10-K

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	for the fiscal year ended December 31, 2004
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	transition period from           to          .

Commission file number 000-25425

Mercer Insurance Group, Inc.

(Exact name of registrant as specified in its charter)

Pennsylvania	23-2934601
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

10 North Highway 31

P.O. Box 278

Pennington, NJ 08534

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(609) 737-0426

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock (no par value)

Title of Each Class:

Common Stock, no par value

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

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

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

     The aggregate market value of the voting and non-voting common stock held by non-affiliates (computed by reference to the price at which the common stock was last sold) as of the last business day of the Registrant’s most recently completed second fiscal quarter was: $85,152,440.

     Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of March 7, 2005. Common Stock, no par value: 6,560,733.

Documents Incorporated by Reference

     Portions of the definitive Proxy Statement for the 2005 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.

FORM 10-K

For the year Ended December 31, 2004

Table of Contents

			Page
PART I				3
	ITEM 1.	Business		3
	ITEM 2.	Properties		27
	ITEM 3.	Legal Proceedings		27
	ITEM 4.	Submission of Matters to a Vote of Security Holders		27
PART II				27
	ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		27
	ITEM 6.	Selected Consolidated Financial Data		29
	ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		30
	ITEM 7A.	Quantitative and Qualitative Disclosures about Market Risk		45
	ITEM 8.	Financial Statements and Supplementary Data.		48
	ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.		72
	ITEM 9A.	Controls and Procedures.		72
PART III				74
	ITEM 10.	Directors and Executive Officers of the Registrant.		74
	ITEM 11.	Executive Compensation.		74
	ITEM 12.	Security Ownership of Certain Beneficial Owners and Management.		74
	ITEM 13.	Certain Relationships and Related Transactions.		74
	ITEM 14.	Principal Accounting Fees and Services.		74
PART IV				74
	ITEM 15.	Exhibits, Financial Statement Schedules.		74
EMPLOYMENT AGREEMENT, DATED AS OF OCTOBER 31, 2004
STOCK INCENTIVE PLAN
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
CERTIFICATION OF CHIEF FINANCIAL OFFICER
CERTIFICATION OF CEO IN ACCORDANCE WITH SECTION 906
CERTIFICATION OF CFO IN ACCORDANCE WITH SECTION 906

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PART I

ITEM 1. BUSINESS

THE CONVERSION TRANSACTION AND THE HOLDING COMPANY

      Mercer Insurance Group, Inc. (the “Company” or the “Holding Company”) is a holding company owning all of the outstanding shares of Mercer Insurance Company, the company resulting from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of organization on December 15, 2003 (the “Conversion”). Prior to the Conversion, and since 1844, Mercer Mutual Insurance Company was engaged in the business of selling property and casualty insurance. Mercer Mutual Insurance Company, a Pennsylvania domiciled company, changed its name to Mercer Insurance Company immediately after the Conversion, and became a subsidiary of the Company.

      The Company had no activity prior to the Conversion, and was formed for the purpose of owning all of the stock of Mercer Mutual Insurance Company after the Conversion. At the time of the Conversion, 6,845,733 shares of Mercer Insurance Group, Inc. were issued (including 502,525 shares issued immediately after the Conversion to acquire the remaining 51% of the common stock as well as all of the manditorily redeemable preferred stock of Franklin Holding Company, Inc., of which Mercer Mutual Insurance Company had acquired 49% for cash in 2001) with net cash proceeds of approximately $53 million received by the Company in exchange for the shares (approximately $27 million of this amount was contributed to the capital of Mercer Insurance Company after the Conversion). Also included in the total shares are 626,111 shares issued in the Conversion to the Mercer Insurance Group, Inc. Employee Stock Ownership Plan, (the “ESOP”) as to which no cash proceeds were received because the ESOP funded the purchase of these shares with a loan from the Company. The shares held by the ESOP will be allocated to participant accounts evenly over a ten-year period. The first and second annual allocations occurred in each of December, 2003 and 2004, in the amount of 62,611 shares each.

      The Holding Company is subject to regulation by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance because it is the holding company for Mercer Insurance Company (Pennsylvania-domiciled), and for, indirectly through Queenstown Holding Company, Inc., Mercer Insurance Company of New Jersey, Inc. (New Jersey-domiciled), and for Franklin Holding Company, Inc. and its subsidiary, Franklin Insurance Company (Pennsylvania-domiciled).

OVERVIEW OF THE BUSINESS

      Mercer Insurance Group, Inc., through its property and casualty insurance subsidiaries, provides a wide array of property and casualty insurance products designed to meet the insurance needs of consumers and small and medium-sized businesses throughout New Jersey and Pennsylvania. We report our operating results in three segments: commercial lines insurance, personal lines insurance and the investment function. However, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our insurance products include commercial multi-peril, other liability, commercial automobile, workers compensation, homeowners, fire and inland marine and personal automobile coverages. We market our products through a network of over 300 independent producers in New Jersey and Pennsylvania. The majority of our producers market both commercial and personal lines products. Our insurance companies have been assigned an “A” (Excellent) rating by A.M. Best for 4 years. An “A” rating is the third highest rating out of A.M. Best’s 16 possible rating categories.

      Prior to 1997, our business was primarily focused on providing personal lines for New Jersey customers. However, over the past seven years we have moved aggressively to expand our commercial and casualty premium volume and geographically diversify our writings into Pennsylvania. In order to attract and retain commercial and casualty business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. In 2004, homeowners insurance represented 22% of our direct premiums written compared to 43% in 1998 and commercial writings represented 62%, up from 45% in 1998. This significant shift in the mix of our writings occurred despite our acquisition in 2001 of a 49% interest in Franklin Insurance Company whose business consists entirely of personal lines policies (as noted above, the

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remaining 51% was acquired by the Company immediately after the completion of the Conversion to a publicly-traded company in December, 2003). Direct premiums written in 2004 in the state of Pennsylvania amounted to 22% of our business, with the remaining 78% being written in New Jersey.

OUR INSURANCE COMPANIES

      Mercer Insurance Company is a Pennsylvania insurance company that was originally incorporated under a special act of the legislature of the State of New Jersey in 1844 as a mutual insurance company. It commenced operations under the name Mercer County Mutual Fire Insurance Company, subsequently changed its name to Mercer Mutual Insurance Company in 1958, and then to Mercer Insurance Company after the Conversion in 2003. On October 16, 1997, it filed Articles of Domestication with Pennsylvania thereby changing its state of domicile from New Jersey to Pennsylvania. Mercer Insurance Company owns all of the issued and outstanding capital stock of Queenstown Holding Company, Inc., which owns all of the issued and outstanding capital stock of Mercer Insurance Company of New Jersey, Inc. Mercer Insurance Company also owns 49% of the issued and outstanding stock of Franklin Holding Company, Inc., which owns all of the issued and outstanding capital stock of Franklin Insurance Company. The remaining 51% of Franklin Holding Company, Inc. is owned by the Mercer Insurance Group, Inc., which acquired the 51%, as well as all manditorily redeemable preferred stock held by third parties, in exchange for 502,525 of its shares immediately after the Conversion.

      Mercer Insurance Company is a property and casualty insurer of small and medium-sized businesses and property owners located in New Jersey and Pennsylvania. It markets commercial multi-peril and homeowners policies, as well as other liability, workers’ compensation, fire, allied, inland marine and commercial automobile insurance through over 300 independent producers. Mercer Insurance Company does not market private passenger automobile insurance in New Jersey. Mercer Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business — Regulation.”

      Mercer Insurance Company of New Jersey, Inc. is a stock property and casualty insurance company that was incorporated in 1981. It writes the same lines of business as Mercer Insurance Company, with its book of business intended to be predominantly located in New Jersey. Mercer Insurance Company of New Jersey, Inc. is subject to examination and comprehensive regulation by the New Jersey Department of Banking and Insurance. See “Business — Regulation.”

      Franklin Insurance Company is a stock property and casualty insurance company that was incorporated in 1997. Mercer Insurance Company acquired 49% of the common stock of Franklin Holding Company, Inc. (“Franklin Holding”), on June 1, 2001. Franklin Holding owns 100% of Franklin Insurance Company. The Company acquired the remaining 51% of Franklin Holding in exchange for its shares immediately after the Conversion. Currently, Franklin Insurance Company offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. Franklin Insurance Company is represented by approximately 50 independent producers. All transactions conducted between Franklin Insurance Company and its producers are performed electronically. Franklin Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business — Regulation.”

OUR BUSINESS STRATEGIES

      We continually strive to improve our profitability and reduce the impact of losses on our business. One of our principal objectives for the future is to become a more geographically diverse property and casualty insurer with at least 75% of our direct written premiums consisting of commercial and casualty business that meets our disciplined underwriting standards. By doing so, we believe that our results of operations will improve and we will lessen the impact of personal property insurance losses. The following discussion describes the strategies we will use to achieve our goals.

Increase our commercial and casualty writings

      Over the last seven years we have taken, and will continue to take, steps to increase commercial and casualty premium volume. Growth in commercial and casualty lines reduces our personal lines exposure as a

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percentage of direct written premiums. This reduces the relative adverse impact that weather-related property losses can have on us. Increased commercial lines business also benefits us because we have greater flexibility in establishing rates for these lines.

      In order to attract and retain commercial and casualty insurance business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. These programs are continually refined and, if successful, expanded based on input from our producers and our marketing personnel.

      We have a program that is available for churches, synagogues and other religious institutions. This program includes many preferred coverages and special pricing, and we have policy forms tailored for these institutions. We use this program to attract producers that have substantial books of business with religious institutions.

      At December 31, 2004, we had approximately 1,400 insured religious institutions with direct written premiums of $7.6 million. The performance of this book of business compares favorably to our commercial segment generally.

      In order to complement our existing commercial accounts, a two-tiered pricing approach for commercial automobile insurance covering light to medium weight trucks and business-owned private passenger-type vehicles used for commercial purposes is available. In addition to a standard rate, a preferred rate for risks meeting specified underwriting standards can be used.

      We believe that there is an opportunity to increase our volume of casualty business by: (1) marketing casualty products to existing producers who have supported the establishment and growth of our commercial lines, and (2) forming and developing relationships with new producers that focus on commercial and casualty business. We believe an increasing share of this market is desirable and attainable given our existing relationships with our producers and our insureds, as well as the extensive experience and producer relationships of our commercial business management personnel.

      Capital raised in the Conversion is available to supply additional surplus to our insurance companies to support an increase in premium volume resulting from this continued diversification of our business lines.

Diversify our business geographically

      For the year ended December 31, 2004, 78% of our business was written in New Jersey. We intend to geographically diversify our risk by increasing our business outside New Jersey. We intend to explore opportunities that may arise in states adjacent to our current operating territories, as well as in most parts of the United States and where we believe commercial lines insurers generally are permitted to manage risk selection and pricing without undue regulatory interference. We also will evaluate potential business opportunities in other jurisdictions to determine whether they would be a good fit with our businesses. If so, we may explore those opportunities as well.

      We expect to accomplish our geographic diversification through the expansion of our existing producer relationships in Pennsylvania, exploration of additional state insurance licenses and through selective strategic acquisitions. We have no current definitive plans for any such acquisitions.

Attract and retain high-quality producers with diverse customer bases

      We believe our insurance companies have a strong reputation for personal attention and prompt, efficient service with producers and insureds. This reputation has allowed us to grow and foster our relationships with many high volume producers. Several of these producers focus primarily on commercial business and are located in areas we have targeted as growth opportunities within Pennsylvania and New Jersey. We intend to focus our marketing efforts on maintaining and improving our relationships with these producers, as well as on attracting new high-quality producers in areas with a substantial potential for growth, particularly in Pennsylvania. We also intend to continue to develop and tailor our commercial programs to enable our

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products to meet the needs of the customers served by our producers. Our religious institutions, “main street” business, and commercial automobile programs are successful examples of this effort.

Reduce our ratio of expenses to net premiums earned

      We are committed to improving our profitability by reducing expenses through the use of enhanced technology and by increasing our premium writings through the strategic deployment of our capital. Currently, we are in the process of converting our information systems from an outside service bureau to an internally staffed system. Our target date for completion of this project is June 30, 2006. When completed, we will be able to eliminate the cost of the outside service bureau. In addition, the additional capital raised in the Conversion has and will continue to allow us to expand our premium writings while maintaining appropriate premium to surplus ratios. We anticipate that this increase in writings can be achieved without a commensurate increase in expenses, and will therefore help to reduce our expense ratio.

      As a company that recently became publicly traded, and met the standards to be considered an accelerated filer under SEC rules, the Group was required to quickly implement the requirements of the Sarbanes — Oxley Act of 2002, which required an extensive and costly effort to document and test the Company’s system of internal controls. This effort resulted in the Company absorbing a substantial cost for Sarbanes — Oxley compliance during its first year as a public company, a cost which should decline substantially once the year of initial implementation passes.

Reduce our reliance on reinsurance

      We have reduced our reliance on reinsurance by increasing the maximum exposure retained by our insurance companies on individual property and casualty risks. The capital raised in the Conversion and contributed to our insurance subsidiaries has allowed us to increase our retentions, as we did in 2004.

      We will determine the appropriate increase in our maximum exposure based on a number of factors, which include:

•  the amount of capital the Company is prepared to dedicate to support its underwriting activities;

•  our evaluation of our ability to absorb multiple losses; and

•  the revised terms and limits that we can obtain from our reinsurers.

      A decrease in reinsurance would result in a decrease in ceded premiums and a corresponding increase in net premium income, but would increase our potential losses from underwriting. See “Business — Reinsurance” for a description of changes to our reinsurance program as of January 1, 2005.

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COMMERCIAL LINES PRODUCTS

      The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our commercial lines products on a consolidated basis for the periods indicated:

			Year Ended December 31,
			2004			2003			2002
Direct Premiums Written:
	Commercial multi-peril		$	22,249		$	18,588		$	13,485
	Other liability			9,771			8,944			6,641
	Workers’ compensation			4,381			3,971			3,665
	Commercial automobile			3,089			3,099			2,787
	Fire, allied, inland marine			1,393			1,201			911
		Total	$	40,883		$	35,803		$	27,489
Net Premiums Earned:
	Commercial multi-peril		$	16,522		$	12,673		$	9,631
	Other liability			7,184			6,295			4,810
	Workers’ compensation			4,691			3,700			2,735
	Commercial automobile			3,185			2,781			2,478
	Fire, allied, inland marine			788			515			434
		Total	$	32,370		$	25,964		$	20,088
Net Loss Ratios:
	Commercial multi-peril			32.6	%		30.9	%		40.7	%
	Other liability			41.0			46.6			21.5
	Workers’ compensation			28.8			41.3			38.4
	Commercial automobile			4.4			52.8			49.9
	Fire, allied, inland marine			63.2			58.6			9.3
		Total		31.9	%		39.1	%		36.3	%
Expense Ratio
	Commercial multi-peril			57.3	%		55.8	%		54.3	%
	Other liability			53.7			47.5			47.7
	Workers’ compensation			29.7			31.2			38.4
	Commercial automobile			38.8			41.5			42.0
	Fire, allied, inland marine			64.8			67.6			68.9
		Total		50.9	%		49.0	%		49.3	%
Combined Ratios(1):
	Commercial multi-peril			89.9	%		86.7	%		95.0	%
	Other liability			94.7			94.1			69.2
	Workers’ compensation			58.5			72.5			76.8
	Commercial automobile			43.2			94.3			91.9
	Fire, allied, inland marine			128.0			126.2			78.2
		Total		82.8	%		88.1	%		85.6	%

(1)  A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

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Commercial Multi-Peril

      We write a number of multi-peril policies in New Jersey and Pennsylvania providing property and liability coverage. These policies include larger apartment risks, condominium associations and 3-4 family dwelling policies. Various other risk classes also are written on this policy. As of December 31, 2004, approximately 1,050 multi-peril policies were in force.

      We are working to increase market penetration for this product because it includes commercial risks that have more flexible and profitable rate structures. One of these marketing initiatives relates to certain habitational classes of business. Due to recent market conditions, we have targeted our business generation efforts toward condominium associations and certain types of garden style apartment complexes. Although pricing in this sector has become more competitive, we continue to view this market segment favorably, and are active in this market.

      Many national insurance carriers have decided not to underwrite condominium associations and garden style apartment complexes because of a perceived inability to underwrite such business profitably. This practice of avoiding a class of business due to such an underwriting perception is known as “class underwriting.” Condominium associations and garden style apartment complexes, as a class, have been determined to be unprofitable by many national carriers because the pricing of this business was driven to inefficient levels during the soft market cycle. Therefore, they are avoiding this class of business entirely, and ignoring any individual risks within the class that can be underwritten profitably. This approach by national carriers has provided us greater opportunity to underwrite and price these risks at appropriate levels.

      We also have a business owners policy that provides property and liability coverages to small businesses. This product is marketed to several distinct groups: (i) apartment building owners with 75 or fewer units; (ii) condominium associations up to 75 units; (iii) business owners who lease their buildings to tenants; (iv) mercantile business owners, such as florists, delicatessens, and beauty parlors; and (v) offices with owner or tenant occupancies. As of December 31, 2004, approximately 3,700 business owners policies were in force.

      We also offer a specialized multi-peril policy specifically designed for religious institutions. This enhanced product includes directors and officers coverage, religious counseling coverage and systems breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools also is available. As of December 31, 2004, approximately 1,400 religious sector insureds were covered under commercial multi-peril policies.

Other Liability

      We write liability coverage for insureds who do not have property exposure or whose property exposure is insured elsewhere. The majority of these policies are written for small contractors such as carpenters, painters or electricians, who choose to self-insure small property exposures. Coverage for both premises and products liability exposures are regularly provided. Coverage is provided for other exposures such as vacant land and habitational risks. Approximately 600 commercial general liability and monoline umbrella policies were in force as of December 31, 2004.

      Commercial umbrella coverage is available for insureds who insure their primary general liability exposures with us through a business owners, commercial multi-peril, religious institution or commercial general liability policy. This coverage typically has limits of $1,000,000 to $5,000,000, but higher limits are available if needed. To improve processing efficiencies and maintain underwriting standards, we prefer to offer this coverage as an endorsement to the underlying liability policy rather than as a separate stand-alone policy, but both versions are available.

Workers’ Compensation

      We typically write workers’ compensation policies in conjunction with an otherwise eligible business owners, commercial multi-peril, religious institution, commercial property or general liability policy. As of December 31, 2004, most of our workers’ compensation insureds have other policies with us. There were approximately 2,500 workers’ compensation policies in effect as of December 31, 2004.

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Commercial Automobile

      This product is designed to cover light and medium weight trucks used in business, as well as company-owned private passenger type vehicles. Other specialty classes such as church vans and funeral director vehicles also can be covered. The policy is marketed as a companion offering to our business owners, commercial multi-peril, religious institution, commercial property or general liability policies. Approximately 1,000 commercial automobile policies were in force as of December 31, 2004.

Fire, Allied Lines and Inland Marine

      Fire and allied lines insurance generally covers fire, lightning, and removal and extended coverage. Inland marine coverage insures merchandise or cargo in transit and business and personal property. We offer these coverages for property exposures in cases where we are not insuring the companion liability exposures. Generally, the rates charged on these policies are higher than those for the same property exposures written on a multi-peril or business owners policy.

PERSONAL LINES PRODUCTS

      The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our personal lines products on a consolidated basis for the periods indicated:

			Year Ended December 31,
			2004			2003			2002
Direct Premiums Written:
	Homeowners		$	14,666		$	14,695		$	13,698
	Personal automobile			7,654			7,881			6,865
	Fire, allied, inland marine			2,050			2,183			2,227
	Other liability			493			544			528
	Workers’ compensation			43			46			51
		Total	$	24,906		$	25,349		$	23,369
Net Premiums Earned:
	Homeowners		$	13,477		$	12,552		$	11,874
	Personal automobile			7,197			6,894			5,948
	Fire, allied, inland marine			2,194			2,103			2,162
	Other liability			505			307			322
	Workers’ compensation			41			44			60
		Total	$	23,414		$	21,900		$	20,366
Net Loss Ratios:
	Homeowners			82.8	%		74.3	%		68.1	%
	Personal automobile			77.0			94.5			67.8
	Fire, allied, inland marine			28.1			53.6			14.8
	Other liability			104.1			200.3			102.7
	Workers’ compensation			0.0			11.1			29.3
		Total		76.1	%		80.3	%		62.8	%
Expense Ratio
	Homeowners			48.1	%		44.8	%		46.5	%
	Personal automobile			38.9			37.8			39.6
	Fire, allied, inland marine			47.7			43.7			45.6
	Other liability			32.6			33.5			41.4
	Workers’ compensation			25.8			26.5			24.7
		Total		44.9	%		42.3	%		44.2	%
Combined Ratios(1):
	Homeowners			130.9	%		119.1	%		114.6	%
	Personal automobile			115.9			132.3			107.4
	Fire, allied, inland marine			75.8			97.3			60.4
	Other liability			136.7			233.8			144.1
	Workers’ compensation			25.8			37.6			54.0
		Total		121.0	%		122.6	%		107.0	%

(1)  A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

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Homeowners

      Our homeowners policy is a multi-peril policy providing property and liability coverages and optional inland marine coverage. The homeowners policy is sold to provide coverage for an insured’s residence. We market both a standard and a preferred homeowner product. The preferred product is offered at a discount to our standard rates to our customers who have a lower risk of loss. As of December 31, 2004, we had approximately 26,000 homeowners policies in force, with 36% of those being the preferred product.

Personal Automobile

      We write comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles. As of December 31, 2004, we had approximately 7,500 personal automobile policies in force. We do not write any private passenger automobile products in New Jersey.

Combination Dwelling Policy

      Our combination dwelling product is a flexible, multi-line package of insurance coverage. It is targeted to be written on an owner or tenant occupied dwelling of no more than two families. The dwelling policy combines property and liability insurance but also may be written on a monoline basis. The property portion is considered a fire, allied lines and inland marine policy, and the liability portion is considered an other liability policy. Approximately 3,100 combination dwelling policies were in force as of December 31, 2004.

Other Liability

      We write personal line excess liability, or “umbrella,” policies covering personal liabilities in excess of amounts covered under our homeowners policies. These policies are available generally with limits of $1 million to $5 million. We do not market excess liability policies to individuals unless we also write an underlying primary liability policy.

Workers’ Compensation

      A small portion of our workers’ compensation premiums are considered personal lines insurance because our New Jersey homeowners policy is required to include workers’ compensation coverage for domestic employees.

MARKETING

      We market our insurance products in New Jersey and Pennsylvania exclusively through independent producers. All of these producers represent multiple carriers and are established businesses in the communities in which they operate. They generally market and write the full range of our insurance companies’ products. We consider our relationships with our producers to be good.

      Our insurance companies manage their producers through quarterly business reviews (with underwriter participation) and establishment of benchmarks/goals for premium volume and profitability. Our insurance companies in recent years have eliminated a number of low volume or unprofitable producers.

      For the years ended December 31, 2004 and 2003, our two largest producers accounted for approximately 24% and 24% of our direct premiums written, respectively. One of these agencies is the Davis Insurance Agency which is owned by H. Thomas Davis, Jr., a director and employee of the Company and the founder of Franklin Insurance Company. Pursuant to an Agency Business Agreement dated June 1, 2001, the Davis Insurance Agency has granted to Mercer Insurance Company a right of first refusal to acquire the Davis Insurance Agency upon any proposed sale by Mr. Davis. Under the Agency Business Agreement, the Davis Insurance Agency also has granted to Franklin Insurance Company a right of first refusal on all personal

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automobile and homeowners insurance produced by the agency. However, the agency may terminate this right if:

      (i) Franklin Insurance Company does not remain reasonably competitive in rates, coverage, service and commissions with the majority of the carriers in its market;

      (ii) Mr. Davis ceases to beneficially own shares of the Company stock in an amount equal to the shares of Company stock exchanged for his shares of voting common stock of Franklin Holding Company, Inc. as a result of the Conversion; or

      (iii) Mercer Insurance Company fails to exercise its right of first refusal within the time period required by the agreement.

      The other top producer is Brown & Brown, Inc., which is not affiliated with us. No other producer accounted for more than 5% of our direct premiums written. For the years ended December 31, 2004 and 2003, our top 10 producers accounted for 44% and 40%, respectively, of direct premiums written, with the largest producer generating approximately $8.0 million and $7.8 million of our premium revenue, respectively.

      We emphasize personal contact between our producers and the policyholders. We believe that our producers’ fast and efficient service and name recognition, as well as our policyholders’ loyalty to and satisfaction with producer relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention.

      Our insurance companies depend upon their producer force to produce new business, to provide customer service, and to be selective underwriters in their screening of risks for our insurance companies to consider underwriting. The network of independent producers also serves as an important source of information about the needs of the communities served by our insurance companies. We use this information to develop new products and new product features.

      Producers are compensated through a fixed base commission with an opportunity for profit sharing depending on the producer’s aggregate premiums earned and loss experience. Profit sharing opportunities are for a producer’s entire book of business with the Company and not specifically for any individual policy. The Company does not have any marketing services agreements, placement services agreements, or similar arrangements. By contract, our producers represent the Company. They are monitored and supported by our marketing representatives, who are employees of BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company. These representatives also have principal responsibility for recruiting and training new producers.

      Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service, resulting in a positive experience for producers and policyholders. We believe that these positive experiences are then conveyed by producers and policyholders to many potential customers.

UNDERWRITING

      Our insurance companies write their personal and commercial lines by evaluating each risk with consistently applied standards. We maintain information on all aspects of our business that is regularly reviewed to determine product line profitability. We also employ numerous underwriters, who generally specialize in either personal or commercial lines, and have many years of experience as underwriters. Specific information is monitored with regard to individual insureds to assist us in making decisions about policy renewals or modifications. New risks are frequently inspected to insure they are as desirable as suggested by the application process.

      We rely on information provided by our independent producers. Subject to certain guidelines, producers also pre-screen policy applicants. The producers have the authority to sell and bind insurance coverages in accordance with pre-established guidelines. Producers’ results are continuously monitored. On occasion, producers with historically poor loss ratios have had their binding authority removed until more profitable underwriting results were achieved. Continued poor loss ratios often result in agency termination.

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CLAIMS

      Claims on insurance policies are received directly from the insured or through our independent producers. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size and complexity of the claim. The adjuster investigates and settles the claim. As of December 31, 2004, we had thirteen in-house adjusters and worked with numerous independent adjusters. The Company also has a contingency plan for adjusting and processing claims resulting from a natural catastrophe.

      Claims settlement authority levels are established for each claims adjuster based upon his or her level of experience. Multi-line teams exist to handle all claims. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims.

      We attempt to minimize claims costs by encouraging the use of alternative dispute resolution procedures. Approximately 25% of all open claims under our policies are in litigation. Litigated claims are assigned to outside counsel.

TECHNOLOGY

      When Mercer Mutual was evaluating its acquisition of Franklin Holding and its subsidiary, Franklin Insurance Company, one of Franklin’s attractive features was its information technology system. Franklin Insurance was formed in 1997 with the idea that, by building an efficient information system, it could reduce expenses for both the producer and the company. Because homeowners’ and private passenger automobile insurance are largely commodity businesses, low cost product delivery is crucial, especially for small companies that do not otherwise enjoy economies of scale. Franklin Insurance licensed a flexible insurance software package and internally built a front-end Internet based interface to the system. All business generated by Franklin Insurance’s producers is processed and maintained in this system through the Internet, and these producers have access to their books of business through the Internet. This system provides efficiency because information for all users is entered only one time.

      The Company has undertaken a project to convert all of its business on to a platform which is a modified version of the system Franklin built for its business. The reasons for this decision include efficiencies to be achieved and a modernized system that will provide greater flexibility and cost savings while bringing our data-processing needs in-house where they can be better managed. Completion of the project should result in cost reduction, because we are currently operating two systems as we gradually move the business from the external system to our internal system.

      Because of the experience and knowledge of the Franklin Insurance staff with the software package, all internal programming is conducted at our branch office in Lock Haven, Pennsylvania. In addition to the expert knowledge of this staff, we are able to hire and maintain staff at a more efficient cost than the cost at the home office location in Pennington, New Jersey due to differences in the cost of living in the respective areas.

      The focus of our ongoing information technology effort is:

•  to continue to re-engineer our internal processes to allow for more efficient operations;

•  to improve our producers’ ability to transact business with us; and

•  to enable our producers to efficiently provide their clients with a high level of service.

•  to enhance agency access to online inquiry capabilities

•  to provide agencies with on-line monthly reporting

      We believe that our technology initiative will increase revenues by making it easier for our insurance companies and producers to exchange information and do business with us. Increased ease of use also should lower expenses. However, our short-term expenses have increased because of costs associated with the implementation of the new system and the need to maintain two systems during the transition.

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      The Company also has an initiative underway to convert from a paper-based filing and policy production/mailing system to a digital imaging and workflow system enabling automatic transfer of policy output to an electronic repository, supporting on-line inquiry and automated mailing.

      We have not taken any steps to legally protect our intellectual property under any statutory scheme. We believe our intellectual property is a trade secret that is protected under common law and provides us with some competitive advantage in the near term, but we believe Internet-based producer/company interfaces will become commonplace and commercially available interfaces will dominate the market. Therefore, we do not believe that taking the costly steps to protect our intellectual property is justified.

REINSURANCE

Reinsurance Ceded

      In accordance with insurance industry practice, our insurance companies reinsure a portion of their exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by our companies are reinsured with other insurance companies principally to:

•  reduce net liability on individual risks;

•  mitigate the effect of individual loss occurrences (including catastrophic losses);

•  stabilize underwriting results;

•  decrease leverage; and

•  increase our insurance companies’ underwriting capacity.

      Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each policy or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of a class of business is automatically reinsured. Reinsurance also can be classified as quota share reinsurance, pro-rata insurance or excess of loss reinsurance. Under quota share reinsurance and pro-rata insurance, the ceding company cedes a percentage of its insurance liability to the reinsurer in exchange for a like percentage of premiums less a ceding commission. The ceding company in turn recovers from the reinsurer the reinsurer’s share of all losses and loss adjustment expenses incurred on those risks. Under excess reinsurance, an insurer limits its liability to all or a particular portion of the amount in excess of a predetermined deductible or retention. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the ceding company to the extent of the coverage ceded.

      We determine the amount and scope of reinsurance coverage to purchase each year based on a number of factors. These factors include the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance. Our reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually. For the year ended December 31, 2004, our insurance companies ceded to reinsurers $8.4 million of written premiums, compared to $10.0 million of written premiums for the year ended December 31, 2003, and $7.2 million for the year ended December 31, 2002.

      The largest exposure that we retained in 2004 on any one individual property risk was $500,000. For 2005, that retention will remain at $500,000. Individual property risks in excess of these amounts are covered on an excess of loss basis pursuant to various reinsurance treaties. All property lines of business, including commercial automobile physical damage, are reinsured under the same treaties.

      Except for umbrella liability, individual casualty risks that are in excess of $500,000 commencing January 1, 2004 ($300,000 in 2003) are covered on an excess of loss basis up to $1.0 million per occurrence, pursuant to various reinsurance treaties. Casualty losses in excess of $1.0 million arising from workers’ compensation claims are reinsured up to $10.0 million on a per occurrence and per person treaty basis by various reinsurers. Umbrella liability losses are reinsured on a 90% quota share basis up to $1.0 million and a 100% quota share basis in excess of $1.0 million up to $5.0 million. Beginning in 2005, umbrella liability losses

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are reinsured on a 75% quota share basis up to $1.0 million, with the same 100% quota share basis in excess of $1.0 million up to $5.0 million. We also purchase casualty contingency loss excess reinsurance providing $3.0 million of coverage in excess of $1.0 million.

      Catastrophic reinsurance protects the ceding insurer from significant aggregate loss exposure. Catastrophic events include windstorms, hail, tornadoes, hurricanes, earthquakes, riots, blizzards, terrorist activities and freezing temperatures. We purchase layers of excess treaty reinsurance for catastrophic property losses. We reinsure 97.5% (100% beginning in 2005) of losses per occurrence in excess of $2.0 million, up to a maximum of $32.0 million per occurrence. In 2003 we also reinsured 100% of any catastrophic losses per occurrence in an amount between $1.0 million and up to $2.0 million, but this coverage was discontinued for 2004 in view of our greater ability to absorb losses as a consequence of the new capital received in the Conversion.

      The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition. As of December 31, 2004, our five largest reinsurers based on percentage of ceded premiums are set forth in the following table:

	Percentage
	of Ceded			A.M. Best
Name	Premiums			Rating
1. American Re-Insurance Co		23.6	%		A
2. GE Reinsurance Corporation		17.3	%		A u
3. Motors Insurance Corporation		12.8	%		A
4. Endurance Reinsurance Corp of America		7.6	%		A
5. Arch Reinsurance Company		6.8	%		A	-

      The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of December 31, 2004.

	Loss and
	Loss Expenses
	Recoverable on		A.M. Best
Name	Unpaid Claims		Rating
	(In thousands)
1. Motors Insurance Corporation	$	991		A
2. SCOR Reinsurance Company		545		B	++
3. GE Reinsurance Corporation		302		A u
4. American Re-Insurance Co		281		A
5. Endurance Reinsurance Corp of America		154		A

      The A and A- ratings are the third and fourth highest of A.M. Best’s 16 ratings. According to A.M. Best, companies with a rating of “A” or “A-” are rated “Excellent”, with “...an excellent ability to meet their ongoing obligations to policyholders.” Companies rated “B++” or “B+” have “...a good ability to meet their ongoing obligations to policyholders.” The subscript “u” after the rating means “under review”. We monitor the solvency of our reinsurers through regular review of their financial statements and their A.M. Best ratings. We have experienced no significant difficulties collecting amounts due from reinsurers.

Reinsurance Assumed

      We generally do not assume risks from other insurance companies. However, we are required by statute to participate in certain residual market pools. This participation requires us to assume business for workers’ compensation and for property exposures that are not insured in the voluntary marketplace. We participate in these residual markets pro rata on a market share basis, and as of December 31, 2004, our participation is not material.

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Changes on Renewal in Reinsurance Ceded

      Effective January 1, 2004, we dropped the first layer of our catastrophe program (as described above, the first layer previously covered 100% of any catastrophic losses per occurrence in an amount between $1.0 million and up to $2.0 million), increased our underlying retention from $300,000 to $500,000, and replaced SCOR Reinsurance Company and PMA Capital Insurance Co. with two new reinsurers: Endurance Reinsurance Corp. of America (rated by A.M. Best at “A”) and GE Reinsurance Corporation. (rated by A. M. Best at “A u”).

INTERCOMPANY AGREEMENTS

      Effective January 1, 2002, our insurance companies are parties to a Reinsurance Pooling Agreement and related Loss Portfolio Transfer Reinsurance Agreements. Under these agreements, all premiums, losses and underwriting expenses of our insurance companies are combined and subsequently shared based on each individual company’s statutory surplus from the most recently filed statutory annual statement. The Reinsurance Pooling Agreement has no impact on our consolidated results.

      The Company’s insurance subsidiaries are parties to a Services Allocation Agreement, effective as of July 1, 2001. Pursuant to this agreement, any and all employees of Mercer Insurance Company and each of its subsidiaries (other than BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company) were transferred to, and became employees of, BICUS. BICUS has agreed to perform all necessary functions and services required by Mercer Insurance Company and each of its subsidiaries in conducting their respective operations. In turn, Mercer Insurance Company and each of its subsidiaries has agreed to reimburse BICUS for its costs and expenses incurred in rendering such functions and services in an amount determined by the parties.

      The Company and its subsidiaries are parties to a consolidated tax allocation agreement that allocates each company a pro rata share of the consolidated income tax expense based upon its contribution of taxable income to the consolidated group.

LOSS AND LAE RESERVES

      Our insurance companies are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (LAE). These reserves are established for both reported claims and for claims incurred but not reported (IBNR), arising from the policies they have issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what our insurance companies expect to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and changing judicial theories of liability.

      Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Our reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. We do not discount our reserves to recognize the time value of money.

      When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by our claims staff as more information becomes available. It is our policy to settle each claim as expeditiously as possible.

      We maintain IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating our insurance companies’

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ultimate net liability for both reported and IBNR claims and then subtracting the case reserves for reported claims.

      Each quarter, we compute our estimated ultimate liability using principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. We do not believe our insurance companies are subject to any material potential asbestos or environmental liability claims.

      The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of the Company and its subsidiaries for the years ended December 31, 2004, 2003 and 2002, prepared in accordance with accounting principles generally accepted in the United States of America.

RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

		Year Ended December 31,
		2004			2003			2002
		(In thousands)
Reserves for losses and loss adjustment expenses at the beginning of period		$	37,261		$	31,348		$	31,059
Less: Reinsurance recoverable and receivables			(5,036	)		(4,150	)		(5,425	)
Net reserves for losses and loss adjustment expenses at beginning of period			32,225			27,198			25,634
Add: Provision for losses and loss adjustment expenses for claims occurring in:
	The current year		29,024			28,329			22,211
	Prior years		(886	)		(596	)		(2,144	)
Total incurred losses and loss adjustment expenses			28,138			27,733			20,067
Less: Loss and loss adjustment expenses payments for claims occurring in:
	The current year		14,626			13,866			11,128
	Prior years		12,772			8,840			7,375
Total losses and loss adjustment expenses paid			27,398			22,706			18,503
Net reserves for losses and loss adjustment expenses at end of period			32,965			32,225			27,198
Add: Reinsurance recoverables and receivables			3,063			5,036			4,150
Reserves for losses and loss adjustment expenses at end of period		$	36,028		$	37,261		$	31,348

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      The following tables show the development of our consolidated reserves for unpaid losses and LAE from 1994 through 2004 determined under U.S. generally accepted accounting principles (GAAP). The top line of each table shows the liabilities at the balance sheet date, including losses incurred but not yet reported. The upper portion of each table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of each table shows the reestimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual years. The redundancy exists when the re-estimated liability at each December 31 is less than the prior liability estimate. The “cumulative redundancy” depicted in the tables, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years.

		Year Ended December 31,
		1994		1995		1996		1997		1998		1999
		(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable		$	18,298	$	19,357	$	20,074	$	19,851	$	22,565	$	23,643
Cumulative amount of liability paid through:
	One year later		6,935		6,368		6,042		4,536		5,525		5,842
	Two years later		10,272		9,554		8,829		7,537		8,655		8,627
	Three years later		12,336		11,539		11,143		9,738		10,605		11,237
	Four years later		13,228		12,819		12,472		10,975		11,893		12,726
	Five years later		13,749		13,690		13,422		11,550		12,554		13,613
	Six years later		14,079		14,196		13,826		11,816		13,034
	Seven years later		14,373		14,450		14,043		12,118
	Eight years later		14,605		14,621		14,236
	Nine years later		14,732		14,785
	Ten years later		14,795
Liability estimated as of:
	One year later		17,344		17,712		19,018		17,874		19,909		19,689
	Two years later		16,860		17,247		17,634		16,440		17,478		18,506
	Three years later		16,495		16,568		16,987		14,711		16,625		17,484
	Four years later		15,810		16,208		15,905		14,204		15,826		16,167
	Five years later		15,641		15,680		15,769		13,913		14,762		16,200
	Six years later		15,376		15,584		15,483		13,273		14,955
	Seven years later		15,358		15,573		14,986		13,462
	Eight years later		15,424		15,349		15,191
	Nine years later		15,281		15,493
	Ten years later		15,397
Cumulative total redundancy		$	2,901	$	3,863	$	4,883	$	6,389	$	7,611	$	7,443
Gross liability — end of year			35,531		36,176		35,221		31,872		30,948		29,471
Reinsurance recoverables			17,233		16,819		15,147		12,021		8,383		5,828
Net liability — end of year		$	18,298	$	19,357	$	20,074	$	19,851	$	22,565	$	23,643
Gross reestimated liability — latest			27,964		27,238		24,845		21,662		20,341		20,972
Reestimated reinsurance recoverables — latest			12,567		11,745		9,654		8,200		5,386		4,772
Net reestimated liability — latest		$	15,397	$	15,493	$	15,191	$	13,462	$	14,955	$	16,200
Gross cumulative redundancy		$	7,567	$	8,938	$	10,376	$	10,210	$	10,607	$	8,499

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		Year Ended December 31,
		2000		2001		2002		2003		2004
		(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable		$	24,091	$	25,634	$	27,198	$	32,225	$	32,965
Cumulative amount of liability paid through:
	One year later		5,726		7,376		8,840		12,772		—
	Two years later		9,428		11,850		15,442
	Three years later		12,142		15,610
	Four years later		14,139
	Five years later Six years later Seven years later Eight years later Nine years later Ten years later Liability estimated as of:
	One year later		20,810		23,490		26,601		31,339		—
	Two years later		19,539		22,084		26,924
	Three years later		17,745		22,522
	Four years later		18,050
	Five years later
	Six years later
	Seven years later
	Eight years later
	Nine years later
	Ten years later
Cumulative total redundancy		$	6,041	$	3,111	$	274	$	886		—
Gross liability — end of year			28,766		31,059		31,348		37,261		36,028
Reinsurance recoverables			4,675		5,425		4,150		5,036		3,063
Net liability — end of year		$	24,091	$	25,634	$	27,198	$	32,225	$	32,965
Gross reestimated liability — latest			22,600		27,842		31,214		36,042
Reestimated reinsurance recoverables — latest			4,550		5,320		4,290		4,703
Net reestimated liability — latest		$	18,050	$	22,522	$	26,924	$	31,339
Gross cumulative redundancy		$	6,166	$	3,216	$	134	$	1,219

INVESTMENTS

      On a consolidated basis, all of our investment fixed income and equity securities are classified as available for sale and are carried at fair value.

      An important component of our consolidated operating results has been the return on invested assets. Our investment objectives are to: (i) maximize current yield, (ii) maintain safety of capital through a balance of high quality, diversified investments that minimize risk, (iii) maintain adequate liquidity for our insurance operations, (iv) meet regulatory requirements, and (v) increase surplus through appreciation. However, in order to enhance the yield on our fixed income securities, our investments generally have a longer duration than the life of our liabilities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subsection entitled “Quantitative and Qualitative Information about Market Risk.”

      Our investment policy requires that investments be made in a portfolio consisting of bonds, equity securities, and short-term money market instruments. Our equity investments are concentrated in companies with larger capitalizations. However, the Company’s second largest equity holding, valued at $1.1 million, is

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our investment in the common stock of Excess Reinsurance Company, which is a privately held, illiquid security (which, in 2004, paid a special dividend to the Group of $274,000). The investment policy does not permit investment in unincorporated businesses, private placements or direct mortgages, foreign denominated securities, financial guarantees or commodities. The Board of Directors of the Company has developed this investment policy and reviews it periodically.

      The following table sets forth consolidated information concerning our investments. The changes in the distribution of the fixed income securities portfolio among the categories in the table below from December 31, 2003 to December 31, 2004 reflects our decision, effective January 1, 2004, to move the management of our fixed income securities to a new management firm, and the reallocation undertaken by that firm to achieve an overall increase in returns while maintaining an investment-grade portfolio.

			At December 31, 2004				At December 31, 2003				At December 31, 2002
			Cost(2)		Fair Value		Cost(2)		Fair Value		Cost(2)		Fair Value
			(In thousands)
Fixed income securities(1):
	United States government and government agencies		$	17,870	$	17,700	$	38,974	$	38,826	$	38,802	$	39,499
	Obligations of states and political subdivisions			35,801		35,745		5,083		5,235		5,976		6,149
	Industrial and miscellaneous			16,896		16,781		2,157		2,147		3,216		3,259
	Mortgage-backed securities			30,535		30,431		68		69		336		340
		Total fixed income securities		101,102		100,657		46,282		46,277		48,330		49,247
Equity securities				16,145		24,447		15,866		22,656		16,697		20,332
Short-term investments				—		—		54,396		54,396		—		—
		Total	$	117,247	$	125,104	$	116,544	$	123,329	$	65,027	$	69,579

(1)	In our consolidated financial statements, investments are carried at fair value.
(2)	Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount.

      The table below contains consolidated information concerning the investment ratings of our fixed maturity investments at December 31, 2004.

		Amortized
Type/Ratings of Investment(1)		Cost		Fair Value		Percentages(2)
		(Dollars in thousands)
U.S. Government and agencies		$	17,870	$	17,700		17.6	%
AAA			49,106		48,899		48.5	%
AA			14,412		14,404		14.3	%
A			14,772		14,757		14.7	%
BBB			4,942		4,897		4.9	%
	Total	$	101,102	$	100,657		100.0	%

(1)	The ratings set forth in this table are based on the ratings assigned by Standard & Poor’s Corporation (S&P). If S&P’s ratings were unavailable, the equivalent ratings supplied by Moody’s Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available.
(2)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

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      The table below sets forth the maturity profile of our consolidated fixed maturity investments as of December 31, 2004:

		Amortized
Maturity		Cost(1)		Fair Value		Percentages(2)
		(Dollars in thousands)
1 year or less		$	65	$	65		0.1	%
More than 1 year through 5 years			18,772		18,661		18.5	%
More than 5 years through 10 years			39,864		39,708		39.5	%
More than 10 years			11,866		11,792		11.7	%
Mortgage-backed securities			30,535		30,431		30.2	%
	Total	$	101,102	$	100,657		100.0	%

(1)	Fixed maturities are carried at fair value in our consolidated financial statements.
(2)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

      The average duration of our fixed maturity investments, excluding mortgage-backed securities that are subject to prepayment, was approximately 3.7 years as of December 31, 2004. As a result, the market value of our investments may fluctuate in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.

      Our consolidated average cash and invested assets, net investment income and return on average cash and invested assets for the years ended December 31, 2004, 2003 and 2002 were as follows:

	Year Ended December 31,
	2004			2003			2002
	(Dollars in thousands)
Average cash and invested assets	$	139,015		$	84,572		$	74,973
Net investment income		2,841			1,707			2,061
Return on average cash and invested assets		2.0	%		2.0	%		2.7	%

A.M. BEST RATING

      A.M. Best rates insurance companies based on factors of concern to policyholders. A.M. Best currently assigns an “A” (Excellent) rating to our insurance companies as a group. This rating is the third highest out of 16 rating classifications. According to the A.M. Best guidelines, A.M. Best assigns “A” ratings to companies that have, on balance, excellent balance sheet strength, operating performance and business profiles. Companies rated “A” are considered by A.M. Best to have “an excellent ability to meet their ongoing obligations to policyholders.” In evaluating a company’s financial and operating performance, A.M. Best reviews:

•  the company’s profitability, leverage and liquidity;

•  its book of business;

•  the adequacy and soundness of its reinsurance;

•  the quality and estimated market value of its assets;

•  the adequacy of its reserves and surplus;

•  its capital structure;

•  the experience and competence of its management; and

•  its marketing presence.

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COMPETITION

      The property and casualty insurance market is highly competitive. Our insurance companies compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Some of these competitors have substantially greater financial, technical and operating resources than our insurance companies. Within our producer’s offices we compete to be a preferred market for desirable business, as well as competing with other carriers to attract and retain the best producers. Our ability to compete successfully in our principal markets is dependent upon a number of factors, many of which are outside our control. These factors include market and competitive conditions. Many of our lines of insurance are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other distribution methods, rather than through independent producers paid on a commission basis (as our insurance companies do). In addition to price, competition in our lines of insurance is based on quality of the products, quality and speed of service, financial strength, ratings, distribution systems and technical expertise.

REGULATION

General

      Insurance companies are subject to supervision and regulation in the states in which they do business. State insurance authorities have broad administrative powers to administer statutes and regulations with respect to all aspects of our insurance business including:

•  approval of policy forms and premium rates;

•  standards of solvency, including establishing statutory and risk-based capital requirements for statutory surplus;

•  classifying assets as admissible for purposes of determining statutory surplus;

•  licensing of insurers and their producers;

•  advertising and marketing practices;

•  restrictions on the nature, quality and concentration of investments;

•  assessments by guaranty associations;

•  restrictions on the ability of our insurance company subsidiaries to pay dividends to us;

•  restrictions on transactions between our insurance company subsidiaries and their affiliates;

•  restrictions on the size of risks insurable under a single policy;

•  requiring deposits for the benefit of policyholders;

•  requiring certain methods of accounting;

•  periodic examinations of our operations and finances;

•  claims practices;

•  prescribing the form and content of records of financial condition required to be filed; and

•  requiring reserves for unearned premium, losses and other purposes.

      State insurance laws and regulations require our insurance companies to file financial statements with insurance departments everywhere they do business, and the operations of our insurance companies and accounts are subject to examination by those departments at any time. Our insurance companies prepare statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by these departments.

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Examinations

      Examinations are conducted by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance every three to five years. The Pennsylvania Insurance Department’s last examination of Mercer Insurance Company was as of December 31, 1999. Their last examination of Franklin Insurance Company was as of December 31, 2001. The New Jersey Department of Banking and Insurance’s last completed examination of Mercer Insurance Company was as of December 31, 1995. Their last examination of Mercer Insurance Company of New Jersey, Inc. was as of December 31, 2000. These examinations did not result in any adjustments to the financial position of any of our insurance companies. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on the operations of our insurance companies. The Group has been notified that normal tri-ennial financial examinations by both the Pennsylvania and New Jersey regulators will commence in 2005.

NAIC Risk-Based Capital Requirements

      In 1990, the National Association of Insurance Commissioners (the “NAIC”) began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over five regulatory areas to be considered for accreditation. The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of December 31, 2004, Pennsylvania and New Jersey, the states in which our insurance company subsidiaries are domiciled, were accredited.

      Pennsylvania and New Jersey both impose the NAIC’s risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business risks and such other relevant risks as are set forth in the RBC instructions. A company’s “total adjusted capital” is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies.

      The requirements provide for four different levels of regulatory attention. The “company action level” is triggered if a company’s total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The “regulatory action level” is triggered if a company’s total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The “authorized control level” is triggered if a company’s total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The “mandatory control level” is triggered if a company’s total adjusted capital is less than 0.7 times its authorized control level; at this level the regulatory authority is mandated to place the company under its control. The capital levels of our insurance companies have never triggered any of these regulatory capital levels. We cannot assure you, however, that the capital requirements applicable to the business of our insurance companies will not increase in the future.

NAIC Ratios

      The NAIC also has developed a set of 11 financial ratios referred to as the Insurance Regulatory Information System or (IRIS). On the basis of statutory financial statements filed with state insurance regulators, the NAIC annually calculates these IRIS ratios to assist state insurance regulators in monitoring

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the financial condition of insurance companies. The NAIC has established an acceptable range for each of the IRIS financial ratios. If four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC, an insurance company may receive inquiries from individual state insurance departments. During each of the years ended December 31, 2003 and 2002, Mercer Insurance Company, Mercer Insurance Company of New Jersey, Inc., and Franklin Insurance Company did not produce results outside the acceptable range for four or more IRIS tests. The results for 2004 are not yet available.

Market Conduct Regulation

      State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations, which the Company is subject to from time to time. A market conduct examination of Franklin Insurance Company was recently completed by the Pennsylvania Insurance Department without any material issues. A market conduct examination of our New Jersey Homeowners and Combination Dwelling lines of business was also recently completed, and we are waiting for the report. To our knowledge, we are currently in substantial compliance with the related provisions.

Property and Casualty Regulation

      Our property and casualty operations are subject to rate and policy form approval. All of the rates and policy forms that we use that require regulatory approval have been filed with and approved by the appropriate insurance regulator. Our operations are also subject to laws and regulations covering a range of trade and claim settlement practices. To our knowledge, we are currently in compliance with these laws and regulations. State insurance regulatory authorities have broad discretion in approving an insurer’s proposed rates. The extent to which a state restricts underwriting and pricing of a line of business may adversely affect an insurer’s ability to operate that business profitably in that state on a consistent basis.

      State insurance laws and regulations require us to participate in mandatory property-liability “shared market,” “pooling” or similar arrangements that provide certain types of insurance coverage to individuals or others who otherwise are unable to purchase coverage voluntarily provided by private insurers. Shared market mechanisms include assigned risk plans; fair access to insurance requirements or “FAIR” plans; and reinsurance facilities, such as the New Jersey Unsatisfied Claim and Judgment Fund. In addition, some states require insurers to participate in reinsurance pools for claims that exceed specified amounts. Our participation in these mandatory shared market or pooling mechanisms generally is related to the amounts of our direct writings for the type of coverage written by the specific arrangement in the applicable state. For the three years ended December 31, 2004, 2003 and 2002, we received earned premium from these arrangements in the amounts of $1,829,000, $1,312,000, and $666,000, respectively, and incurred losses and loss expenses from these arrangements in the amounts of $1,565,000, $582,000, and $415,000, respectively. Because we do not have a significant amount of direct writings in the coverages written under these arrangements, we do not anticipate that these arrangements will have a material effect on us in the future. However, we cannot predict the financial impact of our participation in any shared market or pooling mechanisms that may be implemented in the future by the states in which we do business.

Guaranty Fund Laws

      Many states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. New Jersey and Pennsylvania, the states in which our insurance companies do business, have such laws. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2004, 2003 and 2002, we incurred approximately ($28,000), $101,000, and $99,000, respectively, in assessments pursuant to state insurance guaranty association laws. The negative assessment incurred in 2004 reflects the settlement of guaranty fund assessments for 2002 and 2001 at more favorable rates than anticipated. We establish reserves relating to insurance companies that are subject to insolvency proceedings

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when we are notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on our insurance companies under these laws.

Sarbanes-Oxley Act of 2002

      On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, or the SEC, under the Securities Exchange Act of 1934, or the Exchange Act.

      The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specified issues by the SEC and the Comptroller General.

      The SOA addresses, among other matters:

•  audit committees;

•  certification of financial statements by the chief executive officer and the chief financial officer;

•  the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

•  a prohibition on insider trading during pension plan black out periods;

•  disclosure of off-balance sheet transactions;

•  a prohibition on personal loans to directors and officers;

•  expedited filing requirements for Form 4 statements of changes of beneficial ownership of securities required to be filed by officers, directors and 10% shareholders;

•  disclosure of whether or not a company has adopted a code of ethics;

•  “real time” filing of periodic reports;

•  auditor independence; and

•  various increased criminal penalties for violations of securities laws.

      The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. To date, the SEC has implemented most of the provisions of the SOA. However, the SEC continues to issue final rules, reports, and press releases. As the SEC provides new requirements, we will review those rules and comply as required. In addition, the common stock trades on the Nasdaq National Market. NASDAQ also has adopted corporate governance rules that require additional compliance and supplement the SEC requirements under the SOA. We believe we are in compliance with all NASDAQ rules.

Terrorism Risk Insurance Act of 2002

      On November 26, 2002, President Bush signed the Terrorism Risk Insurance Act of 2002 (TRIA). Under this law, coverage provided by an insurer for losses caused by certified acts of terrorism is partially reimbursed by the United States under a formula under which the government pays 90% of covered terrorism losses, exceeding a prescribed deductible. Therefore, the act limits an insurer’s exposure to certified terrorist acts (as defined by the act) to the deductible formula. The deductible is based upon a percentage of direct earned premium for commercial property and casualty policies. Coverage under the act must be offered to all property, casualty and surety insureds.

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      The immediate effect was to nullify terrorism exclusions previously permitted by state regulators to the extent they exclude losses that would otherwise be covered under the act. The act further states that until December 31, 2003, rates and forms for terrorism risk insurance covered by the act are not subject to prior approval or a waiting period under any applicable state law. Rates and forms of terrorism exclusions and endorsements are subject to subsequent review.

      We are currently charging a premium for certified terrorism coverage on our Businessowners, Commercial Automobile and commercial Workers’ Compensation policies. In 2005, we expect to start charging a premium for certified terrorism coverage for tenant-occupied dwelling policies and for all policies issued under a Special Contractors policy. Insureds who are charged a terrorism premium have the option (except Workers’ Compensation) of deleting certified terrorism coverage to reduce their premium costs, however most do not do so. Insureds under commercial Workers’ Compensation policies do not have the option to delete the certified terrorism coverage. Most other policies include certified terrorism coverage at no additional cost. Where allowed, we exclude coverage for losses that are from events not certified as terrorism events, with no buyback option available to the policyholder.

      The legislation that created the Terrorism Risk Insurance Act of 2002 expires on December 31, 2005. If this legislation is not extended beyond that date, all potential reimbursement for certified terrorism losses will end on that date. In order to limit our exposure for certified terrorism losses, we have received approval from our state regulators to use a contingent certified terrorism exclusion that will exclude coverage for certified terrorism losses that occur after December 31, 2005 in the event that TRIA is not extended.

      We are unable to predict the extent to which this legislation may affect the demand for our products or the risks that will be available for us to consider underwriting. We do not know the extent to which insureds will elect to purchase this coverage when available.

Financial Services Modernized

      The Gramm-Leach-Bliley Act was signed into law by President Clinton on November 12, 1999. The principal focus of the act is to facilitate affiliations among banks, securities firms and insurance companies. The ability of banks and securities firms to affiliate with insurers may increase the number, size and financial strength of our potential competitors.

Privacy

      As mandated by the Gramm-Leach-Bliley Act, states continue to promulgate and refine laws and regulations that require financial institutions, including insurance companies, to take steps to protect the privacy of certain consumer and customer information relating to products or services primarily for personal, family or household purposes. A recent NAIC initiative that affected the insurance industry was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. Our insurance subsidiaries have implemented procedures to comply with the Gramm-Leach-Bliley Act’s privacy requirements.

OFAC

      The Treasury Department’s Office of Foreign Asset Control (OFAC) maintains a list of “Specifically Designated Nationals and Blocked Persons” (the SDN List). The SDN List identifies persons and entities that the government believes are associated with terrorists, rogue nations or drug traffickers. OFAC’s regulations prohibit insurers, among others, from doing business with persons or entities on the SDN List. If the insurer finds and confirms a match, the insurer must take steps to block or reject the transaction, notify the affected person and file a report with OFAC. The focus on insurers’ responsibilities with respect to the SDN List has increased significantly since September 11, 2001.

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New and Proposed Legislation and Regulations

      The property and casualty insurance industry has recently received a considerable amount of publicity because of rising insurance costs, the lack of availability of insurance, and the issue of paying profit-sharing commissions to agents. New regulations and legislation are being proposed to limit damage awards, to control plaintiffs’ counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. We are unable to predict whether, in what form, or in what jurisdictions, any regulatory proposals might be adopted or their effect, if any, on our insurance companies.

Dividends

      Our insurance companies are restricted by the insurance laws of their respective states of domicile regarding the amount of dividends or other distributions they may pay without notice to or the prior approval of the state regulatory authority. The Pennsylvania Insurance Department’s approval of Mercer Insurance Company’s Conversion to stock form was given subject to, among other things, the condition that for a period of three years following the Conversion, Mercer Insurance Company may not declare or pay a dividend to the Holding Company without the approval of the Pennsylvania Insurance Department. After this three-year period has expired, Mercer Insurance Company’s ability to declare and pay dividends to the Holding Company will be subject to Pennsylvania law.

      Pennsylvania law sets the maximum amount of dividends that may be paid by Mercer Insurance Company and Franklin Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. With respect to each insurance company, this amount cannot exceed the greater of 10% of the company’s statutory surplus as reported on the most recent annual statement filed with the Pennsylvania Insurance Department, or the company’s net income for the period covered by the annual statement. If the dividend restrictions contained in the Pennsylvania Insurance Department’s approval of the Conversion were not in effect, then as of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company to the Company in 2005 without the prior approval of the Pennsylvania Insurance Department would be approximately $6.2 million.

      New Jersey law sets the maximum amount of dividends that may be paid by Mercer Insurance Company of New Jersey, Inc. during any twelve-month period after notice to, but without prior approval of, the New Jersey Department of Banking and Insurance. This amount cannot exceed the greater of 10% of Mercer Insurance Company of New Jersey, Inc.’s statutory surplus as reported on the most recent annual statement filed with New Jersey, or the net income, not including realized capital gains, of Mercer Insurance Company of New Jersey, Inc. for the period covered by the annual statement. As of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company of New Jersey, Inc. to Mercer Insurance Company in 2005 (through Queenstown Holding Company, an intermediary holding company) without the prior approval of New Jersey Department of Banking and Insurance would be approximately $1.6 million.

Holding Company Laws

      Most states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine our insurance companies and their holding companies at any time, require disclosure of material transactions by our insurance companies and their holding companies and require prior notice of approval of certain transactions, such as “extraordinary dividends” distributed by our insurance companies.

      All transactions within the holding company system affecting our insurance companies and their holding companies must be fair and equitable. Notice of certain material transactions between our insurance companies and any person or entity in our holding company system will be required to be given to the

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applicable insurance commissioner. In some states, certain transactions cannot be completed without the prior approval of the insurance commissioner.

      Approval of the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In New Jersey and Pennsylvania, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person from (i) making a tender offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Insurance Department.

EMPLOYEES

      All of our employees are employed directly by BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company. Our insurance companies do not have any employees. BICUS provides management services to all of our insurance companies. As of December 31, 2004, the total number of full-time equivalent employees of BICUS was 97. None of these employees are covered by a collective bargaining agreement and BICUS believes that its employee relations are good.

ITEM 2. PROPERTIES

      Our main office is located at 10 North Highway 31, Pennington, New Jersey in a 25,000 square foot facility owned by Mercer Insurance Company. Mercer Insurance Company completed in 2004 an addition of 11,000 square feet to this structure at a cost of $2.9 million. We also own a tract of land adjacent to our main office property.

      Mercer Insurance Company also owns a 32,000 square foot office facility in Lock Haven, Pennsylvania. Mercer Insurance Company sub-leases a portion of this facility. Recent renovations to this facility were completed in December 2002 at a cost of $2.1 million.

ITEM 3. LEGAL PROCEEDINGS

      Our insurance companies are parties to litigation in the normal course of business. Based upon information presently available to us, we do not consider any litigation to be material. However, given the uncertainties attendant to litigation, we cannot be sure that our results of operations and financial condition will not be materially adversely affected by any litigation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

      The common stock trades on the Nasdaq National Market under the symbol “MIGP”. As of March 2, 2005, the Company had 370 shareholders of record holding approximately 1.3 million shares, with the balance of the outstanding shares held in street name.

      The Company does not currently pay a dividend. Any payment of dividends in the future on the common stock is subject to determination and declaration by the Company’s Board of Directors, who will take into consideration the Company’s financial condition, results of operations and future prospects. Additionally, the Company is prohibited from declaring or paying any dividends during the three years following the

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Conversion, unless such dividends are approved by the Pennsylvania Insurance Department. At present, the Company has no plans to pay a dividend to our shareholders.

      Information regarding restrictions and limitations on the payment of cash dividends can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the “Financial Condition, Liquidity and Capital Resources” section.

      The range of closing prices of the Company’s stock, traded on the NASDAQ National Market, during 2004 fell between $11.55 and $13.93 per share. The range of closing prices during each of the quarters in 2004 is shown below:

		4th Quarter				3rd Quarter				2nd Quarter				1st Quarter
		2004		2003		2004		2003		2004		2003		2004		2003
Share price range:
	High	$	13.48	$	12.61	$	12.18		N/A	$	12.82		N/A	$	13.93		N/A
	Low	$	11.65	$	12.15	$	11.55		N/A	$	11.58		N/A	$	12.40		N/A

      Information relating to the Company’s stock repurchase programs and activity in the most recent quarter is presented below:

					Total Number of		Maximum Number
					Shares Purchased as		of Shares that May
					Part of Publicly		Yet be Purchased
					Announced Plans or		Under the Plans or
	Total Number of		Average Price Paid		Programs		Programs
Period	Shares Purchased		per Share		(Notes 1 and 2)		(Notes 1 and 2)
October 1-31, 2004		None		N/A		None		250,000
November 1-30, 2004		6,500	$	12.19		6,500		243,500
December 1-31, 2004		None		N/A		None		243,500
Total		6,500	$	12.19		6,500		243,500

      Note 1 — On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. As of September 30, 2004, 250,000 shares had been repurchased under this authorization for a total consideration of $2,975,000, or $11.90 per share.

      Note 2 — On October 20, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, in addition to the June 16, 2004 authorization, and under the same terms and conditions. The program was intended to continue until October 20, 2005, or until 250,000 shares were repurchased, whichever occurs first, unless the program was extended or expanded. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. From January 1, 2005 through March 2, 2005, 243,500 shares were repurchased under this authorization , thereby completing all purchases currently authorized. The 2005 repurchases of 243,500 shares were completed for $3,210,000, or $13.18 per share. The total cost of repurchases under this authorization (250,000 shares) was $3,290,000, or $13.16 per share.

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ITEM 6. SELECTED FINANCIAL DATA

      The following table sets forth selected consolidated financial data for Mercer Insurance Group, Inc. at and for each of the years in the five year period ended December 31, 2004. You should read this data in conjunction with the Company’s consolidated financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this report.

				Years Ended December 31,
				2004			2003			2002			2001			2000
				(Shares and dollars in thousands, except per share amounts)
Revenue Data:
	Direct premiums written			$	65,790		$	61,152		$	50,858		$	41,497		$	31,782
	Net premiums written				59,504			52,802			44,471			34,710			28,049
Statement of Earnings Data:
	Net premiums earned				55,784			47,864			40,454			30,728			27,635
	Investment income, net of expenses				2,841			1,707			2,061			2,425			2,517
	Net realized investment gains (losses)				484			703			(220	)		42			(288	)
	Total revenue				59,467			50,660			42,624			33,445			30,031
	Conversion expense(1)				—			66			95			—			—
	Minority interest in (income) of subsidiary(2)				—			(131	)		(138	)		(100	)		—
	Net income				3,264			583			2,242			3,300			3,068
	Comprehensive income(3)				3,972			2,073			1,620			2,485			4,983
Balance Sheet Data (End of Period):
	Total assets				180,427			175,875			105,848			97,119			84,857
	Total investments and cash				141,393			138,679			76,780			73,166			69,055
	Minority interest in subsidiary(2)				—			—			3,112			1,926			—
	Stockholders equity				100,408			98,326			37,017			35,397			32,912
Ratios:
	GAAP combined ratio(4)				98.8	%		103.8	%		96.4	%		93.6	%		93.2	%
	Statutory combined ratio(5)				95.4	%		102.2	%		94.7	%		93.4	%		92.9	%
	Statutory premiums to-surplus ratio(6)				0.96	x		1.72	x		1.54	x		1.10	x		0.97	x
Per-share data:(7)
		Net income (loss):
			Basic		0.52			(0.08	)		N/A			N/A			N/A
			Diluted		0.51			(0.08	)		N/A			N/A			N/A
		Stockholders’ equity			16.49			15.65			N/A			N/A			N/A
Weighted average shares:(8)
			Basic		6,236			6,253			N/A			N/A			N/A
			Diluted		6,354			6,253			N/A			N/A			N/A

(1)  Costs and expenses related to the stock conversion incurred in the years ended December 31, 2003 and 2002. These costs and expenses are reported separately in our consolidated income statements within income from continuing operations before income taxes. Stock conversion expenses consist primarily of the costs of engaging independent accounting, valuation, legal and other consultants to advise us and our insurance regulators as to the stock conversion process and related matters, as well as printing and postage costs relating to our communications with our policyholders. These costs and expenses are reported in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 00-3, “Accounting by Insurance Enterprises for Demutualizations and Formations of

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	Mutual Insurance Holding Companies and for Certain Long-Duration Participating Contracts.” SOP 00-3 addresses financial statement presentation and accounting for stock conversion expenses and accounting for retained earnings and other comprehensive income at the date of the stock conversion.
(2)	Income of the Company attributable to the minority interest in Franklin Holding Company, which interest was acquired immediately after the Conversion for shares of the Company.
(3)	Includes Net Income and the change in Unrealized Gains and Losses of the investment portfolio.
(4)	The sum of losses, loss adjustment expenses, underwriting expenses and dividends to policyholders divided by net premiums earned. A combined ratio of less than 100% means a company is making an underwriting profit.
(5)	The sum of the ratio of underwriting expenses divided by net premiums written, and the ratio of losses, loss adjustment expenses, and dividends to policyholders divided by net premiums earned.
(6)	The ratio of net premiums written divided by ending statutory surplus, except for 2003, where a weighted average of statutory surplus is used.
(7)	Earnings per share data reflects only net loss for the period from December 16, 2003, the date of the Conversion, through December 31, 2003. Net loss during this period was ($477,000).
(8)	Unallocated ESOP shares at December 31, 2004 and 2003, are not reflected in weighted average shares.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

      The following presents management’s discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with the condensed consolidated financial statements and notes thereto included in this report, and the “Description of Business” contained in Item 1 of this report. This discussion contains forward-looking information that involves risks and uncertainties. Actual results could differ significantly from these forward-looking statements.

OVERVIEW

      The Company and its subsidiaries underwrite property and casualty insurance in New Jersey and Pennsylvania. Our consolidated operating insurance company subsidiaries are:

•  Mercer Insurance Company, a Pennsylvania property and casualty stock insurance company offering insurance coverages to businesses and individuals in New Jersey and Pennsylvania,

•  Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualty stock insurance corporation offering insurance coverages to businesses and individuals located in New Jersey; and

•  Franklin Insurance Company, a property and casualty stock insurance company offering private passenger automobile and homeowners insurances to individuals located in Pennsylvania.

      We manage our business and report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function. See Note 9 of the notes to our consolidated financial statements included in this report. However, we do not allocate assets to segments, and assets are reviewed in the aggregate for decision-making purposes. Our commercial lines insurance business consists primarily of multi-peril and general liability and related coverages. Our personal lines insurance business consists primarily of homeowners and private passenger automobile insurance coverages. We market both the commercial and personal insurance lines through independent agents.

      Our income is principally derived from insurance premiums received from insureds in the commercial lines (businesses insured) and personal lines (individuals insured) segments, less the costs of underwriting the insurance policies, the costs of settling and paying claims reported on the policies, and from investment income reduced by investment expenses, and from gains or losses on holdings in our investment portfolio. Variability in our income is caused by a variety of circumstances, some within the control of our companies

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and some not within their control. Premium volume is affected by, among other things, the availability of quality, properly-priced underwriting risks being produced by our agents, the ability to retain on renewal existing good-performing accounts, competition from other insurance companies, regulatory rate approvals, our reputation, and other limitations created by the marketplace or regulators. Our underwriting costs are affected by, among other things, the amount of commission and profit-sharing we pay our agents to produce the underwriting risks we receive premiums for, the cost of issuing insurance policies and maintaining our customer and agent relationships, marketing costs, taxes we pay to the states we operate in on the amount of premium we collect, and other assessments and charges imposed on our companies by the regulators in the states in which we do business. Our claim and claim settlement costs are affected by, among other things, the quality of our underwriting accounts, severe weather in our operating region, the nature of the claim, the regulatory and legal environment in our territories, inflation in underlying medical and property repair costs, and the availability and cost of reinsurance. Our investment income and realized gains and losses are determined by, among other things, market forces, the rates of interest and dividends paid on our portfolio holdings, the credit or investment quality of the issuer and the success of its underlying business, the market perception of the company invested in, and other factors such as ratings by rating agencies and analysts.

CRITICAL ACCOUNTING POLICIES

General

      We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operation will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.

Liabilities for Loss and Loss Adjustment Expenses

      The liability for losses and loss adjustment expenses represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported to our insurance companies. The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported claims and loss adjustment expenses are determined using historical information by line of insurance as adjusted to current conditions. Inflation is ordinarily implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results over multiple years.

      Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior accident years. We use historical paid and incurred losses and accident year data to derive expected ultimate loss and loss adjustment expense ratios by line of business. We then apply these expected loss and loss adjustment expense ratios to in-force business to derive a reserve level for each line of business. This amount, together with reserves required by new reported claims and changes to existing case reserves, is compared to existing reserves to establish the adjustment to reserves that is required. In connection with the determination of the reserves, we also consider other specific factors such as recent weather-related losses, trends in historical paid losses, and legal and judicial trends with respect to theories of liability. Because of the nature of our business, which generally provides coverage for short-term risks, loss development is comparatively rapid and historical paid losses, adjusted for known variables, have been a reliable predictive measure of future losses.

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      Nevertheless, reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at December 31, 2004. Changes in estimates or differences between estimates and amounts ultimately paid are reflected in current operations. Loss reserving techniques and assumptions have been consistently applied during the periods presented.

      The table below summarizes the effect on net loss reserves and surplus in the event of reasonably likely changes in the variables considered in establishing loss and loss adjustment expense reserves. The range of reasonably likely changes was established based on a review of changes in accident year development by line of business and applied to loss reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:

								Adjusted Loss
			Adjusted Loss and					and Loss
Change in Loss			Loss Adjustment		Percentage			Adjustment		Percentage
and Loss			Reserves Net of		Change in			Reserves Net of		Change in
Adjustment			Reinsurance as of		Equity as of			Reinsurance as of		Equity as of
Reserves Net of			December 31,		December 31,			December 31,		December 31,
Reinsurance			2004		2004(1)			2003		2003(1)
(Dollars in thousands)
	(10.0	)%	$	29,669		2.2	%	$	29,003		2.2	%
	(7.5	)%		30,493		1.6	%		29,808		1.6	%
	(5.0	)%		31,317		1.1	%		30,614		1.1	%
	(2.5	)%		32,141		0.5	%		31,419		0.5	%
	Base			32,965		—			32,225		—
	2.5	%		33,789		(0.5	)%		33,031		(0.5	)%
	5.0	%		34,613		(1.1	)%		33,836		(1.1	)%
	7.5	%		35,437		(1.6	)%		34,642		(1.6	)%
	10.0	%		36,262		(2.2	)%		35,448		(2.2	)%

(1)  Net of Tax

      The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and construction defect liability, mold, and other uncertain or environmental exposures. We have not experienced significant losses from these types of claims.

      In the discussions that follow, we use the term “loss development,” which refers to the calendar year income statement impact of changes in the provision for loss and loss adjustment expenses incurred in prior accident years.

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      The table below summarizes loss and loss adjustment reserves by major line of business:

		December 31,
		2004		2003		2002
		(Dollars in thousands)
Commercial lines:
	Commercial multi-peril	$	5,441	$	6,998	$	6,017
	Other liability		9,374		8,708		6,390
	Workers’ compensation		4,627		4,684		4,224
	Commercial automobile		1,456		2,251		1,886
	Fire, allied, inland marine		781		242		119
			21,679		22,883		18,636
Personal lines:
	Homeowners		10,095		9,509		8,896
	Personal automobile		2,283		3,073		2,070
	Fire, allied, inland marine		338		328		477
	Other liability		1,596		1,400		1,201
	Workers’ compensation		37		68		68
			14,349		14,378		12,712
Total		$	36,028	$	37,261	$	31,348

Investments

      Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in Stockholders’ Equity as a component of comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an investment below its cost that is deemed other than temporary is charged to earnings as a realized loss. We monitor our investment portfolio and review investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. These evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. In the years ended December 31, 2004, 2003 and 2002, we recorded a pre-tax charge to earnings of $15,000, $454,000, and $647,000, respectively. These charges are primarily with respect to equity securities that we determined were other than temporarily impaired. Adverse investment market conditions, poor operating performance, or other adversity encountered by companies whose stock or fixed maturity securities we own could result in impairment charges in the future. The Company’s policy on impairment of value of investments is as follows: if a security has a market value below cost it is considered impaired. For any such security a review of the financial condition and prospects of the company will be performed by the Investment Committee to determine if the decline in market value is other than temporary. If it is determined that the decline in market value is “other than temporary”, the carrying value of the security will be written down to “realizable value” and the amount of the write down accounted for as a realized loss. “Realizable value” is defined for this purpose as the market price of the security. Write-down to a value other than the market price requires objective evidence in support of that value.

      In evaluating the potential impairment of fixed income securities, the Investment Committee will evaluate relevant factors, including but not limited to the following: the issuer’s current financial condition and ability to make future scheduled principal and interest payments, relevant rating history, analysis and guidance provided by rating agencies and analysts, the degree to which an issuer is current or in arrears in making principal and interest payments, and changes in price relative to the market.

      In evaluating the potential impairment of equity securities, the Investment Committee will evaluate certain factors, including but not limited to the following: the relationship of market price per share versus

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carrying value per share at the date of acquisition and the date of evaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, any rating agency announcements, the issuer’s financial condition and near-term prospects, including any specific events that may influence the issuer’s operations, the independent auditor’s report on the issuer’s financial statements; and any buy/sell/hold recommendations or price projections by outside investment advisors.

      We have one significant non-traded equity security, a non-voting common stock in Excess Reinsurance Company, which is carried at $1.1 million. Excess Reinsurance Company paid a special dividend in 2004 to the Group in the amount of $274,000. Its fair value is estimated at the statutory book value as reported to the National Association of Insurance Commissioners (NAIC). Other non-traded securities, which are not material in the aggregate, are carried at cost.

Policy Acquisition Costs

      We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are directly related to the production of business. These costs are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, loss and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected loss and loss adjustment expenses, may require acceleration of the amortization of deferred policy acquisition costs.

Reinsurance

      Amounts recoverable from property and casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts.

      Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve us of our legal liability to our policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and loss adjustment expenses affect the estimates for the ceded portion of these liabilities.

      We continually monitor the financial condition of our reinsurers.

Income Taxes

      We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.

RESULTS OF OPERATIONS

      Our results of operations are influenced by factors affecting the property and casualty insurance industry in general. The operating results of the United States property and casualty insurance industry are subject to significant variations due to competition, weather, catastrophic events, regulation, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment.

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      Revenue and income by segment is as follows for the years ended December 31, 2004, 2003 and 2002

				December 31,
				2004			2003			2002
				(In thousands)
Revenues:
	Net premiums earned:
		Commercial lines		$	32,370		$	25,964		$	20,088
		Personal lines			23,414			21,900			20,366
			Total net premiums earned		55,784			47,864			40,454
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			386			329
			Total Revenues		59,467			50,660			42,624
Income before income taxes:
	Underwriting income (loss):
		Commercial lines			5,581			3,109			2,892
		Personal lines			(4,908	)		(4,951	)		(1,432	)
			Total underwriting income (loss)		673			(1,842	)		1,460
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			320			234
			Income before income taxes and minority interest in income of subsidiary	$	4,356		$	888		$	3,535

      Our growth in premiums and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is prevalent and makes it difficult to write and retain properly priced personal and commercial lines business. Our policy is to maintain our disciplined underwriting and pricing standards during soft markets, even at the expense of premium growth. After a sustained soft market cycle, the insurance industry entered into a hard market cycle in approximately early 2000, which continued into 2004. Beginning in 2004, the industry has seen increasing competition and a softening of rates in many markets, many of which we compete in, and particularly in property exposures. If market rates continue to soften, it may have a negative impact on our ability to grow, and on our underwriting margins. The cyclicality of the market, and its potential impact on our results, is difficult to predict with any significant reliability.

      On June 1, 2001, we acquired 49% (the controlling interest, when taken into account with other considerations) of the outstanding shares of common stock of Franklin Holding and thereafter consolidated the financial condition and results of operations of Franklin Holding with Mercer Insurance Company. For the period between June 1, 2001 and December 15, 2003, we allocated a portion of Franklin Holding’s net income to the minority interest in Franklin Holding. This resulted in allocations of income to minority interest of $131,000 and $138,000 for the years ended December 31, 2003 and 2002, respectively. The minority interest in Franklin Holding was acquired by the Company immediately after the Conversion, through an exchange of shares in which the owners of the minority interest received 502,525 shares of the Company in exchange for all minority shares in Franklin Holding. Since Franklin Holding Company, Inc. became wholly owned within the group in December, 2003, no further income will be allocated to the minority interest for it.

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YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

      The components of income for 2004 and 2003, and the change and percentage change from year to year, are shown in the charts below. The accompanying narrative refers to the statistical information displayed in the chart immediately above the narrative.

2004 vs. 2003 Income		2004			2003			Change			% Change
Commercial lines underwriting income		$	5,581		$	3,109		$	2,472			79.5	%
Personal lines underwriting loss			(4,908	)		(4,951	)		43			0.9	%
	Total underwriting income (loss)		673			(1,842	)		2,515			N/M
Net investment income			2,841			1,707			1,134			66.4	%
Realized investment gains (losses)			484			703			(219	)		(31.1	)%
Other revenue, net of stock conversion expenses			358			320			38			(7.3	)%
	Income before income taxes and minority interest in income of subsidiary		4,356			888			3,468			N/M
Income taxes			1,092			174			918			N/M
	Income before minority interest in income of subsidiary		3,264			714			2,550			N/M
Minority interest in income of subsidiary			—			(131	)		131			N/M
	Net income	$	3,264		$	583		$	2,681			N/M
Loss/ LAE ratio (GAAP)			50.4	%		57.9	%		(7.5	)%
Underwriting expense ratio (GAAP)			48.4	%		45.9	%		2.5	%
	Combined ratio (GAAP)		98.8	%		103.8	%		(5.0	)%
Loss/ LAE ratio (Statutory)			50.5	%		57.9	%		(7.4	)%
Underwriting expense ratio (Statutory)			44.9	%		44.3	%		0.6	%
	Combined ratio (Statutory)		95.4	%		102.2	%		(6.8	)%

(N/ M means “not meaningful”)

      Charts and discussion relating to each of our segments (commercial lines underwriting, personal lines underwriting, and the investments segment) follow below.

      A strong performance in our commercial lines underwriting results, coupled with a modest improvement in our personal lines underwriting results, resulted in a return to underwriting profitability in 2004 from 2003, with an overall underwriting profit of $673,000, as compared to an underwriting loss of $1.8 million in 2003. Our GAAP combined ratio improved to 98.8% in 2004 from 103.8%, and our statutory combined ratio improved in 2004 to 95.4% from 102.2%. Our net investment income increased 66.4% to $2.8 million, primarily as a result of the increased investment portfolio resulting from the receipt of $53 million in Conversion proceeds on December 16, 2003. Realized investment gains, primarily from the sale of equity securities in both 2004 and 2003, added to the Company’s income as the equities portfolio value continued to grow in 2004. Our other income, primarily service charges recorded on insurance premiums paid over the term of the policy instead of when the policy is issued, declined modestly in 2004. In 2004 there was no minority interest in the income of our subsidiary, as there was in 2003, because all of the minority interest was acquired immediately after the Conversion in the acquisition of the remaining 51% of Franklin Holding Company. Also impacting the Company’s income in 2004 was the cost of being a public company, which adversely impacted both net income and the GAAP underwriting expense ratio, and, to a lesser extent, the statutory underwriting expense ratio.

      Net loss and loss adjustment expenses incurred increased in 2004 overall by only $405,000, or 1.5%, to $28.1 million, reflecting lower claims frequency in 2004 over 2003, despite growth in exposures in 2004 as our net premium earned grew by 16.5%. The lower loss and loss adjustment expense ratio in 2004 resulted from more normal weather patterns than were experienced in our operating territory in 2003, which included hail,

36

tornados, and windstorms, all of which resulted in a higher than usual frequency of claims throughout most of 2003.

      Loss development of prior year net loss and loss adjustment expense reserves was a favorable $0.9 million in 2004 and was generally attributable to accident years 2002 and 2003 for commercial multi-peril, commercial auto and other liability. Loss reserves for these and all other lines of business have been established based on company trends and our consideration of industry trends, and recent settlement of reported cases has been favorable. This favorable development is a reflection of the disciplined underwriting employed by the Company in its risk selection process.

2004 vs. 2003 Revenue		2004		2003		Change			% Change
Direct premiums written		$	65,790	$	61,152	$	4,638			7.6	%
Net premiums written			59,504		52,802		6,702			12.7	%
Net premiums earned			55,784		47,864		7,920			16.5	%
Net investment income			2,841		1,707		1,134			66.4	%
Realized investment gains			484		703		(219	)		(31.2	)%
Other Revenue			358		386		(28	)		(7.3	)%
	Total Revenue	$	59,467	$	50,660	$	8,807			17.4	%

      Total revenues for 2004, were $59.5 million, which was 17.4% greater than 2003 revenues. This increase was due primarily to a $7.9 million increase in net premiums earned in 2004, and an increase in net investment income of $1.1 million.

      Direct premiums written increased 7.6% to $65.8 million in 2004, reflecting the return of the market to a more competitive pricing posture and the Company’s reluctance to take on underwriting risks which are priced inappropriately. Net premiums written increased 12.7% in 2004, a higher growth rate over that of the direct premiums written reflecting the increased retention under the Company’s reinsurance program in 2004. Net premiums earned increased by 16.5% to $55.8 million in 2004.

      Growth in Net Investment Income is discussed below.

2004 vs. 2003 Investment Income and Realized Gains		2004			2003		Change			% Change
Fixed Income securities		$	3,284		$	2,120	$	1,164			54.9	%
Dividends			673			466		207			44.4	%
Cash, cash equivalents & other			398			205		193			94.1	%
	Gross investment income		4,355			2,791		1,564			56.0	%
Investment expenses			1,514			1,084		430			39.7	%
	Net investment income	$	2,841		$	1,707	$	1,134			66.4	%
Realized gains (losses) on fixed income		$	(97	)	$	186	$	(283	)		N/M
Realized gains on equities			590			517		73			N/M
Realized losses — other			(9	)		—		(9	)		N/M
	Net realized gains	$	484		$	703	$	(219	)		(31.2	)%

(N/ M means “not meaningful”)

      Net investment income increased $1.1 million, or 66.4% in 2004, due principally to the increased portfolio holdings resulting from the receipt of approximately $53 million of proceeds upon the completion of the Conversion. In addition, the Company received a special dividend of $274,000 in 2004 on its investment in Excess Reinsurance Company, compared to no dividend in 2003.

      Effective January 1, 2004, the Company engaged a new management firm for its fixed income securities portfolio. One of its assignments was to invest the proceeds of the Conversion, which, given a difficult interest rate environment and fixed income securities market, was not largely completed until the second quarter of 2004. Consequently, a significant portion of the Conversion proceeds earned a cash-equivalent yield during

37

this period. In addition, investment expenses increased in 2004 by approximately $210,000 for the cost of such management, compared to the prior commission-based fixed income securities management which existed while the Company was a mutual insurance company prior to the Conversion.

      In implementing the investment policy guidelines and directions of the Investment Committee of the Board of Directors, the fixed income securities managers have changed the composition of the fixed income securities portfolio to be more heavily weighted in tax-exempt securities, industrial and miscellaneous fixed income securities, and mortgage-backed securities, and less heavily weighted towards U.S government and government agencies fixed income securities. The portfolio remains invested 100% in investment grade fixed income securities, with, as of December 31, 2004, an average rating of AAA, an average duration of 3.7 years (excluding mortgage-backed securities), and average tax equivalent yield of 4.17%. Our average portfolio duration exceeds that of our insurance liabilities, however the portfolio maturities are laddered to ensure adequate liquidity.

      Net realized gains decreased 31.2% to $484,000 in 2004. In 2004, net realized investment gains of $484,000 included gains on securities sales of $1,037,000, offset by other than temporary writedowns of $15,000 and losses on securities sales of $538,000. The losses from securities sales were comprised of $242,000 from the sale of bonds and $296,000 from the sale of equities. The following table summarizes the period of time that equity securities sold at a loss during 2004 had been in a continuous unrealized loss position:

	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss
	(In thousands)
0-6 months	$	1,025	$	292
7-12 months		276		4
More than 12 months		—		—
Total	$	1,301	$	296

      The equity securities sold at a loss had been expected to appreciate in value but after reevaluation were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of changing economic conditions.

      The following table summarizes the length of time equity securities with unrealized losses at December 31, 2004 have been in an unrealized loss position:

					Length of Unrealized Loss
	Fair		Unrealized		Less than		6 to 12		Over 12
December 31, 2004	Value		Losses		6 Months		Months		Months
	(In thousands)
Equity securities unrealized loss	$	498	$	13	$	13	$	0	$	0

      Results of our Commercial Lines segment were as follows:

2004 vs. 2003 Commercial Lines (CL)		2004			2003			Change			% Change
CL Direct premiums written		$	40,883		$	35,803		$	5,080			14.2	%
CL Net premiums written		$	36,492		$	30,315		$	6,177			20.4	%
CL Net premiums earned		$	32,370		$	25,964		$	6,406			24.7	%
CL Loss/ LAE expense ratio (GAAP)			31.9	%		39.1	%		(7.2	)%
CL Expense ratio (GAAP)			50.9	%		49.0	%		1.9	%
	CL Combined ratio (GAAP)		82.8	%		88.1	%		(5.3	)%

      Consistent with our goal of increasing commercial business, we increased commercial lines direct premiums written by $5.1 million, or 14.2% in 2004. With our increased reinsurance retentions in 2004, our commercial lines net premiums written increased by 20.4%, or $6.2 million. Direct commercial multi-peril premiums written, the largest component of our commercial lines segment, increased 19.7% to $22.2 million in

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2004, compared to $18.6 million for 2003, and commercial multi-peril net premiums earned increased by 30.4% to $16.5 million in 2004, compared to $12.7 million for 2003. Our largest increase in policy count was within our Religious Institutions sector, where our increasing market presence is helping us add new premium, and in our Special Contractors sector. We expect this trend of increasing commercial writings to continue by targeting selected types of risks with selected producers.

      In the commercial lines segment for 2004, we had an underwriting gain of $5.6 million, a GAAP combined ratio of 82.8%, a GAAP loss and loss adjustment expense ratio of 31.9% and a GAAP underwriting expense ratio of 50.9%, compared to an underwriting gain of $3.1 million, a GAAP combined ratio of 88.1%, a GAAP loss and loss adjustment expense ratio of 39.1% and an underwriting expense ratio of 49.0% for 2003.

      Results of our Personal Lines segment were as follows:

2004 vs. 2003 Personal Lines (PL)		2004			2003			Change			% Change
PL Direct premiums written		$	24,906		$	25,349		$	(443	)		(1.7	)%
PL Net premiums written		$	23,011		$	22,487		$	524			2.3	%
PL Net premiums earned		$	23,414		$	21,900		$	1,514			6.9	%
PL Loss/ LAE expense ratio (GAAP)			76.1	%		80.3	%		(4.2	)%
PL Expense ratio (GAAP)			44.9	%		42.3	%		2.6	%
	PL Combined ratio (GAAP)		121.0	%		122.6	%		(1.6	)%

      In the personal lines segment for 2004, we had an underwriting loss of $4.9 million, a GAAP combined ratio of 121.0%, a GAAP loss and loss adjustment expense ratio of 76.1% and a GAAP underwriting expense ratio of 44.9%, compared to an underwriting loss of $5.0 million, a GAAP combined ratio of 122.6%, a GAAP loss and loss adjustment expense ratio of 80.3% and a GAAP underwriting expense ratio of 42.3% for 2003.

      The personal lines losses in 2004 were slightly better than in 2003, with the losses in both years heavier than usual and attributable to harsh weather conditions. After a number of winters with relatively mild weather conditions in our operating region, our first quarter of 2004, and our first and fourth quarters of 2003 suffered from unusually cold weather conditions. These conditions lead to a high frequency of losses from frozen pipes, structural collapses, and more frequent automobile losses and accidents. The homeowners loss and loss expense ratio was 82.8% in 2004 and 74.3% for 2003, and the personal automobile loss and loss expense ratio was 77.0% for 2004 and 94.5% for 2003.

      Net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 7.4% to $13.5 million for 2004, compared to $12.6 million for 2003. The growth rate for homeowners insurance reflects the reclassification of certain homeowners risks from our preferred program to our standard program, resulting in a higher premium, as part of a general review of the homeowners program which was completed in late 2003. Premiums are higher for the standard program compared to the preferred program. The Company is preparing to seek a rate increase for the homeowners line in New Jersey, based on an MSO form, which, if approved, will result in an increase in premiums written for this line.

      Personal automobile direct written premiums, written exclusively in Pennsylvania, decreased 2.9% to $7.7 million in 2004, compared to $7.9 million for 2003. Net earned premiums for personal automobile increased by 4.4% to $7.2 million for 2004, from $6.9 million for 2003. The slight decrease in personal automobile direct premiums is attributable to a change in our underwriting guidelines, with a planned decrease in less attractive lower-tier business being replaced by more attractive higher-tier business in 2004, a trend we

39

expect to continue with the result of overall growth in this line. Despite the increases in personal lines premiums, we will continue to focus principally on our commercial lines growth.

2004 vs. 2003 Expenses and Expense Ratio		2004			2003		Change			% Change
Amortization of DAC		$	15,075		$	13,413	$	1,662			12.4	%
	As a % of net premiums earned		27.0	%		28.0		(1.0	)%
Other underwriting expenses			11,898			8,560		3,338			39.0	%
Stock conversion expenses			—			66		(66	)		N/M
	Total expenses excluding losses/ LAE	$	26,973		$	22,039	$	4,934			22.4	%
Underwriting expense ratio			48.4	%		45.9		2.5	%

(N/ M means “not meaningful”)

      Underwriting expenses increased by $4.9 million, or 22.4%, to $27.0 million for 2004, from 2003. This increase was principally attributable to an increase in other underwriting expenses, growth in commissions resulting from higher premium volume, and increased charges relating to corporate expenses and compensation expenses, including bonuses and agents profit-sharing, which were at higher levels than in 2003. In 2004, the Company had pre-tax costs associated with Sarbanes — Oxley compliance of $832,000, for which there were no costs in 2003, pre-tax costs of $383,000 associated with grants of restricted stock, for which there were no costs in 2003, and pre-tax costs of $874,000 associated with the allocation of shares to employee participants by the ESOP for 2004, for which the 2003 pre-tax cost was $568,000.

      We are currently in the process of converting our information system. When completed, we expect some costs to moderate as implementation costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher staffing costs, but we also should be positioned to expand premium volume in the near term without material incremental expense because of increased processing capacity.

      In the third quarter of 2004, we began renewing most of our New Jersey policies in our Mercer Insurance Company of New Jersey, Inc. subsidiary, thus reducing the Company’s liability for retaliatory premium taxes, which should produce, on an annual basis, approximately $800,000 in relief from such taxes.

2004 vs. 2003 Income Taxes		2004			2003			Change			% Change
Income before income taxes and minority interest in income of subsidiary		$	4,356		$	888		$	3,468			N/M
Income taxes			1,092			174			918			N/M
	Income before minority interest in income of subsidiary	$	3,264		$	714		$	2,550			N/M
	Effective tax rate		25.1	%		19.6	%		5.5	%

(N/ M means “not meaningful”)

      Federal income tax expense was $1.1 million for 2004, an effective rate of 25.1%, compared to $174,000, an effective rate of 19.6%, in 2003. The increase in the effective tax rate in 2004 is primarily attributable to the fact that tax-exempt investment income and dividend income (which reduce the effective tax rate) represented a smaller percentage of net income in 2004 than in 2003.

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

      For the year ended December 31, 2003, the Company had net income of $583,000 compared to $2.2 million for the same period in 2002. Although the underwriting gain from our commercial lines segment for 2003 increased 7.5% from the prior year to $3.1 million, our personal lines segment incurred an underwriting loss of $5.0 million in 2003, an increased loss of $3.5 million over the prior comparable period. In our investment segment, net investment income decreased in 2003 by $354,000, when compared to 2002, and realized gains for 2003 were $703,000, as compared to a net realized loss of $220,000 for 2002.

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      Total revenues for 2003, were $50.7 million, which was 19.0% greater than 2002 revenues of $42.6 million. This increase was due primarily to a $7.4 million increase in net premiums earned in 2003, an increase in realized gains of $923,000, and a decrease in net revenues from investments of $354,000 as compared to 2002.

      Direct premiums written increased 20.2% to $61.2 million in 2003 when compared to 2002, and consisted of $35.8 million of commercial lines premiums, a 30.2% increase, and $25.3 million of personal lines premiums, an 8.5% increase. Net premiums earned increased by 18.3% to $47.9 million for 2003 as compared to $40.5 million for the prior year. Commercial lines net premiums earned increased 29.3% to $26.0 million in 2003, and personal lines net premiums earned increased 7.5% to $21.9 million in 2003. The overall increases in direct premiums written and net premiums earned are generally attributable to firmer pricing and continued strong growth in our commercial lines business.

      Consistent with our goal of increasing commercial business, we increased direct commercial multi-peril premiums written, the largest component of our commercial lines segment, by 37.8% to $18.6 million in 2003, compared to $13.5 million for 2002, and increased commercial multi-peril net premiums earned by 31.6% to $12.7 million in 2003, compared to $9.6 million for 2002.

      For the same comparative periods, net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 5.7% to $12.6 million for 2003, compared to $11.9 million for 2002, while the increase in homeowners direct premiums written increased 7.3% to $14.7 million in 2003 from $13.7 million in 2002. The growth rate for homeowners insurance reflects the reclassification of certain homeowners risks from our preferred program to our standard program, resulting in a higher premium, as part of a general review of the homeowners program which is substantially complete. Premiums are higher for the standard program compared to the preferred program.

      Personal automobile direct written premiums, written exclusively in Pennsylvania, increased 14.8% to $7.9 million in 2003, compared to $6.9 million for 2002. Net earned premiums for personal automobile increased by 15.9% to $6.9 million for 2003, from $5.9 million for 2002. Despite the increases in personal lines premiums, we will continue to focus principally on our commercial lines growth.

      Net investment income decreased $354,000, or 17.2%, to $1.7 million in 2003, due to declining interest rates and an increase in investment expenses. Net realized gains increased to $703,000 in 2003, from a realized loss of $220,000 in 2002. In 2003, realized investment gains of $703,000 were comprised of gains on securities sales of $1,396,000, offset by other than temporary writedowns of $454,000 and losses on securities sales of $239,000. Of the equities included in the $454,000 of other than temporary writedowns, equities representing $358,000 of that total were sold in 2003 at a gain of $49,000. The losses from securities sales were comprised of $35,000 from the sale of bonds and $204,000 from the sale of equities. The following table summarizes the period of time that equity securities sold at a loss during 2003 had been in a continuous unrealized loss position:

	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss
	(In thousands)
0-6 months	$	100	$	6
7-12 months		245		114
More than 12 months		735		84
Total	$	1,080	$	204

      The equity securities sold at a loss had been expected to appreciate in value but after reevaluation were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of changing economic conditions.

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      The following table summarizes the length of time equity securities with unrealized losses at December 31, 2003 were in an unrealized loss position:

						Length of Unrealized Loss
		Fair		Unrealized		Less than		6 to 12		Over 12
		Value		Losses		6 Months		Months		Months
		(In thousands)
Equity securities
	More than 80% of cost	$	1,677	$	78	$	74	$	4	$	0
	Less than 80% of cost		0		0		0		0		0
Total		$	1,677	$	78	$	74	$	4	$	0

      For 2003, we had a combined ratio of 103.8%, a loss and loss adjustment expense ratio of 57.9% and an underwriting expense ratio of 45.9%, compared to a combined ratio of 96.4%, a loss and loss adjustment expense ratio of 49.6% and an underwriting expense ratio of 46.8% for 2002.

      In the commercial lines segment for 2003, we had an underwriting gain of $3.1 million, a combined ratio of 88.1%, a loss and loss adjustment expense ratio of 39.1% and an underwriting expense ratio of 49.0%, compared to an underwriting gain of $2.9 million, a combined ratio of 85.6%, a loss and loss adjustment expense ratio of 36.3% and an underwriting expense ratio of 49.3% for 2002.

      In the personal lines segment for 2003, we had an underwriting loss of $5.0 million, a combined ratio of 122.6%, a loss and loss adjustment expense ratio of 80.3% and an underwriting expense ratio of 42.3%, compared to an underwriting loss of $1.4 million, a combined ratio of 107.0%, a loss and loss adjustment expense ratio of 62.8% and an underwriting expense ratio of 44.2% for 2002.

      Net loss and loss adjustment expenses incurred increased overall by $7.6 million, or 38.2%, to $27.7 million for 2003 from 2002. The increase in loss and loss adjustment expenses reflects the increase in commercial and personal lines volume and an increase in the frequency of personal lines losses. The increase in personal lines losses is attributable to harsher weather conditions for 2003 compared to 2002. After a number of winters with relatively mild weather conditions in our operating region, our first and fourth quarters suffered from unusually cold weather conditions. In addition, there was considerably more snow during the first quarter of 2003 compared to the same period in 2002. These conditions lead to losses from frozen pipes, structural collapses, more frequent automobile losses and slip-and-fall accidents. We also had unusual weather events in the second and third quarters, including hail, tornados, and windstorms, all of which resulted in a higher than usual frequency of claims. The increase in these losses is evidenced by the increase in the homeowners loss and loss expense ratio to 74.3% for 2003, compared to 68.1% for 2002, and an increase in the personal automobile loss and loss expense ratio to 94.5% for 2003, compared to 67.8% for 2002. Loss development of prior year net loss and loss adjustment expense reserves was a favorable $0.6 million and was generally attributable to accident years 1998 through 2002 for commercial multi-peril and commercial workers’ compensation. Loss reserves for the commercial multi-peril and workers’ compensation lines have been established based on company trends and our consideration of industry trends. Recent settlement of reported cases has been favorable. In addition, we originally had expected a development of losses that was more in line with the industry, but this has not occurred. These factors have resulted in the favorable development indicated and are a reflection of the disciplined underwriting employed by the Company. Favorable development was also present in other lines of business and resulted from the normal claims review process, and not from changes in key assumptions or reserving philosophy.

      Underwriting expenses increased by $3.0 million, or 16.1%, to $22.0 million for 2003, from 2002. This increase was principally attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume, and the charge of $568,000 (pre-tax) associated with the allocation of shares to employee participants by the ESOP for 2003. We are currently in the process of converting our information system. When completed, we expect some costs to moderate as conversion costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher

42

staffing costs, but we also should be positioned to expand premium volume without material incremental expense because of increased processing capacity.

      We also expect underwriting expenses to moderate in future periods because we intend to significantly reduce the amount of business written in Mercer Insurance Company, the New Jersey business of which became subject to New Jersey’s retaliatory premium tax when it redomesticated to Pennsylvania in 1997. We plan to do this by renewing, to the extent possible, Mercer Insurance Company premium volume in Mercer Insurance Company of New Jersey, Inc., our New Jersey domestic insurer that is not subject to this retaliatory tax. We had not previously renewed policies in our New Jersey subsidiary because only policyholders of Mercer Insurance Company, domiciled in Pennsylvania, had subscription and voting rights. Therefore, renewing policies in the New Jersey subsidiary before completion of the Conversion would have denied subscription rights to Mercer Insurance Company’s policyholders and disenfranchised them. The cost of the additional premium tax was $738,000 for 2003 and $607,000 for 2002.

      Federal income tax expense was $174,000 for 2003, an effective rate of 19.6%, compared to $1,155,000, an effective rate of 32.7%, in 2002. The decrease in the effective tax rate in 2003 is attributable to tax-exempt investment income being a larger percentage of net income than in the prior year.

LIQUIDITY AND CAPITAL RESOURCES

      Our insurance companies generate sufficient funds from their operations and maintain a high degree of liquidity in their investment portfolios. The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments. Mercer Insurance Company in 2004 completed an expansion of its facilities in Pennington, New Jersey, at a cost of $2.9 million. These improvements are fully paid for and will not require any further use of operating cash flow.

      We are also in the process of building an information system platform that will allow our producers to conduct their business through the Internet or through the method they have historically used. As of December 31, 2004, we have spent $3.1 million on the development of this platform, which includes license fees for software used in the platform. It is anticipated to be completed in mid 2006, at an additional cost of $1.0 million. Mercer Insurance Company possesses sufficient resources for these future expenditures without incurring any debt.

      Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments. They maintain a portion of their investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.

      The principal source of liquidity for Mercer Insurance Group will continue to be the net proceeds it retained from the Conversion stock offering, and dividend payments (when allowed by regulators) and other fees received from Mercer Insurance Company. For a period of three years after the Conversion, Mercer Insurance Company may not declare or pay any dividend to Mercer Insurance Group without the approval of the Pennsylvania Insurance Department. After this three-year period, Mercer Insurance Company will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to its holding company. Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Mercer Insurance Company’s statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Insurance Company for the period covered by such annual statement.

      If the dividend restrictions imposed on Mercer Insurance Company related to the Conversion were not in effect, then as of December 31, 2004, the amounts available for payment of dividends from Mercer Insurance Company in 2005, without the prior approval of the Pennsylvania Insurance Department would have been approximately $6.2 million.

      Prior to its payment of any dividends, Mercer Insurance Company of New Jersey, Inc. is required to provide notice of the intended dividends to the New Jersey Department of Banking and Insurance. New Jersey

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law sets the maximum amount of dividends that may be paid, which amount cannot exceed the greater of 10% of Mercer Insurance Company of New Jersey, Inc.’s statutory surplus as reported on the most recent annual statement filed with New Jersey, or the net income, not including realized capital gains, for the period covered by the annual statement. The New Jersey Department has the power to limit or prohibit dividend payments if certain conditions exist. These restrictions or any subsequently imposed restrictions may affect our future liquidity. As of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company of New Jersey, Inc. to Mercer Insurance Company in 2005 without the prior approval of New Jersey Department of Banking and Insurance is approximately $1.6 million.

      As a Pennsylvania domiciled insurance company, dividends payable by Franklin Insurance Company are subject to the same formula limitation described above for Mercer Insurance Company. As of December 31, 2004, the amount available for payment of dividends from Franklin Insurance Company in 2005, without the prior approval of the Pennsylvania Insurance Department, is approximately $0.6 million.

      Total assets increased 2.6%, or $4.6 million to $180.4 million, at December 31, 2004 from December 31, 2003. Increased premium volume drove increases in premium receivables of $2.1 million, or 23%, and deferred policy acquisition costs of $627,000, or 8%. Reinsurance receivables decreased $2.5 million, or 60%, due to higher retentions under the Company’s reinsurance agreements. Investments increased $1.8 million, or 1%, to $125.1 million, and cash balances increased $939,000, or 6%. Other assets decreased $1.6 million, or 59%, to $1.1 million, principally due to a Federal Income Tax refund received in 2004.

      Total liabilities increased 3%, or $2.5 million, in 2004, to $80.0 million. Increased premium volume is primarily responsible for the increase in unearned premium reserves of $3.7 million, or 12%. Loss and loss expense reserves decreased $1.2 million, or 3%, as a result of the payment of a large number of case reserves related to claims accrued but unpaid at the end of 2003, and which related to the unusually high claims frequency experienced by the Company in late 2003.

      Total stockholders’ equity increased by $2 million, or 2%, due principally to 2004 earnings, offset in part by purchases of treasury stock in the amount of $3.1 million. Unrealized gains on the investment portfolio increased $708,000 (after tax), due principally to growth in the value of the Company’s equities portfolio.

      In connection with the Conversion, the ESOP was established, and purchased 626,111 shares from the Company in return for a note bearing interest at 4% on the principal amount of $6,261,110. Mercer Insurance Company will make annual contributions to the ESOP sufficient to repay that loan to the Company. It is anticipated that the loan will be repaid in 10 equal annual installments, and that, in proportion to annual principal and interest payments, approximately 10% of the original ESOP shares will be allocated annually to employee participants of the ESOP. An expense charge will be booked ratably during each year for the shares committed to be allocated to participants that year, determined with reference to the fair market value of the Company’s stock at the time the commitment to allocate the shares is accrued and recognized. The issuance of the shares to the ESOP was fully recognized in the Additional Paid-in Capital account at Conversion, with a contra account entitled Unearned ESOP Shares established in the Stockholders’ Equity section of the balance sheet for the unallocated shares at an amount equal to their original per-share purchase price.

      Mercer Insurance Group adopted a stock-based incentive plan at its 2004 annual meeting of shareholders. Pursuant to that plan, Mercer Insurance Group may issue a total of 876,555 shares, equal to 14% of the shares of common stock that were issued in the Conversion. Of this amount, an amount equal to 4% of the shares of common stock issued in the Conversion, or 250,000 shares, may be used to make restricted stock awards under the stock-based incentive plan. The number of shares available for issuance under the plan will increase automatically each year by 1% of the number of shares outstanding at the end of the preceding year. The Company may purchase shares of its common stock in the open market and contribute those shares to the stock-based incentive plan for use in making restricted stock awards under that plan. The fair market value of any common stock used for restricted stock awards will initially represent unearned compensation. As Mercer Insurance Group accrues compensation expense to reflect the vesting of such shares, unearned compensation will be reduced accordingly. This compensation expense will be deductible for federal income tax purposes upon vesting. As described in the following paragraph, the Company undertook to repurchase shares as a partial offset to the stock incentive plan issuances. During 2004, the Company made grants of 215,000 shares

44

of restricted stock, grants of 173,000 Incentive Stock Options, and grants of 364,700 non-qualified stock options.

      On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares are to be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. As of September 30, 2004, 250,000 shares had been repurchased under this authorization for a total consideration of $3.0 million, or $11.90 per share. On October 20, 2004, the Company’s Board of Directors authorized the repurchase of an additional 250,000 shares of its common stock, under the same terms and conditions. As of March 7, 2005, all 250,000 shares authorized under the second authorization have been purchased, including 243,500 shares purchased in 2005 for $3.2 million. The total cost of repurchases under this authorization was $3.3 million, or $13.16 per share. In the aggregate, 500,000 shares have been purchased under both authorizations, for a total cost of $6.3 million, or $12.53 per share, a price accretive to the Company’s book value. The purchases were funded with available cash or short-term investments maintained in the holding company.

IMPACT OF INFLATION

      Inflation increases consumers’ needs for property and casualty insurance coverage. Inflation also increases claims incurred by property and casualty insurers as property repairs, replacements and medical expenses increase. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We establish property and casualty insurance premiums levels before the amount of losses and loss expenses, or the extent to which inflation may affect these expenses, are known. Therefore, our insurance companies attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, financial results have not been significantly affected by inflation.

      Inflation also often results in increases in the general level of interest rates, and, consequently, generally results in increased levels of investment income derived from our investments portfolio.

OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS

      The Company was not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2004 which would give rise to previously undisclosed market, credit or financing risk.

      The Company and its subsidiaries have no significant contractual obligations at December 31, 2004, other than its insurance obligations under its policies of insurance. Projected cash disbursements pertaining to these insurance obligations, as projected at December 31, 2004, are as follows:

	Jan. 1, 2005		Jan. 1, 2006		Jan. 1, 2008		After
	to Dec. 31,		to Dec. 31,		to Dec. 31,		Dec. 31,
	2005		2007		2009		2009		Total
	(Dollars in thousands)
Property and Casualty Insurance Reserves, Net of Reinsurance	$	12,602		12,399		4,706		3,258	$	32,965
Total Contractual Obligations	$	12,602		12,399		4,706		3,258	$	32,965

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      General. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to three principal types of market risk through our investment activities: interest rate risk, credit risk and equity risk. Our primary market risk exposure is to changes in interest rates. We have not entered, and do not plan to enter, into any derivative financial instruments for hedging, trading or speculative purposes.

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      Interest Rate Risk. Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the market valuation of these securities.

      As of December 31, 2004, the average maturity of our fixed income investment portfolio (excluding mortgage-backed securities) was 3.7 years. Our fixed maturity investments include U.S. government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, corporate bonds and mortgage-backed securities, most of which are exposed to changes in prevailing interest rates. We carry these investments as available for sale. This allows us to manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by our management and board of directors and consultation with our financial advisor.

      Fluctuations in near-term interest rates could have an impact on the results of operations and cash flows. Certain of these fixed income securities have call features. In a declining interest rate environment, these securities may be called by their issuer and replaced with securities bearing lower interest rates. In a rising interest rate environment, we may sell these securities (rather than holding to maturity) and receive less than we paid for them.

      As a general matter, we do not attempt to match the durations of our assets with the durations of our liabilities. Our goal is to maximize the total return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims.

      The table below shows the interest rate sensitivity of our fixed income financial instruments measured in terms of market value (which is equal to the carrying value for all our securities).

	As of December 31, 2004
	Market Value
	-100 Basis		No Rate		+100 Basis
	Point Change		Change		Point Change
	(In thousands)
Bonds and preferred stocks	$	106,933	$	103,580	$	98,860
Cash and cash equivalents		16,289		16,289		16,289
Total	$	123,222	$	119,869	$	115,149

Credit Risk

      The quality of our interest-bearing investments is generally good. 100% of our fixed maturity securities are rated investment grade.

Equity Risk

      Equity price risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our holdings of common stocks, mutual funds and other equities. Our portfolio of equity securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of techniques. In accordance with accounting principles generally accepted in the United States of America, when an equity security becomes other than temporarily impaired, we record this impairment as a charge against earnings. For the year ended December 31, 2004, we recorded pre-tax charges of $15,000 for an individual equity security that we concluded was other than temporarily impaired, and sold in early 2005.

      Company and industry concentrations are monitored by the Board of Directors. At December 31, 2004, Mercer Insurance Company’s equity portfolio made up 19.5% of the Company’s total investment portfolio, and was relatively concentrated in terms of the number of issuers and industries. At December 31, 2004, Mercer Insurance Company’s top ten equity holdings represented $8.2 million or 33.5% of the equity portfolio.

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Investments in the financial sector represented 30.4% while investments in pharmaceutical companies, conglomerates and information technology companies represented 4.0%, 7.8% and 7.9%, respectively, of the equity portfolio at December 31, 2004. Such concentration can lead to higher levels of short-term price volatility. Due to our long-term investment focus, we are not as concerned with short-term volatility as long as our insurance subsidiaries’ ability to write business is not impaired. The table below summarizes the Company’s equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2004. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios.

				Estimated Fair		Hypothetical
Estimated Fair				Value After		Percentage Increase
Value of Equity				Hypothetical		(Decrease) in
Securities at		Hypothetical		Change in		Stockholders’
12/31/04		Price Change		Prices		Equity(1)
(In thousands)
$	24,447		20% increase	$	29,336		3.2	%
$	24,447		20% decrease	$	19,558		(3.2	)%

(1)  Net of tax

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

      We have audited the accompanying consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Mercer Insurance Group, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2005, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/     KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2004 and 2003

				2004			2003
				(Dollars in thousands,
				except share amounts)
ASSETS
Investments, at fair value:
	Fixed-income securities, available for sale, at fair value (cost $101,102 and $46,282, respectively)			$	100,657		$	46,277
	Equity securities, at fair value (cost $16,145 and $15,866 respectively)				24,447			22,656
	Short-term investments, at cost, which approximates fair value				—			54,396
			Total investments		125,104			123,329
Cash and cash equivalents					16,289			15,350
Premiums receivable					11,217			9,096
Reinsurance receivables					1,683			4,159
Prepaid reinsurance premiums					1,573			1,614
Deferred policy acquisition costs					8,014			7,387
Accrued investment income					1,044			596
Property and equipment, net					9,718			6,944
Goodwill					4,673			4,673
Other assets					1,112			2,727
Total assets				$	180,427			175,875
LIABILITIES AND EQUITY
Liabilities:
	Losses and loss adjustment expenses			$	36,028		$	37,261
	Unearned premiums				34,007			30,329
	Accounts payable and accrued expenses				7,739			7,937
	Other reinsurance balances				10			81
	Other liabilities				1,089			1,228
	Deferred income taxes				1,146			713
			Total liabilities		80,019			77,549
Stockholders’ Equity:
	Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding				—			—
	Common stock, no par value, authorized 15,000,000 shares, issued 7,060,733 shares, outstanding 6,344,844 and 6,282,233 shares				—			—
	Additional paid-in capital				67,651			64,871
	Accumulated other comprehensive income:
		Unrealized gains in investments, net of deferred income taxes			5,186			4,478
	Retained Earnings				37,876			34,612
	Unearned restricted stock compensation				(2,242	)		—
	Unearned ESOP shares				(5,009	)		(5,635	)
	Treasury stock, 256,500 and -0- shares				(3,054	)		—
			Total stockholders’ equity		100,408			98,326
Total liabilities and stockholders’ equity				$	180,427		$	175,875

See accompanying notes to consolidated financial statements.

49

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

Years ended December 31, 2004, 2003, and 2002

			2004		2003			2002
			(Dollars in thousands, except
			per share data)
Revenue:
	Net premiums earned		$	55,784	$	47,864		$	40,454
	Investment income, net of expenses			2,841		1,707			2,061
	Net realized investment gains (losses)			484		703			(220	)
	Other revenue			358		386			329
		Total revenue		59,467		50,660			42,624
Expenses:
	Losses and loss adjustment expenses			28,138		27,733			20,067
	Amortization of deferred policy acquisition costs (related party amounts of $1,775, $1,198 and $955, respectively)			15,075		13,413			10,953
	Other expenses			11,898		8,560			7,974
	Stock conversion expenses			—		66			95
		Total expenses		55,111		49,772			39,089
		Income before income taxes and minority interest in income of subsidiary		4,356		888			3,535
Income taxes				1,092		174			1,155
		Income before minority interest in income of subsidiary		3,264		714			2,380
Minority interest in income of subsidiary				—		(131	)		(138	)
Net income			$	3,264	$	583		$	2,242

				For the Period
				December 16
				through
				December 31,
				2003
Net loss after conversion				$	(477	)
Net income per common share:
	Basic	$	0.52	$	(0.08	)	N/A
	Diluted	$	0.51	$	(0.08	)	N/A

See accompanying notes to consolidated financial statements.

50

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

Years ended December 31, 2004, 2003, and 2002

								Accumulated					Unearned
						Additional		other					Restricted			Uearned
		Preferred		Common		Paid-in		Comprehensive			Retained		Stock			ESOP			Treasury
		Stock		Stock		Capital		Income			Earnings		Compensation			Shares			Stock			Total
								(Dollars in thousands)
Balance, December 31, 2001		$	—		—	$	—	$	3,610		$	31,787	$	—			—			—		$	35,397
Net income												2,242											2,242
Unrealized (losses) on securities:
	Unrealized holding (losses) arising during period, net of related income tax (benefit) of $(395)								(767	)													(767	)
	Less reclassification adjustment for losses included in net income, net of related income tax benefit of $75								145														145
	Other comprehensive loss																						(622	)
Comprehensive income																							1,620
Balance, December 31, 2002		$	—		—	$	—	$	2,988		$	34,029	$	—			—			—		$	37,017
Net income												583											583
Unrealized gains on securities:
	Unrealized holding gains arising during period, net of related income tax expense of $1,006								1,954														1,954
	Less reclassification adjustment for (gains) included in net income, net of related income tax (expense) of $(239)								(464	)													(464	)
	Other comprehensive income																						1,490
Comprehensive income																							2,073
Issuance of common stock							64,871																64,871
Unearned ESOP shares																	(6,261	)					(6,261	)
ESOP shares committed																	626						626
Balance, December 31, 2003		$	—		—	$	64,871	$	4,478		$	34,612	$	—			(5,635	)		—		$	98,326
Net income												3,264											3,264
Unrealized gains on securities:
	Unrealized holding gains arising during period, net of related income tax expense of $529								1,028														1,028
	Less reclassification adjustment for (gains) included in net income, net of related income tax (expense) of $(164)								(320	)													(320	)
	Other comprehensive income																						708
Comprehensive income																							3,972
Unearned restricted stock compensation							2,625							(2,625	)
Amortization of restricted stock compensation														383									383
ESOP shares committed							155										626						781
Treasury stock purchased																				(3,054	)		(3,054	)
Balance, December 31, 2004		$	—		—	$	67,651	$	5,186		$	37,876	$	(2,242	)		(5,009	)		(3,054	)	$	100,408

See accompanying notes to consolidated financial statements.

51

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2004, 2003, and 2002

					2004			2003			2002
					(Dollars in thousands)
Cash flows from operating activities:
	Net income				$	3,264		$	583		$	2,242
	Adjustments to reconcile net income to net cash provided by operating activities:
			Depreciation and amortization of fixed assets			1,472			1,301			819
			Net amortization of premium or (accretion of discount)			346			(61	)		(208	)
			Amortization of restricted stock compensation			383			—			—
			ESOP share commitment			781			778			—
			Net realized investment (gains) losses			(484	)		(703	)		220
			Deferred income tax			68			1,364			(58	)
			Change in assets and liabilities:
				Premiums receivable		(2,121	)		(1,975	)		(1,890	)
				Reinsurance receivables		2,476			(670	)		1,804
				Prepaid reinsurance premiums		41			(468	)		(357	)
				Deferred policy acquisition costs		(627	)		(1,604	)		(821	)
				Other assets		1,167			(1,797	)		(650	)
				Losses and loss expenses		(1,233	)		5,913			289
				Unearned premiums		3,678			5,406			4,375
				Other		(409	)		(68	)		1,396
				Net cash provided by operating activities		8,802			7,999			7,161
Cash flows from investing activities:
	Purchase of fixed income securities, available for sale					(82,036	)		(24,325	)		(35,444	)
	Purchase of equity securities					(3,464	)		(6,951	)		(6,240	)
	Sale (Purchase) of short-term investments, net					54,396			(54,396	)		—
	Sale and maturity of fixed income securities, available for sale					26,773			26,621			32,371
	Sale of equity securities					3,775			8,298			3,528
	Purchase of property and equipment, net					(4,253	)		(2,531	)		(3,299	)
				Net cash used in investing activities		(4,809	)		(53,284	)		(9,084	)
Cash flows from financing activities:
	Purchase of treasury stock					(3,054	)		—			—
	Proceeds from issuance of capital stock					—			53,434			—
	Proceeds from sale of securities in subsidiary to minority interest shareholder					—			—			689
				Net cash (used in) provided by financing activities		(3,054	)		53,434			689
				Net increase (decrease) in cash and cash equivalents		939			8,149			(1,234	)
	Cash and cash equivalents at beginning of period					15,350			7,201			8,435
	Cash and cash equivalents at end of period				$	16,289		$	15,350		$	7,201
	Cash paid (received) during the year for:
		Interest			$	52		$	39		$	33
		Income taxes				(922	)		150			1,605

See accompanying notes to consolidated financial statements.

52

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     (a) Description of Business

      Mercer Insurance Group, Inc. and Subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and BICUS Services Corporation (BICUS), QHC’s subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), and Franklin Holding Company, Inc. (FHC). Mercer Insurance Group, Inc. (MIG) is a holding company owning all the outstanding shares of MIC, the company resulting from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of ownership on December 15, 2003 (“the Conversion”). On June 1, 2002, FHC was added to the Group when MIC purchased a 49% controlling interest in FHC and its wholly owned insurance subsidiary, Franklin Insurance Company (FIC) (note 12). The remaining 51% of FHC was purchased by MIG in conjunction with the Conversion. The companies in the Group are operated under common management. The Group provides property and casualty insurance to both individual and commercial customers in New Jersey and Pennsylvania. The Group’s business activities can be separated into three operating segments, which include commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and general liability coverage. These two commercial lines represented 32% and 14%, respectively, of the Group’s net premiums written in 2004. The personal lines of business consist primarily of homeowners and private passenger automobile insurance. These two personal lines represented 23% and 12%, respectively, of net written premiums in 2004.

     (b) Consolidation Policy and Basis of Presentation

      The consolidated financial statements include the accounts of each member of the Group since the date of acquisition. The insurer affiliates within the Group participate in a reinsurance pooling arrangement (the Pool) whereby each insurer affiliate’s underwriting results are combined and distributed proportionately to each participant. Each insurer’s share in the Pool is based on their respective statutory surplus as of the beginning of each year. The effects of the Pool as well as all other significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, which differ in some respects from those followed in reports to insurance regulatory authorities.

     (c) Use of Estimates

      The preparation of the accompanying 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. Significant items subject to such estimates include liabilities for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance, deferred income tax assets and other than temporary impairment of investments. Actual results could differ from those estimates.

     (d) Concentration of Risk

      Mercer’s business is subject to concentration risk with respect to both gross revenue and geographic concentration. Approximately 24%, 24% and 22% of the Company’s direct premiums written were produced in 2004, 2003 and 2002, respectively, by two agents, including one who is a related party (see Note 16 for information about related party transactions). In addition, the Company’s operating territory is limited to New Jersey and Pennsylvania, with 78%, 77%, and 77% of direct premiums written attributable to New Jersey for 2004, 2003, and 2002, respectively, and the balance attributable to Pennsylvania. Consequently, changes in

53

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

production by these two agents or in the New Jersey or Pennsylvania legal, regulatory or economic environment could adversely affect the Company.

     (e) Investments

      Due to periodic shifts in the portfolio arising from income tax and asset-liability matching, as well as securities markets and economic factors, management considers the entire portfolio of fixed-income securities as available for sale. Fixed-income securities available for sale and equity securities are stated at fair value with changes in fair value, net of deferred income tax, reflected in stockholders’ equity as accumulated other comprehensive income. Realized gains and losses are determined on the specific identification basis. A decline in the market value of an investment below its cost that is deemed other than temporary is charged to earnings. The model used to determine anticipated prepayment assumptions for mortgage-backed securities uses separate home sale, refinancing, curtailment, and full pay-off components, derived from a variety of industry sources and created by the Company’s fixed income securities manager.

      Interest on fixed maturities is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. Premiums and discounts on mortgage-backed securities are amortized using anticipated prepayments with significant changes in anticipated prepayments accounted for prospectively.

     (f) Cash, Cash Equivalents and Short-term Investments

      Cash, cash equivalents, and short-term investments are carried at cost which approximates fair value. The Group considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

     (g) Fair Values of Financial Instruments

      The Group has used the following methods and assumptions in estimating its fair values:

      Investments — The fair values for fixed-income securities available for sale are based on quoted market prices, when available. If not available, fair values are based on values obtained from investment brokers. Fair values for marketable equity securities are based on quoted market prices and on statutory equity for the security indicated below.

      The fair value of an equity security in a reinsurance company is estimated based on statutory book value because the security is not traded and because of restrictions placed on the investors. After receipt of a bona fide offer to purchase this security, the stock must first be offered to the investee or its other shareholders at the lower of statutory book value or the offered price. The investee also has the ability to determine that the potential purchaser is not appropriate and void such an offer. The carrying value of this investment was $1,116 and $1,203 at December 31, 2004 and 2003, respectively.

      Cash, cash equivalents, and short-term investments — The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

      Premium and reinsurance receivables — The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

     (h) Reinsurance

      The Group cedes insurance to, and assumes insurance from, unrelated insurers to limit its maximum loss exposure through risk diversification. Ceded reinsurance receivables and unearned premiums are reported as assets; loss and loss adjustment expense reserves are reported gross of ceded reinsurance credits. Premiums receivable is recorded gross of ceded premiums payable.

54

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

     (i) Deferred Policy Acquisition Costs

      Acquisition costs such as commissions, premium taxes, and certain other expenses which vary with and are directly related to the production of business, are deferred and amortized over the effective period 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 value, which gives effect to premiums to be earned, anticipated investment income, loss and loss adjustment expenses, and certain other maintenance costs expected to be incurred as the premiums are earned. To the extent that deferred policy acquisition costs are not realizable, the deficiency is charged to income currently.

     (j) Property and Equipment

      Property and equipment are carried at cost less accumulated depreciation calculated on the straight-line basis. Property is depreciated over useful lives generally ranging from five to forty years. Equipment is depreciated over three to ten years.

     (k) Premium Revenue

      Premiums include direct writings plus reinsurance assumed less reinsurance ceded to other insurers and are recognized as revenue over the period that coverage is provided using the monthly pro-rata method. Unearned premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.

     (l) Losses and Loss Adjustment Expenses

      The liability for losses includes the amount of claims which have been reported to the Group and are unpaid at the statement date as well as provision for claims incurred but not reported, after deducting anticipated salvage and subrogation. The liability for loss adjustment expenses is determined as a percentage of the liability for losses based on the historical ratio of paid adjustment expenses to paid losses by line of business.

      Management believes that the liabilities for losses and loss adjustment expenses at December 31, 2004 are adequate to cover the ultimate net cost of losses and claims to date, but these liabilities are necessarily based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. Changes in the estimates for losses and loss adjustment expenses are recognized in the period in which they are determined.

55

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

     (m) Stock-Based Compensation

      Stock-based compensation plans are accounted for under the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed stock option grants. Compensation expense would be recorded on the date of a stock option grant only if the current market price of the underlying stock exceeded the exercise price. The following table illustrates the effect on net income and earnings per share as if the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), “Accounting for Stock-Based Compensation,” had been applied to all periods presented.

		Years Ended December 31,
		2004			2003(1)			2002
		(In thousands, except
		per share data)
Net income, as reported		$	3,264			(477	)		N/A
Plus: Stock-based employee compensation expense included in reported net income, net of related tax effects			253			—			N/A
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(538	)		—			N/A
Pro forma net income		$	2,979			(477	)		N/A
Basic earnings per share:
	As reported	$	0.52			(0.08	)		N/A
	Pro forma	$	0.48			N/A			N/A
Diluted earnings per share:
	As reported	$	0.51			(0.08	)		N/A
	Pro forma	$	0.47			N/A			N/A

(1)  For 2003, earnings and earnings per share are presented for the post-conversion period of December 16 to December 31, 2003. See footnote (13), Earnings Per Share, for further information.

      See Note 1(p) below, “New Accounting Pronouncements” for further information about the Group’s adoption of Financial Accounting Standards No. 123(R), “Share-Based Payment.”

     (n) Income Taxes

      The Group uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Group’s assets and liabilities and operating loss carryforwards. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.

     (o) Goodwill

      Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Group determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting

56

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

unit in a manner similar to a purchase price allocation, in accordance with Statement No. 141, “Business Combinations”. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Group has only one reporting unit with goodwill. The Group performed the annual impairment tests as of December 31, 2004 and 2003, and the results indicated that the fair value of the reporting unit exceeded its carrying amount.

     (p) New Accounting Pronouncements

      In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payments,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The compensation cost will be measured based on the fair value of the equity or liability instruments issued. The Statement is effective as of the beginning of the first interim or annual period beginning after June 15, 2005. The impact of adopting SFAS No. 123(R) on net income and earnings per share is not currently expected to be materially different from the pro forma amounts included in note 1(m) above, which includes all share-based payment transactions through December 31, 2004. The impact that any future share-based payment transactions will have on our financial position or results of operations is not yet known.

(2) INVESTMENTS

      Net investment income, net realized investment gains (losses), and change in unrealized gains (losses) on investment securities are as follows.

      Net investment income and net realized investment gains (losses):

			2004			2003		2002
Investment income:
	Fixed income securities		$	3,284			2,120		2,346
	Equity securities			673			466		470
	Cash and cash equivalents			294			100		170
	Other			104			105		24
		Gross investment income		4,355			2,791		3,010
	Less investment expenses			1,514			1,084		949
		Net investment income		2,841			1,707		2,061
Realized gains (losses):
	Fixed income securities			(97	)		186		281
	Equity securities			590			517		(501	)
	Other			(9	)		—		—
		Net realized gains (losses)		484			703		(220	)
Net investment income and net realized investment gains			$	3,325			2,410		1,841

      Investment expenses include salaries, counseling fees, and other miscellaneous expenses attributable to the maintenance of investment activities.

57

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The changes in unrealized (losses) gains of securities are as follows:

	2004			2003			2002
Fixed-income securities	$	(440	)		(922	)		1,614
Equity securities		1,512			3,155			(2,532	)
	$	1,072			2,233			(918	)

      The cost and estimated fair value of available-for-sale investment securities at December 31, 2004 and 2003 are shown below.

							Gross		Gross		Estimated
							Unrealized		Unrealized		Fair
					Cost(1)		Gains		Losses		Value
2004
	Fixed-income securities, available for sale:
			U.S. government and government agencies		$	17,870		33		203		17,700
			Obligations of states and political subdivisions			35,801		165		221		35,745
			Industrial and miscellaneous			16,896		28		143		16,781
			Mortgage-backed securities			30,535		71		175		30,431
				Total fixed maturities		101,102		297		742		100,657
	Equity securities:
		At market value				16,051		7,293		13		23,331
		At estimated value				94		1,022		—		1,116
				Total equity securities		16,145		8,315		13		24,447
Total available for sale					$	117,247		8,612		755		125,104

							Gross		Gross		Estimated
							Unrealized		Unrealized		Fair
					Cost(1)		Gains		Losses		Value
2003
	Fixed-income securities, available for sale:
			U.S. government and government agencies		$	38,974		290		438		38,826
			Obligations of states and political subdivisions			5,083		168		16		5,235
			Industrial and miscellaneous			2,157		7		17		2,147
			Mortgage-backed securities			68		1		—		69
				Total fixed maturities		46,282		466		471		46,277
	Equity securities:
		At market value				15,772		5,759		78		21,453
		At estimated value				94		1,109		—		1,203
				Total equity securities		15,866		6,868		78		22,656
Total available for sale					$	62,148		7,334		549		68,933

(1)  Original cost of equity securities; original cost of fixed-income securities adjusted for amortization of premium and accretion of discount.

58

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2004 are as follows:

	Less than 12 Months				12 Months or Longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	6,707	$	55	$	5,610	$	148	$	12,317	$	203
Obligations of states and political subdivisions		6,290		210		1,095		11		7,385		221
Corporate securities		11,868		135		1,371		8		13,239		143
Mortgage-backed securities		17,441		175		—		—		17,441		175
Total fixed maturities		42,306		575		8,076		167		50,382		742
Total equity securities		498		13		—		—		498		13
Total securities in a temporary unrealized loss position	$	42,804	$	588	$	8,076	$	167	$	50,880	$	755

      The unrealized losses on fixed maturity investments with unrealized losses for less than twelve months were primarily due to changes in the interest rate environment. At December 31, 2004, the Group has sixteen fixed maturity securities with unrealized losses for more than twelve months. Of the sixteen securities with unrealized losses for more than twelve months, thirteen of them have fair values of no less than 96% of cost, and the other three securities have a fair value greater than 94% of cost. The Group believes these declines are temporary.

      There are three equity securities that are in an unrealized loss position at December 31, 2004. All three securities have been in an unrealized loss position for less than six months. The Group believes these declines are temporary.

      The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2003 are as follows:

	Less than 12 Months				12 Months or Longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	16,715	$	399	$	4,431	$	39	$	21,146	$	438
Obligations of states and political subdivisions		481		16		—		—		481		16
Corporate securities		1,033		17		—		—		1,033		17
Mortgage-backed securities		5		—		8		—		13		—
Total fixed maturities		18,234		432		4,439		39		22,673		471
Total equity securities		1677		78		—		—		1,677		78
Total securities in a temporary unrealized loss position	$	19,911	$	510	$	4,439	$	39	$	24,350	$	549

      The unrealized losses on fixed maturity investments with unrealized losses for less than twelve months were primarily due to changes in the interest rate environment. The Group has twelve fixed maturity securities

59

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

with unrealized losses for more than twelve months. Of the twelve securities with unrealized losses for more than twelve months, eleven of them have fair values of 98% or more of cost, and the other security has a fair value greater than 96% of cost. The Group believes these declines are temporary.

      There are eleven equity securities that are in an unrealized loss position at December 31, 2003. Ten of these securities have been in an unrealized loss position for less than six months. The other equity security has been in an unrealized loss position for less than twelve months. The Group believes these declines are temporary.

      The amortized cost and estimated fair value of fixed-income securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

			Estimated
	Amortized		Fair
	Cost		Value
Due in one year or less	$	65		65
Due after one year through five years		18,772		18,661
Due after five years through ten years		39,864		39,708
Due after ten years		11,866		11,792
		70,567		70,226
Mortgage-backed securities		30,535		30,431
	$	101,102		100,657

      The gross realized gains and losses on investment securities are as follows:

	2004			2003			2002
Gross realized gains	$	1,037			1,396			703
Gross realized losses		(553	)		(693	)		(923	)
	$	484			703			(220	)

      The gross realized investment losses included write-downs for the other than temporary impairment of securities totaling $15, $454, and $647 for the years ended 2004, 2003 and 2002, respectively.

      Proceeds from the sales of available-for-sale securities were $30,548, $34,919, and $35,594 in 2004, 2003, and 2002, respectively.

      Accumulated other comprehensive income included deferred income taxes of $2,671 and $2,306 applicable to net unrealized investment gains at December 31, 2004 and 2003, respectively.

      The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2004 and 2003 was $201 and $202, respectively.

60

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

(3) DEFERRED POLICY ACQUISITION COSTS

      Changes in deferred policy acquisition costs are as follows:

	2004			2003			2002
Balance, January 1	$	7,387			5,783			4,962
Acquisition costs deferred		15,702			15,017			11,774
Amortization charged to earnings		(15,075	)		(13,413	)		(10,953	)
Balance, December 31	$	8,014			7,387			5,783

(4) PROPERTY AND EQUIPMENT

      Property and equipment was as follows:

		2004			2003
Home office:
	Land	$	423			423
	Buildings and improvements		7,145			4,691
	Furniture, fixtures, and equipment		8,816			7,050
			16,384			12,164
	Accumulated depreciation		(6,666	)		(5,220	)
		$	9,718			6,944

(5) LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

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

			2004			2003			2002
Balance, January 1			$	37,261			31,348			31,059
	Less reinsurance recoverable on unpaid losses and loss expenses			(5,036	)		(4,150	)		(5,425	)
		Net balance at January 1		32,225			27,198			25,634
Incurred related to:
	Current year			29,024			28,329			22,211
	Prior years			(886	)		(596	)		(2,144	)
		Total incurred		28,138			27,733			20,067
Paid related to:
	Current year			14,626			13,866			11,128
	Prior years			12,772			8,840			7,375
		Total paid		27,398			22,706			18,503
		Net balance, December 31		32,965			32,225			27,198
	Plus reinsurance recoverable on unpaid losses and loss expenses			3,063			5,036			4,150
Balance at December 31			$	36,028			37,261			31,348

      As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expense decreased by $886, $596, and $2,144, in 2004, 2003, and 2002, respectively. These

61

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

redundancies are primarily concentrated in the commercial automobile, commercial multi-peril, and other liability lines in 2004, the commercial multi-peril and workers’ compensation lines in 2003, and the commercial multi-peril and other liability lines in 2002.

(6) REINSURANCE

      The Group has geographic exposure to catastrophe losses in its operating region. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Group generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance.

      In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group’s retention in 2004 not exceeding $500, and in 2003 and 2002 not exceeding $300 per occurrence. Insurance ceded by the Group does not relieve its primary liability as the originating insurer. The Group also assumes reinsurance from other companies on a pro-rata basis.

      The effect of reinsurance with unrelated insurers on premiums written and earned is as follows:

		2004			2003			2002
Premiums written:
	Direct	$	65,790			61,152			50,858
	Assumed		2,133			1,613			808
	Ceded		(8,419	)		(9,963	)		(7,195	)
Net		$	59,504			52,802			44,471
Premiums earned:
	Direct	$	62,415			56,047			46,625
	Assumed		1,829			1,312			666
	Ceded		(8,460	)		(9,495	)		(6,837	)
Net		$	55,784			47,864			40,454

      The effect of reinsurance on unearned premiums as of December 31, 2004 and 2003 is as follows:

	2004		2003
Direct	$	33,060		29,685
Assumed		947		644
	$	34,007		30,329

62

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The effect of reinsurance on the liability for losses and loss adjustment expenses, and on losses and loss adjustment expenses incurred is as follows:

		2004		2003
Liabilities:
	Direct	$	33,433		35,361
	Assumed		2,595		1,900
		$	36,028		37,261

		2004		2003			2002
Losses and loss expenses incurred:
	Direct	$	26,464		29,861			20,388
	Assumed		1,565		582			415
	Ceded		109		(2,710	)		(736	)
Net		$	28,138		27,733			20,067

      The Group performs credit reviews of its reinsurers, focusing on financial stability. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of a reinsurance agreement, the Group is exposed to the risk of continued liability for such losses. At December 31, 2004, one independent reinsurer accounted for approximately $1,000 of amounts recoverable for paid and unpaid losses and loss adjustment expenses.

(7) RETIREMENT PLANS AND DEFERRED COMPENSATION PLAN

      The Group maintains a 401(k) qualified retirement savings plan covering substantially all employees. Benefits are based on an employee’s annual compensation, with new employees participating after a one-year waiting period. The Group matches a percentage of each employees’ pre-tax contribution and also contributes an amount equal to 2% of each employee’s annual compensation. Deferral amounts in excess of the qualified plan limitations, as well as Company contributions on such compensation, are funded into a nonqualified plan benefiting affected individuals. The cost for these benefits was $134, $135, and $119 for 2004, 2003, and 2002, respectively. In addition, the Company makes a discretionary contribution of up to 5% each year , based on Company profitability, to both the qualified 401(k) plan, and, where applicable, to the nonqualified plan. The cost for this portion of the retirement plan was $255, $223, and $181 for 2004, 2003, and 2002, respectively.

      The Group also maintains a nonqualified unfunded retirement plan for its directors. The plan provides for monthly payments for life upon retirement, with a minimum payment period of ten years. The expense for this plan amounted to $111, $102, and $93, for 2004, 2003, and 2002 respectively. Costs accrued under this plan amounted to $704 and $627 at December 31, 2004 and 2003, respectively.

      The Group also maintains a deferred compensation plan for its directors and officers. Under the plan, participants may elect to defer receipt of all or a portion of their fees or salary amounts. Amounts deferred, together with accumulated earnings, are distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred compensation, including accumulated earnings, amounted to $888 and $749 at December 31, 2004 and 2003, respectively.

      The Group has purchased Company-owned life insurance covering key individuals. The Group’s cost, net of increases in cash surrender value, for the Company-owned life insurance was $5, $32, and $133 for the years ended December 31, 2004, 2003, and 2002, respectively. The cash surrender value of the Company-owned life insurance totaled $767 and $597 at December 31, 2004 and 2003, respectively, and is included in other assets.

63

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      In conjunction with the Conversion described in note 1, the Group established an Employee Stock Ownership Plan (ESOP) and issued 626,111 shares to the ESOP at the Conversion offering price. The ESOP signed a promissory note in the amount of $6,261 to purchase the shares, which is due in 10 equal annual installments including interest at 4%. Shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid, and are allocated to participants based on compensation as described in the plan. During 2004, 62,611 shares were allocated to employee participants, with an equal number of shares allocated to employee participants in the period December 16, 2003 to December 31, 2003. Compensation expense equal to the fair value of the shares allocated is recognized ratably over the period that the shares are committed to be allocated to the employees. In 2004 and 2003 the Group recognized compensation expense of $874 and $568, respectively, related to the ESOP. As of December 31, 2004, the cost of the 500,889 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.

(8) FEDERAL INCOME TAXES

      The tax effect of significant temporary differences that give rise to the Group’s net deferred tax asset (liability) as of December 31, is as follows:

		2004			2003
Net unearned premiums		$	2,241			1,978
Net loss reserve discounting			1,505			1,499
Compensation and benefits			702			478
Net operating loss carryforwards			227			362
Impairment of investments			77			130
Other			37			69
	Deferred tax assets		4,789			4,516
Deferred policy acquisition costs			2,725			2,512
Unrealized gain on investments			2,671			2,306
Depreciation			401			323
Other			138			88
	Deferred tax liabilities		5,935			5,229
Net deferred liability		$	(1,146	)		(713	)

      In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes it is more likely than not the Group will realize the benefits of the deferred tax assets at December 31, 2004 and 2003.

64

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Actual income tax expense differed from expected tax expense, computed by applying the United States federal corporate income tax rate of 34% to income before income taxes, as follows:

	2004			2003			2002
Expected tax expense	$	1,481			302			1,202
Tax-exempt interest		(294	)		(64	)		(135	)
Dividends received deduction		(135	)		(93	)		(94	)
Non-deductible ESOP expense		52			—			—
Company-owned life insurance		2			11			45
Other		(14	)		18			137
Income tax expense	$	1,092			174			1,155

      The components of the provision for income taxes are as follows:

	2004		2003			2002
Current	$	1,024		(1,190	)		1,213
Deferred		68		1,364			(58	)
Income tax expense	$	1,092		174			1,155

      At December 31, 2004, the Group’s subsidiary FHC has net operating loss carryforwards available to offset future federal taxable income as follows:

Expires
	2020	$	537
	2021		131
		$	668

      The utilization of the above net operating losses is subject to an annual limitation of approximately $379 per year.

(9) SEGMENT INFORMATION

      The Group markets its products through independent insurance agents, which sell commercial lines of insurance to small to medium-sized businesses and personal lines of insurance to individuals.

65

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Financial data by segment is as follows:

				2004			2003			2002
Revenues:
	Net premiums earned:
		Commercial lines		$	32,370		$	25,964		$	20,088
		Personal lines			23,414			21,900			20,366
			Total net premiums earned		55,784			47,864			40,454
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			386			329
			Total revenues	$	59,467		$	50,660		$	42,624
Income before income taxes:
	Underwriting income (loss):
		Commercial lines		$	5,582		$	3,109		$	2,892
		Personal lines			(4,909	)		(4,951	)		(1,432	)
			Total underwriting income (loss)		673			(1,842	)		1,460
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			320			234
			Income before income taxes and minority interest in income of subsidiary	$	4,356		$	888		$	3,535

      Assets are not allocated to the commercial and personal lines, and are reviewed in total by management for purposes of decision making.

66

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

(10) RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN

      A reconciliation of the Group’s statutory net income and surplus to the Group’s net income and stockholder’s equity, under U.S. generally accepted accounting principles (GAAP), is as follows:

		2004			2003			2002
Net income:
	Statutory net income	$	2,898			632			1,292
	Deferred policy acquisition costs		627			1,604			821
	Deferred federal income taxes		(68	)		(1,364	)		58
	Minority interest in income of subsidiary		—			(131	)		(138	)
	Parent holding company loss		(238	)		(20	)		—
	Other		45			(138	)		209
GAAP net income		$	3,264			583			2,242
Surplus:
	Statutory surplus	$	61,990			58,338
	Deferred policy acquisition costs		8,014			7,387
	Deferred federal income taxes		(4,223	)		(3,504	)
	Nonadmitted assets		3,043			2,493
	Unrealized loss on fixed-income securities		(444	)		(5	)
	Parent company		31,366			33,557
	Other		662			60
GAAP stockholders’ equity		$	100,408			98,326

      The Group’s insurance companies are required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective January 1, 2001. The codified principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under U.S. generally accepted accounting principles.

      The Group’s insurance companies are required by law to maintain a certain minimum surplus on a statutory basis, and are subject to risk-based capital requirements and to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. A condition imposed in connection with the approval by the Pennsylvania Department of Insurance of the Conversion is that for a period of three years after the Conversion, Mercer Insurance Company may not declare or pay any dividend to Mercer Insurance Group without the approval of the Pennsylvania Insurance Department. After this three-year period, Mercer Insurance Company will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to its holding company. Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Mercer Insurance Company’s statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Insurance Company for the period covered by such annual statement. If the dividend restrictions imposed on

67

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Mercer Insurance Company related to the Conversion were not in effect, then as of December 31, 2004, the amounts available for payment of dividends from Mercer Insurance Company in 2005, without the prior approval of the Pennsylvania Insurance Department would have been approximately $6.2 million.

(11) CONVERSION COSTS

      On December 15, 2003, MIC converted from a mutual form of ownership to a stock form of ownership. The Group incurred expenses of $66 and $95 in 2003 and 2002, respectively, in the mutual to stock conversion.

(12) PURCHASE OF FHC, GOODWILL, AND MINORITY INTEREST

      On June 1, 2001, MIC purchased certain holdings in FHC and its wholly owned insurance subsidiary, FIC (note 1). For an investment of $3,500, MIC acquired 49% of all outstanding voting common stock; 50% of all common stock options; 50% of convertible, redeemable Series A preferred stock and certain rights to purchase the remaining voting common stock in the future. The transaction resulted in goodwill totaling $3,310. In 2002, MIC and a minority interest shareholder exercised options to purchase Series B, nonvoting common stock and paid $662 and $689, respectively, for such shares. These exercises did not change MIC’s ownership percentage in FHC.

      Prior to the acquisition of the remaining 51% in FHC, the Group consolidated FHC as it had a controlling interest in the subsidiary as evidenced by the following: MIC had control of the Board of Directors of FHC (seven of nine board members of FHC were on the board of MIC), MIC had common management with FHC and the ability to direct the policies and management that guide the ongoing activities and all substantive decision making of FHC, and MIC had the option to purchase the remaining stock of FHC. In addition, FHC and MIC entered into a reinsurance pooling agreement in connection with the acquisition whereby 100% of the direct business of FHC is ceded to MIC. MIC then retrocedes a percentage of the combined business to FHC. The effect of this agreement subsequent to the acquisition was eliminated in consolidation. The Group’s investment in FHC including common stock, options to purchase common equity, and preferred stock was eliminated in consolidation.

      On December 15, 2003, at the time of the Conversion, the Group acquired the remaining minority interest in FHC in exchange for 502,525 shares of Group. Additional goodwill of $1,797 was recorded at the time the minority interest was acquired.

      The changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2003 are as follows:

	2004		2003
Balance beginning of year	$	4,673	$	2,876
Goodwill on the purchase of the remaining minority interest in FHC		—		1,797
Balance end of year	$	4,673	$	4,673

(13) EARNINGS PER SHARE

      As described in Note 1, the Conversion resulted in the issuance of common shares of the Group on December 15, 2003. Earnings per share for 2003 are computed by dividing net income for the period subsequent to the Conversion (December 16, 2003 to December 31, 2003) by the weighted average number of common shares outstanding for the period. There were no dilutive potential common shares outstanding during this 2003 period.

68

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The computation of basic and diluted earnings per share is as follows:

	Year/ Period Ended December 31
	2004		2003			2002
	(Dollars in thousands, except
	per share data)
Numerator for basic and diluted earnings per share:
Net income	$	3,264		(477	)		N/A
Denominator for basic earnings per share – weighted-average shares outstanding		6,236,163		6,252,884			N/A
Effect of stock incentive plans		117,570		0			N/A
Denominator for diluted earnings per share		6,353,733		6,252,884			N/A
Basic earnings per share	$	0.52		(0.08	)		N/A
Diluted earnings per share	$	0.51		(0.08	)		N/A

(14) STOCK-BASED COMPENSATION

      Mercer has accounts for its stock based compensation plans under Accounting Principles Board (APB) opinion no. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), Accounting for Stock Based Compensation,” the Company has adopted the pro forma footnote disclosure-only provisions. See Note 1(m) for the pro forma effect on net income and earnings per share as if the Company had adopted FAS 123. See Note 1(p), “New Accounting Pronouncements” for further information regarding adoption of SFAS 123(R), “Share-Based Payment”.

      The Company adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on June 16, 2004. Awards under the Plan may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee Directors. The Plan limits to 250,000 the number of shares that may be awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options may be granted. The total number of shares authorized in the plan is 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of the previous year. The Plan provides that stock options and restricted stock awards may include vesting restrictions and performance criteria at the discretion of the Compensation Committee of the Board of Directors. The term of options may not exceed ten years for incentive stock options, and ten years and 1 month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. The 2004 grants have vesting periods of 3 or 5 years on restricted stock, incentive stock options, and nonqualified stock options.

69

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Information regarding fixed stock option activity in Mercer Insurance Group’s plan is presented below:

				Weighted Average
		Number of		Exercise Price
		Shares		per Share
Outstanding at December 31, 2003			0	$	0.00
Granted — 2004			537,700		12.21
Exercised — 2004			0		0.00
Forfeited — 2004			0		0.00
Outstanding at December 31, 2004			537,700	$	12.21
Exercisable at:
	December 31, 2004		0	$	0.00
	Weighted-average remaining contractual life		9.5 years

      In determining the pro-forma effect described in Note 1(m), the per share weighted-average fair value of options granted during 2004 was $4.19, estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2004: dividend yield of 0%; expected volatility of 20.91%; risk-free interest rate of 4.73%, and an expected life of 6.5 years.

      Included in the 2004 stock option grants were grants of 173,000 Incentive Stock Options, and 364,700 non-qualified stock options.

      Grants of 215,000 shares of restricted stock were awarded to employees and non-employee Directors in 2004. The weighted average price per share on the grant date was $12.21 per share.

(15) CONTINGENCIES

      The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group’s business practices are regularly subject to review by various state insurance regulatory authorities. These reviews may result in changes or clarifications of the Group’s business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group.

(16) RELATED-PARTY TRANSACTIONS

      The Group produces a large percentage of its business through one insurance agent who is also an officer and board member of the companies within the Group, Davis Insurance Agency (Davis). In 2004, 2003, and 2002, premiums written through Davis totaled 12%, 13% and 14%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,336, $1,314 and $1,182 in 2004, 2003, and 2002, respectively.

      Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided investment management services to the Group since the year 2000. Fees to Van Rensselaer, Ltd. amounted to $166 in 2004, $141 in 2003, and $139 in 2002.

70

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

(17) QUARTERLY FINANCIAL DATA (unaudited)

      The Group’s unaudited quarterly financial information is as follows:

Mercer Insurance Group, Inc. and Subsidiaries

Quarterly Financial Data

		First Quarter						Second Quarter						Third Quarter				Fourth Quarter
		2004			2003			2004			2003			2004		2003		2004		2003
		(Unaudited, in thousands, except per share data)
Net premiums written		$	12,919		$	11,259		$	15,854		$	14,922		$	13,420	$	13,052	$	17,310	$	13,569
Net premiums earned			13,862			11,056			13,723			11,327			14,032		12,379		14,167		13,102
Net investment income earned			668			427			626			394			639		400		908		486
Net realized gains (losses)			(97	)		149			196			(186	)		340		167		45		573
Net income			229			232			1,071			40			1,121		173		843		138
Other comprehensive income (loss)			771			(380	)		(1,974	)		1,081			962		312		949		477
Comprehensive income (loss)		$	1,000		$	(148	)	$	(903	)	$	1,121		$	2,083	$	485	$	1,792	$	615
Net income (loss) per share (Note 1 and 2):
	Basic	$	.04			N/A		$	0.17			N/A		$	0.18		N/A	$	0.14		(0.08	)
	Diluted	$	.04			N/A		$	0.17			N/A		$	0.17		N/A	$	0.13		(0.08	)

      Note 1 — Earnings per share data for 2003 reflects only the net loss for the period from December 16, 2003, through December 31, 2003, the period subsequent to the Conversion. Net loss during this period was $477.

      Note 2 — Earnings per share for the periods prior to December 16, 2003 are not applicable because the Group was then organized as a mutual insurance company.

(18) SUBSEQUENT EVENT

Shareholders equity

      On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares are to be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. All shares under this authorization had been purchased as as of September 30, 2004, for a total consideration of $3.0 million, or $11.90 per share. On October 20, 2004, the Board of Directors authorized the repurchase of an additional 250,000 shares of its common stock, under the same terms and conditions. As of March 7, 2005, all 250,000 shares authorized under the second authorization have been purchased, with 243,500 of the shares purchased after December 31, 2004. The total cost of the 243,500 shares purchased in 2005 was $3.2 million, or $13.18 per share, bringing the total cost of the purchase of the 500,000 shares to $6.3 million, or $12.53 per share.

71

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

      None.

ITEM 9A. CONTROLS AND PROCEDURES.

Management’s Annual Report on Internal Control Over Financial Reporting

      The management of Mercer Insurance Group, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2004.

      Mercer Insurance Group, Inc.’s independent auditor, KPMG LLP, a registered public accounting firm, has issued an audit report on our management’s assessment of our internal control over financial reporting. This audit report appears below.

	Mercer Insurance Group, Inc.
March 16, 2005	By: /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer
March 16, 2005	By: /s/ David B. Merclean David B. Merclean Senior Vice President of Finance and Chief Financial Officer

72

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

      We have audited management’s assessment, included in the accompanying management’s report on internal control over financial reporting, that Mercer Insurance Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Mercer Insurance Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that Mercer Insurance Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Mercer Insurance Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 16, 2005, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

73

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

      The information required by Item 10 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

ITEM 11. EXECUTIVE COMPENSATION.

      The information required by Item 11 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

      The information required by Item 12 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      The information required by Item 13 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

      The information required by Item 14 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

      (a) (1) The following consolidated financial statements are filed as a part of this report in Item 8.

Consolidated Financial Statements:

74

      (2) The following consolidated financial statement schedules for the years 2004, 2003 and 2002 are submitted herewith:

Financial Statement Schedules:
Report of Independent Registered Public Accounting Firm
Schedule I.	Summary of Investments — Other Than Investments in Related Parties
Schedule II.	Condensed Financial Information of Parent Company
Schedule III.	Supplementary Insurance Information
Schedule IV.	Reinsurance
Schedule V.	Allowance for Uncollectible Premiums and other Receivables
Schedule VI.	Supplemental Insurance Information Concerning Property and Casualty Subsidiaries

      All other schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.

      (3) Exhibits:

      The exhibits required by Item 601 of Regulation SK are listed in the Exhibit Index. Documents not accompanying this report are incorporated by reference as indicated on the Exhibit Index.

75

EXHIBIT INDEX

Number			Title
	2	.1	Plan of Conversion from Mutual to Stock Organization of Mercer Mutual Insurance Company, dated as of December 13, 2002 and amended and restated on March 19, 2003, April 15, 2003 and June 18, 2003 (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)
	3	.1	Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)
	3	.2	Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)
	4	.1	Form of certificate evidencing shares of common stock of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)
	8	.1	Private Letter Ruling, dated May 8, 2003, from the Internal Revenue Service to Mercer Mutual Insurance Company (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)
	10	.1	Mercer Insurance Group, Inc. Employee Stock Ownership Plan (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)
	10	.2	Employment Agreement, dated as of October 31, 2004, among BICUS Services Corporation, Mercer Insurance Company and David Merclean (filed herewith)
	10	.3	Mercer Mutual Insurance Company Executive Nonqualified ‘Excess‘ Plan dated June 1, 2002 (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)
	10	.4	Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)
	10	.5	Mercer Insurance Group, Inc. 2004 Stock Incentive Plan dated June 16, 2004, (filed herewith)
	14	.1	Code of Ethics (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)
	31	.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
	31	.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
	32	.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)
	32	.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

76

SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

Mercer Insurance Group, Inc.

March 16, 2005 By: /s/ Andrew R. Speaker
  Andrew R. Speaker
President and Chief Executive Officer
and a Director

March 16, 2005 By: /s/ David B. Merclean
  David B. Merclean
Senior Vice President of Finance
and Chief Financial Officer

      Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.

By:	/s/ Roland D. Boehm Roland D. Boehm	Vice Chairman of the Board of Directors	March 16, 2005
By:	/s/ H. Thomas Davis H. Thomas Davis	Senior Vice President and a Director	March 16, 2005
By:	/s/ William V. R. Fogler William V. R. Fogler	Director	March 16, 2005
By:	/s/ William C. Hart William C. Hart	Director	March 16, 2005
By:	/s/ George T. Hornyak, Jr. George T. Hornyak, Jr.	Director	March 16, 2005
By:	/s/ Samuel J. Malizia Samuel J. Malizia	Director	March 16, 2005

77

By:	/s/ Richard U. Niedt Richard U. Niedt	Director	March 16, 2005
By:	/s/ Andrew R. Speaker Andrew R. Speaker	President and Chief Executive Officer and a Director	March 16, 2005
By:	/s/ Richard G. Van Noy Richard G. Van Noy	Chairman of the Board of Directors	March 16, 2005

78

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

      Under date of March 16, 2005, we reported on the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, which are included in the annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules in the annual report on Form 10-K. These financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.

      In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

79

Mercer Insurance Group, Inc. and Subsidiaries

Schedule I — Summary of Investments — Other than

Investments in Related Parties as of December 31, 2004

Column A			Column B		Column C		Column D
					Market		Balance
Type of Investment			Cost		Value		Sheet
			(Dollars in thousands)
Fixed maturities:
Bonds:
	United States Government and government agencies and authorities		$	17,870		17,700		17,700
	States, municipalities and political subdivisions			35,801		35,745		35,745
	All other			47,431		47,212		47,212
		Total bonds		101,102		100,657		100,657
	Preferred stock			2,825		2,923		2,923
		Total fixed maturities		103,927		103,580		103,580
Equity securities:
Common stocks:
	Banks, trust and insurance companies			815		3,673		3,673
	Industrial, miscellaneous and all other			12,505		17,851		17,851
		Total equity securities		13,320		21,524		21,524
		Total investments	$	117,247		125,104		125,104

80

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Balance Sheet

December 31, 2004 and 2003

				2004			2003
				(Dollars in thousands)
ASSETS
Fixed income securities, available for sale, at fair value				$	22,798			0
Investment in common stock of subsidiaries (equity method)					71,137			66,864
Investment in preferred stock of subsidiaries (equity method)					2,475			2,475
Short-term investments, at cost, which approximates fair value					—			25,495
Cash and cash equivalents					829			1,547
Goodwill					1,797			1,797
Other assets					1,309			255
Deferred tax asset					123			0
Total assets				$	100,468			98,433
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
	Accounts payable and accrued expenses			$	60			107
			Total liabilities		60			107
Stockholders’ Equity:
	Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding				—			—
	Common stock, no par value, authorized 15,000,000 shares, issued 7,060,733 shares, outstanding 6,344,844 and 6,282,233 shares				—			—
	Additional paid-in capital				67,651			64,871
	Accumulated other comprehensive income:
		Unrealized gains in investments, net of deferred income taxes			5,186			4,478
	Retained Earnings				37,876			34,612
	Unearned restricted stock compensation				(2,242	)		—
	Unearned ESOP shares				(5,009	)		(5,635	)
	Treasury stock, 256,500 and -0- shares				(3,054	)		—
			Total stockholders’ equity		100,408			98,326
Total liabilities and stockholders’ equity				$	100,468			98,433

81

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statement of Earnings

For the Year ended December 31, 2004 and the period December 16, 2003 to December 31, 2003

			2004			2003
			(Dollars in thousands)
Revenue:
	Investment income, net of expenses		$	574			5
		Total revenue		574			5
Expenses:
	Other expenses			972			36
		Total expenses		972			36
		Loss before tax benefit		(398	)		(31	)
Income tax benefit				(160	)		(11	)
Loss before equity in income (loss) of subsidiaries				(238	)		(20	)
Equity in income (loss) of subsidiaries				3,502			(457	)
Net income (loss)			$	3,264			(477	)

82

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statements of Cash Flows

For the Year ended December 31, 2004 and the period December 16, 2003 to December 31, 2003

				2004			2003
				(Dollars in thousands)
Cash flows from operating activities:
	Net income (loss)			$	3,264			(477	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Equity in undistributed (income) loss of subsidiaries			(3,502	)		457
		Accretion of discount			178			—
		ESOP share allocation			780			35
		Amortization of restricted stock compensation			383			—
		Deferred income tax			(90	)		(11	)
		Other			(1,100	)		(139	)
			Net cash used in operating activities		(87	)		(135	)
Cash flows from investing activities:
	Purchase of fixed income securities				(23,508	)		—
	Sale and maturity of fixed income securities				436			—
	Sale of short-term investments				25,495			—
	Purchase of short-term investments				—			(25,495	)
			Net cash provided by (used in) investing activities		2,423			(25,495	)
Cash flows from financing activities:
	Proceeds from issuance of capital stock				—			54,177
	Capital contribution to subsidiary				—			(27,000	)
	Purchase of treasury stock				(3,054	)		—
			Net cash (used in) provided by financing activities		(3,054	)		27,177
			Net (decrease) increase in cash and cash equivalents		(718	)		1,547
Cash and cash equivalents at beginning of period					1,547			—
Cash and cash equivalents at end of period				$	829			1,547
Cash paid during the year for:
	Interest			$	—			—
	Income taxes				—			—

83

Mercer Insurance Group, Inc. and Subsidiaries

Schedule III — Supplementary Insurance Information

Column A			Column B		Column C		Column D		Column E		Column F
					Future Policy
			Deferred		Benefits,				Other Policy
			Policy		Losses, Claims,				Claims and
			Acquisition		and Loss		Unearned		Benefits		Premium
Segment			Costs		Expenses		Premiums		Payable		Revenue
			(Dollars in thousands)
December 31, 2004
	Commercial lines		$	5,327		21,679		22,822		0		32,370
	Personal lines			2,687		14,349		11,185		0		23,414
		Total	$	8,014		36,028		34,007		0		55,784
December 31, 2003
	Commercial lines		$	4,590		22,883		19,099		0		25,964
	Personal lines			2,797		14,378		11,230		0		21,900
		Total	$	7,387		37,261		30,329		0		47,864
December 31, 2002
	Commercial lines			XXXXX		XXXXX		XXXXX		XXXXX		20,088
	Personal lines			XXXXX		XXXXX		XXXXX		XXXXX		20,366
		Total		XXXXX		XXXXX		XXXXX		XXXXX		40,454

			Column G		Column H		Column I		Column J		Column K
					Benefits,
					Claims,
			Net		Losses and				Other
			Investment		Settlement		Amortization		Operating		Premiums
			Income		Expenses		of DPAC		Expenses		Written
			(Dollars in thousands)
December 31, 2004
	Commercial lines		$		$	10,325		9,202		7,261		36,492
	Personal lines					17,813		5,873		4,637		23,012
		Total	$	2,841		28,138		15,075		11,898		59,504
December 31, 2003
	Commercial lines		$		$	10,145		7,758		4,952		30,315
	Personal lines					17,588		5,655		3,608		22,487
		Total	$	1,707		27,733		13,413		8,560		52,802
December 31, 2002
	Commercial lines		$		$	7,283		5,737		4,176		23,591
	Personal lines					12,784		5,216		3,798		20,880
		Total	$	2,061		20,067		10,953		7,974		44,471

84

Mercer Insurance Group, Inc. and Subsidiaries

Schedule IV — Reinsurance

For the years ended December 31, 2004, 2003 and 2002

Column A	Column B		Column C		Column D		Column E		Column F
					Assumed				Percentage
			Cede to		from				of Amount
	Gross		Other		Other		Net		Assumed
Premiums Earned	Amount		Companies		Companies		Amount		to Net
			(Dollars in thousands)
For the year ended December 31, 2004	$	62,415		8,460		1,829		55,784		3.3	%
For the year ended December 31, 2003		56,047		9,495		1,312		47,864		2.7	%
For the year ended December 31, 2002		46,625		6,837		666		40,454		1.6	%

85

Mercer Insurance Group, Inc. and Subsidiaries

Schedule V — Allowance for Uncollectible Premiums and Other Receivables

For the years ended December 31, 2004, 2003 and 2002

Premiums Earned	2004			2003			2002
	(Dollars in thousands)
Balance, January 1	$	97		$	72		$	60
Additions		129			228			77
Deletions		(123	)		(203	)		(65	)
Balance, December 31	$	103		$	97		$	72

86

Mercer Insurance Group, Inc. and Subsidiaries

Schedule VI — Supplemental Information

For the years ended December 31, 2004, 2003 and 2002

Column A

Column B

Column C

Column D

Column E

Column F

Column G

Deferred

Reserve for

Discount if

Policy

Losses and

any

Net

Net

Acquisition

Loss Adj.

Deducted in

Unearned

Earned

Investment

Affiliation with Registrant

Costs

Expenses

Column C

Premiums

Premiums

Income

(Dollars in thousands)

Year ended December 31, 2004

8,014

36,028

0

34,007

55,784

2,841

Year ended December 31, 2003

7,387

37,261

0

30,329

47,864

1,707

Year ended December 31, 2002

5,783

31,348

0

24,923

40,454

2,061

	Column H					Column I		Column J		Column K
	Losses and							Paid
	Current		LAEor					Losses and		Net
	Incurre		dYear			Amortization		Adjustment		Written
						of DPAC		Expenses		Premiums
	Year
	(Dollars in thousands)
Year ended December 31, 2004		29,024		(886	)		15,075		27,398		59,504
Year ended December 31, 2003		28,329		(596	)		13,413		22,706		52,802
Year ended December 31, 2002		22,211		(2,144	)		10,953		18,503		44,471

87 EX-10.2 2 e05550exv10w2.htm EMPLOYMENT AGREEMENT, DATED AS OF OCTOBER 31, 2004

EXHIBIT 10.2

EMPLOYMENT AGREEMENT

     AGREEMENT made as of the 31st day of October, 2004, by and among BICUS SERVICES CORPORATION, a Pennsylvania corporation, MERCER INSURANCE COMPANY, a Pennsylvania corporation, and DAVID B. MERCLEAN.

     Bicus Services Corporation, a wholly-owned subsidiary of Mercer Insurance Company, desires to employ Mr. Merclean, and Mr. Merclean is willing to serve Bicus Services Corporation on the terms and conditions herein provided.

     In order to effect the foregoing, the parties hereto desire to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties contained herein, and intending to be legally bound hereby, the parties hereto agree as follows:

     1. Definitions. Each capitalized word and term used herein shall have the meaning ascribed to it in the glossary appended hereto, unless the context in which such word or term is used otherwise clearly requires. Such glossary is incorporated herein by reference and made a part hereof.

     2. Employment. The Company hereby agrees to employ the Executive, and the Executive hereby agrees to serve the Company, on the terms and conditions set forth herein.

     3. Term of Agreement. The Executive’s employment under this Agreement shall commence on the date this Agreement and, except as otherwise provided herein, shall continue until March 31, 2007; provided, however, that commencing on March 31, 2005 and each March 31 thereafter, the term of this Agreement shall automatically be extended for one additional year beyond the term otherwise established unless, prior to such March 31st date, the Company shall not have given a Notice of Extension.

     4. Position and Duties. The Executive shall serve as Senior Vice President and Chief Financial Officer of the Company, and he shall have such responsibilities, duties and authority as may, from time to time, be generally associated with such positions. In addition, the Executive shall serve in such capacity, with respect to each Subsidiary or Affiliate, as the Board of Directors of each such Subsidiary or Affiliate shall designate from time to time. During the term of this Agreement, he shall devote substantially all of his working time and efforts to the business and affairs of the Company, the Subsidiaries and the Affiliate; provided, however, that nothing herein shall be construed as precluding him from devoting a reasonable amount of time to civic, charitable, trade association, and similar activities, at least to the extent he is presently devoting time.

     5. Compensation and Related Matters.

     Base Compensation. During the period of the Executive’s employment hereunder, the Company shall pay to him annual base compensation of $200,000.

     Thereafter, the Board of Directors of the Company shall periodically review the Executive’s employment performance, in accordance with policies generally in effect from time to time, for possible merit or cost-of-living increases in such base compensation. Except for a

1

reduction which is proportionate to a company-wide reduction in executive pay, the annual base compensation paid to the Executive in any period shall not be less than the annual base compensation paid to him in any prior period. The frequency and manner of payment of such base compensation shall be in accordance with the Company’s executive payroll practices from time to time in effect. Nothing herein shall be construed as precluding the Executive from entering into any salary reduction or deferral plan or arrangement during the term of this Agreement; provided, however, that his base compensation shall be determined without regard to any such salary reduction or deferral for purposes of calculating the amount of any compensation and benefits to which he or his surviving spouse may be entitled under Paragraph 6, 7, 10, or 11 following his termination of employment. The amounts set forth in the first sentence of this subparagraph shall be pro rated to the extent such period is less than a year.

          (a) Incentive Compensation. During the period of the Executive’s employment hereunder, he shall be entitled to participate in all incentive plans, stock option plans, stock appreciation rights plans, and similar arrangements maintained by the Company or its Affiliates for executive officers on a basis and at award levels consistent and commensurate with his position and duties hereunder.

          (b) Employee Benefit Plans and Other Plans or Arrangements. The Executive shall be entitled to participate in all Employee Benefit Plans of the Company and its Affiliates on the same basis as other executive officers of the Company. In addition, he shall be entitled to participate in and enjoy any other plans and arrangements which provide for sick leave, vacation, sabbatical, or personal days, company-provided automobile, club memberships and dues, education payment or reimbursement, business-related seminars, and similar fringe benefits provided to or for the executive officers of the Company and its Affiliates from time to time, but at least to the extent he is presently entitled to participate in and enjoy such plans and arrangements.

          (c) Expenses. During the period of the Executive’s employment hereunder, he shall be entitled to receive prompt reimbursement for all reasonable and customary expenses, including transportation expenses, incurred by him in performing services hereunder in accordance with the general policies and procedures established by the Company.

     6. Termination By Reason of Disability.

          (a) In General. In the event the Executive becomes unable to perform his duties on a full-time basis by reason of the occurrence of his Disability and, within 30 days after a Notice of Termination is given, he shall not have returned to the full-time performance of such duties, his employment may be terminated by the Company.

          (b) Compensation and Benefits. In the event of the termination of the Executive’s employment under Subparagraph (a), the Company shall pay or provide the compensation and benefits set forth below:

               (1) The Executive shall be paid an amount per annum equal to the greater of (i) his highest base compensation received during one of the two calendar years immediately preceding the calendar year in which the Date of Termination occurs, or (ii) his base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason) for

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one year beginning with such Date of Termination. The frequency and manner of payment of such amounts shall be in accordance with the Company’s executive payroll practices from time to time in effect.

               (2) The Executive shall be paid an amount equal to the higher of the aggregate bonus(es), if any, paid to him with respect to one of the two years immediately preceding the year in which the Date of Termination occurs. Such amount shall be paid to him in cash on the first anniversary date of the Date of Termination.

               (3) The Executive shall be paid an amount equal to the highest annual contribution made on his behalf (other than his own salary reduction contributions) to each tax-qualified and non-qualified Defined Contribution Plan of the Company or its Affiliates with respect to the year in which the Date of Termination occurs or one of the two years immediately preceding such year. The amount separately determined for each such plan shall be aggregated and shall be paid to him in cash on the first anniversary date of the Date of Termination.

               (4) The Executive shall accrue benefits equal to the excess of (i) the aggregate retirement benefits he would have received under the terms of each tax-qualified and non-qualified Defined Benefit Plan of the Company or its Affiliates as in effect immediately prior to the Date of Termination had he (A) continued to be employed for one more year, and (B) received (on a pro rated basis, as appropriate) the greater of (I) the highest compensation taken into account under each such plan with respect to one of the two years immediately preceding the year in which the Date of Termination occurs, or (II) his annualized base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason), over (ii) the retirement benefits he actually receives under such plans. The frequency, manner and extent of payment of such benefits shall be consistent with the terms of the plans to which they relate and any elections made thereunder.

               (5) The Executive and his eligible dependents shall be entitled to continue to participate at the same aggregate benefit levels, for one year and at no out-of-pocket or tax cost to him, in the Welfare Benefit Plans in which he was a participant immediately prior to the Date of Termination, to the extent permitted under the terms of such plans and applicable law. To the extent the Company or its Affiliates are unable to provide for continued participation in a Welfare Benefit Plan, it shall provide an equivalent benefit directly at no out-of-pocket or tax cost to him. For purposes of the preceding two sentences, the Company shall be deemed to have provided a benefit at no tax cost to him if it pays an additional amount to him or on his behalf, with respect to those benefits which would otherwise be nontaxable to him, calculated in a manner consistent with the provisions of Paragraph 12.

          (c) Adjustment to Certain Subparagraph (b) Compensation and Benefits. Notwithstanding the provisions of Subparagraph (b)(5), the Company or its Affiliates’ obligation to pay or fund any disability insurance premiums on behalf of the Executive shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts otherwise due under Subparagraph (b) shall

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be reduced (but not below zero) by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, by the Company or its Affiliates.

          (d) Earlier Cessation of Certain Welfare Benefits. Notwithstanding the provisions of Subparagraph (b)(5), neither the Company nor an Affiliate shall be required to provide, at its cost, the welfare benefits covered therein after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document).

          (e) Death During Remaining Term of Agreement.

               (1) In the event the Executive dies during the remaining term of this Agreement following his termination for Disability and he is survived by a spouse, the compensation and benefits remaining to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Subparagraph (b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that neither the Company nor an Affiliate shall be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall the Company or an Affiliate be required to provide, at its cost, the other welfare benefits described in Subparagraph (b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document).

               (2) In the event the Executive dies during the remaining term of this Agreement following his termination for Disability and he is not survived by a spouse, (i) the Company or an Affiliate shall thereafter make the remaining payments described in Subparagraphs (b)(1) through (b)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Subparagraph (b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) the Company and its Affiliates’ obligation to provide continued benefits under Subparagraph (b)(5) shall terminate.

          (f) Compensation and Benefits Upon Expiration of Remaining Term of Agreement. Upon the expiration of the remaining term of this Agreement following the Executive’s termination for Disability, and provided his Disability then continues, he shall be entitled to receive the compensation and benefits provided under the terms of the Company or an Affiliates’ long-term disability plan in effect on the Date of Termination or, if greater, at the expiration of such remaining term. Such compensation and benefits shall continue until the earlier of (i) his death, or (ii) the later of (A) his attainment of age 65, or (B) the date specified in the plan document for benefit termination. To the extent the Company or an Affiliate is unable to provide such compensation and benefits under its long-term disability plan, it shall provide equivalent compensation and benefits directly at no out-of-pocket or tax cost to him. For purposes of the preceding sentence, the Company or the Affiliate shall be deemed to have provided compensation and benefits at no tax cost to him if it pays an additional amount to him

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or on his behalf, with respect to the compensation and benefits which would otherwise be nontaxable to him, calculated in a manner consistent with the provisions of Paragraph 12.

     7. Termination By Reason of Death.

          (a) Compensation and Benefits to Surviving Spouse. In the event the Executive dies while he is employed under this Agreement and is survived by a spouse, the Company or an Affiliate shall pay or provide the compensation and benefits set forth below:

               (1) The surviving spouse shall be paid an amount equal to the greater of (i) the Executive’s highest base compensation received during one of the two calendar years immediately preceding the calendar year in which the Date of Termination occurs, or (ii) his base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason) for a period of one year, beginning with such Date of Termination. The frequency and manner of payment of such amounts shall be in accordance with the Company’s executive payroll practices from time to time in effect.

               (2) The surviving spouse shall be paid an amount equal to the highest payment made to Executive under each incentive bonus plan of the Company with respect to one of the two years immediately preceding the year in which the Date of Termination occurs. Such amount shall be paid in cash to her within 30 days after the Date of Termination.

               (3) The surviving spouse shall be paid an amount equal to the sum of the highest annual contribution made on the Executive’s behalf (other than his own salary reduction contributions) to each tax-qualified and non-qualified Defined Contribution Plan of the Company or an Affiliate with respect to the year in which the Date of Termination occurs or one of the two years immediately preceding such year. Such amount shall be paid in cash to her within 30 days after the Date of Termination or within 30 days after such amount can first be determined, whichever is later.

               (4) Subject to the following sentence, the surviving spouse shall be paid benefits determined by reference to the excess of (i) the aggregate retirement benefits the Executive would have accrued under the terms of each tax-qualified and non-qualified Defined Benefit Plan as in effect immediately prior to the Date of Termination, had he (A) continued to be employed for a period of one year following the Date of Termination, and (B) received (on a pro rated basis, as appropriate) the greater of (I) the highest compensation taken into account under each such plan with respect to one of the two years immediately preceding the year in which the Date of Termination occurs, or (II) his annualized base compensation in effect immediately prior to the Date of Termination (or prior to any reduction which entitled him to terminate his employment for Good Reason), over (ii) the retirement benefits actually determined under such plans. The frequency, manner, and extent of payment of such benefits shall be consistent with the terms of the plans to which they relate and any elections made thereunder.

               (5) The surviving spouse and her eligible dependents shall be entitled to continue to participate at the same aggregate benefit levels, for a period of one year following the Date of Termination and at no out-of-pocket or tax cost to her, in the

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Welfare Benefit Plans in which the Executive was a participant immediately prior to the Date of Termination, to the extent permitted under the terms of such plans and applicable law; provided, however, that neither the Company nor its Affiliates shall be required to provide continued benefits with respect to her deceased husband; and provided further, that neither the Company nor its Affiliates shall thereafter be required to provide, at its cost, the other welfare benefits covered by such plans to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming the Executive was employed until age 65 or the normal retirement date, if any, specified in such document). To the extent the Company or an Affiliate is unable to provide for continued participation in a Welfare Benefit Plan as required, it shall provide an equivalent benefit directly at no out-of-pocket or tax cost to her. For purposes of the preceding two sentences, the Company or the Affiliate shall be deemed to have provided a benefit at no tax cost to her if it pays an additional amount to her or on her behalf, with respect to those benefits which would otherwise be nontaxable to her, calculated in a manner consistent with the provisions of Paragraph 12.

          (b) Compensation and Benefits to Estate, Etc. In the event the Executive dies while he is employed under this Agreement and is not survived by a spouse, (i) the Company or an Affiliate shall make the payments described in Subparagraphs (a)(1) through (a)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Subparagraph (a)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) the Company and its Affiliates’ obligation to provide benefits under Subparagraph (a)(5) shall terminate.

     8. Termination By the Company for Cause.

          (a) In General. In the event the Company intends to terminate the Executive’s employment for Cause, it shall deliver a Notice of Termination to him which specifies a Date of Termination not less than 30 days following the date of such notice, unless a shorter period of notice is required by the principal regulator of any Affiliate of the Company.

          (b) Compensation. Within 30 days after the Executive’s termination under Subparagraph (a), the Company shall pay him, in one lump sum, his accrued but unpaid base compensation and vacation compensation earned through the Date of Termination.

     9. Termination By the Executive Without Good Reason.

          (a) In General. In the event the Executive intends to terminate his employment without Good Reason, he shall deliver a Notice of Termination to the Company which specifies a Date of Termination not less than (i) 90 days following the date of such notice, if a Change in Control shall not have occurred, or (ii) 30 days following the date of such notice, if a Change in Control shall have occurred.

          (b) Compensation. Within 30 days after the Executive’s termination under Subparagraph (a), the Company shall pay him, in one lump sum, his accrued but unpaid base compensation and vacation compensation earned through the Date of Termination.

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     10. Termination By the Company Without Disability or Cause.

          (a) In General. In the event the Company intends to terminate the Executive’s employment for any reason other than Disability or Cause, it shall deliver a Notice of Termination to him which specifies a Date of Termination not less than 90 days following the date of such notice.

          (b) Compensation and Benefits During Remaining Term of Agreement. In the event of the termination of the Executive’s employment under Subparagraph (a), the Company or an Affiliate shall pay or provide the compensation and benefits described in Paragraph 6(b) for one year beginning with the Date of Termination.

          (c) Adjustment to Certain Subparagraph (b) Compensation and Benefits. In the event the Executive suffers a Disability during the one year following the Date of Termination, the Company or an Affiliate’s obligation to pay or fund any disability insurance premiums on his behalf shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts described in Paragraph 6(b) and otherwise payable under Subparagraph (b) shall be reduced (but not below zero) by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, by the Company or an Affiliate.

          (d) Earlier Cessation of Certain Welfare Benefits. Notwithstanding the provisions of Subparagraph (b), neither the Company nor an Affiliate shall be required to provide, at its cost, the welfare benefits covered by Paragraph 6(b)(5) after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document).

          (e) Death During Remaining Term of Agreement.

               (1) In the event the Executive dies during the year following his termination without Disability or Cause by the Company and he is survived by a spouse, the compensation and benefits required to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that neither the Company nor an Affiliate shall be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall the Company nor an Affiliate be required to provide, at its cost, the other welfare benefits described in Paragraph 6(b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document).

               (2) In the event the Executive dies during the year following his termination without Disability or Cause and he is not survived by a spouse, (i) the Company shall thereafter make the remaining payments described in Paragraphs 6(b)(1) through 6(b)(3) directly to his estate, (ii) the extent of the rights of any person to the

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accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) the Company and any Affiliate’s obligation to provide the continued benefits described in Paragraph 6(b)(5) shall terminate.

     11. Termination By the Executive for Good Reason.

          (a) In General. In the event the Executive intends to terminate his employment for Good Reason, he shall deliver a Notice of Termination to the Company which specifies a Date of Termination not less than 30 days following the date of such notice.

          (b) Compensation and Benefits During Remaining Term of Agreement. In the event of the termination of the Executive’s employment under Subparagraph (a), the Company shall pay or provide the compensation and benefits described in Paragraph 6(b) for one year beginning with the Date of Termination.

          (c) Adjustment to Certain Subparagraph (b) Compensation and Benefits. In the event the Executive suffers a Disability during the year following the Date of Termination, the Company or any Affiliate’s obligation to pay or fund any disability insurance premiums on his behalf shall be suspended while his Disability continues, provided the cessation of payment or funding does not result in the termination of disability benefits. Any amounts described in Paragraph 6(b) and otherwise payable under Subparagraph (b) shall be reduced (but not below zero) by the dollar amount of disability benefits received by him pursuant to plans or policies funded, directly at its cost, to the Company or any Affiliate.

          (d) Earlier Cessation of Certain Welfare Benefits. Notwithstanding the provisions of Subparagraph (b), neither the Company nor an Affiliate shall be required to provide, at its cost, the welfare benefits covered by Paragraph 6(b)(5) after the later of (i) the attainment by the Executive and his spouse (if any) of age 65, or (ii) the date specified in the relevant plan document for benefit termination (assuming that he was employed until age 65 or the normal retirement date, if any, specified in such document).

          (e) Death During Remaining Term of Agreement.

               (1) In the event the Executive dies during the year following his termination for Good Reason and he is survived by a spouse, the compensation and benefits required to be paid and provided under Subparagraph (b) shall be unaffected by his death and shall be paid and provided to her or on her behalf; provided, however, that the extent of her rights to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans; and provided further, that neither the Company nor any Affiliate shall be required to provide continued benefits with respect to her deceased husband; and provided further, that in no event shall the Company or any Affiliate be required to provide, at its cost, the other welfare benefits described in Paragraph 6(b)(5) to such spouse and her eligible dependents after the earlier of (i) her death, or (ii) the later of (A) her attainment of age 65, or (B) the date specified in the relevant plan document for benefit termination (assuming that the Executive was employed until age 65 or the normal retirement date, if any, specified in such document).

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               (2) In the event the Executive dies during the year following his termination for Good Reason and he is not survived by a spouse, (i) either the Company or any Affiliate shall thereafter make the remaining payments described in Paragraphs 6(b)(1) through 6(b)(3) directly to his estate, (ii) the extent of the rights of any person to the accrued benefits described in Paragraph 6(b)(4) shall be determined by reference to the relevant plan provisions and any elections made under such plans, and (iii) the Company or any Affiliate’s obligation to provide the continued benefits described in Paragraph 6(b)(5) shall terminate.

     12. Provisions Relating to Excise Taxes.

          (a) In General. In the event the Executive becomes liable, for any taxable year, for the payment of an Excise Tax (because of a change in control) with respect to the compensation and benefits payable by the Company or an Affiliate under this Agreement or otherwise, the Company shall make one or more Gross-Up Payments to the Executive or on his behalf. The amount of any Gross-Up Payment shall be calculated by a certified public accountant or other tax professional designated jointly by the Executive and the Company. The provisions of this paragraph shall apply with respect to the Executive’s surviving spouse or estate, where relevant.

          (b) Methodology for Calculation of Gross-Up Payment. For purposes of determining the amount of any Gross-Up Payment, the Executive shall be deemed to pay income taxes at the highest federal, state, and local marginal rates of tax for the calendar year in which the Gross-Up Payment is to be made, net of the maximum reduction in federal income tax which could be obtained from the deduction of state and local income taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account at the time the Gross-Up Payment was made, the Executive shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to the reduction (plus a portion of the Gross-Up Payment attributable to the Excise Tax and the federal, state, and local income taxes imposed on the portion of the Gross-Up Payment being repaid by the Executive to the extent such repayment results in a reduction in Excise Tax or federal, state, or local income tax), plus interest on the amount of such repayment. Such interest shall be calculated by using the rate in effect under Section 1274(d)(1) of the IRC, on the date the Gross-Up Payment was made, for debt instruments with a term equal to the period of time which has elapsed from the date the Gross-Up Payment was made to the date of repayment. In the event that the Excise Tax is subsequently determined to exceed the amount taken into account at the time the Gross-Up Payment was made (including by reason of any payment the existence or amount of which could not be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment with respect to the excess at the time the amount thereof is finally determined, plus interest calculated in a manner similar to that described in the preceding sentence.

          (c) Time of Payment. Any Gross-Up Payment provided for herein shall be paid not later than the 30th day following the payment of any compensation or the provision of any benefit which causes such payment to be made; provided, however, that if the amount of such payment cannot be finally determined on or before such day, the Company shall pay on such day an estimate of the minimum amount of such payment and shall pay the remainder of such payment (together with interest calculated in a manner similar to that described in

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Subparagraph (b)) as soon as the amount thereof can be determined. In the event that the amount of an estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the 30th day after demand by the Company (together with interest calculated in a manner similar to that described in Subparagraph (b)).

          (d) Notwithstanding the provisions of this paragraph to the contrary, the actual amounts payable hereunder as Gross-Up Payments shall be coordinated with any similar amounts paid to the Executive under any other contract, plan, or arrangement.

     13. Fees and Expenses of the Executive. After a Change in Control and except as provided in the following sentence, the Company shall pay, within 30 days following demand by the Executive, all legal, accounting, actuarial, and related fees and expenses incurred by him in connection with the enforcement of this Agreement. An arbitration panel or a court of competent jurisdiction shall be empowered to deny payment to the Executive of such fees and expenses only if it determines that he instituted a proceeding hereunder, or otherwise acted, in bad faith.

     14. Reduction for Compensation and Benefits Received Under the Company Severance Policy, Etc. Notwithstanding anything herein to the contrary, in the event the Executive, his surviving spouse, or any other person becomes entitled to continued compensation and benefits hereunder by reason of the Executive’s termination of employment and, in addition, compensation or similar benefits are payable under a severance policy, program or arrangement maintained by the Company (other than retirement plans), then the compensation or benefits otherwise payable hereunder shall be reduced by the compensation or benefits provided under such severance policy, program or arrangement.

     15. Mitigation. The Executive shall not be required to mitigate the amount of any compensation or benefits which may become payable hereunder by reason of his termination by seeking other employment or otherwise, nor, except as otherwise provided in the following sentence or elsewhere herein, shall the amount of any such compensation or benefits be reduced by any compensation or benefits received by the Executive as the result of his employment by another employer. Notwithstanding anything in this Agreement to the contrary, the Company or any Affiliate’s obligation to provide any medical and dental benefits hereunder may be suspended, with the written concurrence of the Executive or, if applicable, his surviving spouse during any period of time that such benefits are being provided by reason of his or her employment.

     16. Funding of Compensation and Benefits; Acceleration of Certain Payments.

          (a) Grantor Trust. In the event the Executive’s employment is terminated without Cause or he terminates his employment for Good Reason and a Change in Control has occurred as of the Date of Termination or occurs thereafter, the Executive shall have the right to require the Company to establish a grantor trust (taxable to the Company ) and fund such trust, on an actuarially sound basis, to provide the compensation and benefits to which he is entitled hereunder, other than those which may be paid pursuant to the provisions of Subparagraph (c). The specific terms of such trust shall be as agreed to by the parties in good faith; provided, however, that the trustee shall be a financial institution independent of the Company; and provided further, that in no event shall the Company be entitled to withdraw funds from the trust

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for its benefit, or otherwise voluntarily assign or alienate such funds, until such time as all compensation and benefits required hereunder are paid and provided. The determination of the extent of required funding, including any supplemental funding in the event of adverse investment performance of trust assets, shall be made by an actuary or a certified public accountant retained by each party. To the extent such professionals cannot agree on the proper level of funding, they shall select a third such professional whose determination shall be binding upon the parties. Notwithstanding the foregoing, the Company and its Affiliates shall remain liable for all compensation and benefits required to be paid or provided hereunder.

          (b) Alternate Security. In lieu of the right given to the Executive under Subparagraph (a), he shall have the right under such circumstances to require that the Company or its Affiliates provide (i) an irrevocable standby letter of credit issued by a financial institution other than the Company or any Subsidiary of the Company with a senior debt credit rating of “A” or better by Moody’s Investors Service or Standard & Poor’s Corporation, or (ii) other security reasonably acceptable to him, to secure the payment of such compensation and benefits.

          (c) Accelerated Payment of Present Value of Certain Compensation. In the event the Executive’s employment is terminated without Cause or he terminates his employment for Good Reason and a Change in Control has occurred as of the Date of Termination or occurs thereafter, the Executive shall have the continuing right to demand that the present value of the remaining payments described in Paragraphs 6(b)(1) through (3), and payable by reason of the provisions of Paragraph 10 or 11 (as the case may be), be paid to him in one lump sum within 30 days after the date written demand is given. For purposes of calculating the present value of such payments, a discount factor shall be applied to each such payment which is equal to the relevant applicable federal rate in effect on the date written demand is given by him, determined by reference to the period of time between the date of such notice and the scheduled time such payment would otherwise be made. In the event any payment described in Paragraphs 6(b)(1) through (3) is not yet determinable on the date written demand is made, the other payments shall nonetheless be made as provided above; and the undetermined payment shall be made within 30 days after it becomes determinable, calculated as provided in the preceding sentence but by treating the date on which the payment becomes determinable as the date of written notice. Nothing in this subparagraph shall be construed as affecting the Executive’s right to one or more Gross-Up Payments in accordance with the provisions of Paragraph 12; and a Gross-Up Payment (if applicable) will be calculated and made with any payment made under this subparagraph, as well as any other Gross-Up Payments that may be required hereunder at a subsequent date.

     17. Withholding Taxes. All compensation and benefits provided for herein shall, to the extent required by law, be subject to federal, state, and local tax withholding.

     18. Confidential Information. The Executive agrees that subsequent to his employment with the Company, he will not, at any time, communicate or disclose to any unauthorized person, without the written consent of the Company, any proprietary or other confidential information concerning the Company or any Subsidiary or any Affiliate of the Company; provided, however, that the obligations under this paragraph shall not apply to the extent that such matters (i) are disclosed in circumstances where the Executive is legally obligated to do so, or (ii) become generally known to and available for use by the public otherwise than by his wrongful act or omission; and provided further, that he may disclose any

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knowledge of insurance, financial, legal and economic principles, concepts and ideas which are not solely and exclusively derived from the business plans and activities of the Company.

     19. Covenants Not to Compete or to Solicit.

          (a) Noncompetition. If the Executive’s employment terminates under Paragraph 8 or 9 prior to a Change in Control, he agrees that for a period of 12 months after the Date of Termination he will not, without the written consent in writing of the Board of Directors of the Company, become an officer, employee, agent, partner, director, or a four and nine-tenths percent or greater shareholder or equity owner of any licensed direct property and casualty insurance company with its corporate headquarters located within Pennsylvania or New Jersey. If at the time of the enforcement of this paragraph a court holds that the duration, scope, or area restrictions stated herein are unreasonable under the circumstances then existing and, thus, unenforceable, the Company and the Executive agree that the maximum duration, scope, or area reasonable under such circumstances shall be substituted for the stated duration, scope, or area.

          (b) Nonsolicitation. During his employment and for a period of 12 months following the Date of Termination, the Executive shall not, whether on his own behalf or on behalf of any other individual or business entity, solicit, endeavor to entice away from the Company, a Subsidiary or any Affiliate, or otherwise interfere with the relationship of the Company, a Subsidiary or any Affiliate with any person who is, or was within the then most recent 12 month period, an employee or associate thereof; provided, however, that this subparagraph shall not apply following the occurrence of a Change in Control.

     20. Arbitration. To the extent permitted by applicable law, any controversy or dispute arising out of or relating to this Agreement, or any alleged breach hereof, shall be settled by arbitration in Pennington, New Jersey, in accordance with the commercial rules of the American Arbitration Association then in existence (to the extent such rules are not inconsistent with the provisions of this Agreement), it being understood and agreed that the arbitration panel shall consist of three individuals acceptable to the parties hereto. In the event that the parties cannot agree on three arbitrators within 20 days following receipt by one party of a demand for arbitration from another party, then the Executive and the Company shall each designate one arbitrator and the two arbitrators selected shall select the third arbitrator. The arbitration panel so selected shall convene a hearing no later than 90 days following the selection of the panel. The arbitration award shall be final and binding upon the parties, and judgment may be entered thereon in the Commonwealth of Pennsylvania Court of Common Pleas or in any other court of competent jurisdiction.

     21. Additional Equitable Remedy. The Executive acknowledges and agrees that the Company’s remedy at law for a breach or a threatened breach of the provisions of Paragraphs 18 and 19 would be inadequate; and, in recognition of this fact and notwithstanding the provisions of Paragraph 20, in the event of such a breach or threatened breach by him, it is agreed that the Company shall be entitled to request equitable relief in the form of specific performance, temporary restraining order, temporary or permanent injunction, or any other equitable remedy which may then be available. Nothing in this paragraph shall be construed as prohibiting the Company from pursuing any other remedy available under this Agreement for such a breach or threatened breach.

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     22. Related Agreements. Except as may otherwise be provided herein, to the extent that any provision of any other agreement between the Company and the Executive shall limit, qualify, duplicate, or be inconsistent with any provision of this Agreement, the provision in this Agreement shall control and such provision of such other agreement shall be deemed to have been superseded, and to be of no force or effect, as if such other agreement had been formally amended to the extent necessary to accomplish such purpose.

     23. No Effect on Other Rights. Except as otherwise specifically provided herein, nothing contained in this Agreement shall be construed as adversely affecting any rights the Executive may have under any agreement, plan, policy or arrangement to the extent any such right is not inconsistent with the provisions hereof.

     24. Exclusive Rights and Remedy. Except for any explicit rights and remedies the Executive may have under any other contract, plan or arrangement with the Company, the compensation and benefits payable hereunder and the remedy for enforcement thereof shall constitute his exclusive rights and remedy in the event of his termination of employment.

     25. Director and Officer Liability Insurance; Indemnification. The Company and Mercer shall provide the Executive (including his heirs, executors, and administrators) with coverage under a standard directors’ and officers’ liability insurance policy, at the Company and Mercer’s expense, in amounts consistent with amounts provided by peer corporations to their directors and officers, and shall indemnify him as both a director and as an officer (and his heirs, executors, and administrators) to the fullest extent permitted under Pennsylvania law against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been an officer or director of the Company or any Subsidiary or Affiliate (whether or not he continues to be such an officer or director at the time of incurring such expenses or liabilities). Such expenses and liabilities shall include, but not be limited to, judgments, court costs, and attorneys’ fees, and the costs of reasonable settlements.

     26. Notices. Any notice required or permitted under this Agreement shall be sufficient if it is in writing and shall be deemed given (i) at the time of personal delivery to the addressee, or (ii) at the time sent certified mail, with return receipt requested, addressed as follows:

If to the Executive—

                    Mr. David B. Merclean

                    8 Demarest Drive

                    Mendham, New Jersey 07945

If to Mercer, or the Company—

                    10 North Highway 31

                    P.O. Box 278

                    Pennington, NJ 08534

                    Attention: President and Chief Executive Officer

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The name or address of any addressee may be changed at any time and from time to time by notice similarly given.

     27. No Waiver. The failure by any party to this Agreement at any time or times hereafter to require strict performance by any other party of any of the provisions, terms, or conditions contained in this Agreement shall not waive, affect, or diminish any right of the first party at any time or times thereafter to demand strict performance therewith and with any other provision, term, or condition contained in this Agreement. Any actual waiver of a provision, term, or condition contained in this Agreement shall not constitute a waiver of any other provision, term, or condition herein, whether prior or subsequent to such actual waiver and whether of the same or a different type. The failure of the Company to promptly terminate the Executive’s employment for Cause or the Executive to promptly terminate his employment for Good Reason shall not be construed as a waiver of the right of termination, and such right may be exercised at any time following the occurrence of the event giving rise to such right.

     28. Joint and Several Obligations of Mercer and the Company. Mercer and the Company shall be jointly and severally liable for all compensation and benefits that may become payable hereunder to or on behalf of the Executive or, if applicable, his surviving spouse, estate or beneficiaries.

     29. Survival. Notwithstanding the nominal termination of this Agreement and the Executive’s employment hereunder, the provisions hereof which specify continuing obligations, compensation and benefits, and rights (including the otherwise applicable term hereof) shall remain in effect until such time as all such obligations are discharged, all such compensation and benefits are received, and no party or beneficiary has any remaining actual or contingent rights hereunder.

     30. Severability. In the event any provision in this Agreement shall be held illegal or invalid for any reason, such illegal or invalid provision shall not affect the remaining provisions hereof, and this Agreement shall be construed, administered and enforced as though such illegal or invalid provision were not contained herein.

     31. Binding Effect and Benefit. The provisions of this Agreement shall be binding upon and shall inure to the benefit of the successors and assigns of the Company and the executors, personal representatives, surviving spouse, heirs, devisees, and legatees of the Executive.

     32. Entire Agreement. This Agreement embodies the entire agreement among the parties with respect to the subject matter hereof, and it supersedes all prior discussions and oral understandings of the parties with respect thereto.

     33. No Assignment. This Agreement, and the benefits and obligations hereunder, shall not be assignable by any party hereto except by operation of law.

     34. No Attachment. Except as otherwise provided by law, no right to receive compensation or benefits under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to set off,

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execution, attachment, levy, or similar process, and any attempt, voluntary or involuntary, to effect any such action shall be null and void.

     35. Captions. The captions of the several paragraphs and subparagraphs of this Agreement have been inserted for convenience of reference only. They constitute no part of this Agreement and are not to be considered in the construction hereof.

     36. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed one and the same instrument which may be sufficiently evidenced by any one counterpart.

     37. Number. Wherever any words are used herein in the singular form, they shall be construed as though they were used in the plural form, as the context requires, and vice versa.

     38. Applicable Law. Except to the extent preempted by federal law, the provisions of this Agreement shall be construed, administered, and enforced in accordance with the domestic internal law of the Commonwealth of Pennsylvania.

     39. Prior Agreements. The execution of this Agreement terminates any and all previous employment agreements among the Company, its Affiliates and Mr. Merclean.

     IN WITNESS WHEREOF, the parties have executed this Agreement, or caused it to be executed, as of the date first above written.

David B. Merclean

BICUS SERVICE CORPORATION

By:

Attest:

MERCER INSURANCE COMPANY

By:

Attest:

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GLOSSARY

     “Affiliate” means with respect to any Person, a Person or entity that, directly or indirectly, controls, or is controlled by, or is under common control with such Person or entity, including without limitation, Mercer and Mercer Insurance Group, Inc.

     “Board of Directors” means the board of directors of the relevant corporation.

     “Cause” means (i) a documented repeated and willful failure by the Executive to perform his duties, but only after written demand and only if termination is effected by action taken by a vote of (A) prior to a Change in Control, at least a majority of the directors of the Company then in office, or (B) after a Change in Control, at least 80% of the nonofficer directors of the Company then in office, (ii) his final conviction of a felony, (iii) conduct by him which constitutes moral turpitude which is directly and materially injurious to the Company or any Subsidiary or affiliated company, (iv) willful material violation of corporate policy, or (v) the issuance by the regulator of the Company or any Subsidiary or Affiliate of an unappealable order to the effect that he be permanently discharged.

     For purposes of this definition, no act or failure to act on the part of the Executive shall be considered “willful” unless done or omitted not in good faith and without reasonable belief that the action or omission was in the best interest of the Company or any of its Subsidiaries or Affiliate.

     “Change in Control” means the occurrence of any of the following events:

          (a) any Person (except (i) the Company or any Subsidiary or Affiliate of the Company, or (ii) any Employee Benefit Plan (or any trust forming a part thereof) maintained by the Company or any Subsidiary or Affiliate) is or becomes the beneficial owner, directly or indirectly, of the Company or any Affiliate’s securities representing 19.9% or more of the combined voting power of the Company or any Affiliate’s then outstanding securities, or 50.1% or more of the combined voting power of a Material Subsidiary’s then outstanding securities, other than pursuant to a transaction described in Clause (c);

          (b) there occurs a sale, exchange, transfer or other disposition of substantially all of the assets of the Company, Mercer or a Material Subsidiary to another entity, except to an entity controlled directly or indirectly by the Company or an Affiliate;

          (c) there occurs a merger, consolidation, share exchange, division or other reorganization of or relating to the Company or Mercer, unless—

               (i) the shareholders of the Company or Mercer immediately before such merger, consolidation, share exchange, division or reorganization own, directly or indirectly, immediately thereafter at least two-thirds of the combined voting power of the outstanding voting securities of the Surviving Company in substantially the same proportion as their ownership of the voting securities immediately before such merger, consolidation, share exchange, division or reorganization; and

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               (ii) the individuals who, immediately before such merger, consolidation, share exchange, division or reorganization, are members of the Incumbent Board continue to constitute at least two-thirds of the board of directors of the Surviving Company; provided, however, that if the election, or nomination for election by the Company or Mercer’s shareholders, of any new director was approved by a vote of at least two-thirds of the Incumbent Board, such director shall, for the purposes hereof, be considered a member of the Incumbent Board; and provided further, however, that no individual shall be considered a member of the Incumbent Board if such individual initially assumed office as a result of either an actual or threatened Election Contest or Proxy Contest, including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest; and

               (iii) no Person (except (A) the Company or any Subsidiary or Affiliate of the Company, (B) any Employee Benefit Plan (or any trust forming a part thereof) maintained by the Company or any Subsidiary or Affiliate of the Company, or (C) the Surviving Company or any Subsidiary or Affiliate of the Surviving Company) has beneficial ownership of 19.9% or more of the combined voting power of the Surviving Company’s outstanding voting securities immediately following such merger, consolidation, share exchange, division or reorganization;

          (d) a plan of liquidation or dissolution of the Company or Mercer, other than pursuant to bankruptcy or insolvency laws, is adopted; or

          (e) during any period of two consecutive years, individuals who, at the beginning of such period, constituted the Board of Directors of the Company or Mercer cease for any reason to constitute at least a majority of such Board of Directors, unless the election, or the nomination for election by the Company or Mercer’s shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period; provided, however, that no individual shall be considered a member of the Board of Directors of the Company or Mercer at the beginning of such period if such individual initially assumed office as a result of either an actual or threatened Election Contest or Proxy Contest, including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest.

Notwithstanding the foregoing, a Change in Control shall not be deemed to have occurred if a Person becomes the beneficial owner, directly or indirectly, of securities representing 19.9% or more of the combined voting power of the Company or Mercer’s then outstanding securities solely as a result of an acquisition by the Company or Mercer of its voting securities which, by reducing the number of shares outstanding, increases the proportionate number of shares beneficially owned by such Person; provided, however, that if a Person becomes a beneficial owner of 19.9% or more of the combined voting power of the Company or Mercer’s then outstanding securities by reason of share repurchases by the Company or Mercer and thereafter becomes the beneficial owner, directly or indirectly, of any additional voting securities of the Company or Mercer, then a Change in Control shall be deemed to have occurred with respect to such Person under Clause (a).

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     Notwithstanding anything contained herein to the contrary, if the Executive’s employment is terminated and he reasonably demonstrates that such termination (i) was at the request of a third party who has indicated an intention of taking steps reasonably calculated to effect a Change in Control and who effects a Change in Control, or (ii) otherwise occurred in connection with, or in anticipation of, a Change in Control which actually occurs, then for all purposes hereof, a Change in Control shall be deemed to have occurred on the day immediately prior to the date of such termination of his employment.

     “Company” means Bicus Services Corporation, a Pennsylvania corporation, and any successor thereto.

     “Date of Termination” means:

          (a) if the Executive’s employment is terminated for Disability, 30 days after the Notice of Termination is given (provided that he shall not have returned to the performance of his duties on a full-time basis during such 30-day period);

          (b) if the Executive’s employment terminates by reason of his death, the date of his death;

          (c) if the Executive’s employment is terminated by the Company for Cause, the date specified in the Notice of Termination;

          (d) if the Executive’s employment is terminated by him without Good Reason, the date specified in the Notice of Termination;

          (e) if the Executive’s employment is terminated by the Company for any reason other than for Disability or Cause, the date specified in the Notice of Termination; or

          (f) if the Executive’s employment is terminated by him for Good Reason, the date specified in the Notice of Termination;

provided, however that the Date of Termination shall mean the actual date of termination in the event the parties mutually agree to a date other than that described above.

     “Defined Benefit Plan” has the meaning ascribed to such term in Section 3(35) of ERISA.

     “Defined Contribution Plan” has the meaning ascribed to such term in Section 3(34) of ERISA.

     “Disability” has the meaning ascribed to the term “permanent and total disability” in Section 22(e)(3) of the IRC.

     “Election Contest” means a solicitation with respect to the election or removal of directors that is subject to the provisions of Rule 14a-11 of the 1934 Act.

     “Employee Benefit Plan” has the meaning ascribed to such term in Section 3(3) of ERISA.

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     “ERISA” means the Employee Retirement Income Security Act of 1974, as amended and as the same may be amended from time to time.

     “Excise Tax” means the tax imposed by Section 4999 of the IRC (or any similar tax that may hereafter be imposed by federal, state or local law).

     “Executive” means David B. Merclean, an individual residing in Mendham, New Jersey.

     “Good Reason” means:

          (a) prior to a Change in Control—

               (i) a change in the Executive’s status or position, or any material diminution in his duties or responsibilities;

               (ii) a reduction in the Executive’s base compensation, other than a reduction which is proportionate to a company-wide reduction in executive pay;

               (iii) a failure to increase the Executive’s base compensation, consistent with his performance rating, within 24 months since the last increase, other than similar treatment on a company-wide basis for executives or a voluntary deferral by him of an increase;

               (iv) delivery to the Executive of a Notice of Nonextension; or

               (v) any purported termination of the Executive’s employment which is not in accordance with the terms of this Agreement; and

          (b) after a Change in Control—

               (i) a change in the Executive’s status or position, or any material diminution in his duties or responsibilities;

               (ii) any increase in the Executive’s duties inconsistent with his position;

               (iii) any reduction in the Executive’s base compensation;

               (iv) a failure to increase the Executive’s base compensation, consistent with his performance review, within 12 months of the last increase; or a failure to consider Executive for an increase within 12 months of his last performance review;

               (v) a failure to continue in effect any Employee Benefit Plan in which the Executive participates, including (whether or not they constitute Employee Benefit Plans) incentive bonus, stock option, or other qualified or nonqualified plans of deferred compensation (A) other than as a result of the normal expiration of such a plan, or (B) unless such plan is merged or consolidated into, or replaced with, a plan with benefits which are of equal or greater value;

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               (vi) requiring the Executive to be based anywhere other than the county where his principal office was located immediately prior to the Change in Control;

               (vii) refusal to allow the Executive to attend to matters or engage in activities in which he was permitted to engage prior to the Change in Control;

               (viii) delivery to the Executive of a Notice of Nonextension;

               (ix) failure to secure the affirmation by a Successor, within three business days prior to a Change in Control, of this Agreement and its or the Company’s continuing obligations hereunder (or where there is not at least three business days advance notice that a Person may become a Successor, within one business day after having notice that such Person may become or has become a Successor); or

               (x) any purported termination of the Executive’s employment which is not in accordance with the terms of this Agreement.

Notwithstanding anything herein to the contrary, at the election of the Executive, beginning with the 181st day following a Change in Control and continuing through the first anniversary of such Change in Control, he may terminate his employment for any reason or no reason and such termination will be treated as having occurred for Good Reason.

     “Gross-Up Payment” means an additional payment to be made to or on behalf of the Executive in an amount such that the net amount retained by him, after deduction of any Excise Tax on the Total Payments and any federal, state, and local income tax and Excise Tax on such additional payment, equals the Total Payments.

     “Incumbent Board” means the Board of Directors of the Company or an Affiliate as constituted at any relevant time.

     “IRC” means the Internal Revenue Code of 1986, as amended and as the same may be amended from time to time.

     “Material Subsidiary” means a Subsidiary whose net worth, determined under generally accepted accounting principles, at the fiscal year end immediately prior to any relevant time is at least 25% of the aggregate net worth of the controlled group of corporations of which Mercer is the common parent.

     “1934 Act” means the Securities Exchange Act of 1934, as amended and as the same may be amended from time to time.

     “Mercer” means Mercer Insurance Company.

     “Notice of Extension” means a written notice delivered to or by the Executive which advises that the Agreement will be extended as provided in Paragraph 3.

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     “Notice of Termination” means a written notice that (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated, and (iii) gives the required advance notice of termination.

     “Person” has the same meaning as such term has for purposes of Sections 13(d) and 14(d) of the 1934 Act.

     “Proxy Contest” means the solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors of the Company.

     “Subsidiary” means any business entity of which a majority of its voting power or its equity securities or equity interests is owned, directly or indirectly by Mercer.

     “Successor” means any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), the Company’s business directly, by merger or consolidation, or indirectly, by purchase of the Company’s voting securities or all or substantially all of its assets.

     “Surviving Company” means the business entity that is a resulting company following a merger, consolidation, share exchange, division or other reorganization of or relating to the Company or any Affiliate.

     “Total Payments” means the compensation and benefits that become payable under the Agreement or otherwise (and which may be subject to an Excise Tax) by reason of the Executive’s termination of employment, determined without regard to any Gross-Up Payments that may also be made.

     “Welfare Benefit Plan” has the meaning ascribed to the term “employee welfare benefit plan” in Section 3(1) of ERISA. For purposes of determining the Executive’s or his dependents’ right to continued welfare benefits hereunder following his termination of employment, the meaning of such term shall include any retiree health plan maintained by the Company at any time after the relevant Date of Termination, notwithstanding the fact that the Executive is not a participant therein prior to such date.

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EX-10.2

exv10w2

EX-10.5

EXHIBIT 10.5

MERCER INSURANCE GROUP, INC.
2004 STOCK INCENTIVE PLAN
Effective June 16, 2004

MERCER INSURANCE GROUP, INC.

2004 STOCK INCENTIVE PLAN

TABLE OF CONTENTS

ARTICLE	PAGE
ARTICLE 1. PURPOSE OF THE PLAN; TYPES OF AWARDS		2
ARTICLE 2. DEFINITIONS		2
ARTICLE 3. ADMINISTRATION		6
ARTICLE 4. COMMON STOCK SUBJECT TO THE PLAN		7
ARTICLE 5. ELIGIBILITY		8
ARTICLE 6. STOCK OPTIONS IN GENERAL		9
ARTICLE 7. TERM, VESTING AND EXERCISE OF OPTIONS		10
ARTICLE 8. EXERCISE OF OPTIONS FOLLOWING TERMINATION OF
EMPLOYMENT OR SERVICE		11
ARTICLE 9. RESTRICTED STOCK		13]
ARTICLE 10. ADJUSTMENT PROVISIONS		14
ARTICLE 11. GENERAL PROVISIONS		15

ARTICLE 1. PURPOSE OF THE PLAN; TYPES OF AWARDS

     1.1 Purpose. The Mercer Insurance Group, Inc. 2004 Stock Incentive Plan is intended to provide selected employees and non-employee directors of Mercer Insurance Group and its Subsidiaries with an opportunity to acquire Common Stock of the Corporation. The Plan is designed to help the Corporation attract, retain and motivate employees and non-employee directors to make substantial contributions to the success of the Corporation’s business and the businesses of its Subsidiaries. Awards will be granted under the Plan based, among other things, on a participant’s level of responsibility and performance.

     1.2 Authorized Plan Awards. Incentive Stock Options, Nonqualified Stock Options, and Restricted Stock may be awarded within the limitations of the Plan herein described.

ARTICLE 2. DEFINITIONS

     2.1 “Agreement.” A written or electronic agreement between the Corporation and a Participant evidencing the grant of an Award. A Participant may be issued one or more Agreements from time to time, reflecting one or more Awards.

     2.2 “Award.” The grant of a Stock Option or Restricted Stock.

     2.3 “Board.” The Board of Directors of the Corporation.

     2.4 “Change in Control.” Except as otherwise provided in an Agreement, the first to occur of any of the following events:

          (a) any “Person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), except for any of the Corporation’s employee benefit plans, or any entity holding the Corporation’s voting securities for, or pursuant to, the terms of any such plan (or any trust forming a part thereof) (the “Benefit Plan(s)”), is or becomes the beneficial owner, directly or indirectly, of the Corporation’s securities representing 19.9% or more of the combined voting power of the Corporation’s then outstanding securities other than pursuant to a transaction excepted in Clause (d);

          (b) there occurs a contested proxy solicitation of the Corporation’s shareholders that results in the contesting party obtaining the ability to vote securities representing 19.9% or more of the combined voting power of the Corporation’s then outstanding securities;

          (c) a binding written agreement is executed providing for a sale, exchange, transfer or other disposition of all or substantially all of the assets of the Corporation to another entity, except to an entity controlled directly or indirectly by the Corporation;

          (d) the shareholders of the Corporation approve a merger, consolidation, or other reorganization of the Corporation, unless:

               (i) under the terms of the agreement providing for such merger, consolidation or reorganization, the shareholders of the Corporation immediately before such merger, consolidation or reorganization, will own, directly or indirectly immediately

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following such merger, consolidation or reorganization, at least 51% of the combined voting power of the outstanding voting securities of the Corporation resulting from such merger, consolidation or reorganization (the “Surviving Corporation”) in substantially the same proportion as their ownership of the voting securities immediately before such merger, consolidation or reorganization;

               (ii) under the terms of the agreement providing for such merger, consolidation or reorganization, the individuals who were members of the Board immediately prior to the execution of such agreement will constitute at least 51% of the members of the board of directors of the Surviving Corporation after such merger, consolidation or reorganization; and

               (iii) based on the terms of the agreement providing for such merger, consolidation or reorganization, no Person (other than (A) the Corporation or any Subsidiary of the Corporation, (B) any Benefit Plan, (C) the Surviving Corporation or any Subsidiary of the Surviving Corporation, or (D) any Person who, immediately prior to such merger, consolidation or reorganization had beneficial ownership of 19.9% or more of the then outstanding voting securities) will have beneficial ownership of 19.9% or more of the combined voting power of the Surviving Corporation’s then outstanding voting securities;

          (e) a plan of liquidation or dissolution of the Corporation, other than pursuant to bankruptcy or insolvency laws, is adopted; or

          (f) during any period of two consecutive years, individuals, who at the beginning of such period, constituted the Board cease for any reason to constitute at least a majority of the Board unless the election, or the nomination for election by the Corporation’s shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period.

      Notwithstanding Clause (a), a Change in Control shall not be deemed to have occurred if a Person becomes the beneficial owner, directly or indirectly, of the Corporation’s securities representing 19.9% or more of the combined voting power of the Corporation’s then outstanding securities solely as a result of an acquisition by the Corporation of its voting securities which, by reducing the number of shares outstanding, increases the proportionate number of shares beneficially owned by such Person to 19.9% or more of the combined voting power of the Corporation’s then outstanding securities; provided, however, that if a Person becomes a beneficial owner of 19.9% or more of the combined voting power of the Corporation’s then outstanding securities by reason of share purchases by the Corporation and shall, after such share purchases by the Corporation, become the beneficial owner, directly or indirectly, of any additional voting securities of the Corporation (other than as a result of a stock split, stock dividend or similar transaction), then a Change in Control of the Corporation shall be deemed to have occurred with respect to such Person under Clause (a). In no event shall a Change in Control of the Corporation be deemed to occur under Clause (a) with respect to Benefit Plans.

       2.5 “Code.” The Internal Revenue Code of 1986, as amended.

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     2.6 “Code of Conduct.” The policies and procedures related to employment of employees by the Corporation or a Subsidiary set forth in the Corporation’s employee handbook. The Code of Conduct may be amended and updated at any time. The term “Code of Conduct” shall also include any other policy or procedure that may be adopted by the Corporation or a Subsidiary and communicated to Employees and Non-Employee Directors of the Corporation or a Subsidiary.

     2.7 “Committee.” The Compensation Committee of the Board.

     2.8 “Common Stock.” The common stock of the Corporation (no par value) as described in the Corporation’s Articles of Incorporation, or such other stock as shall be substituted therefor.

     2.9 “Corporation.” Mercer Insurance Group, Inc., a Pennsylvania corporation.

     2.10 “Employee.” Any common law employee of the Corporation or a Subsidiary. An Employee does not include any individual who: (i) does not receive payment for services directly from the Corporation’s or a Subsidiary’s payroll; (ii) is employed by an employment agency that is not a Subsidiary; or (iii) who renders services pursuant to a written arrangement that expressly provides that the service provider is not eligible for participation in the Plan, regardless if such person is later determined by the Internal Revenue Service or a court of law to be a common law employee.

     2.11 “Exchange Act.” The Securities Exchange Act of 1934, as amended.

     2.12 “Incentive Stock Option.” A Stock Option intended to satisfy the requirements of Code Section 422(b).

     2.13 “Non-Employee Director.” A member of the Board who is not an Employee.

     2.14 “Nonqualified Stock Option.” A Stock Option which does not satisfy the requirements of Code Section 422(b).

     2.15 “Optionee.” A Participant who is awarded a Stock Option pursuant to the provisions of the Plan.

     2.16 “Participant.” An Employee or Non-Employee Director to whom an Award has been granted and remains outstanding.

     2.17 “Performance Criteria.” Any objective determination based on one or more of the following areas of performance of the Corporation, a Subsidiary, or any division, department or group of either which includes, but is not limited to: (a) earnings, (b) cash flow, (c) revenue, (d) financial ratios, (e) market performance, (f) shareholder return, (g) operating profits (including earnings before interest, taxes, depreciation and amortization), (h) earnings per share, (i) return on assets, (j) return on equity, (k) return on investment, (l) stock price, (m) asset quality, (n) expense reduction, (o) systems conversion, (p) special projects as determined by the Committee, and (q) acquisition integration initiatives. Performance Criteria shall be established by the Committee prior to the issuance of a Performance Grant.

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     2.18 “Performance Goal.” One or more goals established by the Committee, with respect to an Award intended to constitute a Performance Grant, that relate to one or more Performance Criteria. A Performance Goal shall relate to such period of time, not less than one year (unless coupled with a vesting schedule of at least one year) or more than five years, as may be specified by the Committee at the time of the awarding of a Performance Grant.

     2.19 “Performance Grant.” An Award, the vesting or receipt without restriction of which, is conditioned on the satisfaction of one or more Performance Goals.

     2.20 “Plan.” The Mercer Insurance Group, Inc. 2004 Stock Incentive Plan.

     2.21 “Restricted Stock.” An award of Common Stock pursuant to the provisions of the Plan, which award is subject to such restrictions and other conditions, including achievement of one or more performance goals, as may be specified by the Committee at the time of such award.

     2.22 “Retirement.” The termination of a Participant’s employment following the first day of the month coincident with or next following attainment of age 65, as the term “Normal Retirement Date” is defined in the Mercer Insurance Group, Inc. Employee Stock Ownership Plan, or attainment of age 55 and the completion of five (5) years service as described in the Mercer Insurance Group, Inc. Employee Stock Ownership Plan.

     2.23 “Securities Act.” The Securities Act of 1933, as amended.

     2.24 “Stock Option” or “Option.” A grant of a right to purchase Common Stock pursuant to the provisions of the Plan.

     2.25 “Subsidiary.” A subsidiary corporation, as defined in Code Section 424(f), that is a subsidiary of a relevant corporation.

     2.26 “Termination or Dismissal For Cause.” Termination of an Employee by the Corporation or a Subsidiary or dismissal of a Non-Employee Director from the Board after:

          (a) any government regulatory agency recommends or orders in writing that the Corporation or a Subsidiary terminate the employment of such Employee or relieve him or her of his or her duties;

          (b) such Employee or Non-Employee Director is convicted of or enters a plea of guilty or nolo contendere to a felony, a crime of falsehood, or a crime involving fraud or moral turpitude, or the actual incarceration of the Employee or Non-Employee Director for a period of 45 consecutive days;

          (c) a determination by the Committee that such Employee willfully failed to follow the lawful instructions of the Board or any officer of the Corporation or a Subsidiary after such Employee’s receipt of written notice of such instructions, other than a failure resulting from the Employee’s incapacity because of physical or mental illness;

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          (d) a determination by the Committee that the willful or continued failure by such Employee or Non-Employee Director to substantially and satisfactorily perform his duties with the Corporation or a Subsidiary (other than any such failure resulting from the Employee or Non-Employee Director being “disabled” (as defined in the Corporation’s group long term disability policy) or as a result of physical or mental illness), within a reasonable period of time after a demand for substantial performance or notice of lack of substantial or satisfactory performance is delivered to the Employee or Non-Employee Director, which demand identifies the manner in which the Employee or Non-Employee Director has not substantially or satisfactorily performed his or her duties; or

          (e) a determination by the Committee that such Employee or Non-Employee Director has failed to conform to the Corporation’s Code of Conduct.

   For purposes of the Plan, no act, or failure to act, on a Employee’s or Non-Employee Director’s part shall be deemed “willful” unless done, or omitted to be done, by such Employee or Non-Employee Director not in good faith and without reasonable belief that such Employee’s or Non-Employee Director’s action or omission was in the best interest of the Corporation or a Subsidiary.

ARTICLE 3. ADMINISTRATION

     3.1 The Committee. The Plan shall be administered by the Compensation Committee of the Board composed of two or more members of the Board, all of whom are (a) “non-employee directors” as such term is defined under the rules and regulations adopted from time to time by the Securities and Exchange Commission pursuant to Section 16(b) of the Exchange Act, and (b) ”outside directors” within the meaning of Code Section 162(m). The Board may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, however caused, shall be filled by the Board.

     3.2 Powers of the Committee.

          (a) The Committee shall be vested with full authority to make such rules and regulations as it deems necessary or desirable to administer the Plan and to interpret the provisions of the Plan, unless otherwise determined by a majority of the disinterested members of the Board. Any determination, decision, or action of the Committee in connection with the construction, interpretation, administration or application of the Plan shall be final, conclusive, and binding upon all Participants and any person claiming under or through a Participant, unless otherwise determined by a majority of the disinterested members of the Board.

          (b) Subject to the terms, provisions and conditions of the Plan and subject to review and approval by a majority of the disinterested members of the Board, the Committee shall have exclusive jurisdiction to:

               (i) determine and select the Employees and Non-Employee Directors to be granted Awards (it being understood that more than one Award may be granted to the same person);

               (ii) determine the number of shares subject to each Award;

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               (iii) determine the date or dates when the Awards will be granted;

               (iv) determine the exercise price of shares subject to an Option in accordance with Article 6;

               (v) determine the date or dates when an Option may be exercised within the term of the Option specified pursuant to Article 7;

               (vi) determine whether an Option constitutes an Incentive Stock Option or a Nonqualified Stock Option;

               (vii) determine the Performance Criteria and establish Performance Goals with respect thereto, to be applied to an Award; and

               (viii) prescribe the form, which shall be consistent with the Plan document, of the Agreement evidencing any Awards granted under the Plan.

     3.3 Liability. No member of the Board or the Committee shall be liable for any action or determination made in good faith by the Board or the Committee with respect to this Plan or any Awards granted under this Plan.

     3.4 Establishment and Certification of Performance Goals. The Committee shall establish, prior to grant, Performance Goals with respect to each Award intended to constitute a Performance Grant. Except as may otherwise be provided in Article 8 hereof, no Option that is intended to constitute a Performance Grant may be exercised until the Performance Goal or Goals applicable thereto is or are satisfied, nor shall any share of Restricted Stock that is intended to constitute a Performance Grant be released to a Participant until the Performance Goal or Goals applicable thereto is or are satisfied.

     3.5 No Waiver of Performance Goals. Except as may otherwise be provided in Article 8 hereof, the Committee or the Board shall not waive any Performance Goals with respect to the grant of any Award hereunder.

     3.6 Performance Grants Not Mandatory. Nothing herein shall be construed as requiring that any Award be made a Performance Grant.

ARTICLE 4. COMMON STOCK SUBJECT TO THE PLAN

     4.1 Common Stock Authorized.

          (a) The initial total aggregate number of shares of Common Stock for which Options may be granted under the Plan or which may be awarded as Restricted Stock under the Plan shall not exceed 876,555. Notwithstanding the foregoing, the number of shares of Common Stock available for issuance under the Plan shall automatically increase on the first trading day of January of each calendar year during the term of the Plan, beginning with calendar year 2005, by an amount equal to one percent (1%) of the shares of Common Stock outstanding on the last trading day in December of the immediately preceding calendar year. No Incentive Stock Options may be granted on the basis of the additional shares of Common Stock resulting from

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such annual increases. The limitation established by the preceding sentence shall also be subject to adjustment as provided in Article 10.

          (b) The maximum aggregate number of shares of Common Stock for which Restricted Stock may be awarded under the Plan shall not exceed 250,000. The limitation established by the preceding sentence shall be subject to adjustment in proportion to any increase in the total number of shares available for issuance under the Plan as provided in Section 4.1(a) above and Article 10.

          (c) The maximum aggregate number of shares of Common Stock for which Incentive Stock Options may be granted under the Plan shall not exceed 500,000. The limitation established by the preceding sentence shall be subject to adjustment as provided in Article 10.

          (d) The maximum aggregate number of shares of Common Stock for which Awards may be granted under the Plan to non-employee directors shall not exceed 350,000. The limitation established by the preceding sentence shall be subject to adjustment as provided in Article 10.

          (e) If any Option is exercised by tendering Common Stock, either actually or by attestation, to the Corporation as full or partial payment in connection with the exercise of such Option under the Plan, or if the tax withholding requirements are satisfied through such tender, only the number of shares of Common Stock issued net of the Common Stock tendered shall be deemed delivered for purposes of determining the maximum number of shares available for Awards under the Plan.

     4.2 Shares Available. The Common Stock to be issued under the Plan shall be the Corporation’s Common Stock which shall be made available at the discretion of the Board, either from authorized but unissued Common Stock or from Common Stock acquired by the Corporation, including shares purchased in the open market. In the event that any outstanding Award under the Plan for any reason expires, terminates, or is forfeited, the shares of Common Stock allocable to such expiration, termination, or forfeiture may thereafter again be made subject to an Award under the Plan.

ARTICLE 5. ELIGIBILITY

     5.1 Participation. Awards shall be granted by the Committee only to persons who are Employees and Non-Employee Directors.

     5.2 Incentive Stock Option Eligibility. Incentive Stock Option Awards may only be granted to Employees of the Corporation. Notwithstanding any other provision of the Plan to the contrary, an individual who owns more than ten percent of the total combined voting power of all classes of outstanding stock of the Corporation shall not be eligible for the grant of an Incentive Stock Option, unless the special requirements set forth in Sections 6.1 and 7.1 are satisfied. For purposes of this section, in determining stock ownership, an individual shall be considered as owning the stock owned, directly or indirectly, by or for his brothers and sisters (whether by the whole or half blood), spouse, ancestors and lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be considered as

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being owned proportionately by or for its shareholders, partners or beneficiaries. “Outstanding stock” shall include all stock actually issued and outstanding immediately before the grant of the Option. “Outstanding stock” shall not include shares authorized for issue under outstanding Options held by the Optionee or by any other person.

ARTICLE 6. STOCK OPTIONS IN GENERAL

     6.1 Exercise Price. The exercise price of an Option to purchase a share of Common Stock shall be, in the case of an Incentive Stock Option, not less than 100% of the fair market value of a share of Common Stock on the date the Option is granted, except that the exercise price shall be not less than 110% of such fair market value in the case of an Incentive Stock Option granted to any individual described in the second sentence of Section 5.2. The exercise price of an Option to purchase a share of Common Stock shall be, in the case of a Nonqualified Stock Option, not less than 100% of the fair market value of a share of Common Stock on the date the Option is granted. The exercise price shall be subject to adjustment pursuant to the limited circumstances set forth in Article 10.

     6.2 Limitation on Incentive Stock Options. The aggregate fair market value (determined as of the date an Option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by any individual in any calendar year (under the Plan and all other plans maintained by the Corporation and Subsidiaries) shall not exceed $100,000.

     6.3 Determination of Fair Market Value.

          (a) If the Common Stock is not listed on an established stock exchange or exchanges but is listed on NASDAQ, the fair market value per share shall be the closing sale price for the Common Stock on the day an Option is granted. If no sale of Common Stock has occurred on that day, the fair market value shall be determined by reference to such price for the next preceding day on which a sale occurred.

          (b) If the Common Stock is not listed on an established stock exchange or on NASDAQ, fair market value per share shall be the mean between the closing dealer “bid” and “asked” prices for the Common Stock for the day an Option is granted, and if no “bid” and “asked” prices are quoted for the day an Option is granted, the fair market value shall be determined by reference to such prices on the next preceding day on which such prices were quoted.

          (c) If the Common Stock is listed on an established stock exchange or exchanges, the fair market value shall be deemed to be the closing price of Common Stock on such stock exchange or exchanges on the day an Option is granted. If no sale of Common Stock has been made on any stock exchange on that day, the fair market value shall be determined by reference to such price for the next preceding day on which a sale occurred.

          (d) In the event that the Common Stock is not traded on an established stock exchange or on NASDAQ, and no closing dealer “bid” and “asked” prices are available on the

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day an Option is granted, then fair market value will be the price established by the Committee in good faith.

   In connection with determining the fair market value of a share of Common Stock on any relevant day, the Committee may use any source deemed reliable; and its determination shall be final and binding on all affected persons, absent clear error.

     6.4 Limitation on Option Awards. Awards under this Plan (and any other plan of the Corporation or a Subsidiary providing for stock option awards) to an Employee described in Code Section 162(m)(3) shall not exceed, in the aggregate, Options to acquire 50,000 shares of Common Stock during any period of 12 consecutive months. Such limitation shall be subject to adjustment in the manner described in Article 10.

     6.5 Transferability of Options.

          (a) Except as provided in Subsection (b), an Option granted hereunder shall not be transferable other than by will or the laws of descent and distribution, and such Option shall be exercisable, during the Optionee’s lifetime, only by him or her.

          (b) An Optionee may, with the prior approval of the Committee, transfer a Nonqualified Stock Option for no consideration to or for the benefit of one or more members of the Optionee’s “immediate family” (including a trust, partnership or limited liability company for the benefit of one or more of such members), subject to such limits as the Committee may impose, and the transferee shall remain subject to all terms and conditions applicable to the Option prior to its transfer. The term “immediate family” shall mean an Optionee’s spouse, parents, children, stepchildren, adoptive relationships, sisters, brothers and grandchildren (and, for this purpose, shall also include the Optionee).

ARTICLE 7. TERM, VESTING AND EXERCISE OF OPTIONS

     7.1 Term and Vesting. Each Option granted under the Plan shall terminate on the date determined by the Committee, and specified in the Agreement; provided, however, that (i) each intended Incentive Stock Option granted to an individual described in the second sentence of Section 5.2 shall terminate not later than five years after the date of the grant, (ii) each other intended Incentive Stock Option shall terminate not later than ten years after the date of grant, and (iii) each Option granted under the Plan which is intended to be a Nonqualified Stock Option shall terminate not later than ten years and one month after the date of grant. Each Option granted under the Plan shall be fully exercisable (i.e., become 100% vested) only after the earlier of the date on which (i) the Optionee has completed one year of continuous employment with, or service with respect to, the Corporation or a Subsidiary immediately following the date of the grant of the Option (or such later date as may be specified in an Agreement, including a date that may be tied to the satisfaction of one or more Performance Goals); (ii) unless otherwise provided in an Agreement, a Change in Control occurs; and (iii) unless otherwise provided in an Agreement, the Optionee’s death, being “disabled” (as defined in the Corporation’s long term disability policy) or Retirement after completing three or more years of service from the date of the grant of the Option. Except as provided in Article 8 an Option may be exercised only during the continuance of the Optionee’s employment, with or service with respect to, the Corporation.

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     7.2 Exercise.

          (a) A person electing to exercise an Option shall give notice to the Corporation of such election and of the number of shares he or she has elected to purchase and shall at the time of exercise tender the full exercise price of the shares he or she has elected to purchase. The exercise notice shall be delivered to the Corporation in person, by certified mail, or by such other method (including electronic transmission) and in such form as determined by the Committee. The exercise price shall be paid in full, in cash, upon the exercise of the Option; provided, however, that in lieu of cash, with the approval of the Committee at or prior to exercise, an Optionee may exercise an Option by tendering to the Corporation shares of Common Stock owned by him or her and having a fair market value equal to the cash exercise price applicable to the Option (with the fair market value of such stock to be determined in the manner provided in Section 6.3) or by delivering such combination of cash and such shares as the Committee in its sole discretion may approve; further provided, however, that no such manner of exercise shall be permitted if such exercise would violate Section 402 of the Sarbanes-Oxley Act of 2002. Notwithstanding the foregoing, Common Stock acquired pursuant to the exercise of an Incentive Stock Option may not be tendered as payment unless the holding period requirements of Code Section 422(a)(1) have been satisfied, and Common Stock not acquired pursuant to the exercise of an Incentive Stock Option may not be tendered as payment unless it has been held, beneficially and of record, for at least six months (or such longer time as may be required by applicable securities law or accounting principles to avoid adverse consequences to the Corporation or a Participant).

          (b) A person holding more than one Option at any relevant time may, in accordance with the provisions of the Plan, elect to exercise such Options in any order.

          (c) At the request of the Participant and to the extent permitted by applicable law, the Committee may, in its sole discretion, selectively approve arrangements whereby the Participant irrevocably authorizes a third party to sell shares of Common Stock (or a sufficient portion of the shares) acquired upon the exercise of an Option and to remit to the Corporation a sufficient portion of the sales proceeds to pay the entire exercise price and any tax withholding required as a result of such exercise.

     7.3 Deferred Delivery of Nonqualified Stock Option Shares. The Committee may approve an arrangement whereby an Optionee may elect to defer receipt of Common Stock otherwise issuable to him or her upon exercise of a Nonqualified Stock Option. Any such arrangement, if approved at all, shall be subject to such terms and conditions as the Committee, in its sole discretion, may specify, which terms and conditions may (but need not) include provision for the award of additional shares to take into account dividends paid subsequent to exercise of the Option. No exercise of discretion under this section with respect to an event or person shall create an obligation to exercise such discretion in any similar or same circumstance.

ARTICLE 8. EXERCISE OF OPTIONS FOLLOWING TERMINATION

OF EMPLOYMENT OR SERVICE

     8.1 Retirement; Other Termination by Corporation or Subsidiary; Change in Control. In the event of an Optionee’s termination of employment or service as a Non-Employee Director

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(i) due to Retirement, (ii) by the Corporation or a Subsidiary other than Termination for Cause, or (iii) due to a Change in Control, such Optionee’s Option shall lapse at the earlier of the expiration of the term of such Option or:

          (a) in the case of an Incentive Stock Option, three months from the date of such termination of employment; and

          (b) in the case of a Nonqualified Stock Option, one year from the date of such termination of employment or service as a Non-Employee Director.

     8.2 Death or Total Disability. In the event of an Optionee’s termination of employment or service as a Non-Employee Director due to death or being “disabled”(as defined in the Corporation’s group long term disability policy), such Optionee’s Option shall lapse at the earlier of the expiration of the term of such Option or:

          (a) in the case of an Incentive Stock Option, one year from the date of such termination of employment; and

          (b) in the case of a Nonqualified Stock Option, one year from the date of such termination of employment or service as a Non-Employee Director.

     8.3 Termination or Dismissal For Cause; Other Termination by Optionee. In the event of an Optionee’s Termination or Dismissal For Cause, or in the event of termination of employment at the election of an Optionee, such Optionee’s Option shall lapse upon such termination.

     8.4 Special Termination Provisions for Options.

          (a) In the event that an Optionee’s employment or service as a Non-Employee Director is terminated and the Committee deems it equitable to do so, the Committee may, in its discretion and subject to the approval of a majority of the disinterested members of the Board, waive any continuous service requirement for vesting (but not any Performance Goal or Goals) specified in an Agreement pursuant to Section 7.1 and permit exercise of an Option held by such Optionee prior to the satisfaction of such continuous service requirement. Any such waiver may be made with retroactive effect, provided it is made within 60 days following the Optionee’s termination of employment or service as a Non-Employee Director.

          (b) In the event the Committee waives the continuous service requirement with respect to an Option as set forth in Section 8.4(a) above and the circumstance of an Optionee’s termination of employment or service as a Non-Employee Director is described in Section 8.1, the affected Option will lapse as otherwise provided in the relevant section.

          (c) In the event the Committee waives the continuous service requirement with respect to an Option as set forth in Section 8.4(a) above, such Option shall lapse at the earlier of the expiration of the term of such Option or:

               (i) in the case of an Incentive Stock Option, three months from the date of termination of employment; and

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               (ii) in the case of a Nonqualified Stock Option, one year from the date of termination of employment or service as a Non-Employee Director.

ARTICLE 9. RESTRICTED STOCK

     9.1 In General. Each Restricted Stock Award shall be subject to such terms and conditions as may be specified in the Agreement issued to a Participant to evidence the grant of such Award. Subject to Section 3.6, a Restricted Stock Award shall be subject to a vesting schedule or Performance Goals, or both.

     9.2 Minimum Vesting Period for Certain Restricted Stock Awards. Each Restricted Stock Award granted to a Participant shall be fully exercisable (i.e., become 100% vested) only after the earlier of the date on which (i) the Participant has completed one year of continuous employment with, or service with respect to, the Corporation or a Subsidiary immediately following the date that the Restricted Stock was awarded (or such later date as may be specified in an Agreement, including a date that may be tied to the satisfaction of one or more Performance Goals); (ii) unless otherwise provided in an Agreement, a Change in Control occurs; or (iii) unless otherwise provided in an Agreement, the Participant’s death, being “disabled” (as defined in the Corporation’s group long term disability policy) or Retirement after completing three or more years of service from the date of the Award.

     9.3 Waiver of Vesting Period for Certain Restricted Stock Awards. In the event that a Participant’s employment or service as a Non-Employee Director is terminated and the Committee deems it equitable to do so, the Committee may, in its discretion and subject to the approval of a majority of the disinterested members of the Board, waive any minimum vesting period (but not any Performance Goal or Goals) with respect to a Restricted Stock Award held by such Participant. Any such waiver may be made with retroactive effect, provided it is made within 60 days following such Participant’s termination of employment or service as a Non-Employee Director.

     9.4 Limitation on Restricted Stock Awards. Grants under this Plan (and any other plan of the Corporation or a Subsidiary providing for restricted stock awards) to any Employee described in Code Section 162(m)(3) shall not exceed, in the aggregate, Restricted Stock Awards for 25,000 shares of Common Stock during any period of 12 consecutive months. Such limitation shall be subject to adjustment in the manner described in Article 10.

     9.5 Issuance and Retention of Share Certificates By Corporation. One or more share certificates shall be issued upon the grant of a Restricted Stock Award; but until such time as the Restricted Stock shall vest or otherwise become distributable by reason of satisfaction of one or more Performance Goals, the Corporation shall retain such share certificates.

     9.6 Stock Powers. At the time of the grant of a Restricted Stock Award, the Participant to whom the grant is made shall deliver such stock powers, endorsed in blank, as may be requested by the Corporation.

     9.7 Release of Shares. Within 30 days following the date on which a Participant becomes entitled under an Agreement to receive shares of previously Restricted Stock, the

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Corporation shall deliver to him or her a certificate evidencing the ownership of such shares, together with an amount of cash (without interest) equal to the dividends that have been paid on such shares with respect to record dates occurring on and after the date of the related Award.

     9.8 Forfeiture of Restricted Stock Awards. In the event of the forfeiture of a Restricted Stock Award, by reason of a Participant’s termination of employment or termination of service as a Non-Employee Director prior to vesting, the failure to achieve a Performance Goal or otherwise, the Corporation shall take such steps as may be necessary to cancel the affected shares and return the same to its treasury.

     9.9 Assignment, Transfer, Etc. of Restricted Stock Rights. The potential rights of a Participant to shares of Restricted Stock may not be assigned, transferred, sold, pledged, hypothecated, or otherwise encumbered or disposed of until such time as unrestricted certificates for such shares are received by him or her.

     9.10 Deferred Delivery of Formerly Restricted Stock. The Committee may approve an arrangement whereby a Participant may elect to defer receipt of Restricted Stock beyond the date on which a restriction terminates or a Performance Goal is satisfied with respect thereto. Any such arrangement, if approved at all, shall be subject to such terms and conditions as the Committee, in its sole discretion, may specify, including terms covering the accumulation or distribution of dividends previously paid with respect to the subject shares and those that may thereafter be paid.

ARTICLE 10. ADJUSTMENT PROVISIONS

     10.1 Share Adjustments.

          (a) In the event that the shares of Common Stock of the Corporation, as presently constituted, shall be changed into or exchanged for a different number or kind of shares of stock or other securities of the Corporation, or if the number of such shares of Common Stock shall be changed through the payment of a stock dividend, stock split or reverse stock split, then (i) the shares of Common Stock authorized hereunder to be made the subject of Awards, (ii) the shares of Common Stock then subject to outstanding Awards and the exercise price thereof (where relevant), (iii) the maximum number of Awards that may be granted within a 12-month period and (iv) the nature and terms of the shares of stock or securities subject to Awards hereunder shall be increased, decreased or otherwise changed to such extent and in such manner as may be necessary or appropriate to reflect any of the foregoing events.

          (b) If there shall be any other change in the number or kind of the outstanding shares of the Common Stock of the Corporation, or of any stock or other securities into which such Common Stock shall have been changed, or for which it shall have been exchanged, and if a majority of the disinterested members of the Board shall, in its sole discretion, determine that such change equitably requires an adjustment in any Award which was theretofore granted or which may thereafter be granted under the Plan, then such adjustment shall be made in accordance with such determination.

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          (c) The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Corporation to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge, to consolidate, to dissolve, to liquidate or to sell or transfer all or any part of its business or assets.

     10.2 Corporate Changes. A liquidation or dissolution of the Corporation, a merger or consolidation in which the Corporation is not the surviving Corporation or a sale of all or substantially all of the Corporation’s assets, shall cause each outstanding Award to terminate, except to the extent that another corporation may and does, in the transaction, assume and continue the Award or substitute its own awards.

     10.3 Fractional Shares. Fractional shares resulting from any adjustment in Awards pursuant to this article may be settled as the Committee shall determine.

     10.4 Binding Determination. To the extent that the foregoing adjustments relate to stock or securities of the Corporation, such adjustments shall be made by a majority of the disinterested members of the Board, whose determination in that respect shall be final, binding and conclusive. Notice of any adjustment shall be given by the Corporation to each holder of an Award which shall have been so adjusted.

ARTICLE 11 GENERAL PROVISIONS

     11.1 Effective Date. The Plan shall become effective upon the approval of the Plan by the shareholders of the Corporation within 12 months of adoption by the Board.

     11.2 Termination of the Plan. Unless previously terminated by the Board, the Plan shall terminate on, and no Award shall be granted after, the day immediately preceding the tenth anniversary of its adoption by the Board.

     11.3 Limitation on Termination, Amendment or Modification.

          (a) The Board may at any time terminate, amend, modify or suspend the Plan, provided that, without the approval of the shareholders of the Corporation, no amendment or modification shall be made solely by the Board which:

               (i) increases the maximum number of shares of Common Stock as to which Awards may be granted under the Plan (except as provided in Section 10.1);

               (ii) changes the class of eligible Participants; or

               (iii) otherwise requires the approval of shareholders under applicable state law or under applicable federal law to avoid potential liability or adverse consequences to the Corporation or a Participant.

          (b) No amendment, modification, suspension or termination of the Plan shall in any manner affect any Award theretofore granted under the Plan without the consent of the Participant or any person validly claiming under or through the Participant.

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     11.4 No Right to Grant of Award or Continued Employment or Service. Nothing contained in this Plan or otherwise shall be construed to (a) require the grant of an Award to an individual who qualifies as an Employee or Non-Employee Director, or (b) confer upon a Participant any right to continue in the employ or service of the Corporation or any Subsidiary or limit in any respect the right of the Corporation or of any Subsidiary to terminate the Participant’s employment or service at any time and for any reason.

     11.5 No Obligation. No exercise of discretion under this Plan with respect to an event or person shall create an obligation to exercise such discretion in any similar or same circumstance, except as otherwise provided or required by law.

     11.6 Withholding Taxes.

          (a) Subject to the provisions of Subsection (b), the Corporation will require, where sufficient funds are not otherwise available, that a Participant who is an Employee pay or reimburse to it any withholding taxes at such time as withholding is required by law.

          (b) With the permission of the Committee, a Participant who is an Employee may satisfy the withholding obligation described in Subsection (a), in whole or in part, by electing to have the Corporation withhold shares of Common Stock (otherwise issuable to him or her) having a fair market value equal to the amount required to be withheld. An election by a Participant who is an Employee to have shares withheld for this purpose shall be subject to such conditions as may then be imposed thereon by any applicable securities law.

     11.7 Listing and Registration of Shares.

          (a) No Option granted pursuant to the Plan shall be exercisable in whole or in part, and no share certificate shall be delivered, if at any relevant time the Committee determines in its discretion that the listing, registration or qualification of the shares of Common Stock subject to an Award on any securities exchange or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, such Award, until such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Committee.

          (b) If a registration statement under the Securities Act with respect to the shares issuable under the Plan is not in effect at any relevant time, as a condition of the issuance of the shares, a Participant (or any person claiming through a Participant) shall give the Committee a written or electronic statement, satisfactory in form and substance to the Committee, that he or she is acquiring the shares for his or her own account for investment and not with a view to their distribution. The Corporation may place upon any stock certificate for shares issued under the Plan the following legend or such other legend as the Committee may prescribe to prevent disposition of the shares in violation of the Securities Act or other applicable law:

‘THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 (“ACT”) AND MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE

16

TRANSFERRED OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THEM UNDER THE ACT OR A WRITTEN OPINION OF COUNSEL FOR THE CORPORATION THAT REGISTRATION IS NOT REQUIRED.’

     11.8 Disinterested Director. For purposes of this Plan, a director shall be deemed “disinterested” if such person could qualify as a member of the Committee under Section 3.1.

     11.9 Gender; Number. Words of one gender, wherever used herein, shall be construed to include each other gender, as the context requires. Words used herein in the singular form shall include the plural form, as the context requires, and vice versa.

     11.10 Applicable Law. Except to the extent preempted by federal law, this Plan document, and the Agreements issued pursuant hereto, shall be construed, administered, and enforced in accordance with the domestic internal law of the Commonwealth of Pennsylvania.

     11.11 Headings. The headings of the several articles and sections of this Plan document have been inserted for convenience of reference only and shall not be used in the construction of the same.

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EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Andrew R. Speaker, President and Chief Executive Officer of Mercer Insurance Group, Inc., certify that:

1. I have reviewed this annual report on Form 10-K of Mercer Insurance Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report was being prepared;

(b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function:

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: March 16, 2005

/s/ Andrew R. Speaker

Andrew R. Speaker

President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, David B. Merclean, Senior Vice President and Chief Financial Officer of Mercer Insurance Group, Inc., certify that:

1. I have reviewed this annual report on Form 10-K of Mercer Insurance Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report was being prepared;

(b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: March 16, 2005

/s/ David B. Merclean

David B. Merclean

Senior Vice President
and Chief Financial Officer

EX-32.1

EXHIBIT 32.1

MERCER INSURANCE GROUP, INC.

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Mercer Insurance Group, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Andrew R. Speaker, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Andrew R. Speaker

Andrew R. Speaker

President and Chief Executive Officer

March 16, 2005

EX-32.2

EXHIBIT 32.2

MERCER INSURANCE GROUP, INC.

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Mercer Insurance Group, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David B. Merclean, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ David B. Merclean

David B. Merclean

Senior Vice President
and Chief Financial Officer

March 16, 2005