockholders and do not have cumulative voting
rights. Accordingly, a holder of a majority of the outstanding shares of our
common stock entitled to vote in any election of directors may elect all the
directors standing for election. Holders of our common stock are entitled to
receive ratably dividends, if any, as may be declared by our board of
directors. Upon the liquidation, dissolution or winding up of the company,
holders of our common stock are entitled to receive ratably the net assets of
the company available for distribution after the payment of all debts and other
liabilities of the company, subject to prior and superior rights of the
preferred stock. Holders of our common stock have no preemptive, subscription,
redemption or conversion rights. The outstanding shares of common stock are,
and the shares offered by this prospectus when issued and paid for will be,
fully paid and nonassessable.

Preferred Stock

No shares of preferred stock have been issued and we do not presently plan
to issue any. Our board of directors is empowered by our articles of
incorporation to designate and issue from time to time one or more classes or
series of preferred stock without stockholder action. The board may fix and
determine the relative rights, preferences and limitations of each class or
series so authorized. The issuance of, or the ability to issue, preferred stock
could adversely affect the voting power and other rights of the holders of our
common stock or could have the effect of decreasing the market price of the
common stock or of discouraging or making difficult any attempt by a person or
group to obtain control of us, including any attempt involving a bid for our
common stock at a premium over the then market price.

Corporate Anti-Takeover Provisions

Our articles of incorporation and bylaws contain a number of provisions
relating to corporate governance and the rights of stockholders. Some of these
provisions may have a potential "anti-takeover" effect because they may delay,
defer or prevent a change of control. These provisions include:

. the authority of our 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.

For nominations or other business to be properly brought before an annual
meeting of stockholders by a stockholder, our bylaws require that stockholder
to deliver a notice to our President, absent specified circumstances, not less
than 60 days nor more than 90 days prior to the first anniversary of the
preceding year's annual meeting. In addition, the Pennsylvania Business
Corporation Law of 1988, as amended, or "BCL", provides that directors may, in
discharging their duties, consider the interests of a number of different
constituencies, including stockholders, employees, suppliers, customers,
creditors and the community in which a company is located. Directors are not
required to consider the interests of the stockholders to a greater degree than
other constituencies' interests. The BCL expressly provides that directors do
not violate their fiduciary duties solely by relying on poison pills or the
BCL's anti-takeover provisions.

We have elected, as permitted under the BCL, not to be subject to provisions
that:

. permit stockholders in some change of control transactions to demand
payment from a new 20% stockholder of the fair market value of the
demanding stockholders' shares;

. in some cases, prohibit a business combination with a stockholder or group
of stockholders beneficially owning more than 20% of the voting power of a
public corporation, for a 5-year period following the date on which the
holder obtains the 20% ownership;

. limit the voting power of stockholders acquiring more than 20%, 33% and/or
50% of a corporation's voting securities; and

. in some cases, permit a corporation to recover profits resulting from a
sale of shares by a stockholder, after the stockholder has acquired or
expressed an intent to acquire at least 20% of the corporation's voting
shares.

By making the above election, we have opted not to take advantage of
provisions which are intended to limit the possibility of a takeover of us.

MATERIAL U.S. TAX CONSEQUENCES TO NON-U.S. HOLDERS

The following summary describes the material United States federal income
and estate tax consequences of the purchase, ownership and disposition of our
common stock by a Non-U.S. holder (as defined below) as of the date hereof.
This discussion does not address all aspects of U.S. federal income and estate
taxes and does not deal with foreign, state and local consequences that may be
relevant to such Non-U.S. holders in light of their personal circumstances.
Special rules may apply to certain Non-U.S. holders that are subject to special
treatment under the Internal Revenue Code of 1986, as amended (also referred to
as the Code), such as:

. certain United States expatriates;

. "controlled foreign corporations";

. "passive foreign investment companies";

. "foreign personal holding companies"; and

. corporations that accumulate earnings to avoid United States federal
income tax.

Such Non-U.S. holders should consult their own tax advisors to determine the
United States federal, state, local and other tax consequences that may be
relevant to them. Furthermore, the discussion below is based upon the
provisions of the Code, and regulations, rulings and judicial decisions
thereunder as of the date hereof, and such authorities may be repealed, revoked
or modified, perhaps retroactively, so as to result in United States federal
income tax consequences different from those discussed below.

As used herein, a U.S. holder of our common stock means a holder that is for
United States federal income tax purposes:

. a citizen or resident of the United States;

. a corporation or partnership created or organized in or under the laws of
the United States or any political subdivision thereof;

. an estate the income of which is subject to United States federal income
taxation regardless of its source; or

. a trust (X) if a court within the United States is able to exercise
primary supervision over its administration and one or more United States
persons have the authority to control all of its substantial decisions or
(Y) that has a valid election in effect under applicable United States
Treasury regulations to be treated as a United States person.

A Non-U.S. holder is a holder that is not a U.S. holder.

If a partnership holds our common stock, the tax treatment of a partner will
generally depend on the status of the partner and the activities of the
partnership. Persons who are partners of partnerships holding our common stock
should consult their tax advisors.

Persons considering the purchase, ownership or disposition of our common
stock should consult their own tax advisors concerning the United States
federal income tax consequences in light of their particular situations as well
as any consequences arising under the laws of any other taxing jurisdiction.

Dividends

Dividends paid to you generally will be subject to withholding of United
States federal income tax at a 30% rate or such lower rate as may be specified
by an applicable income tax treaty. However, dividends that are effectively
connected with your conduct of a trade or business within the United States,
and, where a tax treaty applies, are attributable to a United States permanent
establishment are not subject to the withholding tax, but instead are subject
to United States federal income tax on a net income basis at applicable
graduated individual or

corporate rates. Certain certification and disclosure requirements must be
satisfied for effectively connected income to be exempt from withholding. Any
such effectively connected dividends received by a foreign corporation may be
subject to an additional "branch profits tax" at a 30% rate or such lower rate
as may be specified by an applicable income tax treaty.

If you wish to claim the benefit of an applicable treaty rate (and avoid
backup withholding as discussed below) for dividends paid to you, you will be
required (a) to complete Internal Revenue Service (also referred to as the IRS)
Form W-8BEN (or other applicable form) and certify under penalties of perjury
that you are not a United States person or (b) if you hold our common stock
through certain foreign intermediaries, satisfy the relevant certification
requirements of applicable United States Treasury regulations. Special
certification and other requirements apply to certain Non-U.S. holders that are
entities rather than individuals.

If you are eligible for a reduced rate of United States withholding tax
pursuant to an income tax treaty, you may obtain a refund of any excess amounts
withheld by filing an appropriate claim for refund with the IRS.

Gain on Disposition of Common Stock

You generally will not be subject to United States federal income tax with
respect to gain recognized on a sale or other disposition of our common stock
unless:

. the gain is effectively connected with your conduct of a trade or business
within the United States, and, where a tax treaty applies, is attributable
to a United States permanent establishment, in which case you will be
subject to tax on the net gain derived from the sale under regular
graduated United States federal income tax rates, and, if you are a
corporation, an additional 30% branch profits tax on your effectively
connected earnings and profits, or such lower rate as may be specified by
an applicable income tax treaty;

. if you are an individual and hold our common stock as a capital asset, you
are present in the United States for 183 or more days in the taxable year
of the sale or other disposition and certain other conditions are met, in
which case you will be subject to a flat 30% tax on the gain derived from
the sale, which tax may be offset by United States source capital losses
(even though you are not considered a resident of the United States); or

. we are or have been a "United States real property holding corporation"
for United States federal income tax purposes.

We believe we are not and do not anticipate becoming a "United States real
property holding corporation" for United States federal income tax purposes.
However, if we are or become a United States real property holding corporation,
then assuming our common stock is regularly traded on an established securities
market, you will only be subject to United States federal income tax on the
disposition of our common stock if you hold or held (at any time during the
shorter of the five-year period ending on the date of disposition and your
holding period of our common stock) more than 5% of our common stock.

Federal Estate Tax

If you are an individual Non-U.S. holder, common stock held by you at the
time of death will be included in your gross estate for United States federal
estate tax purposes, unless an applicable estate tax treaty provides otherwise.

Information Reporting and Backup Withholding

We must report annually to the IRS and to you the amount of dividends paid
to you and the tax withheld with respect to such dividends, regardless of
whether withholding was required. Copies of the information returns reporting
such dividends and withholding may also be made available to the tax
authorities in the country in which you reside under the provisions of an
applicable income tax treaty.

You will not be subject to backup withholding on dividends paid to you
provided that we do not have actual knowledge or reason to know that you are a
U.S. holder and you provide your name and address on an IRS Form W-8BEN (or
other applicable form) and certify, under penalties of perjury, that you are
not a United States holder. Alternative documentation may be applicable in some
situations, and special certification rules apply to holders that are
pass-through entities.

In addition, you will be subject to information reporting and, depending on
the circumstances, backup withholding regarding the proceeds of the sale,
exchange or other disposition of our common stock made within the United States
or through certain United States-related financial intermediaries, unless the
payor receives the statement described above and does not have actual knowledge
or reason to know that you are a U.S. holder, or you otherwise establish an
exemption.

Any amounts withheld under the backup withholding rules may be allowed as a
refund or a credit against your United States federal income tax liability
provided the required information is furnished to the IRS.

UNDERWRITING

Subject to the terms and conditions of an Underwriting Agreement, dated
, 2002, the underwriters named below, acting through their
representatives, Bear, Stearns & Co. Inc., Ferris, Baker Watts, Incorporated
and Keefe, Bruyette & Woods, Inc. have severally agreed with us to purchase
from us the number of shares of common stock set forth below opposite their
respective names.

Number of
Underwriters Shares
------------ ---------

Bear, Stearns & Co. Inc...........
Ferris, Baker Watts, Incorporated.
Keefe, Bruyette & Woods, Inc......
---------
Total.......................... 2,600,000
=========

The Underwriting Agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares of our common stock
offered by this prospectus are subject to approval by their counsel of legal
matters and to other conditions set forth in the Underwriting Agreement. The
underwriters are obligated to purchase and accept delivery of all shares of our
common stock offered hereby, other than those shares covered by the
over-allotment option described below, if any are purchased.

The underwriters' representatives have advised us that the underwriters
propose to offer the shares of common stock to the public at the public
offering price set forth on the cover page of this prospectus and to certain
dealers at that price less a concession of not in excess of $ per share,
of which $ may be reallowed to other dealers. After this offering, the
public offering price, concession and reallowance to dealers may be reduced by
the representatives. No such reduction shall change the amount of proceeds to
be received by us as set forth on the cover page of this prospectus. The common
stock is offered by the underwriters as stated herein, subject to receipt and
acceptance by them and subject to their right to reject any order in whole or
in part. The underwriters do not intend to confirm sales to any accounts over
which they exercise discretionary authority.

We have granted to the underwriters an option, exercisable within 30 days
after the date of this prospectus, to purchase from time to time up to a total
of 390,000 shares of common stock from us to cover over-allotments, if any, at
the public offering price less underwriting discounts and commissions. If the
underwriters exercise their over-allotment option to purchase any of the
additional 390,000 shares of common stock, each underwriter, subject to certain
conditions, will become obligated to purchase its pro-rata portion of these
additional shares based on the underwriter's percentage underwriting commitment
in the offering as indicated in the table above. If purchased, these additional
shares will be sold by the underwriters on the same terms as those on which the
shares offered hereby are being sold. We will be obligated, pursuant to the
over-allotment option, to sell shares to the underwriters to the extent the
over-allotment option is exercised. The underwriters may exercise the
over-allotment option only to cover over-allotments made in connection with the
sale of the shares of common stock offered in this offering.

The following table shows the public offering price, underwriting discounts
and commissions and proceeds, before expenses, to us. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' over-allotment
option to purchase additional shares.

Total
-----------------------------
Per With Without
Share Over-Allotment Over-Allotment
----- -------------- --------------

Public offering price...............................
Underwriting discounts and commissions payable by us
Proceeds, before expenses, to us....................

The expenses of the offering, other than underwriting discounts and
commissions referred to above, are estimated at $ and are payable entirely
by us.

We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act and liabilities arising from
breaches of representations and warranties contained in the Underwriting
Agreement, or to contribute to payments that the underwriters may be required
to make in respect of those liabilities.

Each of our executive officers, directors and principal stockholders, and
certain of our officers, have agreed for a period of 90 days after the date of
this prospectus, subject to limited exceptions, not to:

. offer to sell, contract to sell, or otherwise sell, dispose of, loan,
pledge or grant any rights with respect to any shares of common stock or
any options or warrants to purchase any shares of common stock, or any
securities convertible into or exchangeable for shares of common stock
owned as of the date of this prospectus or thereafter acquired directly
by those holders or with respect to which they have the power of
disposition; or

. enter into any swap or other arrangement that transfers all or a portion
of the economic consequences associated with the ownership of any common
stock (regardless of whether any of these transactions are to be settled
by the delivery of common stock, or such other securities, in cash or
otherwise)

without the prior written consent of Bear, Stearns & Co. Inc. Bear, Stearns &
Co. Inc. may, in its sole discretion and at any time or from time to time
before the termination of the 90-day period, without notice, release all or any
portion of the securities subject to lock-up agreements. There are no existing
agreements between the representatives and any of our stockholders who have
executed a lock-up agreement providing consent to the sale of shares prior to
the expiration of the lock-up period.

In addition, we have agreed that, subject to certain exceptions, during the
90-day lock-up period we will not, without the prior written consent of Bear,
Stearns & Co. Inc., consent to the disposition of any shares held by
stockholders subject to lock-up agreements prior to the expiration of the
lock-up period, or issue, sell, contract to sell, or otherwise dispose of, any
shares of common stock, any options or warrants to purchase any shares of
common stock or any securities convertible into, exercisable for or
exchangeable for shares of common stock, other than the sale of common stock in
the offering and the options or shares of common stock under existing stock
option and incentive plans.

Other than in the United States, no action has been taken by us or the
underwriters that would permit a public offering of the shares of common stock
offered by this prospectus in any jurisdiction where action for that purpose is
required. The shares of common stock offered by this prospectus may not be
offered or sold, directly or indirectly, nor may this prospectus or any other
offering material or advertisements in connection with the offer and sale of
any such shares of common stock be distributed or published in any
jurisdiction, except under circumstances that will result in compliance with
the applicable rules and regulations of that jurisdiction. Persons into whose
possession this prospectus comes are advised to inform themselves about and to
observe any restriction relating to the offering and the distribution of this
prospectus. The underwriters may distribute this prospectus electronically to
certain institutional investors upon their request. This prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any shares of
common stock offered by this prospectus in any jurisdiction in which such an
offer or a solicitation is unlawful.

Our common stock is listed on the New York Stock Exchange under the symbol
"PNG."

The representatives have advised us that, pursuant to Regulation M under the
Securities Exchange Act, some participants in the offering may engage in
transactions, including stabilizing bids, syndicate covering transactions or
the imposition of penalty bids, that may have the effect of stabilizing or
maintaining the market price of the shares of common stock at a level above
that which might otherwise prevail in the open market. A "stabilizing bid" is a
bid for or the purchase of shares of common stock on behalf of the underwriters
for the purpose of fixing or maintaining the price of the common stock. A
"syndicate covering transaction" is the bid for or purchase of common stock on
behalf of the underwriters to reduce a short position incurred by the
underwriters in connection with the offering. A "penalty bid" is an arrangement
permitting the representatives to reclaim the selling concession otherwise
accruing to an underwriter or syndicate member if in connection with this
offering if the common stock originally sold by such underwriter or syndicate
member is purchased by the representatives in a syndicate covering transaction
and has therefore not been effectively placed by such underwriter or syndicate
member. The representatives have advised us that such transactions may be
effected on the New York Stock Exchange or otherwise and, if commenced, may be
discontinued at any time.

Certain of the underwriters and their affiliates have in the past provided,
and may in the future provide, investment banking and other financial and
banking services to us for which they have in the past received, and may in the
future receive, customary commissions and fees.

LEGAL MATTERS

Certain legal matters have been passed upon for us by Reed Smith LLP,
Philadelphia, Pennsylvania. Certain legal matters will be passed upon for the
underwriters by Simpson Thacher & Bartlett, New York, New York.

EXPERTS

The consolidated financial statements and schedules of Penn-America Group,
Inc. as of December 31, 2001 and 2000, and for each of the years in the
three-year period ended on December 31, 2001 included herein and elsewhere in
the registration statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given upon the authority of such firm
as experts in auditing and accounting.

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the Securities and Exchange Commission a registration
statement on Form S-2 under the Securities Act with respect to the common stock
offered by this prospectus. This prospectus, which constitutes a part of the
registration statement, does not contain all of the information set forth in
the registration statement or the exhibits and schedules which are part of the
registration statement. Statements contained in this prospectus relating to the
contents of any contract, agreement or other document referred to are not
necessarily complete. With respect to each such contract, agreement or other
document filed as an exhibit to the registration statement, reference is made
to the exhibit for a more complete description of the matter involved, and each
such statement shall be deemed qualified by such reference. For further
information with respect to us and our common stock, reference is made to the
registration statement and the exhibits and schedules thereto.

We have filed reports, proxy statements and other information with the
Securities and Exchange Commission. Copies of these reports, proxy statements
and other information may be inspected and copied at the public reference
facilities maintained by the SEC at Judiciary Plaza, Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of this material can also be
obtained by mail at prescribed rates from the Public Reference Room of the SEC
at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 or by
calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains
our reports, proxy statements and other information. The address of this
website is http://www.sec.gov. Our common stock is traded on the New York Stock
Exchange and our reports can also be inspected at the offices of the New York
Stock Exchange, 20 Broad Street, 17/th/ Floor, New York, NY 10005.

INCORPORATION OF DOCUMENTS BY REFERENCE

The Commission allows us to incorporate by reference the information we file
with them. This means that we can disclose information to you by referring you
to those documents. The documents that have been incorporated by reference are
an important part of the prospectus, and you should review that information in
order to understand the nature of any investment by you in the common stock.
Information contained in this prospectus automatically updates and supercedes
previously filed information. We are incorporating by reference the documents
listed below.

. our Annual Report on Form 10-K/A for the fiscal year ended December 31,
2001;

. our Annual Report on Form 10-K for the fiscal year ended December 31,
2001;

. our Annual Report to stockholders for the fiscal year ended December 31,
2001;

. our Quarterly Report on Form 10-Q for the quarter ended March 31, 2002;

. our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002;

. our Quarterly Report on Form 10-Q for the quarter ended September 30,
2002;

. our Current Reports on Form 8-K filed with the Securities and Exchange
Commission on March 1, 2002, April 1, 2002, April 11, 2002, May 15, 2002,
August 13, 2002, and November 18, 2002; and

. our 2002 Proxy Statement filed with the Securities and Exchange
Commission on April 5, 2002, and amended on April 30, 2002.

Any statement contained in a document incorporated by reference herein shall
be deemed to be modified or superseded for purposes of this prospectus to the
extent that a statement is modified or replaced by a statement herein. Any such
statement so modified or superseded shall not be deemed, except as so modified
or replaced, to constitute a part of this prospectus. We will provide without
charge to each person to whom this prospectus is delivered, upon written or
oral request of such person, a copy of any or all of the documents referred to
above that have been incorporated in this prospectus by reference (other than
exhibits to such documents unless such exhibits are themselves specifically
incorporated by reference). If you would like a copy of any of these documents,
at no cost, please write or call us at Penn-America Group, Inc., Investor
Relations Department, 420 South York Road, Hatboro, Pennsylvania 19040, or by
telephone at (215) 443-3656, or send an e-mail request to info@penn-america.com.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
----

Interim Consolidated Financial Statements:

Consolidated Balance Sheets at September 30, 2002 (unaudited) and December 31, 2001................. F-2

Unaudited Consolidated Statements of Operations for the three months and nine months ended
September 30, 2002 and 2001....................................................................... F-3

Unaudited Consolidated Statement of Stockholders' Equity for the nine months ended
September 30, 2002................................................................................ F-4

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and
2001.............................................................................................. F-5

Notes to Unaudited Consolidated Financial Statements................................................ F-6

Consolidated Financial Statements:

Report of Independent Auditors...................................................................... F-12

Consolidated Balance Sheets at December 31, 2001 and 2000........................................... F-13

Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.......... F-14

Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999 F-15

Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.......... F-16

Notes to Consolidated Financial Statements.......................................................... F-17

F-1

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

September 30, December 31,
2002 2001
------------- ------------
(Unaudited) (Restated)

ASSETS
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 2002, $166,938; 2001,
$130,976)................................................................. $176,108 $135,253
Held to maturity, at amortized cost (fair value 2002, $2,034;
2001, $15,317)............................................................ 1,965 15,084
Equity securities, at fair value (cost 2002, $22,177; 2001, $24,720)............ 23,378 25,149
-------- --------
Total investments........................................................... 201,451 175,486
Cash............................................................................... 27,649 13,129
Accrued investment income.......................................................... 2,117 2,199
Premiums receivable................................................................ 14,239 12,285
Reinsurance recoverable............................................................ 27,031 25,804
Prepaid reinsurance premiums....................................................... 8,778 4,241
Deferred policy acquisition costs.................................................. 13,240 9,083
Capital lease, affiliate........................................................... 1,601 1,666
Deferred income taxes.............................................................. 2,439 3,790
Income tax recoverable............................................................. -- 66
Other assets....................................................................... 333 366
-------- --------
Total assets................................................................ $298,878 $248,115
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses...................................... $131,759 $119,598
Unearned premiums............................................................... 66,223 41,034
Accounts payable and accrued expenses........................................... 7,148 3,800
Capitalized lease obligation, affiliate......................................... 1,464 1,570
Income tax payable.............................................................. 395 --
Other liabilities............................................................... 1,823 1,722
-------- --------
Total liabilities........................................................... 208,812 167,724
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares;
None issued................................................................... -- --
Common stock, $.01 par value; authorized 20,000,000 shares; issued 2002
and 2001, 15,335,223 and 15,228,351 shares, respectively; outstanding
2002 and 2001, 11,585,223 and 11,478,351 shares, respectively................. 153 152
Additional paid-in capital...................................................... 71,523 70,735
Accumulated other comprehensive income.......................................... 6,845 3,106
Retained earnings............................................................... 36,545 31,320
Treasury stock, 3,750,000 shares at cost........................................ (24,161) (24,161)
Officers' stock loans........................................................... (629) (629)
Unearned compensation from restricted stock awards.............................. (210) (132)
-------- --------
Total stockholders' equity.................................................. 90,066 80,391
-------- --------
Total liabilities and stockholders' equity.................................. $298,878 $248,115
======== ========

See accompanying notes to unaudited consolidated financial statements

F-2

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

Three months ended Nine months ended
September 30, September 30,
----------------------- ------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------

Revenues
Premiums earned.................................. $ 30,705 $ 20,946 $ 80,922 $ 66,194
Net investment income............................ 3,038 2,851 8,796 8,516
Net realized investment gain (loss).............. 1,172 40 (173) (192)
----------- ----------- ----------- -----------
Total revenues................................ 34,915 23,837 89,545 74,518
----------- ----------- ----------- -----------
Losses and expenses
Losses and loss adjustment expenses.............. 20,799 14,553 53,449 46,740
Amortization of deferred policy acquisition costs 7,527 4,957 20,277 17,188
Other underwriting expenses...................... 2,209 2,028 6,032 5,246
Corporate expenses............................... 118 141 462 492
Interest expense................................. 35 40 105 120
----------- ----------- ----------- -----------
Total losses and expenses..................... 30,688 21,719 80,325 69,786
----------- ----------- ----------- -----------
Income before income tax......................... 4,227 2,118 9,220 4,732
Income tax expense............................... 1,330 567 2,655 1,220
----------- ----------- ----------- -----------
Net income....................................... $ 2,897 $ 1,551 $ 6,565 $ 3,512
=========== =========== =========== ===========
Net income per share
Basic......................................... $ 0.25 $ 0.14 $ 0.57 $ 0.31
Diluted....................................... $ 0.25 $ 0.13 $ 0.56 $ 0.31

Weighted average shares outstanding
Basic......................................... 11,585,043 11,437,697 11,565,749 11,404,539
Diluted....................................... 11,775,916 11,532,284 11,765,175 11,489,607

Cash dividends per share......................... $ 0.03875 $ 0.035 $ 0.11583 $ 0.105

See accompanying notes to unaudited consolidated financial statements

F-3

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

(Unaudited)

For the nine months ended September 30, 2002

(In thousands, except per share data)

Unearned
Accumulated Compensation
Additional Other Officers' From Total
Common Paid-In Comprehensive Retained Treasury Stock Restricted Stockholders'
Stock Capital Income Earnings Stock Loans Stock Awards Equity
------ ---------- ------------- -------- -------- --------- ------------ -------------

Balance at December 31,
2001 (Restated)............ $152 $70,735 $3,106 $31,320 $(24,161) $(629) $(132) $80,391
Net income.................. -- -- -- 6,565 -- -- -- 6,565
Other comprehensive income:
net unrealized gain on
investments, net of tax
and reclassification
adjustment............... -- -- 3,739 -- -- -- -- 3,739
-------
Comprehensive income........ 10,304
-------
Issuance of common stock.... 1 788 -- -- -- -- -- 789
Unearned compensation from
restricted stock awards
issued..................... -- -- -- -- -- -- (155) (155)
Amortization of compensation
expense from restricted
stock awards issued........ -- -- -- -- -- -- 77 77
Cash dividends paid
($0.11583 per share)....... -- -- -- (1,340) -- -- -- (1,340)
---- ------- ------ ------- -------- ----- ----- -------
Balance at September 30,
2002....................... $153 $71,523 $6,845 $36,545 $(24,161) $(629) $(210) $90,066
==== ======= ====== ======= ======== ===== ===== =======

See accompanying notes to unaudited consolidated financial statements

F-4

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

Nine months ended
September 30,
------------------
2002 2001
-------- --------

Cash flows from operating activities:
Net income $ 6,565 $ 3,512
Adjustments to reconcile net income to net cash provided by operating activities:
Net (accretion)/amortization and depreciation expense............................ (100) 48
Net realized investment loss..................................................... 173 192
Deferred income tax.............................................................. (575) (402)
Net increase (decrease) in premiums receivable, prepaid reinsurance premiums
and unearned premiums.......................................................... 18,698 (5,095)
Net increase in unpaid losses and loss adjustment expenses and reinsurance
recoverable.................................................................... 10,934 2,120
Accrued investment income........................................................ 82 210
Deferred policy acquisition costs................................................ (4,157) 1,415
Income tax recoverable/payable................................................... 461 1,622
Other assets..................................................................... (29) 20
Accounts payable and accrued expenses............................................ 3,348 172
Other liabilities................................................................ 590 (1,011)
-------- --------
Net cash provided by operating activities........................................ 35,990 2,803
-------- --------
Cash flows from investing activities:
Purchases of equity securities....................................................... (1,500) (3,062)
Purchases of fixed maturities available for sale..................................... (69,372) (25,625)
Proceeds from sales of equity securities............................................. 1,494 2,020
Proceeds from sales and maturities of fixed maturities available for sale............ 35,924 19,242
Proceeds from maturities and calls of fixed maturities held to maturity.............. 13,130 2,000
-------- --------
Net cash used by investing activities............................................ (20,324) (5,425)
-------- --------
Cash flows from financing activities:
Issuance of common stock............................................................. 300 410
Officers' stock loans................................................................ -- (109)
Principal payments on capital lease obligations, affiliate........................... (106) (93)
Dividends paid....................................................................... (1,340) (1,198)
-------- --------
Net cash used by financing activities............................................ (1,146) (990)
-------- --------
Decrease in cash........................................................................ 14,520 (3,612)
Cash, beginning of period............................................................... 13,129 11,425
-------- --------
Cash, end of period..................................................................... $ 27,649 $ 7,813
======== ========

See accompanying notes to unaudited consolidated financial statements

F-5

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1--Organization and Basis of Presentation

Penn-America Group, Inc. ("PAGI") is an insurance holding company.
Approximately 40% of the outstanding common stock of PAGI was owned by Penn
Independent Corporation ("Penn Independent") at September 30, 2002. The
accompanying financial statements include the accounts of PAGI and its wholly
owned subsidiary, Penn-America Insurance Company ("Penn-America") and its
wholly owned subsidiary, Penn-Star Insurance Company ("Penn-Star"),
(collectively the "Company").

The Company markets and underwrites general liability, commercial property
and multi-peril insurance for small businesses located primarily in small towns
and suburban and rural areas. The Company can write business in all fifty
states and the District of Columbia on both an admitted and non-admitted basis.

The accompanying interim condensed unaudited consolidated financial
statements and notes have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP") for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting of normal and recurring adjustments)
considered necessary for a fair presentation of results for the interim periods
have been included. All significant intercompany accounts and transactions have
been eliminated in consolidation. It is suggested that these interim condensed
unaudited consolidated financial statements and related notes be read in
conjunction with the financial statements and related notes in the Company's
Form 10-K/A for the year ended December 31, 2001. The Company's results of
operations for interim periods are not necessarily indicative of the results to
be expected for the entire year.

In conjunction with the Company's registration statement filing relating to
the issuance of additional shares of common stock, the Company has resolved
various accounting and disclosure comments from the Securities and Exchange
Commission ("SEC"). One of the comments addressed related to the timing of the
recording of other than temporary ("OTT") declines in the market value of
certain equity securities. The Company agreed to amend its accounting policy
and record OTT write-downs on these securities for the periods ending December
31, 2001, 2000 and 1999. This restatement affects net income for each of these
periods but has no effect on aggregate stockholders' equity since the
unrealized loss on these securities was already recorded in Accumulated Other
Income (Loss) in the Consolidated Balance Sheets and Statements of
Stockholders' Equity. This restatement resulted in an increase to accumulated
other comprehensive income of $2,014,000 and decrease to retained earnings of
the same amount as of December 31, 2001.

The table below shows a comparison of previously reported and restated total
revenues, net income and net income per share (basic and diluted) for the
periods affected.

For the years ended,
-----------------------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
----------------------- ---------------------- -----------------------
As Reported As Restated As Reported As Restated As Reported As Restated
----------- ----------- ----------- ----------- ----------- -----------
(in thousands except per share data)

F-6

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The restatement had no effect on net income for the three and nine months
ended September 30, 2001. The effect of this restatement is reflected in the
Consolidated Balance Sheets and Consolidated Statement of Stockholders' Equity
for balances at December 31, 2001.

Note 2--Reinsurance

Premiums earned are presented net of amounts ceded to reinsurers of $5.1
million and $2.8 million for the three months ended September 30, 2002 and
2001, respectively. Losses and loss adjustment expenses are presented net of
amounts ceded to reinsurers of $3.2 million and $1.1 million for the three
months ended September 30, 2002 and 2001, respectively.

Premiums earned are net of amounts ceded to reinsurers of $12.3 million and
$8.8 million for the nine months ended September 30, 2002 and 2001,
respectively. Losses and loss adjustment expenses are net of amounts ceded to
reinsurers of $6.0 million and $4.5 million for the nine months ended September
30, 2002 and 2001, respectively.

Note 3--Comprehensive Income

Accumulated other comprehensive income consists solely of unrealized gains
or losses on investment securities net of applicable income tax expense or
benefit and reclassification adjustments. Comprehensive income was $5.2 million
for the three months ended September 30, 2002 compared with $3.6 million for
the three months ended September 30, 2001. Comprehensive income was $10.3
million and $6.0 million for the nine months ended September 30, 2002 and 2001,
respectively.

Note 4--Income Per Share

Income per share for the three and nine months ended September 30, 2002 and
2001 is computed by dividing net income by the basic and diluted weighted
average number of common shares outstanding during the respective periods. The
following table is a reconciliation of the numerators and denominators of the
basic and diluted income per share computations:

F-7

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(in thousands, except per share data)

Basic per share computation:
Net income............................... $ 2,897 $ 1,551 $ 6,565 $ 3,512
Weighted average common shares (1)....... 11,585,043 11,437,697 11,565,749 11,404,539
----------- ----------- ----------- -----------
Basic net income per share (1)........... $ 0.25 $ 0.14 $ 0.57 $ 0.31
=========== =========== =========== ===========
Diluted per share computation:
Net income............................... $ 2,897 $ 1,551 $ 6,565 $ 3,512
Weighted average common shares (1)....... 11,585,043 11,437,697 11,565,749 11,404,539
Additional shares outstanding after the
assumed assumed exercise of stock
options by applying the treasury stock
method (1)............................. 190,873 94,587 199,426 85,068
----------- ----------- ----------- -----------
Total shares (1)......................... 11,775,916 11,532,284 11,765,175 11,489,607
=========== =========== =========== ===========
Diluted net income per share (1)............ $ 0.25 $ 0.13 $ 0.56 $ 0.31
=========== =========== =========== ===========

--------

(1)Adjusted to reflect a three-for-two stock split effected on May 9, 2002.

Note 5--Retroactive Adjustment for Stock Split

The common stock issued and outstanding and treasury stock at December 31,
2001 have been restated to reflect the three-for-two stock split announced on
April 11, 2002 and distributed on May 9, 2002. Accordingly, the balance sheet
values for common stock and additional paid-in capital have been adjusted for
the effect of the stock split. This adjustment resulted in a $51,000 increase
in common stock and a $51,000 decrease in additional paid-in capital. The
following table illustrates share information on a pre stock split and a post
stock split basis as of December 31, 2001:

Pre Stock Split Post Stock Split
Basis Basis
--------------- ----------------

Common stock issued..... 10,152,234 15,228,351
Common stock outstanding 7,652,234 11,478,351
Treasury stock.......... 2,500,000 3,750,000

F-8

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 6--Segment Information

The Company had two reportable segments: non-standard personal automobile
and commercial lines. These segments were managed separately because they had
different customers, pricing and expense structures. The Company exited the
non-standard personal automobile business in 1999 and announced that it would
run-off its remaining portfolio of such business. The Company will continue to
report on this segment separately until the amounts relating to the
non-standard personal automobile business become immaterial to the financial
statements presented. The Company does not allocate assets between segments
because assets are reviewed in total by management for decision-making purposes.

The accounting policies of the segments are the same as those more fully
described in the summary of significant accounting policies in Note 1 of the
Company's 2001 Form 10-K/A. The Company evaluates segment results based on
profit or loss from operating activities. Segment profits or losses from
operations are pre-tax and do not include unallocated expenses but do include
investment income attributable to insurance transactions. Segment profit or
loss therefore excludes federal income taxes, unallocated expenses and
investment income attributable to equity.

The following is a summary of the Company's segment revenues, expenses and
profit:

Three months ended September 30, 2002
------------------------------------
Personal
Commercial Automobile Total
---------- ---------- -------
(in thousands)

Premiums earned....................................... $30,705 $-- $30,705
Net investment income and net realized investment loss
from insurance operations........................... 2,227 -- 2,227
------- --- -------
Total segment revenues................................ 32,932 -- 32,932
------- --- -------
Segment losses and loss adjustment expenses........... 20,799 -- 20,799
Segment expenses...................................... 8,225 -- 8,225
------- --- -------
Total segment expenses................................ 29,024 -- 29,024
------- --- -------
Segment income........................................ $ 3,908 $-- $ 3,908
------- --- -------
Plus unallocated items:
Net investment income from equity.................. 1,983
Unallocated expenses............................... (1,664)
Income tax expense................................. (1,330)
-------
Net income............................................ $ 2,897
=======

F-9

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Three months ended September 30, 2001
------------------------------------
Personal
Commercial Automobile Total
---------- ---------- -------
(in thousands)

Premiums earned.................................. $20,946 $-- $20,946
Net investment income and net realized investment
loss from insurance operations................. 1,926 85 2,011
------- --- -------
Total segment revenues........................... 22,872 85 22,957
------- --- -------
Segment losses and loss adjustment expenses...... 14,553 -- 14,553
Segment expenses................................. 5,731 5 5,736
------- --- -------
Total segment expenses........................... 20,284 5 20,289
------- --- -------
Segment income................................... $ 2,588 $80 $ 2,668
------- --- -------
Plus unallocated items:
Net investment income from equity............. 880
Unallocated expenses.......................... (1,430)
Income tax expense............................ (567)
-------
Net income....................................... $ 1,551
=======

Total segment revenue of $32,932,000 and $22,957,000 plus unallocated net
investment income from equity of $1,983,000 and $880,000 equals total Company
revenues of $34,915,000 and $23,837,000 for the three months ended September
30, 2002 and 2001, respectively.

The following is a summary of the Company's segment revenues, expenses and
profit:

Nine months ended September 30, 2002
-----------------------------------
Personal
Commercial Automobile Total
---------- ---------- -------
(in thousands)

Premiums earned.................................. $80,922 $-- $80,922
Net investment income and net realized investment
loss from insurance operations................. 4,666 -- 4,666
------- --- -------
Total segment revenues........................... 85,588 -- 85,588
------- --- -------
Segment losses and loss adjustment expenses...... 53,449 -- 53,449
Segment expenses................................. 22,459 -- 22,459
------- --- -------
Total segment expenses........................... 75,908 -- 75,908
------- --- -------
Segment income................................... $ 9,680 $-- $ 9,680
------- --- -------
Plus unallocated items:
Net investment income from equity............. 3,957
Unallocated expenses.......................... (4,417)
Income tax expense............................ (2,655)
-------
Net income....................................... $ 6,565
=======

F-10

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Nine months ended September 30, 2001
-----------------------------------
Personal
Commercial Automobile Total
---------- ---------- -------
(in thousands)

Premiums earned.................................. $66,172 $ 22 $66,194
Net investment income and net realized investment
loss from insurance operations................. 5,360 240 5,600
------- ------- -------
Total segment revenues........................... 71,532 262 71,794
------- ------- -------
Segment losses and loss adjustment expenses...... 48,233 (1,493) 46,740
Segment expenses................................. 18,880 15 18,895
------- ------- -------
Total segment expenses........................... 67,113 (1,478) 65,635
------- ------- -------
Segment income................................... $ 4,419 $ 1,740 $ 6,159
------- ------- -------
Plus unallocated items:
Net investment income from equity............. 2,724
Unallocated expenses.......................... (4,151)
Income tax expense............................ (1,220)
-------
Net income....................................... $ 3,512
=======

Total segment revenue of $85,588,000 and $71,794,000 plus unallocated net
investment income from equity of $3,957,000 and $2,724,000 equals total Company
revenues of $89,545,000 and $74,518,000 for the nine months ended September 30,
2002 and 2001, respectively.

Note 7--Trust Preferred Securities

On or about December 4, 2002, we expect that Penn-America Statutory Trust I,
our wholly-owned business trust subsidiary, will issue 15,000 of floating rate
capital securities with a liquidation amount of $1,000 per security. These
securities will have a thirty-year maturity, with a provision that allows us to
call these securities at par after five years from the date of issuance. We
expect cash distributions to be paid quarterly in arrears at a rate of 400
basis points over three-month London Interbank Offered Rates. Distributions on
these securities can be deferred for up to five years, but if so deferred, we
may not declare or pay cash dividends or distributions on our common stock. We
will guarantee all obligations of Penn-America Statutory Trust I with respect
to distributions and payments of these securities.

F-11

REPORT OF INDEPENDENT AUDITORS

The Board of Directors

Penn America Group, Inc.

We have audited the accompanying consolidated balance sheets of Penn-America
Group, Inc. (the Company) as of December 31, 2001 and 2000, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2001. Our audit also
included the financial statement schedules listed in Item 14(a) as of December
31, 2001 and for the year then ended. These financial statements and schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedules based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, the Company
has restated its 2001, 2000, and 1999 financial statements regarding the timing
of recording other than temporary declines in the market value of certain
equity securities.

In our opinion the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Penn-America Group, Inc. as restated at December 31, 2001 and 2000, and the
consolidated results of its operations and its cash flows as restated for each
of the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.

/s/ Ernst & Young LLP

Philadelphia, Pennsylvania

January 18, 2002

except for share and per share information in Notes 2, 11, 14 and 15, the
section entitled "restatement of financial information" in Note 1, the 7th and
13th paragraphs in Note 1, all information marked "restated" in the notes to
consolidated financial statements, the first paragraph in Note 3, the
next-to-last paragraphs in Note 4 and Note 8, and the last paragraph in Note 6,
as to which the date is November 1, 2002

F-12

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except for per share data)

December 31,
--------------------
2001 2000
---------- ----------
(Restated) (Restated)

ASSETS...................................................................................
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 2001, $130,976; 2000,
$123,873)....................................................................... $135,253 $125,477
Held to maturity, at amortized cost (fair value 2001, $15,317; 2000, $17,441)..... 15,084 17,282
Equity securities, at fair value (cost 2001, $24,720; 2000, $24,895).................. 25,149 24,491
-------- --------
Total investments................................................................. 175,486 167,250
Cash..................................................................................... 13,129 11,425
Accrued investment income................................................................ 2,199 2,181
Premiums receivable (net of allowances of $972 in 2001 and $422 in 2000)................. 12,285 9,695
Reinsurance recoverable.................................................................. 25,804 24,447
Prepaid reinsurance premiums............................................................. 4,241 4,635
Deferred policy acquisition costs........................................................ 9,083 10,317
Capital lease, affiliate................................................................. 1,666 1,753
Deferred income taxes.................................................................... 3,790 4,272
Income tax recoverable................................................................... 66 2,982
Other assets............................................................................. 366 529
-------- --------
Total assets...................................................................... $248,115 $239,486
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses............................................ $119,598 $115,314
Unearned premiums..................................................................... 41,034 43,239
Accounts payable and accrued expenses................................................. 3,800 2,353
Capitalized lease obligation, affiliate............................................... 1,570 1,701
Other liabilities..................................................................... 1,722 2,828
-------- --------
Total liabilities................................................................. 167,724 165,435
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares; None issued............. -- --
Common stock, $.01 par value; authorized 20,000,000 shares; issued 2001 and 2000,
15,228,351 and 15,114,038 shares, respectively; outstanding 2001 and 2000,
11,478,351 and 11,364,038 shares, respectively...................................... 152 151
Additional paid-in capital............................................................ 70,735 70,114
Accumulated other comprehensive income................................................ 3,106 792
Retained earnings..................................................................... 31,320 27,980
Treasury stock, 3,750,000 shares, at cost............................................. (24,161) (24,161)
Officers' stock loans................................................................. (629) (546)
Unearned compensation from restricted stock awards.................................... (132) (279)
-------- --------
Total stockholders' equity........................................................ 80,391 74,051
-------- --------
Total liabilities and stockholders' equity........................................ $248,115 $239,486
======== ========

See accompanying notes to consolidated financial statements

F-13

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

Year ended December 31,
-------------------------------------
2001 2000 1999
----------- ----------- -----------
(Restated) (Restated) (Restated)

Revenues
Premiums earned.................................. $ 88,934 $ 91,449 $ 85,677
Net investment income............................ 11,339 10,454 9,537
Net realized investment loss..................... (1,178) (2,808) (110)
----------- ----------- -----------
Total revenues................................ 99,095 99,095 95,104
----------- ----------- -----------
Losses and expenses
Losses and loss adjustment expenses.............. 60,921 75,378 63,187
Amortization of deferred policy acquisition costs 22,715 25,219 24,802
Other underwriting expenses...................... 8,030 5,850 4,733
Corporate expenses............................... 548 791 1,306
Interest expense................................. 160 161 145
----------- ----------- -----------
Total losses and expenses..................... 92,374 107,399 94,173
----------- ----------- -----------
Income (loss) before income tax.................. 6,721 (8,304) 931
Income tax expense (benefit)..................... 1,781 (3,473) (479)
----------- ----------- -----------
Net income (loss) $ 4,940 $ (4,831) $ 1,410
=========== =========== ===========
Net income (loss) per share
Basic......................................... $ 0.43 $ (0.42) $ 0.11
Diluted....................................... $ 0.43 $ (0.42) $ 0.11

Weighted average shares outstanding
Basic......................................... 11,420,213 11,518,968 12,887,651
Diluted....................................... 11,501,703 11,518,968 12,986,603

Cash dividend per share.......................... $ 0.14 $ 0.14 $ 0.1383

See accompanying notes to consolidated financial statements

F-14

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands, except per share amounts)

Unearned
Accumulated Compensation
Additional Other Officers' From Total
Common Paid-In Comprehensive Retained Treasury Stock Restricted Stockholders'
Stock Capital Income (Loss) Earnings Stock Loans Stock Awards Equity
------ ---------- ------------- ---------- -------- --------- ------------ -------------
(Restated) (Restated)

Balance at December 31, 1998....... $149 $68,985 $ 2,714 $34,779 $ (5,643) $ 0 $(354) $100,630
Net income......................... -- -- -- 1,410 -- -- -- 1,410
Other comprehensive loss:
Unrealized loss on
investments, net of tax
and reclassification
adjustment..................... -- -- (6,410) -- -- -- -- (6,410)
--------
Comprehensive loss................. (5,000)
--------
Issuance of common stock........... 1 556 -- -- -- -- -- 557
Unearned compensation from
restricted stock awards issued.... -- -- -- -- -- -- (91) (91)
Amortization of compensation
expense from restricted stock
awards issued..................... -- -- -- -- -- -- 120 120
Cash dividends paid ($0.1383 per
share)............................ -- -- -- (1,767) -- -- -- (1,767)
Purchase of treasury stock, at cost -- -- -- -- (13,831) -- -- (13,831)
---- ------- ------- ------- -------- ----- ----- --------
Balance at December 31, 1999....... $150 $69,541 $(3,696) $34,422 $(19,474) $ 0 $(325) $ 80,618
---- ------- ------- ------- -------- ----- ----- --------
Net loss........................... -- -- -- (4,831) -- -- -- (4,831)
Other comprehensive income:
Unrealized gains on
investments, net of tax
and reclassification
adjustment..................... -- -- 4,488 -- -- -- -- 4,488
--------
Comprehensive loss................. (343)
--------
Issuance of common stock........... 1 573 -- -- -- -- -- 574
Officers' stock loans.............. -- -- -- -- -- (546) -- (546)
Unearned compensation from
restricted stock awards issued.... -- -- -- -- -- -- (74) (74)
Amortization of compensation
expense from restricted stock
awards issued..................... -- -- -- -- -- -- 120 120
Cash dividends paid ($0.14 per
share)............................ -- -- -- (1,611) -- -- -- (1,611)
Purchase of treasury stock, at cost -- -- -- -- (4,687) -- -- (4,687)
---- ------- ------- ------- -------- ----- ----- --------
Balance at December 31, 2000....... $151 $70,114 $ 792 $27,980 $(24,161) $(546) $(279) $ 74,051
---- ------- ------- ------- -------- ----- ----- --------
Net income......................... -- -- -- 4,940 -- -- -- 4,940
Other comprehensive income:
Unrealized gains on
investments, net of tax
and reclassification
adjustment..................... -- -- 2,314 -- -- -- -- 2,314
--------
Comprehensive income............... 7,254
--------
Issuance of common stock........... 1 621 -- -- -- -- -- 622
Officers' stock loans.............. -- -- -- -- -- (83) -- (83)
Forfeiture of restricted stock
awards............................ -- -- -- -- -- -- 32 32
Amortization of compensation
expense from restricted stock
awards issued..................... -- -- -- -- -- -- 115 115
Cash dividends paid ($0.14 per
share)............................ -- -- -- (1,600) -- -- -- (1,600)
---- ------- ------- ------- -------- ----- ----- --------
Balance at December 31, 2001....... $152 $70,735 $ 3,106 $31,320 $(24,161) $(629) $(132) $ 80,391
==== ======= ======= ======= ======== ===== ===== ========

See accompanying notes to consolidated financial statements

F-15

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Year ended December 31,
-------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)

Cash flows from operating activities:
Net income (loss)........................................................... $ 4,940 $ (4,831) $ 1,410
Adjustments to reconcile net income (loss) to net cash provided by
Operating activities:
Bond amortization (accretion) and depreciation expense, net............. (5) 393 493
Net realized investment loss............................................ 1,178 2,808 110
Deferred income tax benefit............................................. (711) (1,096) (586)
Net (increase) decrease in premiums receivable, prepaid reinsurance
premiums and unearned premiums........................................ (4,401) 5,087 2,727
Net increase in unpaid losses and loss adjustment expenses and
reinsurance recoverable............................................... 2,927 15,432 5,264
Accrued investment income............................................... (18) (216) (94)
Deferred policy acquisition costs....................................... 1,234 (1,011) (578)
Income tax recoverable.................................................. 2,915 (1,330) (768)
Other assets............................................................ 23 (134) (64)
Accounts payable and accrued expenses................................... 1,447 598 576
Other liabilities....................................................... (1,106) (709) 112
-------- -------- --------
Net cash provided by operating activities............................ 8,423 14,991 8,602
-------- -------- --------
Cash flows from investing activities:
Purchases of equity securities.............................................. (4,162) (10,405) (8,320)
Purchases of fixed maturities available for sale............................ (28,672) (87,573) (38,521)
Purchases of fixed maturities held to maturity.............................. -- (9,974) (2,785)
Proceeds from sales of equity securities.................................... 3,146 11,202 4,462
Proceeds from sales of fixed maturities available for sale.................. 21,911 78,154 --
Proceeds from maturities of fixed maturities available for sale............. -- -- 25,995
Proceeds from maturities and calls of fixed maturities held to maturity..... 2,250 9,000 13,256
Change in short-term investments............................................ -- 449 548
-------- -------- --------
Net cash used by investing activities................................... (5,527) (9,147) (5,365)
-------- -------- --------
Cash flows from financing activities:
Issuance of common stock.................................................... 622 500 465
Purchase of treasury stock.................................................. -- (4,687) (13,831)
Officers' stock loans....................................................... (83) (546) --
Principal payments on capital lease obligations, affiliate.................. (131) (120) (136)
Dividends paid.............................................................. (1,600) (1,611) (1,767)
-------- -------- --------
Net cash used by financing activities................................... (1,192) (6,464) (15,269)
-------- -------- --------
Increase (decrease) in cash.................................................... 1,704 (620) (12,032)
Cash, beginning of period...................................................... 11,425 12,045 24,077
-------- -------- --------
Cash, end of period............................................................ $ 13,129 $ 11,425 $ 12,045
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid, affiliate.................................................... $ 160 $ 161 $ 145
Taxes (recovered) paid...................................................... (492) (950) 875

See accompanying notes to consolidated financial statements

F-16

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1--Summary of Significant Accounting Policies

Basis of Presentation and Description of Business

Penn-America Group, Inc. ("PAGI") is an insurance holding company. Penn
Independent Corporation ("Penn Independent") owned approximately 40% of the
outstanding common stock of PAGI at December 31, 2001. The accompanying
financial statements include the accounts of PAGI and its wholly owned
subsidiary, Penn-America Insurance Company ("Penn-America") and its wholly
owned subsidiary Penn-Star Insurance Company ("Penn-Star"), (collectively the
"Company"). All significant inter-company accounts and transactions have been
eliminated in consolidation. These financial statements are prepared in
conformity with accounting principles generally accepted in the United States,
which differ in some respects from those required by insurance regulatory
authorities.

The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and 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. Actual results could differ from those estimates.

The Company underwrites commercial property and general liability insurance
and multi-peril insurance for small businesses located primarily in small towns
and suburban and rural areas. The Company can write business in all fifty
states and the District of Columbia. The Company writes business on both an
admitted and non-admitted basis in thirty-six states, on only an admitted basis
in two states and on only a non-admitted basis in twelve states and the
District of Columbia.

Restatement of Financial Information

In conjunction with the Company's registration statement filing relating to
the issuance of additional shares of common stock, the Company has resolved
various accounting and disclosure comments from the Securities and Exchange
Commission ("SEC"). One of the comments addressed the timing of recording other
than temporary ("OTT") declines in the market value of certain equity
securities. In order to resolve the comment, the Company agreed to amend its
accounting policy and record OTT write-downs on these securities for the
periods ending December 31, 2001, 2000, and 1999. This restatement affects net
income for each of these periods but has no affect on stockholders' equity
since the unrealized loss on these securities was already recorded in
Accumulated Other Income (Loss) in the Consolidated Balance Sheets and
Statements of Stockholders' Equity. By means of this filing, the Company is
restating its previously issued financial statements for the years ended
December 31, 2001, 2000, and 1999.

Below is a table showing a comparison of previously reported and restated
total revenues, net income and net income per share (basic and diluted) for the
periods affected.

For the years ended,
------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
As As As As As As
Reported Restated Reported Restated Reported Restated
-------- -------- -------- -------- -------- --------
(in thousands except per share data)

F-17

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In addition, the SEC requested that the Company add certain disclosures. The
consolidated financial statements have been amended as appropriate to respond
to these requests.

Revenue Recognition

Premiums written are recognized as earned ratably over the terms of the
respective policies and include estimates for premiums earned but not yet
billed of $1,185,000 and $0 as of December 31, 2001, and 2000, respectively.
Unearned premiums represent the portion of premiums written applicable to the
unexpired terms of policies in force and are calculated on a semi-monthly
pro-rata basis.

Valuation of Premiums Receivable

The Company evaluates the collectibility of premiums receivable based on a
combination of factors. In circumstances in which the Company is aware of a
specific customer's inability to meet its financial obligations to the Company,
a specific reserve for bad debts against amounts due is recorded to reduce the
net receivable to the amount reasonably believed to be collectible. No such
instances occurred in 2001. For all remaining balances, reserves are recognized
for bad debts based on the length of time the receivables are past due based on
historical statistics.

Investments

At the time of purchase of fixed-maturity investments, management makes a
determination as to the investment classification ("Available for Sale" or
"Held to Maturity"). Factors taken into consideration by management in
determining the appropriate investment category are: maturity, yield, cash flow
requirements and anticipated changes in interest rates. Fixed maturities
classified as "Available for Sale" are carried at fair value with unrealized
investment gains or losses, net of deferred income taxes, included as a
separate component of accumulated other comprehensive income in stockholders'
equity. "Held to Maturity" investments are carried at amortized cost.

Investments in fixed-maturity securities are adjusted for amortization of
premium and accretion of discounts to maturity date using the interest method.
Interest income is recognized on the accrual basis.

The amortized cost of mortgage-backed and asset-backed securities is
calculated using the interest method including consideration of anticipated
prepayments at the date of purchase. Significant changes in estimated cash
flows from the original assumptions are accounted for using the composite
method.

Equity securities are carried at fair value with the change in unrealized
investment gains or losses, net of deferred income taxes, included as a
separate component of accumulated other comprehensive income in stockholders'
equity.

Realized gains or losses represent the difference between the book value of
securities sold and the proceeds realized upon sale. The Company uses the
specific identification method to determine the cost of securities sold. The
cost of securities is adjusted where appropriate to include a provision for a
decline in value that is considered to be other- than-temporary. The Company
considers four factors in determining if an other-than-temporary decline
exists: length of time and extent that a security has been in an unrealized
loss position; the existence of an event that would impair the issuer's future
earnings potential; the near term prospects for recovery of the market value of
a security; and the intent and ability of the Company to hold the security
until the market value recovers. Realized gains or losses, including any
provision for other-than-temporary declines in value, are included in the
statement of operations.

F-18

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Policy Acquisition Costs

Policy acquisition costs such as commissions, salaries, premium taxes and
certain other underwriting expenses, which vary with and are directly related
to the production of business, are deferred and amortized over the effective
periods of the related insurance policies. The method followed in computing
deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable values, which gives effect to the premium to be
earned, related investment income, losses and loss adjustment expenses and
certain other costs expected to be incurred as the premium is earned.

Losses and Loss Adjustment Expenses

The liability for losses and loss adjustment expenses represents estimates
of amounts needed to pay reported and unreported claims and related expenses.
These estimates are based on certain actuarial and other assumptions related to
the ultimate cost to pay such claims. All estimates are reviewed periodically
and as experience develops and new information becomes known, the reserves are
adjusted as necessary. Such adjustments are reflected in the results of
operations in the period in which they are determined.

Fair Values of Financial Instruments

The Company uses the following methods or assumptions in determining fair
values:

Investment Securities: Fair values are based on quoted market prices or on
quoted market prices of comparable instruments or values obtained from
independent pricing services.

Premium and Reinsurance Receivables and Payables: The carrying amounts
reported in the balance sheet for these instruments approximate their fair
values.

Capitalized Lease Obligation: Fair value is based upon the present value of
the underlying cash flows discounted at the Company's incremental borrowing
rate at year-end. The carrying amounts reported in the balance sheet
approximate fair value.

Reinsurance

In the ordinary course of business, the Company reinsures certain risks,
generally on an excess-of-loss basis, with other insurance companies which
principally are rated "A" or higher by A.M. Best. Such reinsurance arrangements
serve to limit the Company's maximum loss. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liabilities arising from
the reinsured policies and incurred but not reported losses.

Capitalized Lease

The capitalized lease is carried at cost less accumulated amortization.
Amortization is calculated using the interest method over 20 years, which
represents the term of the mortgage on the office space that the Company rents
from a related party.

Income Tax

Deferred income taxes are accounted for under the liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.

F-19

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Comprehensive Income (Loss)

Comprehensive income (loss) encompasses all changes in stockholders' equity
(except those arising from transactions with stockholders) and includes net
income and net unrealized investment gains and losses on fixed-income
investments classified as "available-for-sale" and equity securities, net of
deferred income tax.

Reclassification

Certain prior-year amounts have been reclassified to conform to 2001
classifications.

Note 2--Income Per Share

Basic net income (loss) per share is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for each period. Diluted net income (loss) per share includes the
potential dilution that could occur if the contracts to issue common stock were
exercised and converted into common stock.

The following is a reconciliation of the basic and diluted net income (loss)
per share computations:

Year ended December 31,
------------------------------------
2001 2000 1999
----------- ----------- -----------
(Restated) (Restated) (Restated)
(In thousands, except per share data)

Basic per share computation:
Net income (loss)........................................... $ 4,940 $ (4,831) $ 1,410
Weighted average common shares outstanding.................. 11,420,213 11,518,968 12,887,651
----------- ----------- -----------
Basic net income (loss) per share........................... $ 0.43 $ (0.42) $ 0.11
----------- ----------- -----------
Diluted per share computation:
Net income (loss)........................................... $ 4,940 $ (4,831) $ 1,410
Weighted average common shares outstanding.................. 11,420,213 11,518,968 12,887,651
Additional shares outstanding after the assumed exercise of
options by applying the treasury stock method............. 81,490 * 98,952
----------- ----------- -----------
Total shares.................................................. 11,501,703 11,518,968 12,986,603
----------- ----------- -----------
Diluted net income (loss) per share........................... $ 0.43 $ (0.42) $ 0.11
=========== =========== ===========

--------

* As of December 31, 2000, the Company issued options to purchase 538,875
shares of common stock to employees and directors at prices ranging from
$3.61 to $12.67. These options were not considered in the 2000 computation,
as the impact was anti-dilutive.

F-20

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 3--Transactions with Affiliates

Penn-America was formed by Irvin Saltzman, chairman of PAGI's board of
directors and a director of Penn Independent. Jon S. Saltzman, Irvin Saltzman's
son, is President and Chief Executive Officer of PAGI and a director of Penn
Independent. The Saltzman family, substantially through their ownership of Penn
Independent, owns approximately 40% of the outstanding common stock of PAGI at
December 31, 2001.

Penn-America leases its home office facility from Irvin Saltzman and the
lease is accounted for as a capital lease. The amount of property capitalized
of $2,227,000 is presented net of accumulated amortization of $561,000 and
$474,000 as of December 31, 2001 and 2000, respectively. Capitalized lease
obligations of $1,570,000 and $1,701,000 were recorded at December 31, 2001 and
2000, respectively, representing the lease obligation arising from this lease,
which carries an 8.5% interest rate. Penn Independent and its subsidiaries also
lease a portion of the building in which the Company's home office facility is
located. Management believes that the lease terms are at market rates.

At December 31, 2001, the future minimum lease payments for the capitalized
lease obligation are $281,000 per year in 2002 through 2006 and the total
minimum lease payments are $2,262,000, of which $692,000 is the amount
representing interest.

Penn Independent provides the Company with human resource management and
other services. The Company paid $212,000, $200,000 and $200,000 in 2001, 2000
and 1999, respectively, for such services. Such amounts are based on
allocations of estimated costs. All costs incurred by Penn Independent on
behalf of the Company have been allocated to the Company and are reflected in
the financial statements. Management believes that the methods used to allocate
such costs are reasonable and that the Company's expenses on a stand-alone
basis would not be materially different.

Gross written premiums with insurance agency affiliates of Penn Independent
were $3,888,000, $3,282,000 and $1,732,000 in 2001, 2000 and 1999,
respectively. Commissions paid to such affiliates were $857,000, $740,000 and
$441,000 in 2001, 2000 and 1999 respectively. Premiums receivable includes
receivable from affiliates of $454,000 and $535,000 as of December 31, 2001 and
2000, respectively.

F-21

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 4--Investments

The Company invests primarily in investment-grade fixed maturities,
substantially all of which are rated "A" or higher by Standard & Poor's. The
cost, gross unrealized gains and losses and fair values of investments are as
follows:

December 31, 2001
-----------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- --------
(Restated) (Restated) (Restated)
(In thousands)

Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of U.S. government
agencies.................................................. $ 4,013 $ 182 $ -- $ 4,195
Corporate securities................................. 49,981 2,091 51 52,021
Mortgage-backed securities........................... 26,483 863 30 27,316
Other structured securities.......................... 20,758 725 21 21,462
Municipal securities................................. 20,569 457 22 21,004
Public utilities..................................... 9,172 259 176 9,255
-------- ------ ---- --------
Total available for sale................................. 130,976 4,577 300 135,253
-------- ------ ---- --------
Held to maturity:
U.S. Treasury securities and obligations of U.S.
government agencies................................ 13,812 213 -- 14,025
Corporate securities................................. 276 14 -- 290
Public utilities..................................... 996 6 -- 1,002
-------- ------ ---- --------
Total held to maturity................................... 15,084 233 -- 15,317
-------- ------ ---- --------
Total fixed-maturity securities............................. 146,060 4,810 300 150,570
Equity securities........................................... 24,720 607 178 25,149
-------- ------ ---- --------
Total investments........................................... $170,780 $5,417 $478 $175,719
======== ====== ==== ========

F-22

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 2000
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of U.S.
government agencies.................................... $ 4,015 $ 107 $ -- $ 4,122
Corporate securities..................................... 52,084 668 387 52,365
Mortgage-backed securities............................... 23,321 629 6 23,944
Other structured securities.............................. 21,381 497 6 21,872
Municipal securities..................................... 15,882 537 -- 16,419
Public utilities......................................... 7,190 44 479 6,755
-------- -------- ------- --------
Total available for sale..................................... 123,873 2,482 878 125,477
-------- -------- ------- --------
Held to maturity:
U.S. Treasury securities and obligations of U.S.
government agencies.................................... 13,760 162 14 13,908
Corporate securities..................................... 2,378 -- 4 2,374
Municipal securities..................................... 150 -- -- 150
Public utilities......................................... 994 15 -- 1,009
-------- -------- ------- --------
Total held to maturity....................................... 17,282 177 18 17,441
-------- -------- ------- --------
Total fixed-maturity securities................................. 141,155 2,659 896 142,918
Equity securities............................................... 24,895 454 858 24,491
-------- -------- ------- --------
Total investments............................................... $166,050 $ 3,113 $ 1,754 $167,409
-------- -------- ------- --------

Fixed maturities at December 31, 2001, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call or to prepay obligations with or
without call or prepayment penalties.

Available for Sale Held to Maturity
--------------------------- ---------------------------
Amortized Amortized
Cost Fair Value Cost Fair Value
---------- ---------- ---------- ----------
(In thousands)
Due in one year or less......................................... $ 3,055 $ 3,132 $12,118 $ 12,261
Due after one year through five years........................... 45,659 47,565 2,966 3,056
Due after five years through ten years.......................... 27,198 27,585 -- --
Due after ten years............................................. 7,823 8,193 -- --
Mortgage-backed and other structured securities................. 47,241 48,778 -- --
-------- -------- ------- --------
Total........................................................... $130,976 $135,253 $15,084 15,317
======== ======== ======= ========

F-23

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

A summary of net investment income is as follows:

Year ended December 31,
------------------------
2001 2000 1999
------- ------- ------
(In thousands)

Interest on fixed maturities............... $ 9,835 $ 8,508 $7,629
Dividends on equity securities............. 1,421 1,422 1,492
Interest on short-term investments and cash 377 815 787
Other...................................... 37 26 4
------- ------- ------
Total investment income.................... 11,670 10,771 9,912
Less investment expense.................... (331) (317) (375)
------- ------- ------
Net investment income...................... $11,339 $10,454 $9,537
======= ======= ======

All investments in fixed-maturity securities were income-producing during
2001, 2000 and 1999. Realized pre-tax gains (losses) on the sale of investments
are as follows:

Year ended December 31,
----------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Fixed maturities:
Gross realized gains............ $ 218 $ 24 $ 66
Gross realized losses........... (203) (1,461) (23)
------- ------- -------
Net realized investment gain (loss) 15 (1,437) 43

Equity securities:
Gross realized gains............ 240 1,128 1,266
Gross realized losses........... (1,433) (2,499) (1,419)
------- ------- -------
Net realized investment loss....... (1,193) (1,371) (153)
------- ------- -------
Total net realized investment loss. $(1,178) $(2,808) $ (110)
======= ======= =======

Income tax benefit on net realized losses was $400,000, $955,000 and $38,000
in 2001, 2000, and 1999, respectively. Gross realized losses on equity
securities for the year ended December 31, 2001, 2000 and 1999, included an
other-than-temporary impairment write-down of $1,226,000, $1,770,000, and
$951,000, respectively.

The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 2001 and 2000 amounted to $10,998,000 and
$10,992,000, respectively.

Note 5--Reinsurance

In the normal course of business, the Company seeks to reduce the losses
that may arise from catastrophes or other events that cause unfavorable
underwriting results by reinsuring certain levels of risks in various areas of
exposure with other insurance enterprises or reinsurers. Reinsurance contracts
do not relieve the Company of its obligations to policyholders. Failure of
reinsurers to honor their obligations could result in losses to the Company.
Allowances have been established for amounts deemed uncollectible. The Company
evaluates the financial condition of its reinsurers and monitors concentrations
of credit risk arising from similar geographic regions, activities or economic
characteristics of the reinsurers to minimize its exposure to significant losses

F-24

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

from reinsurer insolvencies. At December 31, 2001, reinsurance recoverable and
prepaid reinsurance premiums associated with two major reinsurers, General
Reinsurance Corporation and American Reinsurance Corporation, were $24.3
million and $5.0 million, respectively.

Written premiums and premiums earned consisted of the following:

Year ended December 31,
-------------------------
2001 2000 1999
-------- -------- -------
(In thousands)

Written premiums:
Gross.......... $ 98,412 $109,791 $95,983
Ceded.......... 11,289 12,541 8,947
-------- -------- -------
Net of reinsurance $ 87,123 $ 97,250 $87,036
-------- -------- -------
Premiums earned:
Gross.......... $100,617 $102,883 $93,904
Ceded.......... 11,683 11,434 8,227
-------- -------- -------
Net of reinsurance $ 88,934 $ 91,449 $85,677
======== ======== =======

Loss and loss adjustment expenses are net of recoveries recognized under
reinsurance contracts as follows: $7,446,000, $9,438,000 and $7,182,000 in
2001, 2000 and 1999, respectively.

Note 6--Unpaid Losses and Loss Adjustment Expenses

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

Year ended December 31,
-------------------------
2001 2000 1999
-------- -------- -------
(In thousands)

Balance, beginning of year.... $115,314 $ 93,719 $88,937
Less reinsurance recoverable.. 24,093 18,086 16,502
-------- -------- -------
Net balance, beginning of year 91,221 75,633 72,435
Incurred related to:
Current year............... 60,885 66,214 54,768
Prior years................ 36 9,164 8,419
-------- -------- -------
Total incurred................ 60,921 75,378 63,187
Paid related to:
Current year............... 19,913 26,273 23,540
Prior years................ 38,183 33,517 36,449
-------- -------- -------
Total paid.................... 58,096 59,790 59,989
Net balance, end of year...... 94,046 91,221 75,633
Plus reinsurance recoverable.. 25,552 24,093 18,086
-------- -------- -------
Balance, end of year.......... $119,598 $115,314 $93,719
======== ======== =======

F-25

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In 2001, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $36,000. This increase related
entirely to the commercial automobile line of business. During 2001, the
Company increased its estimate for the commercial multi-peril liability line of
business by $1.8 million due to the development of outstanding claim reserves
on claims occurring primarily in 1998 and 1999. This increase was almost
entirely offset by a reduction in the Company's estimate for the non-standard
personal automobile line of business due to favorable settlements on closed
claims.

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
primarily attributable to changes in the Company's estimates for losses and
loss adjustment expense reserves of $1.4 million for commercial automobile,
$3.9 million for commercial multi-peril liability and $3.4 million for other
liability lines of business. The Company began writing commercial automobile
coverage for vehicles and light trucks in 1998. The Company's initial estimates
for 1998 and 1999 were based on a relatively low level of claims reported. In
2000, the Company received a significant number of claims relating to accidents
incurred in 1998 and 1999. In the fourth quarter of 2000, the Company exited
the commercial automobile line of business due to unsatisfactory underwriting
results. The Company's change in estimates in 2000 for the commercial
multi-peril liability line of business resulted principally from its increased
exposure to liquor liability losses for policies primarily written in 1998 and
1999. In 2000, the Company revised its underwriting approach significantly to
reduce its exposure to liquor liability claims. The Company's change in
estimates in 2000 for the other liability line resulted principally from
construction defect claims, which were new claims that were not anticipated by
the Company when the Company wrote these policies between 1991 and 1996. These
claims predominantly related to residential contractors and sub-contractors in
California. In 2000, the Company completed its withdrawal from the residential
contractors and sub-contractors industry segment.

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
primarily attributable to changes in estimates for losses and loss adjustment
expense reserves for our non-standard personal automobile line of business. For
1999, the Company received a significant number of claims relating to accidents
incurred prior to 1999, resulting in an increase in the Company's loss
estimates. For 1999, the Company exited the nonstandard personal automobile
lines. Incurred losses and loss adjustment expenses include estimates, recorded
as loss and loss adjustment expense reserves on the balance sheet, for the
ultimate payment on both reported and unreported claims. The Company changes
its estimates for loss and loss adjustment expenses reserves as new events
occur, as more loss experience is acquired, or as additional information is
received. The Company's estimates for loss and loss adjustment expense reserves
result from a continuous review process and the change in these estimates, as
required by Financial Accounting Standards Board No. 60, Accounting and
Reporting by Insurance Enterprises, paragraph 18, is recorded in the period
that the change in these estimates is made.

F-26

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 7--Income Tax

The components of income tax expense (benefit) are as follows:

Year ended December 31,
-------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Current.................... $2,492 $(2,377) $ 107
Deferred................... (711) (1,096) (586)
------ ------- -----
Total tax expense (benefit) $1,781 $(3,473) $(479)
====== ======= =====

The actual income tax rate differed from the statutory income tax rate
applicable to income before income taxes as follows:

Year ended December 31,
------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)
---------- ---------- ----------
(In thousands)

Statutory income tax rate........................... 34.0% (34.0)% 34.0%
Tax-exempt interest and dividends received deduction (7.7) (10.2) (44.5)
Other............................................... 0.2 2.4 (40.9)
---- ----- -----
26.5% (41.8)% (51.4)%
==== ===== =====

The tax effects of temporary differences that result in a net deferred tax
asset as of December 31, are summarized as follows:

2001 2000
---------- ----------
(Restated) (Restated)
(In thousands)

Assets
Effect of discounting unpaid losses and loss adjustment expenses.. $4,490 $4,070
Excess of tax over financial reporting of earned premium.......... 2,502 2,625
Realized investment losses due to other-than temporary write-downs 1,241 826
Other............................................................. 609 763
------ ------
Total deferred assets............................................. 8,842 8,284
------ ------
Liabilities
Deferred policy acquisition costs................................. $3,088 $3,508
Net unrealized investment gain.................................... 1,600 408
Other............................................................. 364 96
------ ------
Total deferred liabilities........................................ 5,052 4,012
------ ------
Net deferred tax asset............................................ $3,790 $4,272
====== ======

The Company is required to establish a valuation allowance for any portion
of the deferred tax asset that management believes will not be realized. In the
opinion of management, it is probable that the Company will realize the benefit
of the deferred tax asset and, therefore, no such valuation allowance has been
established.

F-27

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 8--Segment Information

The Company had two reportable segments: personal lines and commercial
lines. These segments were managed separately because they have different
customers, pricing and expense structures. The Company exited the non-standard
personal automobile business in 1999 and announced that it would run-off its
remaining portfolio of such business. The Company will continue to report on
this segment separately until the amounts relating to the non-standard personal
automobile business become immaterial to the financial statements presented.
The Company does not allocate assets between segments because assets are
reviewed in total by management for decision-making purposes.

The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates segment
profit based on profit or loss from operating activities. Segment profit or
loss from operations is pre-tax and does not include unallocated expenses but
does include investment income attributable to insurance transactions. Segment
profit or loss therefore excludes income taxes, unallocated expenses and
investment income attributable to equity.

The following is a summary of the Company's segment revenues, expenses and
profit:

Year ended December 31, 2001
-------------------------------
Commercial Personal Total
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Premiums earned...................................................... $88,912 $ 22 $88,934
Net investment income and net realized investment loss from insurance
operations......................................................... 6,667 -- 6,667
------- ------- -------
Total segment revenues............................................... 95,579 22 95,601
------- ------- -------
Segment losses and loss adjustment expenses.......................... 62,414 (1,493) 60,921
Segment expenses..................................................... 26,087 8 26,095
------- ------- -------
Total segment expenses............................................... 88,501 (1,485) 87,016
------- ------- -------

Segment profit....................................................... $ 7,078 $ 1,507 $ 8,585
------- ------- -------
Plus unallocated items:..............................................
Net investment income from equity................................. 3,494
Unallocated expenses.............................................. (5,358)
Income tax expense................................................ (1,781)
-------
Net income........................................................... $ 4,940
=======

F-28

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Year ended December 31, 2000
-------------------------------
Commercial Personal Total
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Premiums earned...................................................... $87,556 $3,893 $ 91,449
Net investment income and net realized investment loss from insurance
operations......................................................... 3,801 353 4,154
------- ------ --------
Total segment revenues............................................... 91,357 4,246 95,603
------- ------ --------
Segment losses and loss adjustment expenses.......................... 72,893 2,485 75,378
Segment expenses..................................................... 25,614 1,362 26,976
------- ------ --------
Total segment expenses............................................... 98,507 3,847 102,354
------- ------ --------

Segment profit (loss)................................................ $(7,150) $ 399 $ (6,751)
------- ------ --------
Plus unallocated items:..............................................
Net investment income from equity................................. 3,492
Unallocated expenses.............................................. (5,045)
Income tax benefit................................................ 3,473
--------
Net loss............................................................. $ (4,831)
========

Year ended December 31, 1999
-------------------------------
Commercial Personal Total
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Premiums earned...................................................... $71,731 $13,946 $85,677
Net investment income and net realized investment gain from insurance
operations......................................................... 3,917 662 4,579
------- ------- -------
Total segment revenues............................................... 75,648 14,608 90,256
------- ------- -------
Segment losses and loss adjustment expenses.......................... 49,744 13,443 63,187
Segment expenses..................................................... 21,905 4,533 26,438
------- ------- -------
Total segment expenses............................................... 71,649 17,976 89,625
------- ------- -------

Segment profit (loss)................................................ $ 3,999 $(3,368) $ 631
------- ------- -------
Plus unallocated items:..............................................
Net investment income from equity................................. 4,848
Unallocated Expenses.............................................. (4,548)
Income tax benefit................................................ 479
-------
Net income........................................................... $ 1,410
=======

Total segment revenues of $95,601,000, $95,603,000 and $90,256,000, plus
unallocated net investment income from equity of $3,494,000, $3,492,000 and
$4,848,000, equals total Company revenues of $99,095,000, $99,095,000 and
$95,104,000 for the years ended December 31, 2001, 2000, and 1999, respectively.

F-29

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In 2001, the Company had one general agency that accounted for approximately
11% of gross premiums earned. In 2000 and 1999, no general agent accounted for
more than 10% of gross premiums earned.

Note 9--Dividends from Subsidiaries and Statutory Information

Penn-America and Penn-Star are highly regulated by the state in which they
are incorporated and the states in which they do business. Such regulations,
among other things, limit the amount of dividends, impose restrictions on the
amount and types of investments and regulate rates insurers may charge for
various products.

A source of cash for the payment of common stock dividends to PAGI's
stockholders is dividends from Penn-America. Penn-America is required by law to
maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of a
dividend from statutory surplus may require prior approval of the Pennsylvania
regulatory authorities. In 2001, the Company paid dividends of $1.6 million to
PAGI. No ordinary dividends were paid in 2000. In 2000, the Penn-America paid a
$6.4 million return of capital to PAGI, after receiving approval from the
Pennsylvania Insurance Department. The maximum dividend that may be paid by
Penn-America to PAGI without prior approval of regulatory authorities in 2002
is $6,473,325.

The National Association of Insurance Commissioners ("NAIC") has developed
Property and Casualty Risk-Based Capital ("RBC") standards that relate an
insurer's reported statutory surplus to the risks inherent to overall
operations. The RBC formula uses the statutory annual statement to calculate
the minimum indicated capital level to support asset risk and underwriting
risk. The NAIC model law calls for various levels of regulatory action based on
the magnitude of an indicated RBC capital deficiency, if any. The Company
regularly monitors capital requirements along with the NAIC's RBC developments.
The Company has determined that its capital levels are in excess of the minimum
capital requirements for all RBC action levels and that its capital levels are
sufficient to support the level of risk inherent in its operations.

The following tables reconcile statutory surplus and net income (loss) of
the Company as determined in accordance with accounting procedures prescribed
by the insurance regulatory authorities to stockholders' equity and net income
(loss) of the Company calculated in accordance with accounting principles
generally accepted in the United States as reported herein:

Year ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
(In thousands)

Statutory surplus as regards to policyholders $64,733 $55,530 $69,515
Deferred policy acquisition costs............ 9,083 10,317 9,306
Deferred income taxes........................ (574) 4,272 5,483
Net unrealized investment gain (loss)........ 4,151 1,974 (5,027)
Non-admitted assets.......................... 2,171 1,175 896
Provision for uncollectible accounts......... (1,022) (522) (522)
Holding company assets....................... 1,594 1,156 938
Other, net................................... 255 149 29
------- ------- -------
GAAP stockholders' equity.................... $80,391 $74,051 $80,618
======= ======= =======

F-30

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Year ended December 31,
-------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Statutory net income (loss)........................... $ 6,827 $(5,020) $1,869
Deferred policy acquisition costs..................... (1,268) 1,010 578
Deferred income tax................................... 499 594 281
Allowance for uncollectible accounts.................. (500) -- 100
Holding company expenses, net of tax.................. (345) (500) (825)
GAAP restatement - other than temporary impairment (1) (411) (975) (628)
Other, net............................................ 138 60 35
------- ------- ------
GAAP net income (loss)................................ $ 4,940 $(4,831) $1,410
======= ======= ======

--------

(1)See Note 1 to the Consolidated Financial Statements.

The NAIC revised the Statutory Accounting Practices and Procedures Manual in
a process referred to as Codification. The objective of Codification is to
standardize the accounting practices prescribed by each State's Insurance
Department. The revised manual was effective January 1, 2001. Pennsylvania, the
domiciliary state for Penn-America and Penn-Star, has adopted the provisions
for the revised manual. The revised manual has changed, to some extent,
prescribed statutory accounting practices and has resulted in changes to the
accounting practices that Penn-America and Penn-Star use to prepare their
statutory-basis financial statements. These changes resulted in an increase in
the statutory-basis capital and surplus of the Company of $3.3 million at
January 1, 2001.

Note 10--Incentive Savings and Retirement Plan

Penn-America participates in a profit-sharing and a 401(k) plan with Penn
Independent that covers qualified employees. Penn-America's contributions under
the 401(k) plan were $117,000, $72,000 and $105,000 for 2001, 2000, and 1999,
respectively. There were no profit-sharing distributions in 2001, 2000, and
1999.

Note 11--Stock Incentive Plans

Stock options: In August 1993, the Company adopted a Stock Incentive Plan
(the "Plan"), which was later amended and restated in April of 1994 and amended
in April 2000. The purpose of the Plan is to enable officers, employees,
directors, consultants, advisors and service providers of the Company and its
affiliates (as defined in the Plan) to participate in the Company's future and
to enable the Company to attract and retain these persons by offering them
proprietary interests in the Company. The Plan authorized the issuance of up to
1,237,500 shares of common stock pursuant to the exercise of stock options or
the award of restricted stock. Options are exercisable according to the various
terms under which they were granted varying from one year to ten years after
the date of grant. All options are subject in general to earlier termination if
the optionee leaves the employ of the Company.

The fair value of options is estimated on the grant date using the
Black-Scholes option pricing model. The model assumes the following for 2001,
2000, and 1999, respectively: expected annual dividend rates of 2.0%, 2.8% and
1.9%; risk-free interest rates of 2.0% for 2001 and 6.0% for 2000 and 1999;
weighted-average expected life of the options of 4.8 years for 2001 and 2.5
years for 2000 and 1999; and expected stock price volatility of 22% for 2001
and 30% for 2000 and 1999.

F-31

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company has elected to account for these stock options in accordance
with the provisions of Accounting Principles Board Opinion ("APB") #25,
"Accounting for Stock Issued to Employees" and accordingly, no compensation
expense has been recorded for such grants. Statement of Financial Accounting
Standards ("SFAS") #123 "Accounting for Stock-Based Compensation," effective in
1996, would require that compensation expense be recorded for these option
grants. Accounting for such options using APB 25 and SFAS 123 are both
acceptable alternatives under GAAP. Had the Company elected to adopt SFAS 123,
the effect on the Company's net income and per share results would have been:

Year ended December 31,
---------------------------------
2001 2000 1999
---------- ---------- ----------
(Restated) (Restated) (Restated)
(in thousands)

Net income (loss):
As reported...................... $4,940 $(4,831) $1,410
Pro forma........................ 4,914 (4,973) 1,385

Diluted net income (loss) per share:
As reported...................... $ 0.43 $ (0.42) $ 0.11
Pro forma........................ 0.43 (0.43) 0.11

A summary of the status of and changes in the Company's stock option plan is
presented below:

Year ended December 31,
-----------------------
2001 2000 1999
----- ----- -----
(in thousands, except
per share data)

Outstanding at beginning of year (average price of $4.75, $4.73 and $4.65) 539 461 447
Granted (average price of $5.17, $4.96 and $7.09 per share)............... 54 111 14
Exercised (average price of $4.12 and $2.95 per share).................... (81) (24) --
Forfeited (average price of $4.95 and $10.92 per share)................... (20) (9) --
----- ----- -----
Outstanding at end of year (average price of $4.87, $4.75 and $4.73)...... 492 539 461
===== ===== =====
Options exercisable at end of year........................................ 418 442 447
----- ----- -----
Weighted average fair value of options granted during the year............ $0.81 $1.94 $2.19

F-32

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The following table summarizes information about stock options outstanding
at December 31, 2001:

Options Outstanding Options Exercisable
--------------------------------- --------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
12/31/01 Contractual Exercise 12/31/01 Exercise
Exercise Prices (in 000's) Life (Years) Price (in 000's) Price
--------------- ----------- ------------ -------- ----------- --------

$3.60 - $3.80.. 12 0.4 $ 3.63 12 $ 3.63
$3.81 - $5.07.. 347 2.8 $ 4.17 323 $ 4.11
$5.07 - $6.33.. 54 2.9 $ 5.56 36 $ 5.76
$6.34 - $7.60.. 45 3.4 $ 6.79 13 $ 7.09
$7.61 - $10.13. 21 1.4 $ 9.17 21 $ 9.17
$10.14 - $12.67 13 2.4 $12.67 13 $12.67

On January 2, 2002, the Company granted 262,335 stock options to employees
at an exercise price equal to the market price on the date of the grant. These
stock option grants vest over a five-year period beginning January 2, 2003.

Restricted Stock: The Company has awarded shares of restricted stock to
certain employees. Such shares are held by the Company and released to each
grantee at the rate of 20% per year provided that the grantee is still employed
by the Company or its affiliates. The Company charged $115,000 in 2001 and
$120,000 in 2000 and 1999 to compensation expense relating to these awards.
During 2001, 2000 and 1999, 15,750, 9,750 and 9,750 shares, respectively, of
the restricted stock were released to the applicable employees as allowed by
the provisions of the grant.

Agents' Contingent Commission Plan: The Company's Agents' Contingent
Commission Plan allows its agents to receive up to 100% of their contingent
profit commission awards in PAGI common stock. Agents' common stock awards for
the 2000, 1999 and 1998 years, which were issued in May of 2001, 2000 and 1999,
amounted to 35,189, 89,384, and 63,053 shares, respectively.

Note 12--Commitments and Contingencies

The Company's insurance subsidiaries are subject to routine legal
proceedings in connection with their property and casualty business.
Penn-America has been named as a defendant in litigation commenced in the
Superior Court of California, County of Los Angeles, on November 6, 2000 and in
an identical suit on December 18, 2000 in the County of Orange relating to the
Company's exited non-standard personal automobile business. It is not possible
at this time to evaluate the probability of a favorable or unfavorable outcome,
nor is it possible to estimate the amount of loss, if any. Management believes
that its position is defensible as to such litigation and is of the opinion
that the amount of loss, if any, will not have a material affect on the
Company's financial statements. The Company is involved in no other pending or
threatened legal or administrative proceedings which management believes might
have a material adverse effect on the Company's financial condition or results
of operations.

F-33

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company leases various computer equipment for use by its insurance
subsidiaries. These leases have terms primarily expiring in less than a
three-year period. Rental expenses for these operating leases were $391,000
$349,000 and $392,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.

At December 31, 2001, the future minimum rental payments required under
operating leases that have initial or remaining non-cancellable lease terms in
excess of one year were $341,000, $150,000 and $11,000 for 2002, 2003 and 2004,
respectively.

Note 13--Other Comprehensive Income

Accumulated other comprehensive income (loss) of the Company consists solely
of net unrealized gains and losses. The following table illustrates the
components of accumulated other comprehensive income:

Year ended December 31, 2001
--------------------------------
Pre-tax Tax Net of Tax
Amount Expense Amount
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Unrealized gains on investments:
Unrealized holding gains arising during period................. $2,328 $ (792) $1,536
Reclassification adjustments for losses realized in net income. 1,178 (400) 778
------ ------- ------
Other comprehensive income........................................ $3,506 $(1,192) $2,314
====== ======= ======

Year ended December 31, 2000
--------------------------------
Pre-tax Tax Net of Tax
Amount Expense Amount
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Unrealized gains on investments:
Unrealized holding gains arising during period................. $3,992 $(1,357) $2,635
Reclassification adjustments for losses realized in net income. 2,808 (955) 1,853
------ ------- ------
Other comprehensive income........................................ $6,800 $(2,312) $4,488
====== ======= ======

Year ended December 31, 1999
-------------------------------
Pre-tax Tax Net of Tax
Amount Benefit Amount
---------- ---------- ----------
(Restated) (Restated) (Restated)
(In thousands)

Unrealized losses on investments:
Unrealized holding losses arising during period................ $(9,822) $3,340 $(6,482)
Reclassification adjustments for losses realized in net income. 110 (38) 72
------- ------ -------
Other comprehensive loss.......................................... $(9,712) $3,302 $(6,410)
======= ====== =======

F-34

PENN-AMERICA GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 14--Unaudited Quarterly Financial Information

2001
------------------------------------------
First Second Third Fourth Total
------- ------- ------- ---------- -------
(Restated)
(In thousands except per share data)

Revenues............. $25,994 $24,687 $23,837 $24,577 $99,095
Net income........... 967 994 1,551 1,428 4,940
Net income per share:
Basic............. 0.09 0.09 0.14 0.12 0.43
Diluted........... 0.08 0.09 0.13 0.12 0.43

2000
--------------------------------------------
First Second Third Fourth Total
------- ------- ------- ---------- -------
(Restated)
(In thousands except per share data)

Revenues............. $23,933 $24,923 $24,971 $25,268 $99,095
Net income (loss).... 1,583 (662) (5,078) (674) (4,831)
Net income per share:
Basic............. 0.13 (0.06) (0.45) (0.06) (0.42)
Diluted........... 0.13 (0.06) (0.45) (0.06) (0.42)

Note 15--Subsequent Event

On April 11, 2002, the Company announced a three-for-two stock split to be
effected in the form of a 50% Stock dividend payable to shareholders of record
as of April 25, 2002. The distribution date was May 9, 2002. The number of
shares of common stock issued and outstanding and shares of treasury stock in
the stockholders' equity section of the consolidated balance sheet have been
adjusted to reflect the effect of the stock split. The balances for common
stock and additional paid-in capital have been adjusted to reflect the effect
of the stock split. The basic and diluted net income per share and basic and
diluted weighted average shares outstanding on the consolidated statement of
operations have been adjusted to reflect the effect of the stock split. The
cash dividend paid per share and the balances of common stock and additional
paid-in capital on the consolidated statement of stockholders' equity have been
adjusted to reflect the effect of the stock split. The per share information in
notes 2, 11 and 14 have been adjusted to reflect the effect of the stock split.

F-35

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

You should rely only on the information contained in this document or that
which we have referred you to. We have not authorized anyone to provide you
with any additional information. You should not assume that the information
included in or incorporated by reference into this prospectus or any prospectus
supplement is accurate as of any date later than the date on the front of the
prospectus or prospectus supplement.

----------------------

TABLE OF CONTENTS

----------------------

Page
----

Prospectus Summary........................ 1
Risk Factors.............................. 6
Forward-Looking Statements................ 12
Use of Proceeds........................... 12
Price Range of Common Stock and
Dividend Policy.......................... 13
Capitalization............................ 14
Selected Consolidated Financial Data...... 15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 16
Our Business.............................. 29
Certain Transactions...................... 40
Description of Capital Stock.............. 43
Material U.S. Tax Consequences to Non-U.S.
Holders.................................. 45
Underwriting.............................. 48
Legal Matters............................. 50
Experts................................... 50
Where You Can Find More Information....... 51
Incorporation of Documents by Reference... 51
Index to Consolidated Financial Statements F-1

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

[LOGO] Group (R)

Penn-America
Group, Inc.

2,600,000 Shares

Common Stock

-------------

PROSPECTUS

-------------

Bear, Stearns & Co. Inc.

--------------------

Ferris, Baker Watts
Incorporated

Keefe, Bruyette & Woods, Inc.

, 2002

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 14. Other Expenses of Issuance and Distribution

The estimated fees of the distribution, all of which are to be borne by us,
are as follows:

SEC Registration Fee......................... $ 4,370.00
Accounting Fees and Expenses................. 80,000.00*
Transfer Agent Fees; Taxes; Printing......... 100,000.00*
NASD Fee..................................... 5,250.00
Legal Fees and Expenses...................... 100,000.00*
Miscellaneous................................ 140,380.00*
-----------
Total..................................... $430,000.00*
===========

-
* Estimated

Item 15. Indemnification of Directors and Officers

Pursuant to the provisions of the Pennsylvania Business Corporation Law, the
bylaws of Penn-America Group, Inc. provide that a director shall not be
personally liable, as such, for monetary damages for any action taken, unless
the director breaches or fails to perform a duty of his office and such breach
or failure to perform constitutes self-dealing, willful misconduct or
recklessness. This limitation does not apply to criminal liability or liability
for the payment of taxes. Penn-America Group, Inc.'s bylaws also provide for
indemnification of its directors and officers to the fullest extent permitted
by Pennsylvania law.

Item 16. Exhibits

1.1 Form of Underwriting Agreement.++

5.1 Opinion of Reed Smith LLP.*

10.1 1993 Casualty Excess of Loss Reinsurance Agreement with National Reinsurance Corporation, filed as
Exhibit 10.3 to the Registrant's Registration Statement on Form S-1 (No. 33-66892), which was filed
with the Commission on August 2, 1993.+

10.2 Endorsements Nos. 4 through 6 (Termination Endorsement) to 1993 Casualty Excess of Loss
Reinsurance Agreement with National Reinsurance Corporation.*

10.3 Agreement dated August 20, 1993, between Penn Independent Corporation ("Penn Independent") and
the Registrant regarding the reimbursement of certain employment costs, filed as Exhibit 10.7 to
Amendment No. 1 to the Registrant's Registration Statement on Form S-1 (No. 33-66892), which was
filed with the Commission on August 26, 1993.+

10.4 Amendment dated January 1, 2002, to August 20, 1993 Agreement between Penn Independent and
Registrant regarding the sharing of certain operating costs.*

10.5 Agreement dated April 15, 1997, among General Re-New England Asset Management, Inc., Penn-
America Insurance Company, and its subsidiary, Penn-Star Insurance Company, filed as Exhibit 10.9(ii)
to the Registrant's Annual Report on Form 10-K for the period ended December 31, 1997, which was
filed with the Commission on March 27, 1998.+

10.6 Amendment dated November 7, 2000, to Agreement dated April 15, 1997, among General Re-New
England Asset Management, Inc., Penn-America Insurance Company, and its subsidiary, Penn-Star
Insurance Company, filed as Exhibit 10.9(v) to the Registrant's Annual Report on Form 10-K for the
period ended December 31, 2000, which was filed with the Commission on March 30, 2001.+

II-1

10.7 1993 Stock Incentive Plan, filed as Exhibit 10.10 to Amendment No. 4 to the Registrant's Registration
Statement on Form S-1 (No. 33-66892), which was filed with the Commission on September 29, 1993.+

10.8 Penn-America Group, Inc. 1993 Stock Incentive Plan, as amended and restated April 4, 1994, filed as
Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 (No. 33-82728), which was filed
with the Commission on August 11, 1994.+

10.9 Amendment dated April 1, 2000, to Penn-America Group, Inc. 1993 Stock Incentive Plan, as amended
and restated April 4, 1994, filed as Exhibit 10.10(iii) to the Registrant's Annual Report on Form 10-K
for the period ended December 31, 2000, which was filed with the Commission on March 30, 2001.+

10.10 Amended and Restated 2002 Stock Incentive Plan (f/k/a 1993 Stock Incentive Plan), filed as Exhibit 4
to the Registrant's Registration Statement on Form S-8 (No. 333-89846), which was filed with the
Commission on June 5, 2002.+

10.11 Employee Bonus Plan dated January 1, 2000, filed as Exhibit 10.10(ii) to the Registrant's Annual
Report on Form 10-K for the period ended December 31, 1999, which was filed with the Commission
on March 27, 2000.+

10.12 Lease effective July 1, 2000, between Penn-America Insurance Company and Irvin Saltzman, filed as
Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the period ended December 31,
2000, which was filed with the Commission on March 30, 2001.+

10.13 1995 Multiple Line Excess of Loss (Casualty and Property) Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

10.14 Endorsement No. 1 to Multiple Line Excess of Loss Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

10.15 Endorsement No. 2 to Multiple Line Excess of Loss Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

10.16 1996 Property & Liability Reinsurance Agreement with General Re Corporation effective May 1, 1996.*

10.17 Property Catastrophe Excess of Loss Reinsurance Program between subscribing reinsurers and Penn-
America and Penn-Star Insurance Companies, effective January 1, 2000 to January 1, 2002, filed as
Exhibit 10.14(iv) to the Registrant's Annual Report on Form 10-K for the period ended December 31,
2000, which was filed with the Commission on March 30, 2001.+

10.18 Penn-America Group, Inc. 1995 Key Employee Incentive Compensation Plan, filed as Exhibit 4 to the
Registrant's Registration Statement on Form S-8 (No. 333-00050), which was filed with the
Commission on January 4, 1996.+

10.19 Penn-America Insurance Company 2001 Key Employee Incentive Compensation Plan, effective
January 1, 2001, filed as Exhibit 10.16(i) to the Registrant's Annual Report on Form 10-K for the
period ended December 31, 2000, which was filed with the Commission on March 30, 2001.+

10.20 Penn-America Insurance Company's Agency Award and Profit Sharing Plan, filed as Exhibit 4 to the
Registrant's Registration Statement on Form S-3 (No. 333-00046), which was filed with the
Commission on January 4, 1996.+

10.21 Penn-America Insurance Company's Agency Award and Profit Sharing Plan, filed as Exhibit 4 to the
Registrant's Registration Statement on Form S-3 (No. 333-49055), which was filed with the
Commission on March 31, 1998.+

10.22 Form of Amended General Agency Profit Sharing Addendum to Agency Award & Profit Sharing Plan,
filed as Exhibit 10.17(ii) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 1999, which was filed with the Commission on March 27, 2000.+

II-2

10.23 Form of General Agent Contingent Profit Commission Addendum between agents and Penn-America
and Penn-Star Insurance Companies, effective January 1, 2001, filed as Exhibit 10.17(iii) to the
Registrant's Annual Report on Form 10-K for the period ended December 31, 2001, which was filed
with the Commission on March 28, 2002.+

10.24 Agency Performance Award and Profit Sharing Plan, filed as Exhibit 4.1 to the Registrant's Registration
Statement on Form S-2 (No. 333-87698), which was filed with the Commission on May 7, 2002.+

10.25 Stipulation of Termination of Property and Liability Reinsurance Agreement with National
Reinsurance Corporation, effective May 1, 1996.*

10.26 Multiple Line Excess of Loss Agreement of Reinsurance including Endorsement No. 1 between
General Reinsurance Corporation and Penn-America and Penn-Star Insurance Companies, effective
January 1, 2000, filed as Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the period
ended December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.27 Endorsement No. 2 to the Multiple Line Excess of Loss Agreement of Reinsurance including Endorsement
No. 1 between General Reinsurance Corporation and Penn-America and Penn-Star Insurance Companies,
effective September 1, 2001, filed as Exhibit 10.19(i) to the Registrant's Annual Report on Form 10-K for
the period ended December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.28 Property and Casualty Excess of Loss Reinsurance Agreement between American Re-Insurance
Company and Penn-America and Penn-Star Insurance Companies, effective September 1, 2001, filed
as Exhibit 10.20 to the Registrant's Annual Report on Form 10-K for the period ended December 31,
2001, which was filed with the Commission on March 28, 2002.+

10.29 Reinsurance Pooling Agreement between Penn-America Insurance Company and Penn-Star Insurance
Company dated July 1, 1998, filed as Exhibit 30.0 to the Registrant's Annual Report on Form 10-K for
the period ended December 31, 1998, which was filed with the Commission on March 26, 1999.+

10.30 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
Jon S. Saltzman and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated January 17,
2000), filed as Exhibit 31.0 to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.31 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
Jon S. Saltzman and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated March 10,
2000), filed as Exhibit 31.0(i) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.32 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
Jon S. Saltzman and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated September 19,
2001), filed as Exhibit 31.0(ii) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 2001, was filed with the Commission on March 28, 2002.+

10.33 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
J. Ransley Lennon and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated February 16,
2000), filed as Exhibit 31.0(iii) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.34 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
Garland P. Pezzuolo and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated February 11,
2000), filed as Exhibit 31.0(iv) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 2001, which was filed with the Commission on March 28, 2002.+

II-3

10.35 Promissory Note and Security Agreement effective March 9, 2001, between Joseph F. Morris and
Penn-America Insurance Company, filed as Exhibit 31.0(v) to the Registrant's Annual Report on Form
10-K for the period ended December 31, 2001, which was filed with the Commission on March 28,
2002.+

10.36 Promissory Note and Security Agreement effective March 28, 2001, between Joseph F. Morris and
Penn-America Insurance Company, filed as Exhibit 31.0(vi) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on March
28, 2002.+

10.37 Promissory Note and Security Agreement effective March 9, 2001, between Garland P. Pezzuolo and
Penn-America Insurance Company, filed as Exhibit 31.0(vii) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on March
28, 2002.+

10.38 Promissory Note and Security Agreement effective February 16, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed as Exhibit 31.0(viii) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on March
28, 2002.+

10.39 Promissory Note and Security Agreement effective February 23, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed as Exhibit 31.0(ix) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on March
28, 2002.+

10.40 Promissory Note and Security Agreement effective February 27, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed as Exhibit 31.0(x) to the Registrant's Annual Report on Form
10-K for the period ended December 31, 2001, which was filed with the Commission on March 28,
2002.+

10.41 Promissory Note and Security Agreement effective March 21, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed as Exhibit 31.0(xi) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on March
28, 2002.+

11.1 Statement re: computation of per share earnings, incorporated by reference from Note 2 to the
Consolidated Financial Statements filed with Registrant's Annual Report on Form 10-K for the period
ended December 31, 2001, which was filed with the Commission on March 28, 2002.+

13.1 2001 Annual Report to Stockholders, filed as Exhibit 13 to the Registrant's Annual Report on Form
10-K for the period ended December 31, 2001, which was filed with the Commission on March 28,
2002.+

13.2 Annual Report on Form 10-K of the Registrant for the year ended December 31, 2001, filed with the
Commission on March 28, 2002.+

13.3 Quarterly Report on Form 10-Q of the Registrant for the quarter ended March 31, 2002, filed with the
Commission on May 14, 2002.+

13.4 Quarterly Report on Form 10-Q of the Registrant for the quarterly period ended June 30, 2002 filed
with the Commission on August 8, 2002.+

13.5 Annual Report on Form 10-K/A of the Registrant for the year ended December 31, 2001, filed with the
Commission on November 12, 2002.+

13.6 Quarterly Report on Form 10-Q of the Registrant for the quarterly period ended September 30, 2002
filed with the Commission on November 13, 2002.+

23.1 Consent of Reed Smith LLP (included in Exhibit 5.1).*

23.2 Consent of Ernst & Young LLP.

24.1 Power of Attorney.*

--------
* Previously filed.
+ Incorporated by reference to the specified filing.
++ To be filed by amendment.

II-4

Item 17. Undertakings

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers, and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.

The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Exchange Act of 1934 (and where applicable, each filing of an employee benefit
plan's annual report pursuant to Section 15(d) of the Securities Exchange Act
of 1934) that is incorporated by reference in the registration statement shall
be deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.

The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person whom the prospectus is sent or
given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and where interim financial information required to be presented by
Article 3 of Regulation S-X is not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.

II-5

SIGNATURES AND POWERS OF ATTORNEY

Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form S-2 and has duly caused this
Amendment No. 3 to Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Hatboro, Pennsylvania, on November
21, 2002.

PENN-AMERICA GROUP, INC.

By: *
------------------------------
Jon S. Saltzman,
President and Chief Executive
Officer

Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed below by the following persons in the
capacities and on the dates indicated.

Signatures Title Date
---------- ----- ----

* Chief Executive Officer, President and November 21, 2002
------------------- Director (Principal Executive
Jon S. Saltzman Officer)

* Director November 21, 2002
-------------------
Robert A. Lear

* Chairman and Director November 21, 2002
-------------------
Irvin Saltzman

* Director November 21, 2002
-------------------
E. Anthony Saltzman

* Director November 21, 2002
-------------------
Charles Ellman

* Director November 21, 2002
-------------------
M. Moshe Porat

* Director November 21, 2002
-------------------
Paul Simon

* Director November 21, 2002
-------------------
Martin Sheffield

II-6

Signatures Title Date
---------- ----- ----

* Director November 21, 2002
--------------------------
Jami Saltzman-Levy

* Chief Financial Officer and Treasurer November 21, 2002
-------------------------- (Principal Financial and
Joseph F. Morris Accounting Officer)

* Vice President, Secretary and November 21, 2002
-------------------------- General Counsel
Garland P. Pezzuolo

* /S/ GARLAND P. PEZZUOLO November 21, 2002
--------------------------
By Garland P. Pezzuolo,
Attorney-in-fact

II-7

EXHIBIT INDEX

Exhibit No. Description of Exhibit
----------- ----------------------

1.1 Form of Underwriting Agreement.++

5.1 Opinion of Reed Smith LLP.*

10.1 1993 Casualty Excess of Loss Reinsurance Agreement with National Reinsurance Corporation, filed
as Exhibit 10.3 to the Registrant's Registration Statement on Form S-1 (No. 33-66892), which was
filed with the Commission on August 2, 1993.+

10.2 Endorsements Nos. 4 through 6 (Termination Endorsement) to 1993 Casualty Excess of Loss
Reinsurance Agreement with National Reinsurance Corporation.*

10.3 Agreement dated August 20, 1993, between Penn Independent Corporation ("Penn Independent")
and the Registrant regarding the reimbursement of certain employment costs, filed as Exhibit 10.7 to
Amendment No. 1 to the Registrant's Registration Statement on Form S-1 (No. 33-66892), which
was filed with the Commission on August 26, 1993.+

10.4 Amendment dated January 1, 2002, to August 20, 1993 Agreement between Penn Independent and
Registrant regarding the sharing of certain operating costs.*

10.5 Agreement dated April 15, 1997, among General Re-New England Asset Management, Inc., Penn-
America Insurance Company, and its subsidiary, Penn-Star Insurance Company, filed as Exhibit
10.9(ii) to the Registrant's Annual Report on Form 10-K for the period ended December 31, 1997,
which was filed with the Commission on March 27, 1998.+

10.6 Amendment dated November 7, 2000, to Agreement dated April 15, 1997, among General Re- New
England Asset Management, Inc., Penn-America Insurance Company, and its subsidiary, Penn-Star
Insurance Company, filed as Exhibit 10.9(v) to the Registrant's Annual Report on Form 10-K for the
period ended December 31, 2000, which was filed with the Commission on March 30, 2001.+

10.7 1993 Stock Incentive Plan, filed as Exhibit 10.10 to Amendment No. 4 to the Registrant's
Registration Statement on Form S-1 (No. 33-66892), which was filed with the Commission on
September 29, 1993.+

10.8 Penn-America Group, Inc. 1993 Stock Incentive Plan, as amended and restated April 4, 1994, filed
as Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 (No. 33-82728), which was
filed with the Commission on August 11, 1994.+

10.9 Amendment dated April 1, 2000, to Penn-America Group, Inc. 1993 Stock Incentive Plan, as
amended and restated April 4, 1994, filed as Exhibit 10.10(iii) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2000, which was filed with the Commission on
March 30, 2001.+

10.10 Amended and Restated 2002 Stock Incentive Plan (f/k/a 1993 Stock Incentive Plan), filed as Exhibit
4 to the Registrant's Registration Statement on Form S-8 (No. 333-89846), which was filed with the
Commission on June 5, 2002.+

10.12 Lease effective July 1, 2000, between Penn-America Insurance Company and Irvin Saltzman, filed
as Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the period ended December 31,
2000, which was filed with the Commission on March 30, 2001.+

10.13 1995 Multiple Line Excess of Loss (Casualty and Property) Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

10.14 Endorsement No. 1 to Multiple Line Excess of Loss Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

II-8

Exhibit No. Description of Exhibit
----------- ----------------------

10.15 Endorsement No. 2 to Multiple Line Excess of Loss Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1, 1995.*

10.16 1996 Property & Liability Reinsurance Agreement with General Re Corporation effective May 1,
1996.*

10.17 Property Catastrophe Excess of Loss Reinsurance Program between subscribing reinsurers and Penn-
America and Penn-Star Insurance Companies, effective January 1, 2000 to January 1, 2002, filed as
Exhibit 10.14(iv) to the Registrant's Annual Report on Form 10-K for the period ended December
31, 2000, which was filed with the Commission on March 30, 2001.+

10.18 Penn-America Group, Inc. 1995 Key Employee Incentive Compensation Plan, filed as Exhibit 4 to
the Registrant's Registration Statement on Form S-8 (No. 333-00050), which was filed with the
Commission on January 4, 1996.+

10.22 Form of Amended General Agency Profit Sharing Addendum to Agency Award & Profit Sharing
Plan, filed as Exhibit 10.17(ii) to the Registrant's Annual Report on Form 10-K for the period ended
December 31, 1999, which was filed with the Commission on March 27, 2000.+

10.23 Form of General Agent Contingent Profit Commission Addendum between agents and Penn-
America and Penn-Star Insurance Companies, effective January 1, 2001, filed as Exhibit 10.17(iii) to
the Registrant's Annual Report on Form 10-K for the period ended December 31, 2001, which was
filed with the Commission on March 28, 2002.+

10.24 Agency Performance Award and Profit Sharing Plan, filed as Exhibit 4.1 to the Registrant's
Registration Statement on Form S-2 (No. 333-87698), which was filed with the Commission on
May 7, 2002.+

10.25 Stipulation of Termination of Property and Liability Reinsurance Agreement with National
Reinsurance Corporation, effective May 1, 1996.*

10.26 Multiple Line Excess of Loss Agreement of Reinsurance including Endorsement No. 1 between
General Reinsurance Corporation and Penn-America and Penn-Star Insurance Companies, effective
January 1, 2000, filed as Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the
period ended December 31, 2001, which was filed with the Commission on March 28, 2002.+

10.27 Endorsement No. 2 to the Multiple Line Excess of Loss Agreement of Reinsurance including
Endorsement No. 1 between General Reinsurance Corporation and Penn-America and Penn-Star
Insurance Companies, effective September 1, 2001, filed as Exhibit 10.19(i) to the Registrant's
Annual Report on Form 10-K for the period ended December 31, 2001, which was filed with the
Commission on March 28, 2002.+

II-9

Exhibit No. Description of Exhibit
----------- ----------------------

10.29 Reinsurance Pooling Agreement between Penn-America Insurance Company and Penn-Star
Insurance Company dated July 1, 1998, filed as Exhibit 30.0 to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 1998, which was filed with the Commission on
March 26, 1999.+

10.32 Amended and Restated Promissory Note and Security Agreement effective January 2, 2001, between
Jon S. Saltzman and Penn-America Insurance Company (amending and restating in its entirety,
including any amendments thereto, the Promissory Note and Security Agreement dated
September 19, 2001), filed as Exhibit 31.0(ii) to the Registrant's Annual Report on Form 10-K for
the period ended December 31, 2001, was filed with the Commission on March 28, 2002.+

10.35 Promissory Note and Security Agreement effective March 9, 2001, between Joseph F. Morris and
Penn-America Insurance Company, filed as Exhibit 31.0(v) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on
March 28, 2002.+

10.38 Promissory Note and Security Agreement effective February 16, 2001, between Thomas P. Bowie
and Penn-America Insurance Company, filed as Exhibit 31.0(viii) to the Registrant's Annual Report
on Form 10-K for the period ended December 31, 2001, which was filed with the Commission on
March 28, 2002.+

II-10

Exhibit No. Description of Exhibit
----------- ----------------------

10.39 Promissory Note and Security Agreement effective February 23, 2001, between Thomas P. Bowie
and Penn-America Insurance Company, filed as Exhibit 31.0(ix) to the Registrant's Annual Report
on Form 10-K for the period ended December 31, 2001, which was filed with the Commission on
March 28, 2002.+

10.40 Promissory Note and Security Agreement effective February 27, 2001, between Thomas P. Bowie
and Penn-America Insurance Company, filed as Exhibit 31.0(x) to the Registrant's Annual Report on
Form 10-K for the period ended December 31, 2001, which was filed with the Commission on
March 28, 2002.+

11.1 Statement re: computation of per share earnings, incorporated by reference from Note 2 to the
Consolidated Financial Statements filed with Registrant's Annual Report on Form 10-K for the
period ended December 31, 2001, which was filed with the Commission on March 28, 2002.+

13.2 Annual Report on Form 10-K of the Registrant for the year ended December 31, 2001, filed with the
Commission on March 28, 2002.+

13.3 Quarterly Report on Form 10-Q of the Registrant for the quarter ended March 31, 2002, filed with
the Commission on May 14, 2002.+

13.4 Quarterly Report on Form 10-Q of the Registrant for the quarterly period ended June 30, 2002 filed
with the Commission on August 8, 2002.+

13.5 Annual Report on Form 10-K/A of the Registrant for the period ended December 31, 2001 filed with
the Commission on November 12, 2002.+

13.6 Quarterly Report on Form 10-Q of the Registrant for the quarterly period ended September 30, 2002
filed with the Commission on November 13, 2002.+

23.1 Consent of Reed Smith LLP (included in Exhibit 5.1).*

23.2 Consent of Ernst & Young LLP.

24.1 Power of Attorney.*

--------
* Previously filed.
+ Incorporated by reference to the specified filing.
++ To be filed by amendment.

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