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, 2006

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
(State or other jurisdiction of
incorporation or organization) 23-2934601
(I.R.S. Employer
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:

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ

     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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o     Accelerated filer þ      Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     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: $122,694,986.

     Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of March 10, 2007. Common Stock, no par value: 6,560,720.

Documents Incorporated by Reference

     Portions of the definitive Proxy Statement for the 2007 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, 2006

Table of Contents

PART I	3
ITEM 1. Business.	3
ITEM 1A. Risk Factors.	30
ITEM 1B. Unresolved Staff Comments.	34
ITEM 2. Properties.	34
ITEM 3. Legal Proceedings.	34
ITEM 4. Submission of Matters to a Vote of Security Holders.	34
PART II	34
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	34
ITEM 6. Selected Financial Data.	37
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.	38
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.	61
ITEM 8. Financial Statements and Supplementary Data.	64
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	100
ITEM 9A. Controls and Procedures.	100
ITEM 9B. Other Information.	102
PART III	102
ITEM 10. Directors, Executive Officers and Corporate Governance.	102
ITEM 11. Executive Compensation.	102
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	103
ITEM 13. Certain Relationships and Related Transactions, and Director Independence.	103
ITEM 14. Principal Accounting Fees and Services.	103
PART IV	103
ITEM 15. Exhibits, Financial Statement Schedules.	103
Amended and Restated Employment Agreement dated March 15, 2007
Amendment No. 1 to Employment Agreement dated March 15, 2007
Mercer Insurance Group, Inc. 401(k) Mirror Plan
Consent of independent registered public accounting firm
Certification of Chief Executive Officer pursuant to Section 302
Certification of Chief Financial Officer pursuant to Section 302
Certification of Chief Executive Officer pursuant to Section 906
Certification of Chief Financial Officer pursuant to Section 906

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PART I

ITEM 1. BUSINESS

THE HOLDING COMPANY

     Mercer Insurance Group, Inc. (the “Holding Company” or “MIG”) is a holding company which resulted 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 Holding Company.

     Mercer Insurance Group, Inc. and subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and its subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Holding Company, Inc. (FHC) and its subsidiary Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS). Effective October 1, 2005, Financial Pacific Insurance Group, Inc. (FPIG or Financial Pacific) was acquired through a subsidiary of MIG, and its subsidiaries Financial Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA).

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 individuals in New Jersey and Pennsylvania, and small and medium-sized businesses throughout Arizona, California, Nevada, New Jersey, Oregon and Pennsylvania.

     The Group’s operating subsidiaries are licensed collectively in twenty two states, but are currently focused on doing business in six states; Arizona, California, Nevada, New Jersey, Pennsylvania and Oregon. Mercer Insurance Company and Mercer Insurance Company of New Jersey, Inc. have recently been licensed to write property and casualty insurance in New York. It is intended that these companies will initially write business which supports existing accounts, with possible future expansion in other programs. Financial Pacific Insurance Company holds an additional fifteen state licenses outside of the Group’s current focus area. Currently, only direct mail surety is being written in some of these states.

     The insurance affiliates within the Group participate in a reinsurance pooling arrangement (the “Pool”) whereby each insurance affiliate’s underwriting results are combined and then distributed proportionately to each participant. FPIC joined the Pool effective January 1, 2006, after receiving regulatory approvals. Each insurer’s share in the Pool is based on their respective statutory surplus from the most recently filed statutory annual statement as of the beginning of each year.

     All insurance companies in the Group have been assigned a group rating of “A” (Excellent) by A.M. Best. The Group has been assigned that rating for the past 6 years. An “A” rating is the third highest rating of A.M. Best’s 16 possible rating categories.

     The Group is subject to regulation by the insurance regulators of each state in which it is licensed to transact business. The primary regulators are the Pennsylvania Insurance Department, the California Department of Insurance, and the New Jersey Department of Banking and Insurance, because these are the regulators for the states of domicile of the Group’s insurance subsidiaries, as follows: Mercer Insurance Company (Pennsylvania-domiciled), Financial Pacific Insurance Company (California-domiciled), Mercer Insurance Company of New Jersey, Inc. (New Jersey-domiciled), and Franklin Insurance Company (Pennsylvania-domiciled).

     We manage our business and report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function. Assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our commercial lines insurance business consists primarily of multi-peril, general liability, commercial auto, and related insurance coverages. Our personal

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lines insurance business consists primarily of homeowners (in New Jersey and Pennsylvania) and private passenger automobile (in Pennsylvania only) insurance coverages. The Group markets its products through a network of approximately 535 independent agents, of which approximately 292 are located in New Jersey and Pennsylvania, 180 in California with the balance in Arizona, Nevada and Oregon.

ACQUISITION OF FINANCIAL PACIFIC INSURANCE GROUP

     On October 1, 2005, the Group acquired all the outstanding stock of Financial Pacific Insurance Group, Inc. for approximately $41.1 million in cash, including transaction costs. The transaction was effected through a merger of a wholly owned subsidiary of the Group into FPIG. The financial results of FPIG have been included subsequent to the date of the acquisition.

     The acquisition was made using funds of the Holding Company, as well as funds advanced to the Holding Company from Mercer Insurance Company in the form of both an extraordinary dividend as well as an intercompany loan. The Pennsylvania Insurance Department approved both the extraordinary dividend and the intercompany loan arrangement.

     Financial Pacific Insurance Group, Inc. is a holding company which wholly owns Financial Pacific Insurance Company. FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities.

     The acquisition has allowed the Group to continue growing its commercial lines segment, to achieve product and geographic diversification, and to achieve greater scale over time in connection with infrastructure costs such as information technology. Financial Pacific Insurance Company currently writes property and casualty insurance for small and medium-sized businesses in the contractor, manufacturing, retail, services and wholesaling sectors in Arizona, California, Nevada and Oregon, and is licensed in another fifteen states outside the Group’s present focus areas.

OUR INSURANCE COMPANIES

     Mercer Insurance Company

     Mercer Insurance Company is a Pennsylvania insurance company originally incorporated under a special act of the legislature of the State of New Jersey in 1844 as a mutual insurance company. On October 16, 1997, it filed Articles of Domestication with Pennsylvania which changed its state of domicile from New Jersey to Pennsylvania, and then subsequently changed its name to Mercer Insurance Company after the Conversion in 2003. 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.

     Mercer Insurance Company is a property and casualty insurer of primarily 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. 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.

     Mercer Insurance Company of New Jersey, Inc. is a 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 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.”

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     Franklin Insurance Company

     Franklin Insurance Company is a stock property and casualty insurance company that was incorporated in 1997. Mercer Insurance Company acquired 49% of Franklin Insurance Company in 2001, with the remaining 51% acquired by Mercer Insurance Group, Inc. as part of the Conversion transaction in 2003. Franklin Insurance Company currently offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. Franklin Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business - - Regulation.”

     Financial Pacific Insurance Company

     Financial Pacific Insurance Company is a stock property and casualty company that was incorporated in California in 1986 and commenced business in 1987. The Group acquired all of the outstanding stock of Financial Pacific Insurance Group, Inc., the holding company for Financial Pacific Insurance Company, on October 1, 2005. FPIC is based in Rocklin, California, and writes primarily commercial package policies for small to medium-sized businesses in targeted classes. It has developed specialized underwriting and claims handling expertise in a number of classes of business, including apartments, restaurants, artisan contractors and ready-mix operators. FPIC’s business is heavily weighted toward the liability lines of business (commercial multi-peril liability, commercial auto) but also includes commercial multi-peril property, commercial auto physical damage and surety for small and medium-sized businesses. FPIC is licensed in nineteen western states, and actively writes insurance in four (Arizona, California, Nevada and Oregon). Prior to 2000, California accounted for nearly all of Financial Pacific’s written premium, but following a systematic and careful effort to diversify into other territories, at the end of 2006 the percentage of FPIC’s business attributable to California declined to 81% of the FPIC book of business. FPIC is subject to examination and comprehensive regulation by the California Department of Insurance. See “Business – Regulation.”

OUR BUSINESS STRATEGIES

     The acquisition of Financial Pacific Insurance Group, Inc. has moved the Group closer to its goals of a higher proportion of commercial lines premiums as well as product and geographic diversity. As a west coast-based commercial writer, the addition of Financial Pacific resulted in an expansion of our geographic scope and a meaningful line of business diversification. After the acquisition, the Group derives in excess of 85% of its direct written premiums from commercial lines of business, with greater geographic and product diversification. We will continue our efforts to pursue geographic and product line diversification in order to diminish the importance of any one line of business, class of business or territory.

     Increase our commercial writings

     In recent years, and including the Financial Pacific acquisition, the Group has taken steps to increase commercial premium volume, and we will continue our focus on this goal. Growth in commercial lines reduces our personal lines exposure as a percentage of our overall exposure, which 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 insurance business, we have developed insurance products and underwriting guidelines 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 are continually looking for new types of business where we can apply this focus.

     We have specialized pricing approaches and/or products designed for religious institutions, contracting, apartment, restaurant, condominium and “main street” accounts as well as various other types of risks. The products, rates and eligibilities vary based on our opinion of the local market opportunities for products in a given area.

     We believe that there is an opportunity to increase our volume of commercial business by working with our existing producers of commercial lines business and forming and developing relationships with new producers that focus on commercial business. We believe an increasing share of this market is desirable and attainable given our existing relationships with our producers and our insureds.

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Diversify our business geographically

     As a result of the Financial Pacific acquisition, we have achieved greater geographic diversification of our business. As of December 31, 2006, 2005 and 2004 our direct written premium was distributed as follows (note that the Financial Pacific premium volume is included in the table beginning October 1, 2005):

	Years Ended December 31,						% of Total
	2006		2005		2004		2006			2005			2004
	(In thousands)
Arizona	$	5,031	$	1,413	$	—		2.7	%		1.5	%		0.0	%
California		97,628		23,130		—		52.5	%		25.1	%		0.0	%
Nevada		14,235		2,450		—		7.7	%		2.7	%		0.0	%
New Jersey		51,302		49,744		51,090		27.6	%		53.9	%		77.7	%
Oregon		3,107		907		—		1.7	%		1.0	%		0.0	%
Pennsylvania		14,274		14,555		14,700		7.7	%		15.8	%		22.3	%
Other States		168		41		—		0.1	%		0.0	%		0.0	%
Total	$	185,745	$	92,240	$	65,790		100.0	%		100.0	%		100.0	%

     We hold twenty two state licenses, and we are currently focused on doing business in primarily six of these states. These state licenses provide additional opportunity for future growth when market opportunities dictate utilization of those licenses. If market opportunities indicate desirable growth is available through the acquisition of additional state licenses, we will pursue licenses in new states.

     Attract and retain high-quality producers with diverse customer bases

     We believe our insurance companies have a strong reputation with producers and insureds for personal attention and prompt, efficient service. 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 our territories. 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. We also intend to continue to develop and tailor our commercial programs to enable our products to meet the needs of the customers served by our producers.

     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, by increasing our net premium income through the strategic deployment of our capital and by strategically deploying our workforce to build efficiencies in our processes.

     Reduce our reliance on reinsurance

     We continue to reduce our reliance on reinsurance by increasing our retention of business written by our insurance companies on individual property and casualty risks. Our capital is best utilized by retaining as much profitable business as practical. We continually evaluate our reinsurance program to reduce the cost and achieve the optimal balance between cost and protection.

     We determine the appropriate level of reinsurance based on a number of factors, which include:

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

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

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• the 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 also increase our potential losses from underwriting. See “Business – Reinsurance” for a description of our 2006 reinsurance program and changes to the program for 2007.

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,
	2006			2005			2004
	(Dollars in thousands)
Direct Premiums Written:
Commercial multi-peril	$	118,030		$	44,369		$	22,249
Commercial automobile		25,807			7,955			3,089
Other liability		6,246			7,822			9,771
Workers’ compensation		4,697			4,642			4,381
Surety		5,388			1,924			—
Fire, allied, inland marine		1,424			1,003			1,393
Total	$	161,592		$	67,715		$	40,883
Net Premiums Earned:
Commercial multi-peril	$	80,760		$	29,963		$	16,522
Commercial automobile		17,851			5,826			3,185
Other liability		5,710			8,239			7,184
Workers’ compensation		6,001			6,016			4,691
Surety		4,381			1,197			—
Fire, allied, inland marine		413			716			788
Total	$	115,116		$	51,957		$	32,370
Net Loss Ratios:
Commercial multi-peril		64.5	%		71.9	%		32.6	%
Commercial automobile		66.8			48.2			4.4
Other liability		37.3			32.5			41.0
Workers’ compensation		62.7			41.8			28.8
Surety		37.9			15.9			—
Fire, allied, inland marine		93.7			5.4			63.2
Total		62.5	%		57.3	%		31.9	%
Expense Ratio:
Commercial multi-peril		33.6	%		31.5	%		57.3	%
Commercial automobile		29.7			28.4			38.8
Other liability		37.4			44.9			53.7
Workers’ compensation		22.0			27.8			29.7
Surety		17.6			(16.9	)		—
Fire, allied, inland marine		58.9			48.3			64.8
Total		32.1	%		32.0	%		50.9	%
Combined Ratios(1):
Commercial multi-peril		98.1	%		103.4	%		89.9	%
Commercial automobile		96.5			76.6			43.2
Other liability		74.7			77.4			94.7
Workers’ compensation		84.7			69.6			58.5
Surety		55.5			(1.1	)		—
Fire, allied, inland marine		152.6			53.8			128.0
Total		94.6	%		89.3	%		82.8	%

(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 providing property and liability coverage. Various risk classes are written on this policy.

     We 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; (ii) condominium associations; (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 and tenant occupancies. We expect to introduce this product in our California territory within the next two years.

     We offer in New Jersey and Pennsylvania a specialized multi-peril policy specifically designed for religious institutions. This enhanced product offers directors and officers coverage, religious counseling coverage and equipment breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools also is available. We offer versions of this product to individual religious institutions as well as to denomination groups who seek coverage for participating member institutions.

     A custom underwritten commercial multi-peril package policy is written in the western states for select contracting classes, as well as small to medium-sized businesses within specified niche markets. This product is focused on commercial accounts primarily in non-urban areas that do not easily fit within a generic business owner policy. The target markets for this product include apartments, artisan and construction contractors, farm labor operations, service contractors, and mercantile (including restaurants) as well as various other risk types.

     Commercial Automobile

     This product is designed to cover primarily trucks used in business, as well as company-owned private passenger type vehicles. Other specialty classes such as church vans, funeral director vehicles and farm labor buses 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.

     We also write heavy and extra heavy trucks through our refuse hauler, aggregate hauler and ready-mix programs offered primarily in the western states.

     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 contractors such as carpenters, painters or electricians, who often self-insure small property exposures. Coverage for both premises and products liability exposures are regularly provided. Coverage is available for other exposures such as vacant land and habitational risks.

     Commercial umbrella coverage and following form excess 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 million to $10 million, 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, 2006, most of our workers’ compensation insureds have other policies with us. Workers’ compensation is written only in New Jersey and Pennsylvania.

     Surety

     The Group, through Financial Pacific, writes a mix of contract and subdivision bonds as well as

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miscellaneous license and permit bonds in our western states. Our bonds are distributed through both our independent agents as well as a direct marketing effort that includes on-line sales via our web-site Bondnow.com.

     Fire, Allied Lines and Inland Marine

     Fire and allied lines insurance generally covers fire and lightning. 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,
	2006			2005			2004
	(Dollars in thousands)
Direct Premiums Written:
Homeowners	$	15,149		$	14,950		$	14,666
Personal automobile		6,578			7,057			7,654
Fire, allied, inland marine		1,983			2,037			2,050
Other liability		409			442			493
Workers’ compensation		34			39			43
Total	$	24,153		$	24,525		$	24,906
Net Premiums Earned:
Homeowners	$	13,867		$	13,465		$	13,477
Personal automobile		6,226			6,719			7,197
Fire, allied, inland marine		2,091			2,140			2,194
Other liability		341			442			505
Workers’ compensation		32			37			41
Total	$	22,557		$	22,803		$	23,414
Net Loss Ratios:
Homeowners		66.1	%		52.5	%		82.8	%
Personal automobile		89.4			76.1			77.0
Fire, allied, inland marine		27.7			27.9			28.1
Other liability		109.2			175.4			104.1
Workers’ compensation		60.8			141.0			—
Total		69.6	%		59.7	%		76.1	%
Expense Ratio:
Homeowners		41.8	%		50.7	%		48.1	%
Personal automobile		33.5			42.3			38.9
Fire, allied, inland marine		39.1			48.6			47.7
Other liability		53.7			54.8			32.6
Workers’ compensation		20.8			24.5			25.8
Total		39.4	%		48.1	%		44.9	%
Combined Ratios(1):
Homeowners		107.9	%		103.2	%		130.9	%
Personal automobile		122.9			118.4			115.9
Fire, allied, inland marine		66.8			76.5			75.8
Other liability		162.9			230.2			136.7
Workers’ compensation		81.6			165.4			25.8
Total		109.0	%		107.8	%		121.0	%

(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. This product is sold only in New Jersey and Pennsylvania.

     Personal Automobile

     We write comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania only. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles.

     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. This product is available in both New Jersey and Pennsylvania.

     Other Liability

     We write personal lines 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 exclusively through independent producers, with the exception of a relatively small amount of business within our surety book of business marketed online and by direct mail. 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. For the year ending December 31, 2006, there were no agents in the Group that individually produced greater than 5% of the Group’s direct written premiums. For the years ending December 31, 2005 and 2004, approximately 17% and 24% of the Group’s direct premiums written were produced by two agents.

     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 often with an opportunity for profit sharing

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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 Group and not specifically for any individual policy. The Group does not have any marketing services agreements, placement services agreements, or similar arrangements. By contract, our producers represent one or more of the Group’s carriers. They are monitored and supported by our marketing representatives, who are employees of the Group. These company representatives also have principal responsibility for recruiting and training new producers.

     Our insurance companies manage their producers through periodic business reviews (with underwriter and marketing participation) and establishment of benchmarks/goals for premium volume and profitability. Our insurance companies in recent years have terminated a number of underperforming 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 a staff of underwriters, who generally specialize in either personal or commercial lines, and have experience as underwriters in their specialized areas. Specific information is monitored with regard to individual insureds to assist us in making decisions about policy renewals or modifications. New property risks are frequently inspected to insure they are as desirable as suggested by the application process.

     We plan on introducing, for selected products, an automated process for acceptance and rejection of small accounts through an internet-based rating system. Based on the success of this process, our goal would be to expand the process to other products at some point in the future. Though there will be less direct underwriter involvement, we are confident that underwriting standards will continue to be maintained as risks will continue to be subject to our standardized underwriting verification processes, including physical inspections.

     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 in some, but not all cases, provided their historic underwriting performance warrants such authority. Producers’ results are continuously monitored, and continued poor loss ratios often result in agency termination.

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. Our trend is to manage an increasing proportion of our claims internally without the use of independent adjusters where scale permits. The Group 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 and related legal costs by encouraging the use of alternative dispute resolution procedures. Litigated claims are assigned to outside counsel for many types of claims, however most claims files handled in our western state operations are managed by in-house attorneys who have specialized training relating to construction liability issues and other casualty risks. We believe this arrangement reduces dramatically the cost of managing these types of claims, as the use of in-house attorneys dramatically reduces the cost of defense work.

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TECHNOLOGY

     The Group seeks to transact much of its business using technology wherever possible and, in recent years, has made significant investments in information technology platforms, integrated systems and internet-based applications.

     The Group is in the process of phasing out legacy systems, primarily those acquired with Financial Pacific, and consolidating onto one core transactional system. As part of this process, the Group expects to implement a “data warehouse” to house the Group’s legacy data into a similar structure on one technical platform as well as establish an Executive Dashboard with “drill down” capability. This will streamline and simplify management reporting.

     The focus of our ongoing information technology effort is:

• to streamline how our producers’ transact business with us;

• to continue to evolve our internal processes to allow for more efficient operations;

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

• to enhance agency online inquiry capabilities; and

• to provide agencies with on-line reporting

     We believe that our technology initiative may increase revenues by making it easier for our insurance companies and producers to exchange information and do business. Increased ease of use is also an opportunity for us to lower expenses, eliminating the need to operate more than one system once the transition is complete. This will further reduce technology expense and simplify information technology management.

     We take reasonable steps to protect information we are entrusted with in the ordinary course of business. As a core part of our disaster recovery planning, we have implemented a secure and reliable off-site disk-to-disk backup and restore capability.

     The Group has also expanded a Quality Assurance department within IT reporting to the Chief Information Officer. This group is responsible for quality testing all significant new releases of software applications and provides an independent assessment of the reliability and accuracy of new releases.

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

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• 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.

     The amount and scope of reinsurance coverage to purchase each year is determined 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. Reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually. For the year ended December 31, 2006, our insurance companies ceded to reinsurers $42.3 million of written premiums, compared to $19.8 million of written premiums for the year ended December 31, 2005, and $8.4 million for the year ended December 31, 2004. The increase in 2006 and 2005 relates largely to the inclusion of the reinsurance premiums ceded by Financial Pacific Insurance Company, which was acquired by the Group on October 1, 2005.

     The largest exposure retained in 2006, 2005 and 2004 on any one individual property risk was $500,000. For 2007, that retention will increase to $750,000. 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 (excess of $750,000 in 2007) 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. Umbrella liability losses (except for policies issued by Financial Pacific) are reinsured on a 75% quota share basis up to $1.0 million and a 100% quota share basis in excess of $1.0 million. Financial Pacific’s umbrella program is 100% reinsured.

     For the surety line of business, written exclusively by Financial Pacific, the Group maintains an excess of loss contract under which it retains the first $500,000 and 10% of the next $3.0 million resulting in a maximum retention of $800,000 per principal.

     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 100% of losses per occurrence in excess of $2.0 million, up to a maximum of $32.0 million per occurrence. Effective for 2007, the catastrophe coverage retention was increased to $5.0 million and the maximum limit was increased to $55.0 million.

     The Group also carries coverage for acts of terrorism of $10.0 million excess of $2.0 million. Effective 2007, the coverage was changed to $10.0 million excess of $3.0 million. This coverage does not apply to nuclear, chemical or biological events.

     Prior to 2007, Financial Pacific Insurance Company had a separate reinsurance program from the other insurance companies in the Group, which was largely a continuation of the program it had in place immediately prior to its acquisition by the Group. Commercial multi-peril property and auto physical damage coverage was reinsured, through a $1,650,000 excess of $350,000 excess of loss contract. Excess of $2 million, Financial Pacific had a semi-automatic facultative agreement, which provided $8 million of coverage. On casualty business Financial Pacific maintained two reinsurance layers, $250,000 excess of $250,000, and $500,000 excess of $500,000, respectively, for commercial multiple peril liability and

13

commercial automobile liability with a syndicate of reinsurers. The maximum exposure on any one casualty risk was $250,000. Excess of $1 million, there is a semi-automatic facultative agreement, which provides $5 million of coverage.

     As of January 1, 2006, Financial Pacific terminated its 2005 property quota share and casualty excess of loss reinsurance contracts and restructured its reinsurance program to the structure described in the preceding paragraph. The restructuring also included the assumption of ceded unearned premium by Financial Pacific from the 2005 property quota share and casualty excess of loss agreements. These assumed premiums were then ceded into the respective 2006 treaties, which due to the reduced ceding rates, resulted in a $5.6 million increase in net written and earned premium for the year ending December 31, 2006.

     During the third quarter of 2006, the Group commuted all reinsurance agreements with Alea North America Insurance Company (Alea). These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation the Group received a cash payment of $4.5 million, and recorded a pre-tax net loss on commutation of $160,000.

     The reinsurance program renewed for 2007 with a number of changes focused on taking advantage of the Group’s capital position by reducing the level of ceded premium and retaining more of the business it writes. Effective, January 1, 2007, the Group increased its retention to $750,000 on the casualty, property and workers’ compensation lines of business. Additionally, the Group strengthened the credit quality of its reinsurers by replacing the various syndicates of reinsurers on its primary treaties (i.e., treaties covering risk limits less than $1.0 million on casualty lines, less than $5.0 million on property lines and less than $10 million on workers’ compensation) with a single reinsurer, General Reinsurance Corporation, rated A++ (Superior) by A.M. Best, their highest rating.

     In conjunction with the renewal of the reinsurance program in 2007, the 2006 reinsurance treaties were terminated on a run-off basis, which requires that for policies in force as of December 31, 2006, these reinsurance agreements continue to cover losses occurring on these policies in the future. Therefore, the Group will continue to remit premiums to and collect reinsurance recoverables from these syndicates of reinsurers as the underlying business runs off.

     Some of the Group’s reinsurance treaties have included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares on a limited basis in the profitability through contingent ceding commissions. Exposure to the loss experience is contractually defined at minimum and maximum levels, and the terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts presented in the Group’s results of operations.

     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, 2006, the Group’s 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.	Partner Reinsurance Company of the U.S.		26.7	%	A+
2.	QBE Reinsurance Corporation		14.6	%	A
3.	Berkley Insurance Company		12.0	%	A
4.	ACE Property & Casualty Insurance Company		12.0	%	A+
5.	General Reinsurance Company		6.3	%	A++

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     The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of December 31, 2006.

		Loss and
		Loss Expenses
		Recoverable on		A.M. Best
Name		Unpaid Claims		Rating
		(In thousands)
1.	Partner Reinsurance Company of the U.S.	$	22,596	A+
2.	Berkley Insurance Company		18,561	A
3.	QBE Reinsurance Corporation		12,365	A
4.	Continental Casualty Company		9,434	A
5.	GE Reinsurance Corporation		3,896	A+

The A++, A+, A and A- ratings are the top four highest of A.M. Best’s 16 ratings. According to A.M. Best, companies with a rating of “A++” or “A+” are rated “Superior”, with “...a superior ability to meet their ongoing obligations to policyholders.” Companies with a rating of “A” or “A-” are rated “Excellent”, with “...an excellent ability to meet their ongoing obligations to policyholders.”

     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, 2006, our participation is not material. For the years ended December 31, 2006, 2005 and 2004, our insurance companies assumed $2.4 million, $2.9 million and $2.1 million of written premiums, respectively.

INTERCOMPANY AGREEMENTS

     Our insurance companies are parties to a Reinsurance Pooling Agreement. Under this agreement, 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 Pool has no impact on our consolidated results. FPIC joined the Group’s Pool on January 1, 2006, upon completion of the regulatory approval process. In connection with its participation in the Pool, FPIC transferred approximately $54 million in assets to the other companies in the pooling agreement to recognize their assumption of a portion of its loss and loss adjustment expense and unearned premium reserves.

     The Group’s insurance subsidiaries are parties to a Services Allocation Agreement. Pursuant to this agreement, any and all employees of the Group were transferred to, and became employees of, BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company. BICUS has agreed to perform all necessary functions and services required by the subsidiaries of the Group in conducting their respective operations. In turn, the subsidiaries of the Group have agreed to reimburse BICUS for its costs and expenses incurred in rendering such functions and services in an amount determined by the parties. The Services Allocation Agreement has no impact on our consolidated results.

     The Group 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. The Tax Allocation Agreement has no impact on our consolidated results.

LOSS AND LOSS ADJUSTMENT EXPENSE 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 provision must 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 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.

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     In light of such uncertainties, the Group also relies on policy language, developed by the Group and by others, to exclude or limit coverage where not intended. If such language is held by a court to be invalid or unenforceable it could materially adversely affect the Group’s results of operations and financial position. The possibility of expansion of an insurer’s liability, either through new concepts of liability or through a court’s refusal to accept restrictive policy language, adds to the inherent uncertainty of reserving for claims.

     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’ ultimate net liability for both reported and IBNR claims and then subtracting the case reserves and payments made to date for reported claims.

     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 and have a material adverse effect on the Group’s results of operations and financial condition. We do not discount our reserves to recognize the time value of money. We do not believe our insurance companies are subject to any material potential asbestos or environmental liability claims.

     See additional discussion of loss and loss adjustment expense reserves in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies” under the sections titled “Liabilities for Loss and Loss Adjustment Expenses”, “Methods Used to Estimate Loss and Loss Adjustment Expense Reserves” and “Description of Ultimate Loss Estimation Methods”.

     The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of the Group for the years ended December 31, 2006, 2005 and 2004, prepared in accordance with U.S. generally accepted accounting principles.

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RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

	2006			2005			2004
	(In thousands)
Reserves for losses and loss adjustment expenses at the beginning of period	$	211,679		$	36,028		$	37,261
Less: Reinsurance recoverable and receivables		(78,744	)		(3,063	)		(5,036	)
Net reserves for losses and loss adjustment expenses at beginning of period		132,935			32,965			32,225
Reserves acquired in subsidiary acquisition, net		—			91,894			—
Net balance, as adjusted		132,935			124,859			32,225
Add: Provision for losses and loss adjustment expenses for claims occurring in:
Current year		79,275			43,921			29,024
Prior years		8,422			(537	)		(886	)
Total incurred		87,697			43,384			28,138
Less: Loss and loss adjustment expenses payments for claims occurring in:
Current year		23,284			20,729			14,626
Prior years		32,826			14,579			12,772
Total paid		56,110			35,308			27,398
Net balance, December 31		164,522			132,935			32,965
Plus reinsurance recoverable on unpaid losses and loss expenses at end of period		85,933			78,744			3,063
Reserves for losses and loss adjustment expenses at end of period	$	250,455		$	211,679		$	36,028

     As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses increased by $8.4 million in 2006 and decreased by $0.5 million and $0.9 million in 2005 and 2004, respectively.

     The following table presents the increase (decrease) in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2006 by line of business. Amounts shown in the 2005 column of the table include information relating to Financial Pacific Insurance Company, which was acquired on October 1, 2005, and accounted for as a purchase business combination.

				Year Ended December 31,
										2003
	Total			2005			2004			and Prior
				(In Thousands)
Commercial multi-peril	$	9,618		$	7,941		$	334		$	1,343
Commercial automobile		(1,968	)		(2,085	)		29			88
Other liability		(292	)		(510	)		129			89
Workers’ compensation		525			50			1,021			(546	)
Homeowners		(55	)		204			810			(1,069	)
Personal automobile		571			57			217			297
Other lines		23			(132	)		(13	)		168
Net prior year development	$	8,422		$	5,525		$	2,527		$	370

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     Each quarter, we compute our estimated ultimate liability using actuarial principles and procedures applicable to the lines of business written. The establishment of loss and loss adjustment expense reserves is an inherently uncertain process and reserve uncertainty stems from a variety of sources. 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. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustment is made. A discussion of factors contributing to an increase (decrease) in the liability for unpaid losses and loss adjustment expenses for the Group’s two major lines of business, representing 81% of total carried loss and loss adjustment expenses at December 31, 2006, follows:

     Commercial multi-peril

     With $120.1 million of recorded reserves, net of reinsurance, at December 31, 2006, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 73% of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2006. As a result of changes in estimates of insured events in prior years, the liabilities for prior year losses and loss adjustment expenses for the commercial multi-peril line of business increased by $9.6 million in 2006.

     The strengthening of net loss and loss adjustment expense reserves in the commercial multi-peril line reflects refinement in the assumptions and techniques supporting the reserve estimates, primarily on the contractor liability book of business. Contractor liability claims, particularly construction defect claims, are long-tailed in nature and develop over a period of ten to twelve years, based on the related statute of limitations. The increase in our estimates of insured events of prior years relates primarily to a higher than expected level of claims being reported in 2006 for such prior years. Actuarial methods are used to predict future development which is assumed to follow an expected pattern that is supported by historical data and industry trends. This line of business and related reserving assumptions are inherently uncertain and several factors, including newly observed trends, taken into consideration in the actuarial analysis can cause volatility in the determination of net ultimate losses.

     Commercial automobile

     With $13.4 million of recorded reserves, net of reinsurance, at December 31, 2006, commercial automobile is the Group’s second largest reserved line of business, representing 8% of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2006. As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses for the commercial automobile line of business decreased by $2.0 million in 2006. The development of net ultimate losses on the commercial automobile line of business was better than expected in 2006, primarily as a result of a reduction in claims frequency and a lower than expected incurred. Our expansion into heavy vehicle programs such as ready mix and aggregate haulers has not translated into the expected increased level of loss activity.

     The following tables show the development of our consolidated reserves for unpaid losses and LAE from 1996 through 2006 determined under U.S. generally accepted accounting principles (GAAP). The top line of each table shows the liabilities, net of reinsurance, 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 re-estimated 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. A redundancy exists when the re-estimated liability at each December 31 is less than the prior liability estimate. Similarly, a deficiency exists when the re-estimated liability at each December 31 is greater 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.

     Amounts shown in the 2005 column of the table include information relating to Financial Pacific Insurance Company for all accident years prior to 2005.

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	Year Ended December 31,
	1996		1997		1998		1999		2000		2001
	(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable	$	20,074	$	19,851	$	22,565	$	23,643	$	24,091	$	25,634
Cumulative amount of liability paid through:
One year later		6,042		4,536		5,525		5,842		5,726		7,376
Two years later		8,829		7,537		8,655		8,627		9,428		11,850
Three years later		11,143		9,738		10,605		11,237		12,142		15,610
Four years later		12,472		10,975		11,893		12,726		14,139		18,493
Five years later		13,422		11,550		12,554		13,613		15,750		20,123
Six years later		13,826		11,816		13,034		14,865		16,628
Seven years later		14,043		12,118		13,888		15,702
Eight years later		14,236		12,610		14,600
Nine years later		14,581		12,939
Ten years later		14,807
Liability estimated as of:
One year later		19,018		17,874		19,909		19,689		20,810		23,490
Two years later		17,634		16,440		17,478		18,506		19,539		22,084
Three years later		16,987		14,711		16,625		17,484		17,745		22,522
Four years later		15,905		14,204		15,826		16,167		18,050		22,047
Five years later		15,769		13,913		14,762		16,200		17,751		21,817
Six years later		15,483		13,273		14,955		16,604		17,934
Seven years later		14,986		13,462		15,329		16,791
Eight years later		15,191		13,463		15,523
Nine years later		15,356		13,703
Ten years later		15,482
Cumulative total redundancy (deficiency), net	$	4,592	$	6,148	$	7,042	$	6,852	$	6,157	$	3,817
Gross liability — end of year		35,221		31,872		30,948		29,471		28,766		31,059
Reinsurance recoverable — end of year		15,147		12,021		8,383		5,828		4,676		5,425
Net liability — end of year	$	20,074	$	19,851	$	22,565	$	23,643	$	24,090	$	25,634
Gross re-estimated liability — latest		25,291		21,845		20,900		21,701		22,294		26,945
Re-estimated reinsurance recoverable — latest		9,809		8,142		5,376		4,910		4,360		5,128
Net re-estimated liability — latest	$	15,482	$	13,703	$	15,524	$	16,791	$	17,934	$	21,817
Cumulative total redundancy (deficiency), gross	$	9,930	$	10,027	$	10,048	$	7,770	$	6,472	$	4,114

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	Year Ended December 31,
	2002			2003			2004			2005			2006
	(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable	$	27,198		$	32,225		$	32,965		$	132,935		$	164,522
Cumulative amount of liability paid through:
One year later		8,840			12,772			14,580			32,826
Two years later		15,442			20,624			23,011
Three years later		19,947			26,610
Four years later		23,126
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		26,601			31,339			32,427			141,357			—
Two years later		26,924			32,392			35,323
Three years later		26,681			32,763
Four years later		26,507
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative total redundancy (deficiency), net	$	691		$	(538	)	$	(2,358	)	$	(8,422	)	$	—
Gross liability — end of year		31,348			37,261			36,028			211,679			250,455
Reinsurance recoverable — end of year		4,150			5,036			3,063			78,744			85,933
Net liability — end of year	$	27,198		$	32,225		$	32,965		$	132,935		$	164,522
Gross re-estimated liability — latest		31,490			39,105			40,777			222,153
Re-estimated reinsurance recoverable — latest		4,983			6,342			5,453			80,797
Net re-estimated liability — latest	$	26,507		$	32,763		$	35,324		$	141,356
Cumulative total redundancy (deficiency), gross	$	(142	)	$	(1,844	)	$	(4,749	)	$	(10,474	)

INVESTMENTS

     On a consolidated basis, all of our investments in 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 average maturity 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.”

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     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. 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 Group has developed this investment policy and reviews it periodically.

     The following table sets forth consolidated information concerning our investments. The growth and changes in the distribution of the fixed income securities portfolio among the categories in the table below from December 31, 2004 to December 31, 2005 reflects the acquisition of Financial Pacific Insurance Group, Inc. on October 1, 2005.

	At December 31, 2006				At December 31, 2005				At December 31, 2004
	Cost (2)		Fair Value		Cost (2)		Fair Value		Cost (2)		Fair Value
					(In thousands)
Fixed income securities (1):
United States government and government agencies (3)	$	75,683	$	74,981	$	75,864	$	75,001	$	17,870	$	17,700
Obligations of states and political subdivisions		116,361		116,298		80,728		80,278		35,801		35,745
Industrial and miscellaneous		53,298		52,717		55,326		54,732		16,896		16,781
Mortgage-backed securities		29,427		29,458		19,273		19,118		30,535		30,431
Total fixed income securities		274,769		273,454		231,191		229,129		101,102		100,657
Equity securities		10,940		16,522		8,599		14,981		16,145		24,447
Short-term investments		7,692		7,692		4,289		4,289		—		—
Total	$	293,401	$	297,668	$	244,079	$	248,399	$	117,247	$	125,104

(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.
(3)	Includes approximately $48,840 (cost) and $48,548 (estimated fair value) of the mortgage-backed securities backed by the U.S. government and government agencies.

     The table below contains consolidated information concerning the investment ratings of our fixed maturity investments at December 31, 2006.

	Amortized
Type/Ratings of Investment (1)	Cost		Fair Value		Percentages(2)
	(Dollars in thousands)
U.S. government and agencies	$	75,683	$	74,981		27.4	%
AAA		138,047		138,027		50.5	%
AA		22,140		22,000		8.0	%
A		36,639		36,082		13.2	%
BBB		1,870		1,844		0.7	%
BB		390		520		0.2	%
Total	$	274,769	$	273,454		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, 2006 (note that mortgage-backed securities in the below table include securities backed by the U.S. government and agencies):

	Amortized
Maturity	Cost (1)		Fair Value		Percentages (2)
	(Dollars in thousands)
1 year or less	$	6,004	$	5,956		2.2	%
More than 1 year through 5 years		71,712		70,871		25.9	%
More than 5 years through 10 years		76,704		76,193		27.9	%
More than 10 years		42,082		42,428		15.5	%
Mortgage-backed securities		78,267		78,006		28.5	%
Total	$	274,769	$	273,454		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.

     As of December 31, 2006, the average maturity of our fixed income investment portfolio (excluding mortgage-backed securities) was 5.4 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.

     Our consolidated average cash and invested assets, net investment income and return on average cash and invested assets for the years ended December 31, 2006, 2005 and 2004 were as follows:

	Year Ended December 31,
	2006			2005			2004
	(Dollars in thousands)
Average cash and invested assets	$	294,358		$	155,800		$	139,015
Net investment income		10,070			4,467			2,841
Return on average cash and invested assets		3.4	%		2.9	%		2.0	%

     We have one non-traded equity security, a non-voting common stock in Excess Reinsurance Company, which is carried at $0.9 million. Excess Reinsurance Company paid a special dividend to the Group in 2006, 2005 and 2004 in the amount of $228,000, $183,000 and $274,000, respectively. 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.

A.M. BEST RATING

     A.M. Best rates insurance companies based on factors of concern to policyholders. All companies in the Group, including Financial Pacific Insurance Company effective January 1, 2006, participate in the intercompany pooling agreement (see “Intercompany Agreements” above) and have been assigned a group

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rating of “A” (Excellent) by A.M. Best. The Group has been assigned that rating for the past 6 years. An “A” rating is the third highest of A.M. Best’s 16 possible rating categories.

     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.

COMPETITION

     The property and casualty insurance market is very 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.

     Pricing in the property and casualty insurance industry historically has been and remains cyclical. During a soft market cycle, price competition becomes prevalent, which makes it difficult to write and retain properly priced personal and commercial lines business. In response to what management believes is driven by the current soft market, the marketplace is populated with some competitors who are significantly reducing their prices and/or offering coverage terms that are generous in relation to the premium charges being made. We believe that in some instances, the prices and terms being offered, if matched by us, would not provide us with an adequate rate of return, if any.

     Our policy is to maintain disciplined underwriting during soft markets, declining business which is inadequately priced for its level of risk. The market has become very highly competitive, with increasing competition recently being seen in virtually all classes of commercial accounts, package policies and in the Pennsylvania personal auto market. This results in fewer new business opportunities for us and more challenging renewals, which can adversely impact premium revenue levels for the Group. We continue to focus on long-term profitability rather than short-term revenue. We also continue to work with our agents to target classes of business and accounts compatible with our underwriting appetite, which includes certain types of religious institutions risks, contracting risks, small business risks and property risks.

     Many of our competitors offer internet-based quoting and/or policy issuance systems to their producers. In response to this improvement in marketplace technology, are developing information system applications to create an automated process for acceptance and rejection of accounts through an internet-based rating system.

     A new form of competition may enter the marketplace as reinsurers attempt to diversify their insurance risk by writing business in the primary marketplace. The Group also faces competition, primarily in the commercial insurance market, from entities that may desire to self-insure their own risks.

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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.

     Examinations

     Examinations are conducted by the Pennsylvania Insurance Department, the California Department of Insurance, 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, 2004. Their last examination of Franklin Insurance Company was as of December 31, 2004. The New Jersey Department of Banking and Insurance’s last examination of Mercer Insurance Company of New Jersey, Inc. was as of December 31, 2004. The last examination of Financial Pacific Insurance Company by the California Department of Insurance was as of December 31, 2003.

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     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.

     NAIC Risk-Based Capital Requirements

     In 1990, 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, 2006, Pennsylvania, New Jersey, and California, the states in which our insurance company subsidiaries are domiciled, were accredited.

     Pennsylvania, New Jersey and California 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.

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     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 Group is subject to from time to time. No material issues have been raised in the market conduct exams performed on the Group’s insurance subsidiaries.

     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, 2006, 2005 and 2004, we received earned premium from these arrangements in the amounts of $2,539,000, $2,696,000, and $1,829,000, respectively, and incurred losses and loss adjustment expenses from these arrangements in the amounts of $3,908,000, $2,249,000, and $1,565,000, respectively. The increase in the incurred losses and loss adjustment expenses in 2006 reflects an increase in management’s estimate of incurred but not reported claims experience. 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. 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, 2006, 2005 and 2004, we incurred approximately $105,000, $168,000, and ($28,000), 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 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

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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.

     During 2006, the SEC proposed interpretive guidance for management on evaluating internal control over financial reporting. In a related step, the Public Company Accounting Oversight Board proposed a revised standard for audits of internal control over financial reporting. All these actions are intended to make compliance with Section 404 of the SOA more cost-effective. As the SEC provides new requirements, we will review those rules and comply as required.

     The Group’s 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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     We are currently charging a premium for certified terrorism coverage on our businessowners, commercial automobile, commercial workers’ compensation, tenant-occupied dwelling, special contractors, special multi-peril, monoline commercial fire, monoline general liability and religious institution policies. Insureds that 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, 2008. If this legislation is not extended beyond that date, all potential reimbursement for certified terrorism losses will end on that date.

     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.

     New and Proposed Legislation and Regulations

     The property and casualty insurance industry continues to receive a considerable amount of publicity related to pricing, coverage terms, the lack of availability of insurance, and the issue of paying profit-sharing commissions to agents. 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.

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     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.

     Under Pennsylvania law, there is a maximum amount of dividends that may be paid by Mercer Insurance Company to Mercer Insurance Group 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. As of December 31, 2006, the amounts available for payment of dividends from Mercer Insurance Company in 2007, without the prior approval of the Pennsylvania Insurance Department is approximately $5.9 million. In 2005, Mercer Insurance Company applied for, and received, approval to pay an extraordinary dividend of $10 million, which was used in connection with the acquisition of Financial Pacific Insurance Group, Inc.

     All dividends from Financial Pacific Insurance Company to Financial Pacific Insurance Group, Inc. (wholly owned by Mercer Insurance Group, Inc.) require prior notice to the California Department of Insurance. All “extraordinary” dividends require advance approval, and the payment of ordinary dividends made for the purpose of servicing debt of the Group has been restricted and requires prior written consent. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income (excluding unrealized capital gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2006, the amounts available for payment of dividends from Financial Pacific Insurance Company in 2007, without the prior approval, in addition to those dividends required to service debt of the Group, for which pre-approval is required, is approximately $5.6 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 applicable insurance commissioner. In some states, certain transactions cannot be completed without the prior approval of the insurance commissioner.

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, 2006, the total number of full-time equivalent employees of BICUS was 214, as compared to the prior-year total of 193. The increase in 2006 is attributable to the filling of vacant positions at Financial Pacific that were held open until the merger was complete in the fall of 2005 as well as additions in staff Group-wide to support strategic initiatives. None of these employees are covered by a collective bargaining agreement and BICUS believes that its employee relations are good.

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ITEM 1A. RISK FACTORS

Risks Relating to Our Business and Industry

Catastrophic Events

     As a property and casualty insurer, we are subject to claims from catastrophes that may have a significant negative impact on operating and financial results. We have experienced catastrophe losses, and can be expected to experience catastrophe losses in the future. Catastrophe losses can be caused by various events, including coastal storms, snow storms, ice storms, freezing, hurricanes, earthquakes, tornadoes, wind, hail, fires, and other natural or man-made disasters. We also face exposure to losses resulting from acts of war, acts of terrorism and political instability. The frequency, number and severity of these losses are 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.

     We attempt to mitigate catastrophe risk by reinsuring a portion of our exposure. However, reinsurance may prove inadequate if:

- A major catastrophic loss exceeds the reinsurance limit;

- A number of small catastrophic losses occur which individually fall below the reinsurance retention level.

     In addition, because accounting regulations do not permit insurers to reserve for catastrophic events until they occur, claims from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could have a material adverse affect on our financial condition or results of operations. Our ability to write new business also could be adversely affected.

Loss Reserves

     We maintain reserves to cover amounts we estimate will be needed to pay for insured losses and for the expenses necessary to settle claims. Estimating loss and loss expense reserves is a difficult and complex process involving many variables and subjective judgments. Estimates are based on management assessment of the known facts and circumstances, prediction of future events, claims severity and frequency and other subjective factors. We regularly review our reserving techniques and our overall amount of reserves. We review historical data and consider the impact of various factors such as:

- trends in claim frequency and severity;

- information regarding each claim for losses;

- legislative enactments, judicial decisions and legal developments regarding damages; and

- trends in general economic conditions, including inflation.

     Our estimated loss reserves could be incorrect and potentially inadequate. If we determine that our loss reserves are inadequate, we will have to increase them. This adjustment would reduce income during the period in which the adjustment is made, which could have a material adverse impact on our financial condition and results of operation. There is no precise way to determine the ultimate liability for losses and loss settlements prior to final settlement of the claim.

Terrorism

     The threat of terrorism, both within the United States and abroad, and military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and declines in the equity markets in the United States, Europe and elsewhere, as well as loss of life, property damage, additional disruptions to commerce and reduced economic activity. Actual terrorist attacks could cause losses from insurance claims related to the property and casualty insurance operations of the Group as well as a decrease in our stockholders’ equity, net income and/or revenue. The Terrorism Risk Insurance Act of 2002 requires that some coverage for terrorist loss be offered by primary property insurers and provides Federal assistance for recovery of claims through 2008. In addition, some of the assets in our investment portfolio may be adversely affected by declines in the equity markets and economic activity caused by the continued threat of terrorism, ongoing military and other actions and heightened security measures.

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     We cannot predict at this time whether and the extent to which industry sectors in which we maintain investments may suffer losses as a result of potential decreased commercial and economic activity, or how any such decrease might impact the ability of companies within the affected industry sectors to pay interest or principal on their securities, or how the value of any underlying collateral might be affected.

     We can offer no assurances that the threats of future terrorist-like events in the United States and abroad or military actions by the United States will not have a material adverse effect on our business, financial condition or results of operations.

Reinsurance

     Our ability to manage our exposure to underwriting risks depends on the availability and cost of reinsurance coverage. Reinsurance is the practice of transferring part of an insurance company’s liability and premium under an insurance policy to another insurance company. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. The availability and cost of reinsurance are subject to current market conditions and may vary significantly over time.

     Significant variation in reinsurance availability and cost could result in us being unable to maintain our desired reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or obtain new coverage, it will be difficult for us to manage our underwriting risks and operate our business profitably.

     It is also possible that the losses we experience on risks we have reinsured will exceed the coverage limits on the reinsurance. If the amount of our reinsurance coverage is insufficient, our insurance losses could increase substantially.

     If our reinsurers do not pay our claims in a timely manner, we may incur losses. We are subject to loss and credit risk with respect to the reinsurers with whom we deal because buying reinsurance does not relieve us of our liability to policyholders. If our reinsurers are not capable of fulfilling their financial obligations to us, our insurance losses would increase.

Investments

     Our investment portfolio contains a significant amount of fixed-income securities, including at different times bonds, mortgage-backed securities (MBSs) and other securities. The market values of all of our investments fluctuate depending on economic conditions and other factors. The market values of our fixed-income securities are particularly sensitive to changes in interest rates.

     We may not be able to prevent or minimize the negative impact of interest rate changes. Additionally, we may, from time to time, for business, regulatory or other reasons, elect or be required to sell certain of our invested assets at a time when their market values are less than their original cost, resulting in realized capital losses, which would reduce net income.

Regulation

     If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be able to operate profitably.

     Our insurance companies are regulated by government agencies in the states in which we do business, as well as by the federal government. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations are generally administered by a department of insurance in each state in which we do business.

     State insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.

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     In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.

     We are also subject to various accounting and financial requirements established by the NAIC. If we fail to comply with these laws, regulations and requirements, it could result in consequences ranging from a regulatory examination to a regulatory takeover of one or more of our insurance companies. This would make our business less profitable. In addition, state regulators and the NAIC continually re-examine existing laws and regulations, with an emphasis on insurance company solvency issues and fair treatment of policyholders. Insurance laws and regulations could change or additional restrictions could be imposed that are more burdensome and make our business less profitable.

     We are subject to the application of U.S generally accepted accounting principles (GAAP), which is periodically revised and/or expanded. As such, we are periodically required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial Accounting Standards Board. It is possible that future changes required to be adopted could change the current accounting treatment that we apply and such changes could result in a material adverse impact on our results of operations and financial condition.

Geographic

     Due to the geographic concentration of our business (principally, Arizona, California, Nevada, New Jersey, Oregon and Pennsylvania) catastrophe and natural peril losses may have a greater adverse effect on us than they would on a more geographically diverse property and casualty insurer.

     We could be significantly affected by legislative, judicial, economic, regulatory, demographic and other events and conditions in these states. In addition, we have significant exposure to property losses caused by severe weather that affects any of these states. Those losses could adversely affect our results.

     Additionally, a significant portion of our direct premium writings are written in the construction contractor markets, primarily in California. A significant downturn in the United States or California construction industry could adversely affect our direct written premium.

Competition

     The property and casualty insurance market in which we operate is very highly competitive. Competition in the property and casualty insurance business is based on many factors. These factors include the perceived financial strength of the insurer, premiums charged, policy terms and conditions, services provided, reputation, financial ratings assigned by independent rating agencies and the experience of the insurer in the line of insurance to be written. We compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Many of these competitors have substantially greater financial, technical and operating resources than we have.

     We pay producers on a commission basis to produce business. Some of our competitors may offer higher commissions or insurance at lower premium rates through the use of salaried personnel or other distribution methods that do not rely on independent producers. Increased competition could adversely affect our ability to attract and retain business and thereby reduce our profits from operations.

     We believe that our current marketplace is experiencing significant pressure to reduce prices and/or increase coverage that is generous in relation to the premium being charged. This pricing pressure could result in fewer new business opportunities for us and possibly fewer renewals retained which could lead to reduced direct written premium levels.

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     Many of our competitors offer internet-based quoting and/or policy issuance systems to their agents. The Group’s ability to compete with marketplace technology advances could adversely affect its ability to write business and service accounts with the agency force, and could adversely impact its results of operations and financial condition.

     A new form of competition may enter the marketplace as reinsurers attempt to diversify their insurance risk by writing business in the primary marketplace. The Group also faces competition, primarily in the commercial insurance market, from entities that may desire to self-insure their own risks. The Group’s ability to compete with reinsurers and self-insurers could adversely impact its results of operations and financial condition.

Rating

     A reduction in our A.M. Best rating could affect our ability to write new business or renew our existing business. Ratings assigned by the A.M. Best Company, Inc. are an important factor influencing the competitive position of insurance companies. A.M. Best ratings represent independent opinions of financial strength and ability to meet obligations to policyholders and are not directed toward the protection of investors. If our financial position deteriorates, we may not maintain our favorable financial strength rating from A.M. Best. A downgrade of our rating could severely limit or prevent us from writing desirable business or from renewing our existing business.

Key Producers

     Our results of operations may be adversely affected by any loss of business from key producers. Our products are marketed by independent producers. Other insurance companies compete with us for the services and allegiance of these producers. These producers may choose to direct business to our competitors, or may direct less desirable risks to us which could have a material adverse effect on us.

Dividends

     Subsidiaries of the Group may declare and pay dividends to the Holding Company only if they are permitted to do so under the insurance regulations of their respective state of domicile. If our insurance subsidiaries are unable to pay adequate dividends through their respective holding companies to the Holding Company, our ability to pay shareholder dividends would be affected. All of the states in which the Group’s subsidiaries are domiciled regulate the payment of dividends. States, including New Jersey, Pennsylvania, and California require that the Group give notice to the relevant state insurance commissioner prior to its subsidiaries declaring any dividends and distributions payable to the parent. During the notice period, the state insurance commissioner may disallow all or part of the proposed dividend upon determination that: (i) the insurer’s surplus is not reasonable in relation to its liabilities and adequate to its financial needs and those of the policyholders, or (ii) in the case of New Jersey, the insurer is otherwise in a hazardous financial condition. In addition, insurance regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval upon determination that, because of the financial condition of the insurance subsidiary or otherwise, payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary’s policyholders or creditors.

     The Group began paying a quarterly dividend in the second quarter of 2006 which is expected to continue in the future. However, future cash dividends will depend upon our results of operations, financial condition, cash requirements and other factors, including the ability of our subsidiaries to make distributions to us, which ability is restricted in the manner previously discussed in this section. Also, there can be no assurance that we will continue to pay dividends even if the necessary financial conditions are met and if sufficient cash is available for distribution.

Technology

     The Group’s business is increasingly dependent on computer and Internet-enabled technology. The Group’s ability to anticipate or manage problems with technology associated with scalability, security, functionality or reliability could adversely affect its ability to write business and service accounts, and could adversely impact its results of operations and financial condition.

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Acquisitions

     The Group made an acquisition in 2005 and intends to grow its business in part through acquisitions in the future as part of its long term business strategy. These type of transactions involve significant challenges and risks that the business transactions do not advance our business strategy, that we don’t realize a satisfactory return on the investment we make, or that we may experience difficulty in the integration of new employees, business systems, and technology or diversion of management’s attention from our other businesses. These factors could adversely affect our operating results and financial condition.

Key Personnel

     We could be adversely affected by the loss of our key personnel. The success of our business is dependent, to a large extent, on the efforts of certain key management personnel, and the loss of key personnel could prevent us from fully implementing our business strategy and could significantly and negatively affect our financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, and our ability to do so will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. Presently, competition to attract and retain key personnel is intense.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

     Our main office and corporate headquarters is located at 10 North Highway 31, Pennington, New Jersey in a facility of approximately 25,000 square feet 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.

     Financial Pacific Insurance Company leases approximately 25,000 square feet for the Group’s west coast operations headquarters in Rocklin, California. Financial Pacific owns 2.9 acres of land adjacent to its office building, carried at $1.3 million. Financial Pacific also owns a townhouse, used for corporate purposes, in Rocklin, California carried at $0.4 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 February 6, 2007, the Group had 329 shareholders of record holding approximately 0.8 million shares, with the balance of the outstanding shares held in street name.

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     The payment of shareholder dividends is subject to the discretion of the Mercer Insurance Group, Inc.’s Board of Directors which considers, among other factors, the Group’s operating results, overall financial condition, capital requirements and general business conditions. On July 6, 2006, September 29, 2006 and December 29, 2006, Mercer Insurance Group, Inc. paid a quarterly dividend of $0.05 per common share. The amount of dividends paid out on these three dates totaled $0.9 million, which amount was funded by dividends from the Group’s insurance companies, for which approval was sought and received (where necessary) from each of the insurance companies’ primary regulators, and waivers were received pursuant to the requirements of the covenants of the FPIC line of credit. We currently expect that the present quarterly dividend of $0.05 per common share will continue during 2007.

     The Group’s ability to receive dividends, loans or advances from its insurance subsidiaries is subject to the approval and/or review of the insurance regulators in the respective domiciliary states of the insurance subsidiaries. Such approval and review is made under the respective domiciliary states’ insurance holding company act, which generally requires that any transaction between currently related companies be fair and equitable to the insurance company and its policyholders. The Group does not believe that such restrictions limit the ability of the insurance subsidiaries to pay dividends to the Group now or in the foreseeable future.

     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 Group’s stock, traded on the NASDAQ National Market, during 2006 was between $14.81 and $26.87 per share. The range of closing prices during each of the quarters in 2006 and 2005 is shown below:

	4th Quarter				3rd Quarter				2nd Quarter				1st Quarter
	2006		2005		2006		2005		2006		2005		2006		2005
Share price range:
High	$	26.61	$	15.19	$	26.87	$	13.34	$	19.45	$	13.07	$	18.95	$	13.40
Low	$	18.93	$	13.06	$	18.21	$	12.86	$	18.61	$	12.45	$	14.81	$	12.75

As of December 31, 2006, the Group had no outstanding authorization or program for the repurchase of its common stock.

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Performance Graph

     Set forth below is a line graph comparing the cumulative total shareholder return on the Mercer Common Stock to the cumulative total return of the Nasdaq Stock Market (U.S. Companies) and the Nasdaq Insurance Index for the period commencing December 16, 2003 (the day the Mercer Common Stock began trading on Nasdaq) and ended December 31, 2006.

	December 16,		December 31,		December 31,		December 31,		December 31,
	2003		2003		2004		2005		2006
Mercer		100.00		103.29		110.53		123.46		166.34
Nasdaq Companies Index		100.00		104.03		113.21		115.61		127.04
Nasdaq Insurance Index		100.00		103.10		125.17		140.29		158.62

     The graph assumes $100 was invested on December 16, 2003, in Mercer Common Stock and each of the indices, and that dividends were reinvested. The comparisons in the graph are required by the Securities and Exchange Commission and are not intended to forecast or be indicative of possible future performance of our common stock.

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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, 2006. You should read this data in conjunction with the Group’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,
	2006			2005			2004			2003			2002
	(Shares and dollars in thousands, except per share amounts)
Revenue Data:
Direct premiums written	$	185,745		$	92,240		$	65,790		$	61,152		$	50,858
Net premiums written		145,791			75,266			59,504			52,802			44,471
Statement of Earnings Data:
Net premiums earned		137,673			74,760			55,784			47,864			40,454
Investment income, net of expenses		10,070			4,467			2,841			1,707			2,061
Net realized investment gains (losses)		151			1,267			484			703			(220	)
Total revenue		149,929			81,266			59,467			50,660			42,624
Conversion expense (1)		—			—			—			66			95
Minority interest in (income) of subsidiary (2)		—			—			—			(131	)		(138	)
Net income		10,635			7,020			3,264			583			2,242
Comprehensive income (3)		10,599			4,685			3,972			2,073			1,620
Balance Sheet Data (End of Period):
Total assets		506,967			446,698			181,560			175,875			105,848
Total investments and cash		315,286			269,076			141,393			138,679			76,780
Minority interest in subsidiary (2)		—			—			—			—			3,112
Stockholders’ equity		115,839			103,399			100,408			98,326			37,017
Ratios:
GAAP combined ratio (4)		97.0	%		94.9	%		98.8	%		103.8	%		96.4	%
Statutory combined ratio (5)		95.2	%		94.1	%		95.4	%		102.2	%		94.7	%
Statutory premiums to-surplus ratio (6)		1.27	x		1.15	x		0.96	x		1.72	x		1.54	x
Yield on investment, before tax (7)		3.4	%		2.9	%		2.0	%		2.0	%		2.7	%
Return on average equity		9.7	%		6.9	%		3.3	%		0.9	%		6.2	%
Per-share data: (8)
Net income (loss):
Basic		1.77			1.18			0.52			(0.08	)		N/A
Diluted		1.71			1.14			0.51			(0.08	)		N/A
Dividends to stockholders		0.15			—			—			—			N/A
Stockholders’ equity		19.06			17.34			16.49			15.65			N/A
Weighted average shares: (9)
Basic		6,023			5,943			6,236			6,253			N/A
Diluted		6,222			6,160			6,354			6,253			N/A

(1)	Costs and expenses related to the stock conversion incurred in the years ended December 31, 2003 and 2002. 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 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 Group attributable to the minority interest in Franklin Holding Company, which interest was acquired by the Group immediately after the Conversion for shares of the Group.
(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.

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(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)	The ratio of net investment income divided by total cash and investments.
(8)	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).
(9)	Unallocated ESOP shares at December 31, 2006, 2005, 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 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

     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 individuals in New Jersey and Pennsylvania, and small and medium-sized businesses throughout Arizona, California, Nevada, New Jersey, Oregon and Pennsylvania.

     The Group manages its business in three segments: commercial lines insurance, personal lines insurance, and investments. The commercial lines insurance and personal lines insurance segments are managed based on underwriting results determined in accordance with U.S. generally accepted accounting principles, and the investment segment is managed based on after-tax investment returns. In determining the results of each segment, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes.

     The Group’s net income is primarily determined by four elements:

• net premium income;

• underwriting cost and agent commissions;

• investment income;

• amounts paid or reserved to settle insured claims.

     Variations in premium income are subject to a number of factors, including:

• limitations on rates arising from competitive market place conditions or regulation;

• limitation on available business arising from a need to maintain the pricing and quality of underwritten risks;

• the Group’s ability to maintain it’s A (“Excellent”) rating by A.M. Best;

• the ability of the Group to maintain a reputation for efficiency and fairness in claims administration;

• the availability, cost and terms of reinsurance.

     Variations on investment income are subject to a number of factors, including:

• general interest rate levels;

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• specific adverse events affecting the issuers of debt obligations held by the Group;

• changes in prices of equity securities generally and those held by the Group specifically.

     Loss and loss adjustment expenses are affected by a number of factors, including:

• the quality of the risks underwritten by the Group;

• the nature and severity of catastrophic losses;

• weather-related patterns in areas where we insured property risks;

• the availability, cost and terms of reinsurance;

• underlying settlement costs, including medical and legal costs.

     The Group seeks to manage each of the foregoing to the extent within its control. Many of the foregoing factors are partially, or entirely, outside the control of the Group.

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 actuarial 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 earned premium to derive a reserve level for each line of business. 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. Some of our business relates to coverage for short-term risks, and for these risks loss development is comparatively rapid and historical paid losses, adjusted for known variables, have been a reliable predictive measure of future losses for purposes of our reserving. Some of our business relates to longer-term risks, where the claims are slower to emerge and the estimate of damage is more difficult to predict. For these lines of business, more sophisticated actuarial methods, such as the Bornhuetter-Ferguson loss development methods (see “Methods” below) are employed to project an ultimate loss expectation, and then the related loss history must be regularly evaluated and loss expectations updated, with the possibility of variability from the initial estimate of ultimate losses. A substantial portion of the business written by Financial Pacific Insurance Company, is this type of longer-tailed casualty business.

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     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’ ultimate net liability for both reported and IBNR claims and then subtracting the case reserves and payments made to date for reported claims.

Methods Used to Estimate Loss & Loss Adjustment Expense Reserves

     We apply the following general methods in projecting loss and loss adjustment expense reserves for the Group:

1.	Paid loss development
2.	Paid Bornhuetter-Ferguson loss development
3.	Reported loss development
4.	Reported Bornhuetter-Ferguson loss development

Description of Ultimate Loss Estimation Methods

     The reported loss development method relies on the assumption that, at any given state of maturity, ultimate losses can be predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical “age-to-age” loss development factors were calculated to measure the relative development of an accident year from one maturity point to the next. We then selected appropriate age-to-age loss development factors based on these historical factors and use the selected factors to project the ultimate losses.

     The paid loss development method is mechanically identical to the incurred loss development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections.

     The validity of the results from using a loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in a company’s mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimates. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques.

     The Bornhuetter-Ferguson expected loss projection method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are selected judgmentally based upon the historical relationship between premiums and losses for more mature accident years, adjusted to reflect changes in average rates and expected changes in claims frequency and severity. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected incurred loss development factors. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses.

     The calculations underlying the Bornhuetter-Ferguson expected loss projection method based on paid loss data are similar to the incurred Bornhuetter-Ferguson calculations with the exception that paid losses and unpaid percentages replace reported losses and unreported percentages.

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     The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature accident years. For these immature years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort the historical development of losses.

     For the property lines of business (special property, personal auto physical damage, and commercial auto physical damage) the results of the reserve calculations were similar and we relied on an average of the four methods utilized.

     For the homeowners and commercial multi-peril lines of business (excluding California CMP business for policy years 1996 and prior) we relied on the incurred loss development and incurred Bornhuetter-Ferguson methods in estimating loss reserves. These two methods yield more consistent results although the two paid methods yielded reserves that were similar in total to the incurred methods.

     In July of 1995, the California Supreme Court rendered its Opinion of Admiral Insurance Company vs. Montrose Chemical Corporation (the Montrose Decision). In that decision, the Supreme Court ruled that in the case of a continuous and progressively deteriorating loss, such as pollution liability (or construction defect liability), an insurance company has a definitive duty to defend the policyholder until all uncertainty related to the severity and cause of the loss is extinguished.

     As a result of the Montrose Decision, Financial Pacific Insurance Company (a subsidiary of the Group since October 1, 2005) experienced a significant increase in construction defect liability cases, to which it would not have been subject under the old interpretation of the law. In response, Financial Pacific implemented a series of underwriting measures to limit the prospective exposure to Montrose and construction defect liability. These changes to coverage and risk selection resulted in a marked improvement in the post-Montrose underwriting results.

     Financial Pacific evaluates commercial multi-peril liability reserves by segregating pre- and post-Montrose activity as well as segregating contractors versus non-contractor experience. An inception to date ground-up incurred loss database was created as the basis for this new analysis. The pre-Montrose activity is evaluated on a report year basis which eliminates the accident year development distortions caused by the effects of the Montrose Decision. For policy years 1997 and later, the reserves are analyzed using the more traditional accident year analysis.

     For the liability lines (general liability, personal auto liability, commercial auto liability, workers’ compensation) the paid loss development method yielded less than reliable results for the immature years and we did not use the method in selecting ultimate losses and reserves. For these lines we relied on the incurred Bornhuetter-Ferguson method for the most recent accident years and both of the incurred loss development methods for the remaining years.

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

     Each quarter, we compute our estimated ultimate liability using these 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 and have a material adverse effect on the Group’s results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.

     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, 2006.

41

     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 and					Adjusted Loss and
Change in Loss			Loss Adjustment		Percentage			Loss 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			2006		2006 (1)			2005		2005 (1)
			(Dollars in thousands)
	(10.0	)%	$	148,070		9.4	%	$	119,640		8.5	%
	(7.5	)%		152,183		7.0	%		122,964		6.4	%
	(5.0	)%		156,296		4.7	%		126,287		4.2	%
	(2.5	)%		160,409		2.3	%		129,610		2.1	%
Base				164,522		—			132,935		—
	2.5	%		168,635		(2.3	)%		136,257		(2.1	)%
	5.0	%		172,748		(4.7	)%		139,581		(4.2	)%
	7.5	%		176,861		(7.0	)%		142,904		(6.4	)%
	10.0	%		180,974		(9.4	)%		146,227		(8.5	)%

(1) Net of Tax

     The Group’s consulting actuary’s determined range of loss and loss adjustment expense reserves on a net basis range from a low of $140.6 million to a high of $173.7 million. The Group’s net loss and loss adjustment expense reserves are carried at $164.5 million. Management’s point estimate of reserves is at the higher end of its actuarially determined range in recognition of the inherent uncertainty in assessing the potential ultimate liabilities given legal developments as well as the evolution in its operations. The evolution in its operations include such things as changes in coverage and pricing in response to market opportunity as well as higher reinsurance retentions and geographic and product diversification all of which affect management’s reserve estimates.

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     The chart below displays case and IBNR reserves for the Group as of December 31, 2006 and 2005 by line of business:

As of December 31, 2006

									Reinsurance
									Recoverable
									on Unpaid
							IBNR		Losses and
	Case Loss		Case LAE		Total Case		Reserves		Loss		Net
	Reserves		Reserves		Reserves		(including LAE)		Expenses		Reserves
	(In thousands)
Homeowners	$	4,987		—		4,987		1,732		529		6,190
Workers’ compensation		3,943		—		3,943		4,210		892		7,261
Commercial multi-peril		33,984		4,470		38,454		143,071		61,430		120,095
Other liability		4,448		—		4,448		4,973		142		9,279
Other lines		221		—		221		334		110		445
Commercial auto liability		12,350		389		12,739		20,689		20,077		13,351
Commercial auto physical damage		549		18		567		2,652		1,040		2,179
Products liability		45		—		45		75		—		120
Personal auto liability		1,050		—		1,050		737		43		1,744
Personal auto physical damage		332		—		332		92		—		424
Surety		965		19		984		4,120		1,670		3,434
Total Loss & LAE Reserves	$	62,874		4,896		67,770		182,685		85,933		164,522

As of December 31, 2005

									Reinsurance
									Recoverable
									on Unpaid
							IBNR		Losses and
	Case Loss		Case LAE		Total Case		Reserves		Loss			Net
	Reserves		Reserves		Reserves		(including LAE)		Expenses			Reserves
	(In thousands)
Homeowners	$	6,248		—		6,248		1,532		412			7,368
Workers’ compensation		3,219		—		3,219		2,907		399			5,727
Commercial multi-peril		27,553		4,151		31,704		115,335		55,280			91,759
Other liability		4,889		—		4,889		5,459		424			9,924
Other lines		195		1		196		224		204			216
Commercial auto liability		10,800		486		11,286		15,821		15,726			11,381
Commercial auto physical damage		215		6		221		5,153		4,151			1,223
Products liability		195		—		195		45		197			43
Personal auto liability		891		—		891		574		23			1,442
Personal auto physical damage		344		—		344		131		(23	)		498
Surety		2,125		—		2,125		3,180		1,951			3,354
Total Loss & LAE Reserves	$	56,674		4,644		61,318		150,361		78,744			132,935

     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 accumulated other 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, 2006, 2005 and 2004, we recorded a pre-tax charge to earnings of $121,000, $517,000, and $15,000, respectively, for write-downs of other than temporarily impaired securities. In 2006, these charges related to fixed income securities, in 2005 these charges related to preferred stocks and fixed income securities, and in 2004 these charges were 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 Group’s policy on impairment of value of investments is as follows: if a security

43

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 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.

     Policy Acquisition Costs

     We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are primarily 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. If the estimation of net realizable value indicates that the acquisition costs are unrecoverable, further analyses are completed to determine if a reserve is required to provide for losses that may exceed the related unearned premiums.

     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 related 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.

     Many of the reinsurance treaties participated in by the Group have included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares on a limited basis in the profitability of our reinsurance treaties through contingent ceding commissions. The Group’s exposure in the loss experience is contractually defined at minimum and maximum levels. The terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts presented in the Group’s results of operations.

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     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. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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.

     Contingencies

     Besides claims related to its insurance products, the Group is subject to proceedings, lawsuits and claims in the normal course of business. The Group assesses the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. There can be no assurance that actual outcomes will be consistent with those assessments.

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.

     Revenue and income by segment is as follows for the years ended December 31, 2006, 2005 and 2004:

	December 31
	2006			2005			2004
	(In thousands)
Revenues:
Net premiums earned:
Commercial lines	$	115,116		$	51,957		$	32,370
Personal lines		22,557			22,803			23,414
Total net premiums earned		137,673			74,760			55,784
Net investment income		10,070			4,467			2,841
Realized investment gains		151			1,267			484
Other		2,035			772			358
Total revenues		149,929			81,266			59,467
Income before income taxes:
Underwriting income (loss):
Commercial lines		6,218			5,582			5,581
Personal lines		(2,032	)		(1,768	)		(4,908	)
Total underwriting income		4,186			3,814			673
Net investment income		10,070			4,467			2,841
Realized investment gains		151			1,267			484
Other		677			413			358
Income before income taxes	$	15,084		$	9,961		$	4,356

     Our growth in premiums, underwriting results and investment income have been, and continue to be, influenced by market conditions, as well as the acquisition of Financial Pacific on October 1, 2005. The Group’s financial statements include Financial Pacific and its results of operations for the entire year of 2006 and for the period of October 1, 2005 through December 2005.

     Our premiums earned growth reflects the Group’s focus on growing the commercial lines book, while working within our underwriting standards. As the Group increases the net retention of the business it writes,

45

net premiums earned will increase. It is possible in 2007 that direct commercial and personal lines written premium may decline due to increased competition. The impact of increased retentions under our reinsurance program in 2007 may be offset in part by a decline in direct commercial lines written premium due to the increasingly competitive marketplace.

     Pricing in the property and casualty insurance industry historically has been and remains cyclical. During a soft market cycle, price competition is prevalent, which makes it difficult to write and retain properly priced personal and commercial lines business. Our policy is to maintain disciplined underwriting and pricing standards during soft markets, declining business which is inadequately priced for its level of risk. The market has become very highly competitive, with increasing competition recently being seen in virtually all classes of commercial accounts, package policies and in the Pennsylvania personal auto market. This has resulted in slowing premium growth for the Group. We continue to work with our agents to target classes of business and accounts compatible with our underwriting appetite, which includes certain types of religious institution risks, contracting risks, small business risks and property risks.

     The availability of reinsurance at reasonable pricing is an important part of our business. The surge in catastrophic activity in 2005 placed reinsurers under greater financial pressures, and this has been reflected in their underwriting appetite, reinsurance terms, and their rates for catastrophe coverage. Our operating territories and the Group’s claim activity experienced only a minor impact from the residual effects of the hurricanes in 2005 that ravaged the Gulf coast, and this was helpful in keeping our reinsurance program in place in 2006 without significant overall rate change on renewal.

YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005

     The components of income for 2006 and 2005, 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.

2006 vs. 2005 Income	2006			2005			Change			% Change
	(Dollars in thousands)
Commercial lines underwriting income	$	6,218		$	5,582		$	636			11.4	%
Personal lines underwriting loss		(2,032	)		(1,768	)		(264	)		(14.9	)%
Total underwriting income		4,186			3,814			372			9.8	%
Net investment income		10,070			4,467			5,603			125.4	%
Net realized investment gains		151			1,267			(1,116	)		(88.1	)%
Other		1,889			719			1,170			162.7	%
Interest expense		(1,212	)		(306	)		(906	)		296.1	%
Income before income taxes		15,084			9,961			5,123			51.4	%
Income taxes		4,449			2,941			1,508			51.3	%
Net Income	$	10,635		$	7,020		$	3,615			51.5	%
Loss/ LAE ratio (GAAP)		63.7	%		58.0	%		5.7	%
Underwriting expense ratio (GAAP)		33.3	%		36.9	%		(3.6	)%
Combined ratio (GAAP)		97.0	%		94.9	%		2.1	%
Loss/ LAE ratio (Statutory)		61.5	%		55.4	%		6.1	%
Underwriting expense ratio (Statutory)		33.7	%		38.7	%		(5.0	)%
Combined ratio (Statutory)		95.2	%		94.1	%		1.1	%

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

     The Group’s GAAP combined ratio for 2006 was 97.0%, as compared to a combined ratio for the prior year of 94.9%. The statutory combined ratio for 2006 and 2005 was 95.2% and 94.1%, respectively. Our commercial lines underwriting income benefited from the contribution of Financial Pacific Insurance Company, which was acquired on October 1, 2005. The personal lines performance, while benefiting from rate increases initiated in 2005 on our homeowners line of business and a redirection of our Pennsylvania personal auto book to better performing tiers of business, underperformed the prior year. Frequency and severity of claims on personal lines was within the normal range of expectations during 2006. Frequency of

46

losses reported on our commercial lines was also within a normal range of our expectations and we experienced a slight increase in severity during 2006 as compared to 2005. The Group experienced $8.4 million of prior year reserve development in 2006 as compared to a $0.5 million redundancy in 2005. See discussion of prior year development in “Business – Loss and Loss Adjustment Expense Reserves” and “Business – Reconciliation of Reserve for Losses and Loss Adjustment Expenses”.

     Net investment income increased $5.6 million or 125.4% to $10.1 million in 2006 as compared to $4.5 million in 2005, primarily as a result of the acquisition of Financial Pacific in addition to higher short-term and long-term interest rates in 2006. Realized investment gains amounted to $151,000 in 2006 as compared to $1.3 million in 2005. The higher level of realized gains in 2005 was attributable to the disposition of securities in anticipation of funding the acquisition of Financial Pacific on October 1, 2005 for $41.1 million (including acquisition costs). Other revenue, which is primarily service charges recorded on insurance premiums, increased $1.2 million or 162.7% to $1.9 million in 2006 as compared to $0.7 million in 2005, reflecting the impact of the acquisition of Financial Pacific. Interest expense of $1.2 million in 2006 and $0.3 million in 2005 represents the inclusion of the trust preferred obligations of Financial Pacific and their related interest charges for the year ending December 31, 2006 and the quarter ending December 31, 2005.

2006 vs. 2005 Revenue	2006		2005		Change			% Change
	(In thousands)
Direct premiums written	$	185,745	$	92,240	$	93,505			101.4	%
Net premiums written		145,791		75,266		70,525			93.7	%
Net premiums earned		137,673		74,760		62,913			84.2	%
Net investment income		10,070		4,467		5,603			125.4	%
Net realized investment gains		151		1,267		(1,116	)		(88.1	)%
Other revenue		2,035		772		1,263			163.6	%
Total revenue	$	149,929	$	81,266	$	68,663			84.5	%

     Total revenues for 2006 increased $68.7 million or 84.5% to $149.9 million as compared to $81.3 million in 2005. This increase was due primarily to inclusion of the revenue of Financial Pacific for the entire year of 2006 compared to inclusion of revenue of Financial Pacific for only the fourth quarter in 2005. Financial Pacific contributed $84.9 million and $15.9 million in revenue for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively. Net premiums earned totaled $137.7 million in 2006 as compared to $74.8 million in 2005, representing a 84.2% or $62.9 million increase. This increase was due to the Financial Pacific acquisition which contributed $77.3 million and $13.9 million in net premiums earned for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively. Realized investment gains amounted to $151,000 in 2006 as compared to $1.3 million in 2005. The gains in 2005 were the result of sales of mostly equity securities to fund the Financial Pacific acquisition. Net realized gains in 2006 and 2005 also include the mark-to-market fair value adjustment on the interest rate swaps related to the floating-rate trust preferred securities. The mark-to-market on the swaps resulted in a realized (loss)/gain of $(94,000) and $122,000 in 2006 and 2005, respectively.

     In 2006, direct premiums written increased $93.5 million or 101.4% to $185.7 million in 2006 as compared to $92.2 million in 2005. Financial Pacific contributed $120.1 million and $27.9 million in direct written premium for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively.

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     Growth in Net Investment Income is discussed below.

2006 vs. 2005 Investment Income and Realized Gains	2006			2005			Change			% Change
	(In thousands)
Fixed income securities	$	11,044		$	5,195		$	5,849			112.6	%
Dividends		514			559			(45	)		(8.1	)%
Cash, cash equivalents & other		859			748			111			14.8	%
Gross investment income		12,417			6,502			5,915			91.0	%
Investment expenses		2,347			2,035			312			15.3	%
Net investment income	$	10,070		$	4,467		$	5,603			125.4	%
Realized losses — fixed income securities	$	(402	)	$	(608	)	$	206			N/M
Realized gains — equity securities		638			1,751			(1,113	)		N/M
Mark-to-market valuation for interest rate swaps		(94	)		122			(216	)		N/M
Realized gains — other		9			2			7			N/M
Net realized gains	$	151		$	1,267		$	(1,116	)		(88.1	)%

(N/M means “not meaningful”)

     In 2006, net investment income increased $5.6 million, or 125.4% to $10.1 million in 2006 as compared to $4.5 million in 2005. Our investment income benefited in 2006 from higher short-term and long-term interest rates, an increase in average cash and invested assets to $294.4 million in 2006 from $155.8 million in 2005, and increased largely due to the inclusion of the net investment income of Financial Pacific for the entire year of 2006 compared to inclusion of net investment income of Financial Pacific for only the fourth quarter in 2005. Financial Pacific contributed $6.3 million and $1.4 million in net investment income for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively.

     In 2006, investment income on fixed income securities increased $5.8 million, or 112.6% to $11.0 million in 2006 as compared to $5.2 million in 2005. This was driven by an increase in long-term interest rates, an increase in the average invested assets and the inclusion of Financial Pacific for the entire year of 2006. The Group’s tax equivalent yield (yield adjusted for tax-benefit received on tax-exempt securities) on fixed income securities increased to 5.14% in 2006 compared to 4.57% in 2005. Since the acquisition of Financial Pacific, a much larger proportion of the Group’s premium writings relate to casualty, or longer-tail, business. By its nature, longer-tail business requires more time for losses to manifest themselves, with the result that claims tend to be paid later on casualty claims than on other types of claims. The later payment of claims associated with casualty reserves provides a company with the opportunity to use the funds, which will ultimately be paid out as claims, for a longer period of time, thus generating a larger relative portfolio of fixed income securities and higher investment income.

     Dividend income and interest income on cash and cash equivalents was stable in 2006 at $0.5 million and $0.9 million, respectively, as compared to 2005 at $0.6 million and $0.7 million, respectively.

     Investment expenses increased 15.3%, or $0.3 million, to $2.3 million in 2006 from $2.0 million in 2005. Although a full year of expenses are included for Financial Pacific as compared to only a quarter in 2005, investment expenses increased by only 15.3% in 2006 as compared to a 91.0% increase in gross investment income. This reflects cost savings achieved by the Group in consolidating investment strategies, policies and external advisors. As of January 1, 2006, the Group consolidated investment managers and uses only one manager/advisor for all insurance subsidiaries in the Group.

     Net realized gains for 2006 were $0.2 million, as compared to $1.3 million in 2005. As noted above, the 2005 gains were taken as part of the process of funding the acquisition of Financial Pacific. In 2006, net realized investment gains of $0.2 million included gains on securities sales of $1.0 million, offset by losses on securities sales of $0.6 million, $0.1 million from the write-down of a fixed-income security determined to be other-than-temporarily impaired and a loss of $0.1 million relating to the mark-to-market valuation on the interest rate swaps. Securities determined to be other-than-temporarily impaired are written down to our estimate of fair market value. The Group has entered into five interest rate swap

48

agreements to hedge against interest rate risk on its floating rate trust preferred securities. The estimated fair value of the interest rates swaps is obtained from the third-party financial institution counterparties. The Group marks the investments to market using these valuations and records the change in the economic value of the interest rate swap as a realized gain or loss in the consolidated statement of earnings.

     The fixed income portfolio is invested 100% in investment grade securities, with the exception of one fixed maturity investment held with a value of $0.5 million, with, as of December 31, 2006, an average rating of AAA, an average maturity of 5.4 years (excluding mortgage-backed securities), and an average tax equivalent yield of 5.14%. In order to enhance the yield on our fixed income securities, our investments generally have a longer average maturity 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.”

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2006 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
	(In Thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	4,834	$	24	$	50,353	$	869	$	55,187	$	893
Obligations of states and political subdivisions		24,948		90		40,918		552		65,866		642
Corporate securities		4,211		17		41,850		767		46,061		784
Mortgage-backed securities		4,481		24		13,266		159		17,747		183
Total fixed maturities		38,474		155		146,387		2,347		184,861		2,502
Total equity securities		1,991		100		—		—		1,991		100
Total securities in a temporary unrealized loss position	$	40,465	$	255	$	146,387	$	2,347	$	186,852	$	2,602

     Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2006 the Group has 198 fixed maturity securities with unrealized losses for more than twelve months. Of the 198 securities with unrealized losses for more than twelve months, 192 of them have fair values of no less than 96% or more of cost, and the other 6 securities have a fair value greater than 93% of cost. The fixed income portfolio is invested 100% in investment grade securities, with the exception of one fixed maturity investment held with a value of $0.5 million, as of December 31, 2006, and these unrealized losses primarily reflect the current interest rate environment. The Group believes these declines are temporary.

     There are 12 equity securities that are in an unrealized loss position at December 31, 2006. All of these securities have been in an unrealized loss position for less than six months. The Group believes these declines are temporary.

49

     The following table summarizes the period of time that equity securities sold at a loss during 2006 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	$	1,832	$	368
7-12 months		—		—
More than 12 months		—		—
Total	$	1,832	$	368

     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.

     Results of our Commercial Lines segment were as follows:

2006 vs. 2005 Commercial Lines (CL)	2006			2005			Change			% Change
	(Dollars in thousands)
CL Direct premiums written	$	161,592		$	67,715		$	93,877			138.6	%
CL Net premiums written	$	123,484		$	52,311		$	71,173			136.1	%
CL Net premiums earned	$	115,116		$	51,957		$	63,159			121.6	%
CL Loss/ LAE expense ratio (GAAP)		62.5	%		57.3	%		5.2	%
CL Expense ratio (GAAP)		32.1	%		32.0	%		0.1	%
CL Combined ratio (GAAP)		94.6	%		89.3	%		5.3	%

     In 2006, our commercial lines direct premiums written increased by $93.9 million or 138.6% to $161.6 million as compared to direct written premium in 2005 of $67.7 million. This increase was due primarily to inclusion of the direct premiums written of Financial Pacific for the entire year of 2006 compared to inclusion of direct premiums written of Financial Pacific for only the fourth quarter in 2005. Financial Pacific contributed $120.1 million and $27.9 million in direct premiums written for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively. Net premiums earned increased $63.2 million or 121.6% to $115.1 million in 2006 from $52.0 million in 2005, of which Financial Pacific contributed $77.3 million and $13.9 million of net premiums earned for the year ending December 31, 2006 and fourth quarter ending December 31, 2005, respectively.

     Effective January 1, 2006, Financial Pacific restructured its property reinsurance agreement covering the first $2,000,000 of loss from an 80% quota share to a $1,650,000 excess of $350,000 excess of loss contract to take advantage of the Group’s capital. The restructuring also included the assumption of ceded unearned premium at January 1, 2006 by FPIC from the 2005 property quota share and casualty excess of loss agreements. These assumed premiums were then ceded into the respective 2006 treaties, which due to the reduced ceding rates, resulted in a $5.6 million increase in net written and earned premium for the year ending December 31, 2006.

     During the third quarter of 2006, the Group commuted all reinsurance agreements with Alea. These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation, the Group received a cash payment of $4.5 million, and recorded a pre-tax net loss on commutation of $160,000.

     In the commercial lines segment for 2006, we had underwriting income of $6.2 million, a GAAP combined ratio of 94.6%, a GAAP loss and loss adjustment expense ratio of 62.5% and a GAAP underwriting expense ratio of 32.1%, compared to underwriting income of $5.6 million, a GAAP combined ratio of 89.3%, a GAAP loss and loss adjustment expense ratio of 57.3% and a GAAP underwriting expense ratio of 32.0% in 2005. Our commercial lines loss ratio for 2006 reflects a frequency of losses reported within a normal range of our expectations, and includes a slight increase in severity compared to 2005.

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Results of our Personal Lines segment were as follows:

2006 vs. 2005 Personal Lines (PL)	2006			2005			Change			% Change
	(Dollars in thousands)
PL Direct premiums written	$	24,153		$	24,525		$	(372	)		(1.5	)%
PL Net premiums written	$	22,307		$	22,955		$	(648	)		(2.8	)%
PL Net premiums earned	$	22,557		$	22,803		$	(246	)		(1.1	)%
PL Loss/ LAE expense ratio (GAAP)		69.6	%		59.7	%		9.9	%
PL Expense ratio (GAAP)		39.4	%		48.1	%		(8.7	)%
PL Combined ratio (GAAP)		109.0	%		107.8	%		1.2	%

     Personal lines direct premiums written remained stable at $24.2 million and $24.5 million in 2006 and 2005, respectively. Net premiums written and earned also remained stable at $22.3 million and $22.6 million, respectively in 2006 compared to $23.0 million and $22.8 million, respectively in 2005.

     In the personal lines segment for 2006, we had an underwriting loss of $2.0 million, a GAAP combined ratio of 109.0%, a GAAP loss and loss adjustment expense ratio of 69.6% and a GAAP underwriting expense ratio of 39.4%, compared to an underwriting loss of $1.8 million, a GAAP combined ratio of 107.8%, a GAAP loss and loss adjustment expense ratio of 59.7% and a GAAP underwriting expense ratio of 48.1% in 2005.

     Our personal lines performance, while benefiting from rate increases initiated in 2005 on our homeowners line of business and a redirection of our Pennsylvania personal auto book to better performing tiers of business, underperformed in both 2006 and 2005. The frequency and severity of losses in the personal lines book in 2006 was within the range of our normal expectations.

Underwriting Expenses and the Expense Ratio is discussed below.

2006 vs. 2005 Expenses and Expense Ratio	2006			2005			Change			% Change
	(Dollars in thousands)
Amortization of Deferred Acquisition Costs	$	32,694		$	16,849		$	15,845			94.0	%
As a % of net premiums earned		23.7	%		22.5	%		1.2	%
Other underwriting expenses		13,242			10,766			2,476			23.0	%
Total expenses excluding losses/ LAE	$	45,936		$	27,615		$	18,321			66.3	%
Underwriting expense ratio		33.3	%		36.9	%		(3.6	)%

     Underwriting expenses increased by $18.3 million, or 66.3%, to $45.9 million in 2006, as compared to $27.6 million in 2005. The 66.3% increase in underwriting expenses primarily reflects the 84.2% increase in net premiums earned, offset by the inclusion of Financial Pacific which operates at a lower expense ratio than that of the balance of the Group.

     Financial Pacific was included in the Group’s operating results from October 1, 2005. Financial Pacific’s book of business tends to operate with higher loss ratios and lower expense ratios than the Group’s business prior to the acquisition. In addition, due to Financial Pacific’s higher usage of reinsurance, it also records higher levels of ceded commission and contingent ceded commission. In the year ended December 31, 2006, the Group, based on Financial Pacific’s reinsurance participations, recognized ceded commissions and net contingent ceded commissions on reinsurance contracts of $9.7 million and $1.2 million, respectively as compared to the year ended December 31, 2005, where the Group recognized ceded commissions and net contingent ceded commissions on reinsurance contracts relating to Financial Pacific of $4.2 million and $1.5 million, respectively.

     Effective January 1, 2006, the Group adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (SFAS 123R), using the modified-prospective-transition method. As a result of adopting SFAS 123R on January 1, 2006, the Group’s 2006 underwriting expenses included a pre-tax charge of $711,000 to recognize the compensation cost of unvested stock options granted under the Group’s plan and the impact of SFAS 123R on the computation of expense

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relating to grants of restricted stock. In addition to the charge relating to the transition to SFAS 123R, the Group’s 2006 underwriting expenses included a pre-tax charge of $687,000 associated with grants of restricted stock. During 2005, underwriting expenses included a pre-tax charge of $693,000 associated with grants of restricted stock.

2006 vs. 2005 Income Taxes	2006			2005			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	15,084		$	9,961		$	5,123			51.4	%
Income taxes		4,449			2,941			1,508			51.3	%
Net income	$	10,635		$	7,020		$	3,615			51.5	%
Effective tax rate		29.5	%		29.5	%		—	%

     Federal income tax expense was $4.4 million and $2.9 million for 2006 and 2005, respectively. The effective tax rate was 29.5% for both 2006 and 2005. The 2006 effective tax rate was impacted by an increase in the tax rate on current taxable income of 1% (due to the graduated tax rate structure), offset by higher tax-advantaged income (municipal bond interest and dividend income, which reduce the effective tax rate).

YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004

     The components of income for 2005 and 2004, 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.

2005 vs. 2004 Income	2005			2004			Change			% Change
	(Dollars in thousands)
Commercial lines underwriting income	$	5,582		$	5,581		$	1			0.0	%
Personal lines underwriting loss		(1,768	)		(4,908	)		3,140			64.0	%
Total underwriting income		3,814			673			3,141			466.7	%
Net investment income		4,467			2,841			1,626			57.2	%
Net realized investment gain		1,267			484			783			161.8	%
Other		719			358			361			100.8	%
Interest expense		(306	)		—			(306	)		N/M
Income before income taxes		9,961			4,356			5,605			128.7	%
Income taxes		2,941			1,092			1,849			169.3	%
Net Income	$	7,020		$	3,264		$	3,756			115.1	%
Loss/ LAE ratio (GAAP)		58.0	%		50.4	%		7.6	%
Underwriting expense ratio (GAAP)		36.9	%		48.4	%		(11.5	)%
Combined ratio (GAAP)		94.9	%		98.8	%		(3.9	)%
Loss/ LAE Ratio (Statutory)		55.4	%		50.5	%		4.9	%
Underwriting expense ratio (Statutory)		38.7	%		44.9	%		(6.2	)%
Combined ratio (Statutory)		94.1	%		95.4	%		(1.3	)%

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

     Our personal lines underwriting performance in 2005 was significantly better than the prior year. This improved performance was driven by the absence in 2005 of the severe weather which occurred in our operating territories in the first quarter of 2004, during which the Group had a significantly higher number of claims in personal lines. The commercial lines performance was also very good in 2005, despite a number of larger losses in the second and third quarters. The number of new claims in 2005 was on the low side of the

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normal range of expectations, and more favorable than the prior year, and large losses in the aggregate were within the normal range of expectations. The Group’s GAAP combined ratio declined in 2005 from 98.8% to 94.9%, and the statutory combined ratio improved to 94.1% in 2005 from 95.4% in 2004.

     Net investment income increased 57.2% to $4.5 million, primarily as a result of increased yields on short-term investments held in the fixed-income investment portfolio and the acquisition of Financial Pacific and its net investment income. Realized investment gains amounted to $1.3 million in 2005, compared to a gain of $484,000 in 2004, with the higher level of realized gains in 2005 attributable to the disposition of securities in anticipation of funding the acquisition of Financial Pacific on October 1, 2005, for $41.1 million in cash (including acquisition costs). Our other income, primarily service charges recorded on insurance premiums, increased 100.8% in 2005 to $719,000, reflecting the inclusion of service charges recognized by Financial Pacific since its acquisition.

2005 vs. 2004 Revenue	2005		2004		Change		% Change
	(In thousands)
Direct premiums written	$	92,240	$	65,790	$	26,450		40.2	%
Net premiums written		75,266		59,504		15,762		26.5	%
Net premiums earned		74,760		55,784		18,976		34.0	%
Net investment income		4,467		2,841		1,626		57.2	%
Realized investment gains		1,267		484		783		161.8	%
Other revenue		772		358		414		115.6	%
Total revenue	$	81,266	$	59,467	$	21,799		36.7	%

     Total revenues for 2005 were up 36.7%, or $21.8 million, over 2004 revenues to $81.3 million. This increase was due primarily to inclusion of the revenue of Financial Pacific since its acquisition, which added $15.9 million of revenue, or 26.7 percentage points of the 36.7% increase in revenue in 2005. Net premiums earned increased 34.0 %, or $19.0 million, to $74.8 million, with 24.9 percentage points, or $13.9 million of the 2005 increase, relating to the inclusion of Financial Pacific in the Group’s results. In 2005, net investment income increased 57.2% to $4.5 million, driven by higher short-term interest rates, and the inclusion of Financial Pacific’s net investment income since acquisition, which added $1.4 million, or 50.8 percentage points of the 57.2% increase. Realized gains increased 161.8% in connection with sales of mostly equity securities to fund the Financial Pacific acquisition. Realized gains also included in 2005 a gain of $122,000 relating to the mark-to-market fair value adjustment on interest rate swaps related to the floating-rate trust preferred securities.

     In 2005, direct premiums written increased 40.2% over 2004 to $92.2 million from $65.8 million, or $26.5 million. Inclusion of Financial Pacific since its acquisition by the Group added $27.9 million in direct written premium, with the balance of the change attributable to a modest decline in personal lines premium as that book was re-directed, and more competitive pricing existed in the commercial lines marketplace.

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     Growth in Net Investment Income is discussed below.

2005 vs. 2004 Investment Income and Realized Gains	2005			2004			Change			% Change
	(In thousands)
Fixed income securities	$	5,195		$	3,284		$	1,911			58.2	%
Dividends		559			673			(114	)		(16.9	)%
Cash, cash equivalents & other		748			398			350			87.9	%
Gross investment income		6,502			4,355			2,147			49.3	%
Investment expenses		2,035			1,514			521			34.4	%
Net investment income	$	4,467		$	2,841		$	1,626			57.2	%
Realized losses — fixed income securities	$	(608	)	$	(97	)	$	(511	)		N/M
Realized gains — equity securities		1,751			590			1,161			N/M
Mark-to-market valuation for interest rate swaps		122			—			122			N/M
Realized gains/(losses) — other		2			(9	)		11			N/M
Net realized gains	$	1,267		$	484		$	783			161.8	%

(N/M means “not meaningful”)

     In 2005, net investment income increased $1.6 million, or 57.2%. Although our investment income benefited in 2005 from higher short-term interest rates, the majority of the increase, $1.4 million, or 50.8 percentage points of the increase, was attributable to the inclusion of the net investment income of Financial Pacific since its acquisition by the Group.

     Investment income on fixed income securities was up $1.9 million, or 58.2%. The increase included $1.8 million, or 54.0 percentage points of the increase, as a result of the inclusion of the investment income of Financial Pacific since acquisition.

     Dividend income in 2005 was down $114,000, or 16.9% from 2004. The decrease was caused by the sale of some equity securities during 2005 in order to fund the Financial Pacific acquisition, and also because the Group received a special dividend of $183,000 in 2005 on its investment in Excess Reinsurance Company, as compared to $274,000 in 2004.

     Interest on cash and cash equivalents in 2005 increased $350,000, or 87.9%, to $748,000. This increase is attributable to higher short-term rates in 2005, as well as the fact that the Group generated $53 million of funds to invest as a result of its demutualization on December 16, 2003. Given a difficult interest rate environment and fixed income securities market at the time, these funds were not largely invested until the second quarter of 2004, and, consequently, a portion of them earned a short-term yield during much of the first six months of 2004 that was considerably lower than similar yields in 2005. In addition, in accumulating funds for the closing of the acquisition of Financial Pacific, proceeds from the sale of securities were invested in short-term instruments, and generated interest on cash equivalents.

     Investment expenses increased 34.4% in 2005, or $521,000, to $2.0 million. This increase is largely attributable to the inclusion of Financial Pacific since its acquisition.

     Net realized gains for 2005 were $1.3 million, as compared to $484,000 in 2004. As noted above, these gains were taken as part of the process of funding the acquisition of Financial Pacific Insurance Group. In 2005, net realized investment gains of $1.3 million included gains on securities sales of $2.4 million, offset by losses on securities sales of $1.1 million. The losses from securities sales were comprised of $357,000 from the sale of fixed income securities, $245,000 from the sale of equities, and $517,000 from the writedown of securities determined to be other-than-temporarily impaired. These securities were written down to our estimate of fair market value at the time of the write-down. For the quarter and year ended December 31, 2005, the Group’s net realized gain on the interest rate swap agreements was $122,000.

     The fixed income portfolio is invested 100 % in investment grade securities, with, as of December 31, 2005, an average rating of AAA, an average maturity of 5.3 years (excluding mortgage-backed securities), and an average tax equivalent yield of 4.57%. In order to enhance the yield on our fixed income

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securities, our investments generally have a longer average maturity 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.”

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2005 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
	(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	53,785	$	372	$	16,853	$	541	$	70,638	$	913
Obligations of states and political subdivisions		57,979		317		11,397		257		69,376		574
Corporate securities		44,446		373		7,761		235		52,207		608
Mortgage-backed securities		18,646		155		—		—		18,646		155
Total fixed maturities		174,856		1,217		36,011		1,033		210,867		2,250
Total equity securities		604		3		—		—		604		3
Total securities in a temporary unrealized loss position	$	175,460	$	1,220	$	36,011	$	1,033	$	211,471	$	2,253

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2005 the Group has 53 fixed maturity securities with unrealized losses for more than twelve months. Of the 53 securities with unrealized losses for more than twelve months, 46 of them have fair values of no less than 96% or more of cost, and the other 7 securities have a fair value greater than 92% of cost. The fixed income portfolio is invested 100% in investment grade securities, as of December 31, 2005, and these unrealized losses primarily reflected the current interest rate environment. The Group believes these declines are temporary.

     The following table summarizes the period of time that equity securities sold at a loss during 2005 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	$	1,906	$	207
7-12 months		360		38
More than 12 months		—		—
Total	$	2,266	$	245

     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, 2005 have been in an unrealized loss position:

					Length of Unrealized Loss
	Fair		Unrealized		Less than		6 to 12		Over 12
December 31, 2005	Value		Loss		6 Months		Months		Months
	(In thousands)
Equity securities unrealized loss	$	604	$	3	$	3	$	—	$	—

Results of our Commercial Lines segment were as follows:

2005 vs. 2004 Commercial Lines (CL)	2005			2004			Change			% Change
	(Dollars in thousands)
CL Direct premiums written	$	67,715		$	40,883		$	26,832			65.6	%
CL Net premiums written	$	52,311		$	36,492		$	15,819			43.3	%
CL Net premiums earned	$	51,957		$	32,370		$	19,587			60.5	%
CL Loss/ LAE expense ratio (GAAP)		57.3	%		31.9	%		25.4	%
CL Expense ratio (GAAP)		32.0	%		50.9	%		(18.9	)%
CL Combined ratio (GAAP)		89.3	%		82.8	%		6.5	%

     In 2005, our commercial lines direct premiums written increased by $26.8 million, or 65.6%, to $67.7 million, as compared to the same period in 2004. The acquisition of Financial Pacific added $27.9 million, or 68.3 percentage points of the total. Commercial lines net premiums written increased $15.8 million, or 43.3%, to $52.3 million in the same period, of which $16.0 million, or 43.7 percentage points is attributable to the Financial Pacific acquisition. Net premiums earned increased 60.5% in 2005, or $19.6 million, to $52.0 million. Financial Pacific contributed $13.9 million, or 42.9 percentage points of the total increase. In an unusual situation impacting both direct and net written premium, the Group had a large master account with a premium of approximately $2.5 million, which was originally written on a thirteen month policy in December 2004, renew in January, 2006. Although the earned premium relating to this policy in 2005 is reported in the net premium earned above, it is not reflected in the direct and net written premium above because of its renewal date in 2006.

     In the commercial lines segment for 2005, we had underwriting income of $5.6 million, a GAAP combined ratio of 89.3%, a GAAP loss and loss adjustment expense ratio of 57.3% and a GAAP underwriting expense ratio of 32.0%, compared to 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 an underwriting expense ratio of 50.9% for the same period in 2004. Our commercial lines loss ratio for 2005 has been adversely affected by a modestly higher amount of large property and casualty losses as compared to 2004, however the volume of new claims in 2005 is generally favorable. In addition, Financial Pacific’s commercial lines tend to operate with higher loss ratios and lower expense ratios than the Group’s commercial lines business prior to the acquisition of Financial Pacific.

     Direct commercial multi-peril premiums written, the largest component of our commercial lines segment, nearly doubled to $44.4 million in 2005, compared to $22.2 million for 2004, and net commercial multi-peril premiums earned increased by 81.4% to $30.0 million in 2005, compared to $16.5 million for 2004. A substantial portion of the increase is as a result of the Financial Pacific acquisition.

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     Results of our Personal Lines segment were as follows:

2005 vs. 2004 Personal Lines (PL)	2005			2004			Change			% Change
	(Dollars in thousands)
PL Direct premiums written	$	24,525		$	24,906		$	(381	)		(1.5	)%
PL Net premiums written	$	22,955		$	23,011		$	(56	)		(0.2	)%
PL Net premiums earned	$	22,803		$	23,414		$	(611	)		(2.6	)%
PL Loss/ LAE expense ratio (GAAP)		59.7	%		76.1	%		(16.4	)%
PL Expense ratio (GAAP)		48.1	%		44.9	%		3.2	%
PL Combined ratio (GAAP)		107.8	%		121.0	%		(13.2	)%

     Personal lines direct premiums written decreased in 2005 by 1.5% to $24.5 million. Net premiums written was approximately flat with 2004, and net premiums earned decreased by 2.6%, or $611,000, to $22.8 million.

     In the personal lines segment for 2005, we had an underwriting loss of $1.8 million, a GAAP combined ratio of 107.8%, a GAAP loss and loss adjustment expense ratio of 59.7% and a GAAP underwriting expense ratio of 48.1%, compared to 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 an underwriting expense ratio of 44.9% for the same period in 2004. Our personal lines business is unaffected by the acquisition of Financial Pacific, which does not write any personal lines business.

     The personal lines performance in 2005 was affected by a significantly lower frequency of losses and by a lower severity of losses as compared to 2004. The 2004 losses were significantly higher than usual, and were attributable to harsh weather conditions which resulted in a high number of losses from frozen pipes, structural collapses, more frequent automobile losses and accidents, and other losses of the type caused by an extended period of harsh weather.

     Besides the improved loss frequency resulting from the more moderate weather in 2005, the personal lines book benefited from the underwriting initiatives undertaken in both the homeowners and Pennsylvania personal automobile lines in the last two years. These initiatives included the reclassification of certain homeowners risks from our preferred program to our standard program, resulting in a higher premium, as well as modified underwriting standards relating to the types of Pennsylvania personal automobile risks the Group will write.

Underwriting Expenses and the Expense Ratio is discussed below.

2005 vs. 2004 Expenses and Expense Ratio	2005			2004			Change			% Change
	(Dollars in thousands)
Amortization of Deferred Acquisition Costs	$	16,849		$	15,075		$	1,774			11.8	%
As a % of net premiums earned		22.5	%		27.0	%		(4.5	)%
Other underwriting expenses		10,766			11,898			(1,132	)		(9.5	)%
Total expenses excluding losses/ LAE	$	27,615		$	26,973		$	642			2.4	%
Underwriting expense ratio		36.9	%		48.4	%		(11.5	)%

     Underwriting expenses increased by $642,000, or 2.4%, to $27.6 million in 2005, as compared to 2004. This increase was principally attributable to an increase in other underwriting expenses, growth in commissions resulting from higher earned 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 2004. In 2005, the Group had pre-tax external expense associated with Sarbanes – Oxley compliance of $693,000, and pre-tax expense of $693,000 associated with grants of restricted stock, for which expenses were $832,000 and $383,000, respectively, in 2004.

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     Financial Pacific was included in the Group’s operating results from October 1, 2005. It typically operates at a lower expense ratio than that of the balance of the Group. In addition, due to the higher usage of reinsurance, it also records higher levels of ceded commission and contingent ceded commission. In the quarter and year ended December 31, 2005, the Group, based on Financial Pacific’s reinsurance participations, recognized ceded commissions and net contingent ceded commissions on reinsurance contracts of $4.2 million and $1.5 million, respectively.

     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 eliminating the Group’s liability for retaliatory premium taxes. Accordingly, the results for 2005 do not reflect any expense for retaliatory taxes, while 2004 included a pre-tax expense for this item of approximately $200,000. See the Liquidity and Capital Resources section for additional information regarding retaliatory tax and the Group’s claim to recover previously paid retaliatory tax.

2005 vs. 2004 Income Taxes	2005			2004			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	9,961		$	4,356		$	5,605			128.7	%
Income taxes		2,941			1,092			1,849			169.3	%
Net income	$	7,020		$	3,264		$	3,756			115.1	%
Effective tax rate		29.5	%		25.1	%		4.4	%

     Federal income tax expense was $2.9 million for 2005, an effective rate of 29.5%, compared to $1.1 million, an effective rate of 25.1%, in 2004. The increase in the effective tax rate in 2005 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 2005 than in 2004.

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.

     We are in the process of building an information system platform that will phase out legacy systems and consolidate them on one core transactional system. As of December 31, 2006, we have spent $4.4 million on the development of this platform, which includes license fees for software used in the platform.

     Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments. This requires them to ladder the maturity of their portfolios and thereby 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 the Holding Company (which has modest expenses and does not currently, or for the foreseeable future, need a significant regular source of cash flow to cover these expenses other than its debt service on its indebtedness to Mercer Insurance Company and its quarterly dividend to shareholders) is dividend payments and other fees received from the insurance subsidiaries, and payments it receives on the 10-year note it received from the ESOP (see below) when the ESOP purchased shares at the time of the Conversion.

     The Group’s 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. See discussion of restrictions on dividends and distributions in the section “Business – Regulation”.

     In connection with the acquisition of Financial Pacific Insurance Group for approximately $41.1 million in cash including transaction costs on October 1, 2005, all of the securities of Mercer Insurance Group, Inc. (which were purchased with proceeds of the Conversion) were converted into cash, with all but approximately $300,000 of this balance used to fund the acquisition. The remaining liquid assets in Mercer Insurance Group, as well as its other sources of revenue, are adequate to fund its current expenses for the foreseeable future.

58

     As part of the funding of the acquisition, Mercer Insurance Company, with the approval of the Pennsylvania Department of Insurance, paid an extraordinary dividend of $10 million on September 30, 2005, to Mercer Insurance Group, Inc. Mercer Insurance Company also entered into a loan agreement with Mercer Insurance Group, Inc., by which it advanced on September 30, 2005, a loan of $10 million with a 20-year note and a fixed interest rate of 4.75%, repayable in 20 equal annual installments. Mercer Insurance Group has no special limitations on its ability to take periodic dividends from its insurance subsidiaries except for normal dividend restrictions administered by the respective domiciliary state regulators as described above. Additionally, there is a covenant in the Group’s line of credit agreement that requires the Group to maintain at least 50% of its insurance companies capacity to pay dividends without state regulation pre-approval. The Group believes that the resources available to Mercer Insurance Group, Inc., will be adequate for it to meet its obligation under the note to Mercer Insurance Company, the line of credit and its other expenses.

     On July 6, 2006, September 29, 2006 and December 29, 2006, Mercer Insurance Group, Inc. paid a quarterly shareholder dividend of $0.05 per common share. The amount of dividends paid out these dates totaled $0.9 million, which amount was funded from the Group’s insurance companies, for which approval was sought and received (where necessary) from each of the insurance companies’ primary regulators, and waivers were received pursuant to the requirements of the covenants under the FPIC line of credit. The FPIC line of credit was renewed effective December 5, 2006 for Group-wide use and the FPIC dividend limitation was replaced with the Group’s dividend capacity covenant.

     Total assets increased 13%, or $60.3 million, to $507.0 million, at December 31, 2006, from $446.7 million at December 31, 2005. The Group’s total investments increased $49.3 million or 20%, primarily due to net cash provided by operating activities. Reinsurance receivables increased $8.8 million or 11%, primarily due to an increase in ceded loss and loss adjustment expense reserves. Prepaid reinsurance premiums decreased $5.2 million or 24%, primarily due to a change in certain of the Group’s reinsurance contracts for 2006, whereby fewer unearned premium reserves are ceded. Deferred policy acquisition costs increased $5.9 million or 55%, reflecting the increase to net unearned premium reserves. Additionally, deferred income taxes increased $4.2 million or 117%, primarily due to profit commissions received on reinsurance contracts that are currently taxable, increased net unearned premiums and increased net loss and loss adjustment expense reserves.

     Total liabilities increased 14%, or $47.8 million, to $391.1 million, at December 31, 2006, from $343.3 million at December 31, 2005, primarily a result of the increase in loss and loss adjustment expense reserves of $38.8 million or 18%. Other reinsurance balances increased $6.0 million or 32%, primarily due to an increase in contingent ceding commission payable relating to the profit share on reinsurance contracts.

     Total stockholders’ equity increased 12%, or $12.4 million, to $115.8 million, at December 31, 2006, from $103.4 million at December 31, 2005, primarily due to net income of $10.6 million, stock compensation plan amortization of $1.4 million and ESOP shares committed of $1.3 million, offset by stockholder dividends of $0.9 million.

     The Group maintains an Employee Stock Ownership Plan (ESOP), which purchased 626,111 shares from the Group at the time of the Conversion in return for a note bearing interest at 4% on the principal amount of $6,261,110. Mercer Insurance Company makes annual contributions to the ESOP sufficient for it to make its required annual payment under the terms of the loan to the Holding Company. It is anticipated that approximately 10% of the original ESOP shares will be allocated annually to employee participants of the ESOP. An expense charge is 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 Group’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. Shareholder dividends received on unallocated ESOP shares are used to pay-down principal and interest owed on the loan to the Holding Company.

     Mercer Insurance Group, Inc. 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, which

59

amount will increase automatically each year by 1% of the number of shares outstanding at the end of the preceding year. At January 1, 2007, the shares authorized under the plan has been increased under this provision to 1,075,870 shares. During 2006, the Group made grants of 10,000 shares of restricted stock, grants of 26,550 incentive stock options and grants of 13,450 non-qualified stock options. A total of 14,000 shares of restricted stock, 35,075 incentive stock options and 27,425 non-qualified stock options were forfeited during 2006. No options granted under the plan have been exercised as of December 31, 2006.

     On October 20, 2004, the Group’s Board of Directors authorized the repurchase of up to 250,000 additional shares of its common stock (in addition to the 250,000 share repurchase authorized June 16, 2004 and previously completed). The repurchase of the additional 250,000 shares was completed on March 2, 2005. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. In the aggregate, 500,000 shares have been repurchased in the open market since the Conversion, at an aggregate cost of $6.3 million, or $12.53 per share, with 2005 purchases totaling $3.2 million, or $13.18 per share. In addition, 1,563 and 1,950 shares of stock were repurchased from employees in 2005 and 2006, respectively, in order to pay the required tax withholdings on the vesting of restricted stock under the stock incentive plan.

     As previously disclosed in the Group’s SEC filings, during 2003 and 2004 the Group paid an aggregate of $3.2 million, plus interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory tax. In conjunction with making such payments, the Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division to the Group.

     The retaliatory tax generally is imposed on foreign insurers when the foreign company’s home state (i.e., its state of incorporation or domicile) has a higher rate of premium tax than the state imposing the tax, in this case New Jersey. The basis for the Group’s protests was that the Division was denying the Group the benefits of New Jersey’s premium tax cap, which limits the premiums tax to the lesser of the Group’s New Jersey premiums or 12.5 percent of the Group’s total premiums received from both New Jersey and out-of-state policyholders. In its protests, the Group argued that the Division’s position was unconstitutional and was based on an incorrect interpretation of New Jersey law. The protests currently are pending with the Division’s Conferences and Appeals branch.

     For several years, and concurrent with the processing of the Group’s protests of the retaliatory tax, certain other foreign insurers have been litigating virtually identical issues in New Jersey state courts. As a result of such litigation, the Division has held off on making a determination regarding the Group’s protests until a final judicial determination is made in such cases.

     On October 19, 2006, in the case of American Fire & Casualty Company v. New Jersey Division of Taxation (A-134-04), the New Jersey Supreme Court ruled in favor of the foreign insurers, holding that the tax benefits of the premium tax cap afforded to foreign insurers should not be included in calculating the retaliatory tax. Instead, the Court ruled that the retaliatory tax and the premium tax cap must be harmonized to effectuate their respective purposes, thereby preserving the benefits of the premium tax cap for foreign insurers.

     The Group expects that the Division shortly will issue a final determination with respect to the Group’s protests based on the opinion issued by the New Jersey Supreme Court. If, as the Group expects, the Division grants the Group’s protests, a portion or all of the retaliatory tax previously paid by the Group will be refunded. Any such refund would be reduced by related Federal income tax. Due to the contingencies involved, the Group has not accrued any refund of the retaliatory tax.

ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” This statement requires an employer to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. The adoption of SFAS No. 158 did not have a significant effect on operations, financial condition or liquidity.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB No. 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year. SAB No. 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. The adoption of SAB No. 108 did not have a significant effect on operations, financial condition or liquidity.

60

NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED

In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes” which clarifies the accounting for income tax reserves and contingencies recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Group believes that the adoption of FIN 48 will not have a significant effect on operations, financial condition or liquidity.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This accounting standard permits fair value re-measurement for any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”; establishes a requirement to evaluate interests in securitized financial assets to identify them as freestanding derivatives or as hybrid financial instruments containing an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument pertaining to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006. The Group is currently evaluating the impact that SFAS No. 155 will have, if any, on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Group is currently evaluating the impact that SFAS No. 157 will have, if any, on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available for sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Group is currently evaluating the impact that SFAS No. 159 will have, if any, on its consolidated financial statements.

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 Group was not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2006 which would give rise to previously undisclosed market, credit or financing risk.

     The Group and its subsidiaries have no significant contractual obligations at December 31, 2006, other than its insurance obligations under its policies of insurance, Trust preferred securities, a line of credit obligation, and operating lease obligations. Projected cash disbursements pertaining to these obligations, as projected at December 31, 2006, are as follows:

	Jan. 1, 2007		Jan. 1, 2008		Jan. 1, 2010		After
	to Dec. 31,		to Dec. 31,		to Dec. 31,		Dec. 31,
	2007		2009		2011		2011		Total
	(In thousands)
Gross property and casualty insurance reserves	$	58,146		69,656		38,471		84,182	$	250,455
Trust preferred securities, net principal outstanding		—		—		—		15,542		15,542
Interest expense relating to trust preferred securities		1,167		2,680		2,780		29,726		36,353
Line of credit		3,000		—		—		—		3,000
Operating leases		463		772		712		2,955		4,902
Total contractual obligations	$	62,776		73,108		41,963		132,405	$	310,252

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, other than the interest rate swap agreements that hedge the floating rate trust preferred securities which were assumed as part of the Financial Pacific acquisition on October 1, 2005.

     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. Our available-for-sale portfolio of fixed-income securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses reflected on the balance sheet.

     The average duration of our fixed maturity investments, excluding mortgage-backed securities that are subject to prepayment, was approximately 3.6 years as of December 31, 2006. 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.

     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

61

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, 2006
	Market Value
	-100 Basis		No Rate		+100 Basis
	Point Change		Change		Point Change
	(In thousands)
Bonds and preferred stocks	$	287,429	$	275,188	$	262,631
Cash and cash equivalents		17,618		17,618		17,618
Total	$	305,047	$	292,806	$	280,249

     Credit Risk

     The quality of our interest-bearing investments is generally good. 100% of our fixed maturity securities are rated investment grade, with the exception of one fixed maturity investment held with a value of $0.5 million. For the year ended December 31, 2006, we recorded a pre-tax charge to earnings of $121,000 for write-downs of other than temporarily impaired fixed-income securities.

     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 reflected in the balance sheet. 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, 2006, we incurred no impairment charges for other than temporarily impaired equity securities.

     Group and industry concentrations are monitored by the Board of Directors. At December 31, 2006, our equity portfolio made up 5.6% of the Group’s total investment portfolio, and was relatively concentrated in terms of the number of issuers and industries. At December 31, 2006, the top ten equity holdings represented $6.5 million or 39.6% of the equity portfolio. Investments in the financial sector represented 35.8% while investments in pharmaceutical companies, retail specialty companies and information technology companies represented 9.8%, 11.0% and 7.8%, respectively, of the equity portfolio at December 31, 2006. 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 Group’s equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2006. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios.

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			Estimated Fair		Hypothetical
Estimated Fair			Value After		Percentage Increase
Value of Equity			Hypothetical		(Decrease) in
Securities at		Hypothetical	Change in		Stockholders’
12/31/06		Price Change	Prices		Equity (1)
(Dollars in thousands)
$	16,522	20% increase	$	19,826		1.9	%
$	16,522	20% decrease	$	13,218		(1.9	%)

(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, 2006 and 2005, 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, 2006. 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, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

The Company adopted Statement of Financial Accounting Standards No. 123 (R), Share Based Payment, effective January 1, 2006.

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, 2006, 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, 2007, 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, 2007

64

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets
December 31, 2006 and 2005
(Dollars in thousands, except share amounts)

	2006			2005
Assets
Investments, at fair value:
Fixed-income securities, available for sale, at fair value (cost $274,769 and $231,191, respectively)	$	273,454			229,129
Equity securities, at fair value (cost $10,940 and $8,599, respectively)		16,522			14,981
Short-term investments, at cost, which approximates fair value		7,692			4,289
Total investments		297,668			248,399
Cash and cash equivalents		17,618			20,677
Premiums receivable		38,030			37,497
Reinsurance receivables		87,987			79,214
Prepaid reinsurance premiums		16,383			21,554
Deferred policy acquisition costs		16,708			10,789
Accrued investment income		3,204			2,625
Property and equipment, net		11,936			11,720
Deferred income taxes		7,775			3,588
Goodwill		5,625			5,633
Other assets		4,033			5,002
Total assets	$	506,967			446,698
Liabilities and Equity
Liabilities:
Losses and loss adjustment expenses	$	250,455			211,679
Unearned premiums		81,930			78,982
Accounts payable and accrued expenses		13,442			13,761
Other reinsurance balances		24,588			18,574
Trust preferred securities		15,542			15,525
Advances under line of credit		3,000			3,000
Other liabilities		2,171			1,778
Total liabilities		391,128			343,299
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 7,064,233 shares and 7,068,233 shares, outstanding 6,582,232 and 6,463,538 shares		—			—
Additional paid-in capital		68,473			67,973
Accumulated other comprehensive income:
Unrealized gains in investments, net of deferred income taxes		2,815			2,851
Retained Earnings		54,629			44,896
Unearned restricted stock compensation		—			(1,654	)
Unearned ESOP shares		(3,757	)		(4,383	)
Treasury stock, 503,513 and 501,563 shares		(6,321	)		(6,284	)
Total stockholders’ equity		115,839			103,399
Total liabilities and stockholders’ equity	$	506,967			446,698

See accompanying notes to consolidated financial statements.

65

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings
Years ended December 31, 2006, 2005, and 2004
(Dollars in thousands, except per share data)

	2006		2005		2004
Revenue:
Net premiums earned	$	137,673		74,760		55,784
Investment income, net of expenses		10,070		4,467		2,841
Net realized investment gains		151		1,267		484
Other revenue		2,035		772		358
Total revenue		149,929		81,266		59,467
Expenses:
Losses and loss adjustment expenses		87,697		43,384		28,138
Amortization of deferred policy acquisition costs (related party amounts of $1,212, $1,256 and $1,253, respectively)		32,694		16,849		15,075
Other expenses		13,242		10,766		11,898
Interest expense		1,212		306		—
Total expenses		134,845		71,305		55,111
Income before income taxes		15,084		9,961		4,356
Income taxes		4,449		2,941		1,092
Net income	$	10,635		7,020		3,264
Net income per common share:
Basic	$	1.77		1.18		0.52
Diluted	$	1.71		1.14		0.51

See accompanying notes to consolidated financial statements.

66

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2006, 2005, and 2004
(Dollars in thousands)

								Accumulated						Unearned
					Additional			other						restricted			Unearned
	Preferred		Common		paid-in			comprehensive			Retained			stock			ESOP			Treasury
	stock		stock		capital			income			earnings			compensation			shares			stock			Total
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
Net income												7,020												7,020
Unrealized losses on securities:
Unrealized holding losses arising during period, net of related income tax benefit of $772									(1,499	)														(1,499	)
Less reclassification adjustment for gains included in net income, net of related income tax expense of $431									(836	)														(836	)
Other comprehensive loss																								(2,335	)
Comprehensive income																								4,685
Forfeiture of restricted stock grant						(92	)								92
Unearned restricted stock compensation						197									(197	)
Amortization of restricted stock compensation															693									693
Tax benefit from stock compensation plan						11																		11
ESOP shares committed						206												626						832
Treasury stock purchased																					(3,230	)		(3,230	)
Balance, December 31, 2005	$	—		—		67,973			2,851			44,896			(1,654	)		(4,383	)		(6,284	)		103,399
Net income												10,635												10,635
Unrealized gains on securities:
Unrealized holding gains arising during period, net of related income tax expense of $62									120															120
Less reclassification adjustment for gains included in net income, net of related income tax expense of $80									(156	)														(156	)
Other comprehensive loss																								(36	)
Comprehensive income																								10,599
Reclassification of unearned restricted stock compensation						(1,654	)								1,654									—
Stock compensation plan amortization						1,398																		1,398
Tax benefit from stock compensation plan						129																		129
ESOP shares committed						627												626						1,253
Treasury stock purchased																					(37	)		(37	)
Dividends to shareholders												(902	)											(902	)
Balance, December 31, 2006	$	—		—		68,473			2,815			54,629			—			(3,757	)		(6,321	)		115,839

See accompanying notes to consolidated financial statements.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows
Years ended December 31, 2006, 2005, and 2004
(Dollars in thousands)

	2006			2005			2004
Cash flows from operating activities:
Net income	$	10,635			7,020			3,264
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of fixed assets		2,587			1,895			1,472
Net amortization of premium		1,039			592			346
Amortization of restricted stock compensation		1,398			704			383
ESOP share commitment		1,253			832			781
Net realized investment gains		(151	)		(1,267	)		(484	)
Deferred income tax		(4,168	)		380			68
Change in assets and liabilities:
Premiums receivable		(533	)		4,408			(2,121	)
Reinsurance receivables		(8,773	)		(3,155	)		2,476
Prepaid reinsurance premiums		5,171			1,301			41
Deferred policy acquisition costs		(5,919	)		(2,775	)		(627	)
Other assets		388			(1,759	)		1,167
Losses and loss adjustment expenses		38,776			10,232			(1,233	)
Unearned premiums		2,948			(795	)		3,678
Other reinsurance balances		6,014			(3,319	)		(71	)
Other		6			(927	)		(338	)
Net cash provided by operating activities		50,671			13,367			8,802
Cash flows from investing activities:
Purchase of fixed income securities, available for sale		(193,614	)		(35,054	)		(82,036	)
Purchase of equity securities		(5,543	)		(1,012	)		(3,464	)
(Purchase) sale of short-term investments, net		(3,403	)		(4,289	)		54,396
Sale and maturity of fixed income securities, available for sale		148,593			56,228			26,773
Sale of equity securities		3,844			10,309			3,775
Purchase of subsidiary, net of cash acquired		—			(30,276	)		—
Purchase of property and equipment, net		(2,797	)		(1,655	)		(4,253	)
Net cash used in investing activities		(52,920	)		(5,749	)		(4,809	)
Cash flows from financing activities:
Purchase of treasury stock		(37	)		(3,230	)		(3,054	)
Tax benefit from stock compensation plans		129			—			—
Dividends to shareholders		(902	)		—			—
Net cash used in financing activities		(810	)		(3,230	)		(3,054	)
Net (decrease) increase in cash and cash equivalents		(3,059	)		4,388			939
Cash and cash equivalents at beginning of period		20,677			16,289			15,350
Cash and cash equivalents at end of period	$	17,618			20,677			16,289
Cash paid (received) during the year for:
Interest	$	1,222			353			52
Income taxes	$	7,745			3,550			(922	)

See accompanying notes to consolidated financial statements.

68

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 its subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Holding Company, Inc. (FHC) and its subsidiary Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS). Effective October 1, 2005, Financial Pacific Insurance Group, Inc. (FPIG) was acquired through a subsidiary of MIG, and its subsidiaries Financial Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA).
	On October 1, 2005, FPIG and its subsidiaries became wholly-owned members of the Group in an acquisition for cash (see note 11). FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities (see note 17).
	The companies in the Group are operated under common management. The Group’s operating subsidiaries are licensed collectively in twenty two states, but are currently focused on doing business in six states; Arizona, California, Nevada, New Jersey, Pennsylvania and Oregon. Mercer Insurance Company and Mercer Insurance Company of New Jersey, Inc. have recently been licensed to write property and casualty insurance in New York. Financial Pacific Insurance Company holds an additional fifteen state licenses outside of the Group’s current focus area. Currently, only direct mail surety is being written in some of these states.
	The Group’s business activities are separated into three operating segments, which are commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and commercial auto coverage. These two commercial lines represented 61% and 14%, respectively, of the Group’s net premiums written in 2006. The personal lines business consists primarily of homeowners insurance in Pennsylvania and New Jersey and private passenger automobile insurance in Pennsylvania. These two personal lines represented 10% and 4%, respectively, of net written premiums in 2006.
(b)	Consolidation Policy and Basis of Presentation
	The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities, and include the accounts of each member of the Group since the date of acquisition. The insurance subsidiaries within the Group participate in a reinsurance pooling arrangement (the Pool) whereby each insurance affiliate’s underwriting results are combined and then distributed proportionately to each participant. FPIC joined the Pool effective January 1, 2006, after receiving regulatory approvals. 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.
(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

69

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	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 geographic concentration. Although the Group’s operating subsidiaries are licensed collectively in twenty two states, direct premiums written for three states, California, New Jersey and Pennsylvania, constituted 53%, 28% and 8% of the 2006 direct premium written, 25%, 54%, and 16% of the 2005 direct premium written, and 0%, 78% and 22% of the 2004 direct premium written. Consequently, changes in the California, New Jersey or Pennsylvania legal, regulatory or economic environment could adversely affect the Group.
	For the year ending December 31, 2006, there were no agents in the Group that individually produced greater than 5% of the Group’s direct written premiums. For the years ending December 31, 2005 and 2004, approximately 17% and 24% of the Group’s direct premiums written were produced by two agents, including one who is a related party (see Note 15 for information about related party transactions).
(e)	Investments
	Due to periodic shifts in the portfolio arising from income tax planning strategies and asset-liability matching, as well as the need to be flexible in responding to changes in the securities markets and economic factors, management considers the entire portfolio of fixed-income securities as available for sale. Fixed-income securities available for sale are stated at fair value. Equity securities are carried at fair value. 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 accumulated other comprehensive income and, accordingly, have no effect on net income.
	Interest on fixed-income securities 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/accreted using anticipated prepayments with changes in anticipated prepayments, which are evaluated semi-annually, accounted for prospectively. 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 used by the Group’s fixed income securities manager.
	Realized gains and losses are determined on the specific identification basis. When the fair value of any investment is lower than its cost, an assessment is made to determine if the decline is other than temporary. If the decline is deemed to be other than temporary, the investment is written down to fair value and the amount of the write-down is charged to income as a realized loss. The fair value of the investment becomes its new cost basis.
(f)	Cash and Cash Equivalents and Short-term Investments
	Cash and 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.

70

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	Cash and cash equivalents as of December 31, 2006 and 2005 include restricted cash of $683 and $1,057, respectively, consisting of funds held for surety bonds.
(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 the Group holds 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 investors or its other shareholders at the lower of statutory book value or the offered price. The investors also have the ability to determine that the potential purchaser is not appropriate and void such an offer. The carrying value of this investment was $938 and $1,134 at December 31, 2006 and 2005, respectively.
	Cash and cash equivalents, and short-term investments – The carrying amounts reported in the consolidated balance sheet for these instruments approximate their fair values.
	Premium and reinsurance receivables – The carrying amounts reported in the consolidated balance sheet for these instruments approximate their fair values.
	Trust preferred securities and line of credit obligations – The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.
	Interest rate swaps — The estimated fair value of the interest rate swaps is based on valuations received from the financial institution counterparties.
(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.
(i)	Deferred Policy Acquisition Costs
	Acquisition costs such as commissions, premium taxes, and certain other expenses which vary with and are primarily 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 net 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. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the acquisition costs are unrecoverable, further analyses are completed to determine if a reserve is required to provide for losses that may exceed the related unearned premium.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(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.
	The Group applies the provisions of Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” to account for internally developed computer software costs. In accordance with SOP 98-1, the Group has capitalized $625, $718, and $916 in software development costs, respectively, in 2006, 2005 and 2004. These costs are amortized over their useful lives, ranging from three to five years, from the dates the systems technology becomes operational.
	The carrying value of property and equipment is reviewed for recoverability including an evaluation of the estimated useful lives of such assets. Impairment is recognized only if the carrying amount of the property and equipment is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset. A change in the estimated useful lives of such assets is treated as a change in estimate and is accounted for prospectively.
	Upon disposal of assets, the cost and related accumulated depreciation is removed from the accounts and the resulting gain or loss is included in income.
(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 daily pro-rata method. Audit premiums and premium adjustments are recorded when they are considered probable and adequate information exists to estimate the premium. Unearned premiums represent that portion of direct premiums written that are applicable to the unexpired terms of policies in force and is reported as a liability. Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers and is reported as an asset. Premiums receivable are reported net of an allowance for estimated uncollectible premium amounts. Revenue related to service fees is earned over the installment period. Agency commission and related fees are recognized based on the policy issue date.
(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, 2006 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.

72

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(m)	Share-Based Compensation
	The Group makes grants of qualified (ISO’s) and non-qualified stock options (NQO’s), and non-vested shares (restricted stock) under its stock option plan. Stock options are granted at prices that are not less than market price at the date of grant, and are exercisable over a period of ten years for ISO’s and ten years and one month for NQO’s. Restricted stock grants vest over a period of three to five years.
	Prior to January 1, 2006, the Group accounted for this plan under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations, as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”. Under the principles of APB 25, as permitted by SFAS No. 123, stock-based compensation was recognized for grants of restricted stock in the consolidated statement of earnings for the years ended December 31, 2005 and 2004, but not for grants of stock options because options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, the Group adopted the fair value recognition provisions of SFAS No. 123R, “Share-Based Payment”, using the modified-prospective-transition method. Consolidated statement of earnings for prior periods have not been retrospectively adjusted for SFAS No. 123R.
	The Group adopted SFAS No. 123R on January 1, 2006 with no impact upon adoption. The compensation expense for the year ending December 31, 2006 was $711. There would have been no charge to earnings for stock option grants if we had continued to account for stock-based compensation under APB 25 for unvested stock options. SFAS No. 123R also eliminated the presentation of the contra-equity account “Unearned restricted stock compensation,” resulting in a reclass of $1,654 to Additional paid-in capital.
	As of December 31, 2006, the Group has $2,214 of unrecognized total compensation cost related to non-vested stock options and restricted stock. That cost will be recognized over the remaining weighted-average vesting period of 1.9 years, based on the estimated grant date fair value.

73

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The following table shows the pro-forma effect on the consolidated statement of earnings and earnings per share as if the Group had applied SFAS No. 123 to stock options granted under its plan prior to the adoption of SFAS No. 123R on January 1, 2006.

	Years Ended December 31,
	2005			2004
Net income, as reported		7,020			3,264
Plus: Share-based compensation expense included in reported net income, net of related tax effects		457			253
Less: Total share-based compensation expense determined under fair value based method for all awards, net of related tax effects		(995	)		(538	)
Pro forma net income		6,482			2,979
Basic earnings per share:
As reported		1.18			0.52
Pro forma		1.09			0.48
Diluted earnings per share:
As reported		1.14			0.51
Pro forma		1.05			0.47

(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. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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 and Intangible Assets
	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 unit in a manner similar to a purchase price allocation, in accordance with SFAS No. 141, “Business Combinations”. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Group has two reporting units with goodwill as of December 31, 2006 and 2005. The Group performed the annual impairment tests as of December 31, 2006 and 2005, and the results indicated that the fair value of the reporting units exceeded their carrying amounts.
	Intangible assets held by the Group have definite lives and the value is amortized on a straight-line basis over their useful lives, ranging from eight to fourteen years. The carrying amount of these intangible assets are regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset.
(p)	Derivative Instruments and Hedging Activities
	The Group entered into five interest rate swap agreements to hedge against interest rate risk on its floating rate Trust preferred securities. Interest rate swaps are contracts to convert,

74

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	for a period of time, the floating rate of the Trust preferred securities into a fixed rate without exchanging the instruments themselves.
	The Group accounts for its interest rate swaps in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities”. The Group has designated the interest rate swaps as non-hedge instruments. Accordingly, the Group recognizes the fair value of the interest rate swaps as assets or liabilities on the consolidated balance sheets with the changes in fair value recognized in the consolidated statement of earnings. The estimated fair value of the interest rate swaps is based on valuations received from the financial institution counterparties.
(q)	Earnings per Share
	Earnings per share (EPS) is computed in accordance with SFAS No. 128, “Earnings per Share”. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of Diluted EPS reflects the effect of potentially dilutive securities.
(r)	Adoption of New Accounting Pronouncements
	In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” This statement requires an employer to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. The adoption of SFAS No. 158 did not have a significant effect on operations, financial condition or liquidity.
	In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB No. 108 requires that registrants quantify the impact on the current year’s financial statements of correcting all misstatements, including the carryover and reversing effects of prior years’ misstatements, as well as the effects of errors arising in the current year. SAB No. 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. The adoption of SAB No. 108 did not have a significant effect on operations, financial condition or liquidity.
(s)	New Accounting Pronouncements Not Yet Adopted
	In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes” which clarifies the accounting for income tax reserves and contingencies recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Group believes that the adoption of FIN 48 will not have a significant effect on operations, financial condition or liquidity.
	In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This accounting standard permits fair value re-measurement for any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”; establishes a requirement to evaluate interests in securitized financial

75

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	assets to identify them as freestanding derivatives or as hybrid financial instruments containing an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument pertaining to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006. The Group is currently evaluating the impact that SFAS No. 155 will have, if any, on its consolidated financial statements.
	In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Group is currently evaluating the impact that SFAS No. 157 will have, if any, on its consolidated financial statements.
	In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available for sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Group is currently evaluating the impact that SFAS No. 159 will have, if any, on its consolidated financial statements.
(t)	Reclassifications
	Reclassifications have been made in the 2005 and 2004 financial statements and notes to conform them to the presentation of the 2006 financial statements.

76

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(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):

	2006			2005			2004
Investment income:
Fixed income securities	$	11,044			5,195			3,284
Equity securities		514			559			673
Cash and equivalents		614			636			294
Other		245			112			104
Gross investment income		12,417			6,502			4,355
Less investment expenses		2,347			2,035			1,514
Net investment income		10,070			4,467			2,841
Realized gains (losses):
Fixed income securities		(402	)		(608	)		(97	)
Equity securities		638			1,751			590
Mark-to-market valuation for interest rate swaps		(94	)		122			—
Other		9			2			(9	)
Net realized investment gains		151			1,267			484
Net investment income and net realized investment gains	$	10,221			5,734			3,325

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

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

	2006			2005			2004
Fixed-income securities	$	747			(1,617	)		(440	)
Equity securities		(800	)		(1,920	)		1,512
	$	(53	)		(3,537	)		1,072

77

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The cost and estimated fair value of available-for-sale fixed-income and equity investment securities at December 31, 2006 and 2005 are shown below.

			Gross		Gross		Estimated
			Unrealized		Unrealized		Fair
	Cost (1)		Gains		Losses		Value
2006
Fixed-income securities, available for sale:
U.S. government and government agencies (2)	$	75,683		191		893		74,981
Obligations of states and political subdivisions		116,361		579		642		116,298
Industrial and miscellaneous		53,298		203		784		52,717
Mortgage-backed securities		29,427		214		183		29,458
Total fixed maturities		274,769		1,187		2,502		273,454
Equity securities:
At market value		10,846		4,838		100		15,584
At estimated value		94		844		—		938
Total equity securities		10,940		5,682		100		16,522
Total	$	285,709		6,869		2,602		289,976

			Gross		Gross		Estimated
			Unrealized		Unrealized		Fair
	Cost (1)		Gains		Losses		Value
2005
Fixed-income securities, available for sale:
U.S. government and government agencies	$	75,864		50		913		75,001
Obligations of states and political subdivisions		80,728		124		574		80,278
Industrial and miscellaneous		55,326		14		608		54,732
Mortgage-backed securities		19,273		—		155		19,118
Total fixed maturities		231,191		188		2,250		229,129
Equity securities:
At market value		8,505		5,345		3		13,847
At estimated value		94		1,040		—		1,134
Total equity securities		8,599		6,385		3		14,981
Total	$	239,790		6,573		2,253		244,110

(1)	Original cost of equity securities; original cost of fixed-income securities adjusted for amortization of premium and accretion of discount.
(2)	Includes approximately $48,840 (cost) and $48,548 (estimated fair value) of mortgage–backed securities backed by the U.S. government and government agencies.

78

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2006 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	$	4,834	$	24	$	50,353	$	869	$	55,187	$	893
Obligations of states and political subdivisions		24,948		90		40,918		552		65,866		642
Corporate securities		4,211		17		41,850		767		46,061		784
Mortgage-backed securities		4,481		24		13,266		159		17,747		183
Total fixed maturities		38,474		155		146,387		2,347		184,861		2,502
Total equity securities		1,991		100		—		—		1,991		100
Total securities in a temporary unrealized loss position	$	40,465	$	255	$	146,387	$	2,347	$	186,852	$	2,602

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2006 the Group has 198 fixed maturity securities with unrealized losses for more than twelve months. Of the 198 securities with unrealized losses for more than twelve months, 192 of them have fair values of no less than 96% or more of cost, and the other 6 securities have a fair value greater than 93% of cost. The fixed income portfolio is invested 100% in investment grade securities, with the exception of one fixed maturity investment held with a value of $0.5 million, as of December 31, 2006, and these unrealized losses primarily reflect the current interest rate environment. The Group believes these declines are temporary.

There are 12 equity securities that are in an unrealized loss position at December 31, 2006. All of these securities have been in an unrealized loss position for less than six months. The Group believes these declines are temporary.

79

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2005 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	$	53,785	$	372	$	16,853	$	541	$	70,638	$	913
Obligations of states and political subdivisions		57,979		317		11,397		257		69,376		574
Corporate securities		44,446		373		7,761		235		52,207		608
Mortgage-backed securities		18,646		155		—		—		18,646		155
Total fixed maturities		174,856		1,217		36,011		1,033		210,867		2,250
Total equity securities		604		3		—		—		604		3
Total securities in a temporary unrealized loss position	$	175,460	$	1,220	$	36,011	$	1,033	$	211,471	$	2,253

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2005, the Group has 53 fixed maturity securities with unrealized losses for more than twelve months. Of the 53 securities with unrealized losses for more than twelve months, 46 of them have fair values of no less than 96% of cost, and the other 7 securities have a fair value greater than 92% of cost. The fixed income portfolio is invested 100% in investment grade securities, as of December 31, 2006, and these unrealized losses primarily reflect the current interest rate environment. The Group believes these declines are temporary.

There are two equity securities that are in an unrealized loss position at December 31, 2005. Both of these securities have been in an unrealized loss position for less than six months. The Group believes these declines are temporary.

The amortized cost and estimated fair value of fixed-income securities at December 31, 2006, by contractual maturity, are shown below (note that mortgage-backed securities in the below table include securities backed by the U.S. government and agencies). 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.

	Amortized		Estimated
	Cost		Fair Value
Due in one year or less	$	6,004		5,956
Due after one year through five years		71,712		70,871
Due after five years through ten years		76,704		76,193
Due after ten years		42,082		42,428
		196,502		195,448
Mortgage-backed securities		78,267		78,006
	$	274,769		273,454

80

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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

	2006			2005			2004
Gross realized gains	$	1,023			2,386			1,037
Gross realized losses		(872	)		(1,119	)		(553	)
	$	151			1,267			484

	The gross realized investment losses included write-downs for the other than temporary impairment of securities totaling $121, $517, and $15 for the years ended 2006, 2005 and 2004, respectively.
	Proceeds from the sales of securities were $152,438, $66,537, and $30,548 in 2006, 2005, and 2004, respectively.
	Accumulated other comprehensive income was net of deferred income taxes of $1,451 and $1,469 applicable to net unrealized investment gains at December 31, 2006 and 2005, respectively.
	The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2006 and 2005 was $4,954 and $4,675, respectively.
(3)	DEFERRED POLICY ACQUISITION COSTS
	Changes in deferred policy acquisition costs are as follows:

	2006			2005			2004
Balance, January 1	$	10,789			8,014			7,387
Acquisition costs deferred		38,613			19,624			15,702
Amortization charged to earnings		(32,694	)		(16,849	)		(15,075	)
Balance, December 31	$	16,708			10,789			8,014

(4)	PROPERTY AND EQUIPMENT
	Property and equipment was as follows:

	2006			2005
Property and equipment:
Land	$	1,720			1,683
Buildings and improvements		7,607			7,184
Furniture, fixtures, and equipment		12,850			11,084
		22,177			19,951
Accumulated depreciation		(10,241	)		(8,231	)
	$	11,936			11,720

81

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(5)	LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
	Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:

	2006			2005			2004
Balances, January 1	$	211,679			36,028			37,261
Less reinsurance recoverable on unpaid losses and loss expenses		(78,744	)		(3,063	)		(5,036	)
Net balance at January 1		132,935			32,965			32,225
Reserves acquired in subsidiary acquisition, net		—			91,894			—
Net balance, as adjusted		132,935			124,859			32,225
Incurred related to:
Current year		79,275			43,921			29,024
Prior years		8,422			(537	)		(886	)
Total incurred		87,697			43,384			28,138
Paid related to:
Current year		23,284			20,729			14,626
Prior years		32,826			14,579			12,772
Total paid		56,110			35,308			27,398
Net balance, December 31		164,522			132,935			32,965
Plus reinsurance recoverable on unpaid losses and loss expenses		85,933			78,744			3,063
Balance at December 31	$	250,455			211,679			36,028

As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses increased by $8.4 million in 2006 and decreased by $0.5 million and $0.9 million in 2005 and 2004, respectively.

The following table presents the increase (decrease) in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2006 by line of business. Amounts shown in the 2005 column of the table include information relating to Financial Pacific Insurance Company, which was acquired on October 1, 2005, and accounted for as a purchase business combination.

				Year Ended December 31,
										2003
	Total			2005			2004			and Prior
	(In Thousands)
Commercial multi-peril	$	9,618		$	7,941		$	334		$	1,343
Commercial automobile		(1,968	)		(2,085	)		29			88
Other liability		(292	)		(510	)		129			89
Workers’ compensation		525			50			1,021			(546	)
Homeowners		(55	)		204			810			(1,069	)
Personal automobile		571			57			217			297
Other lines		23			(132	)		(13	)		168
Net prior year development	$	8,422		$	5,525		$	2,527		$	370

82

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	Each quarter, we compute the estimated ultimate liability using principles and procedures applicable to the lines of business written. The establishment of loss and loss adjustment expense reserves is an inherently uncertain process and reserve uncertainty stems from a variety of sources. 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. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustment is made. A discussion of factors contributing to an increase (decrease) in the liability for unpaid losses and loss adjustment expenses for the Group’s two major lines of business, representing 81% of total carried loss and loss adjustment expenses at December 31, 2006, follows:
	Commercial multi-peril
	With $120.1 million of recorded reserves, net of reinsurance, at December 31, 2006, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 73% of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2006. As a result of changes in estimates of insured events in prior years, the liabilities for prior year losses and loss adjustment expenses for the commercial multi-peril line of business increased by $9.6 million in 2006.
	The strengthening of net loss and loss adjustment expense reserves in the commercial multi-peril line reflects refinement in the assumptions and techniques supporting the reserve estimates, primarily on the contractor liability book of business. Contractor liability claims, particularly construction defect claims, are long-tailed in nature and develop over a period of ten to twelve years, based on the related statute of limitations. The increase in the estimates of insured events of prior years relates primarily to a higher than expected level of claims being reported in 2006 for such prior years. Actuarial methods are used to predict future development which is assumed to follow an expected pattern that is supported by historical data and industry trends. This line of business and related reserving assumptions are inherently uncertain and several factors, including newly observed trends, taken into consideration in the actuarial analysis can cause volatility in the determination of net ultimate losses.
	Commercial automobile
	With $13.4 million of recorded reserves, net of reinsurance, at December 31, 2006, commercial automobile is the Group’s second largest reserved line of business, representing 8% of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2006. As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses for the commercial automobile line of business decreased by $2.0 million in 2006. The development of net ultimate losses on the commercial automobile line of business was better than expected in 2006, primarily as a result of a reduction in claims frequency and a lower than expected incurred. The Group’s expansion into heavy vehicle programs such as ready mix and aggregate haulers has not translated into the expected increased level of loss activity.
(6)	REINSURANCE
	The Group has geographic exposure to catastrophe losses in its operating territories. 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.

83

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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 2006, 2005 and 2004 not exceeding $500 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.

Many of the reinsurance treaties participated in by the Group have included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares, on a limited basis, in the profitability through contingent ceding commissions. The Group’s exposure in the loss experience is contractually defined at minimum and maximum levels. The terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, particularly in longer-tail lines, the net amounts that will ultimately be realized may vary significantly from the estimated amounts recorded in the accompanying consolidated financial statements.

Effective January 1, 2006, FPIC restructured its property reinsurance agreement covering the first $2,000 of loss from an 80% quota share to a $1,650 excess of $350 excess of loss contract to take advantage of the Group’s capital. The restructuring also included the assumption of ceded unearned premium at January 1, 2006 by FPIC from the 2005 property quota share and casualty excess of loss agreements. These assumed premiums were then ceded into the respective 2006 treaties, which due to the reduced ceding rates, resulted in a $5,600 increase in net written and earned premium for the year ending December 31, 2006.

During the third quarter of 2006, the Group commuted all reinsurance agreements with Alea North America Insurance Company (Alea). These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation, the Group received a cash payment of $4.5 million, and recorded a pre-tax net loss on commutation of $160,000.

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

	2006			2005			2004
Premiums written:
Direct	$	185,745			92,240			65,790
Assumed		2,374			2,868			2,133
Ceded		(42,328	)		(19,842	)		(8,419	)
Net	$	145,791			75,266			59,504
Premiums earned:
Direct	$	182,633			93,205			62,415
Assumed		2,539			2,696			1,829
Ceded		(47,499	)		(21,141	)		(8,460	)
Net	$	137,673			74,760			55,784

84

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The effect of reinsurance on unearned premiums as of December 31, 2006 and 2005 is as follows:

	2006		2005
Direct	$	80,976		77,863
Assumed		954		1,119
	$	81,930		78,982

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

	2006		2005
Liabilities:
Direct	$	244,316		208,141
Assumed		6,139		3,538
	$	250,455		211,679

	2006			2005			2004
Losses and loss expenses incurred:
Direct	$	115,995			48,856			26,464
Assumed		3,908			2,249			1,565
Ceded		(32,206	)		(7,721	)		109
Net	$	87,697			43,384			28,138

	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.
(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 six-month 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 Group contributions on such compensation, are funded into nonqualified plans benefiting affected individuals. The cost for these benefits was $469, $177, and $134 for 2006, 2005, and 2004, respectively. In addition, the Group generally makes a discretionary contribution each year, based on Group profitability, to both the qualified 401(k) plan, and, where applicable, to the nonqualified plans. The cost for this portion of the retirement plan was $389, $201, and $255 for 2006, 2005, and 2004, respectively.
	The Group sponsored the FPIG 401(k) Plan for employees of FPIG effective with the acquisition of FPIG on October 1, 2005 (see note 11). All employees of FPIC, as defined in the FPIG 401(k) Plan, who have completed six months of service were eligible for participation in the Plan. The Group matched 100% of the employee’s pre-tax contribution up to $2 on an annual basis. In the fourth quarter of 2005, the Group recognized a cost of $19 for the FPIG 401(k) Plan. Effective in 2006, the FPIG 401(k) Plan was terminated and all eligible employees were rolled into the Group’s 401(k) Plan described in the preceding paragraph.

85

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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 $145, $115, and $111 for 2006, 2005, and 2004 respectively. Costs accrued under this plan amounted to $897 and $786 at December 31, 2006 and 2005, respectively.

The Group also maintains nonqualified deferred compensation plans for its directors and officers. Under the plans, participants may elect to defer receipt of all or a portion of their fees or salary amounts, although there is no match by the Group. Amounts deferred by directors and officers, 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 $1,222 and $974 at December 31, 2006 and 2005, 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 $(23), $16, and $5 for the years ended December 31, 2006, 2005, and 2004, respectively. The cash surrender value of the Company-owned life insurance totaled $1,003 and $865 at December 31, 2006 and 2005, respectively, and is included in other assets.

On December 15, 2003, Mercer Insurance Group, Inc. was formed from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of ownership (“the Conversion”). 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 with 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 2006, 2005 and 2004, 62,611 shares were allocated to employee participants. 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 2006, 2005 and 2004 the Group recognized compensation expense of $1,253, $832 and $779, respectively, related to the ESOP. As of December 31, 2006, the cost of the 375,667 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.

86

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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

	2006		2005
Net loss reserve discounting	$	5,675		5,197
Net unearned premiums		4,483		2,604
Compensation and benefits		1,079		760
Market discount on investments		472		731
Contingent ceding commission payable		4,060		610
Net operating loss carryforwards		—		98
Impairment of investments		54		60
Other		444		214
Deferred tax assets		16,267		10,274
Deferred policy acquisition costs		5,681		3,668
Unrealized gain on investments		1,451		1,469
Depreciation		443		622
Other		917		927
Deferred tax liabilities		8,492		6,686
Net deferred tax asset	$	7,775		3,588

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, 2006 and 2005.

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:

	2006			2005			2004
Expected tax expense	$	5,129			3,387			1,481
Tax-exempt interest		(1,115	)		(424	)		(294	)
Dividends received deduction		(104	)		(112	)		(135	)
Non-deductible ESOP expense		213			70			52
Non-deductible options expense		74			—			—
Graduated tax rate adjustment		245			—			—
Company-owned life insurance		(8	)		5			2
Other		15			15			(14	)
Income tax expense	$	4,449			2,941			1,092

87

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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

	2006			2005		2004
Current	$	8,617			2,561		1,024
Deferred		(4,168	)		380		68
Income tax expense	$	4,449			2,941		1,092

(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.
	The Group manages its business in three segments: commercial lines insurance, personal lines insurance, and investments. The commercial lines insurance and personal lines insurance segments are managed based on underwriting results determined in accordance with U.S. generally accepted accounting principles, and the investment segment is managed based on after-tax investment returns.
	Underwriting results for commercial lines and personal lines take into account premiums earned, incurred losses and loss adjustment expenses, and underwriting expenses. The investments segment is evaluated by consideration of net investment income (investment income less investment expenses) and realized gains and losses.
	In determining the results of each segment, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes.
	Financial data by segment is as follows:

	2006			2005			2004
Revenues:
Net premiums earned:
Commercial lines	$	115,116		$	51,957		$	32,370
Personal lines		22,557			22,803			23,414
Total net premiums earned		137,673			74,760			55,784
Net investment income		10,070			4,467			2,841
Net realized investment gains		151			1,267			484
Other		2,035			772			358
Total revenues	$	149,929		$	81,266		$	59,467
Income before income taxes:
Underwriting income (loss):
Commercial lines	$	6,218		$	5,582		$	5,582
Personal lines		(2,032	)		(1,768	)		(4,909	)
Total underwriting income		4,186			3,814			673
Net investment income		10,070			4,467			2,841
Net realized investment gains		151			1,267			484
Other		677			413			358
Income before income taxes	$	15,084		$	9,961		$	4,356

88

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(10)	STATUTORY FINANCIAL INFORMATION
	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, is as follows:

	2006			2005			2004
Net income:
Statutory net income	$	8,173			8,899			2,898
Deferred policy acquisition costs		1,027			(785	)		627
Deferred federal income taxes		4,168			(380	)		(68	)
Dividends from affiliates		(1,501	)		—			—
Parent holding company loss		(1,816	)		(747	)		(238	)
Other		584			33			45
GAAP net income	$	10,635			7,020			3,264
Surplus:
Statutory surplus	$	114,863			109,114
Deferred policy acquisition costs		16,708			10,789
Deferred federal income taxes		(2,344	)		(5,052	)
Nonadmitted assets		4,811			4,123
Unrealized loss on fixed-income securities		(1,315	)		(2,062	)
Holding company		(18,988	)		(20,035	)
Other		2,104			6,522
GAAP stockholders’ equity	$	115,839			103,399

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 may be restricted and may require prior approval of regulatory authorities.

Under Pennsylvania law, there is a maximum amount of dividends that may be paid by Mercer Insurance Company to Mercer Insurance Group 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. As of December 31, 2006, the amounts available for payment of dividends from Mercer Insurance Company in 2007, without the prior approval of the Pennsylvania Insurance Department is approximately $5.9 million. In 2005, Mercer Insurance Company applied for, and received, approval to pay an extraordinary dividend of $10 million, which was used in connection with the acquisition of Financial Pacific Insurance Group, Inc. (see note 11).

89

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

	All dividends from Financial Pacific Insurance Company to Financial Pacific Insurance Group, Inc. (wholly owned by Mercer Insurance Group, Inc.) require prior notice to the California Department of Insurance. All “extraordinary” dividends require advance approval, and the payment of ordinary dividends made for the purpose of servicing debt of the Group has been restricted and requires prior written consent. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income (excluding unrealized capital gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2006, the amounts available for payment of dividends from Financial Pacific Insurance Company in 2007, without the prior approval, in addition to those dividends required to service debt of the Group, for which pre-approval is required, is approximately $5.6 million.
	The NAIC has risk-based capital (RBC) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. All of the Group’s insurance subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC.
(11)	ACQUISITIONS, GOODWILL AND INTANGIBLE ASSETS
	On October 1, 2005, the Group acquired all of the outstanding common stock of Financial Pacific Insurance Group, Inc. for $41,107 in cash (including related transaction costs), and its results of operations have been included in the consolidated financial statements of the Group since that date (see note 1(a)). The acquisition was made through a merger whereby FPIG Acquisition Corp, a Delaware corporation wholly owned by the Group, merged with and into Financial Pacific Insurance Group, Inc., which then became the surviving entity operating under the Certificate of Incorporation and Bylaws of FPIG Acquisition Corp. as a wholly owned subsidiary of the Group. Accordingly, this transaction has been accounted for as a purchase business combination by applying fair value estimates to the acquired assets, liabilities and commitments of Financial Pacific Insurance Group, Inc. as of October 1, 2005. A holdback of 11% of the purchase price was held in escrow for a period of one year relating to the terms of the acquisition agreement. This holdback was released without reduction in 2006.
	The acquisition was made to further the Group’s goal of achieving additional product and geographic diversity and expansion of its commercial lines book.
	The purchase price was as follows:

Cash purchase price of Financial Pacific Insurance Group, Inc.	$	40,394
Transaction costs of acquisition		713
Purchase price	$	41,107

90

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

The purchase price has been allocated based on an estimate of the fair value of the assets acquired and liabilities assumed as of October 1, 2005, as follows:

	As of
	October 1, 2005
Investments	$	152,342
Cash and equivalents		10,831
Premiums receivable		30,688
Reinsurance receivables		73,525
Prepaid reinsurance premiums		21,282
Accrued investment income		1,646
Property and equipment		2,223
Intangible assets		484
Goodwill		960
Deferred income taxes		3,908
Other assets		1,606
Loss and loss adjustment expenses		(165,419	)
Unearned premium		(45,770	)
Other reinsurance balances		(21,032	)
Accounts payable, accrued expenses and other liabilities		(7,646	)
Advances under line of credit		(3,000	)
Trust preferred securities		(15,521	)
Allocated purchase price	$	41,107

The allocated purchase price calculated above results in an estimate of the fair value of assets acquired and liabilities assumed as of the merger date, as follows:

	As of October 1, 2005
Assets acquired	$	299,495
Liabilities assumed, including debt obligations of $18,521		(258,388	)
Allocated purchase price	$	41,107

     Intangible assets acquired:

			Approximate
	Amount assigned as of		weighted-average
	October 1, 2005		amortization period
Amortizable intangible asset acquired:
Agency Force (a)	$	374	8 years
Favorable lease (b)		110	14 years
		484	9.4 years
Non-amortizable intangible asset acquired:
Goodwill		960	N/A
		960
Total	$	1,444

(a)	Represents the value of the agency force through which FPIC products are sold.
(b)	Represents the value of the below-market favorable lease terms associated with the building leased by FPIC

91

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

     Intangible assets consist of the following:

	2006			2005
Intangible assets subject to amortization	$	484			484
Less accumulated amortization		(68	)		(14	)
Net intangible assets subject to amortization	$	416			470

Amortization expense for intangible assets subject to amortization was $ 54, $14, $0 in 2006, 2005 and 2004. Estimated amortization expense for 2007 and future years is as follows:

2007	$	54
2008		54
2009		54
2010		54
2011		54
Thereafter		146
Total estimated amortization	$	416

The following unaudited pro forma information presents the combined results of operations of Mercer Insurance Group, Inc. and Financial Pacific Insurance Group, Inc. for the twelve months ended December 31, 2005 and 2004, respectively, with pro forma purchase accounting adjustments as if the acquisition had been consummated as of the beginning of the periods presented. This pro forma information is not necessarily indicative of what would have occurred had the acquisition and related transactions been made on the dates indicated, or of future results of the Group.

(for the year ended December 31, in thousands, except per share data)	2005		2004
Revenue	$	122,451	$	109,332
Net income	$	8,517	$	8,239
Net income per share—basic	$	1.43	$	1.32
Net income per share—diluted	$	1.38	$	1.30

The goodwill associated with the acquisition of Financial Pacific Insurance Group, Inc. will not be tax-deductible.

Since the merger date, the final tax return was filed for FPIG, resulting in a $8 reduction of goodwill. The change in the carrying amount of goodwill for the years ended December 31, 2006 and 2005 is as follows:

	2006			2005
Balance beginning of year	$	5,633			4,673
Goodwill acquired in connection with the acquisition of Financial Pacific Insurance Group, Inc.		—			960
Adjustment to goodwill for final FPIG tax return		(8	)		—
Balance end of year	$	5,625			5,633

92

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(12)	EARNINGS PER SHARE
	The computation of basic and diluted earnings per share is as follows:

	Year Ended
	December 31
	2006		2005		2004
Numerator for basic and diluted earnings per share:
Net income	$	10,635	$	7,020	$	3,264
Denominator for basic earnings per share - weighted-average shares outstanding		6,023		5,943		6,236
Effect of stock incentive plans		199		217		118
Denominator for diluted earnings per share		6,222		6,160		6,354
Basic earnings per share	$	1.77	$	1.18	$	0.52
Diluted earnings per share	$	1.71	$	1.14	$	0.51

	The denominator for diluted earnings per share does not include the effect of outstanding stock options that have an anti-dilutive effect. As of December 31, 2006, 40,000 stock options were considered to be anti-dilutive and were excluded from the earnings per share calculation.
(13)	SHARE-BASED COMPENSATION
	The Group 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. At adoption, the Plan initially limited 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 initially authorized in the Plan was 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of each year. As of January 1, 2007, the Plan’s authorization has been increased under this feature to 1,075,870 shares. 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 one month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. The 2004, 2005 and 2006 grants employ graded vesting over vesting periods of 3 or 5 years for restricted stock, incentive stock options, and nonqualified stock option grants, and include only service conditions. During 2006, the Group made grants of 10,000 shares of restricted stock, grants of 26,550 incentive stock options and grants of 13,450 non-qualified stock options. A total of 14,000 shares of restricted stock, 35,075 incentive stock options and 27,425 non-qualified stock options were forfeited during 2006. No options granted under the plan have been exercised as of December 31, 2006. Upon exercise, it is anticipated that new shares will be issued to the option holder.

93

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

Information regarding 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, 2005		659,200		$	12.42
Granted - 2006		40,000			25.89
Exercised - 2006		—			—
Forfeited - 2006		(62,500	)		13.04
Outstanding at December 31, 2006		636,700		$	13.21
Exercisable at:
December 31, 2006		339,533		$	12.27
Weighted-average remaining contractual life				7.8 years
Compensation remaining to be recognized for unvested stock options at December 31, 2006 (millions)				$	1.1
Weighted-average remaining amortization period				1.9 years
Aggregate Intrinsic Value of outstanding options, December 31, 2006 (millions)				$	4.5
Aggregate Intrinsic Value of exercisable options, December 31, 2006 (millions)				$	2.7

In determining the charge to the consolidated statement of earnings for 2006 and the pro-forma effect for 2005 and 2004 described in Note 1(m), the per share weighted-average fair value of options granted during 2004 was $4.19, for 2005 was $4.44 and for 2006 was $11.05. The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton 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, and in 2005: dividend yield of 0%; expected volatility of 18.44%; risk-free interest rate of 4.04%, and an expected life of 7.5 years, and in 2006: dividend yield of 0.77%; expected volatility of 30.94%; risk-free interest rate of 4.62%, and an expected life of 6.9 years.

Information regarding unvested restricted stock activity in Mercer Insurance Group’s Plan is below:

				Weighted Average
	Number of			Exercise Price
	Shares			per Share
Unvested restricted stock at December 31, 2005		166,417		$	12.29
Granted - 2006		10,000			26.87
Vested - 2006		(56,083	)		12.22
Forfeited - 2006		(14,000	)		13.08
Unvested restricted stock at December 31, 2006		106,334		$	13.61
Compensation remaining to be recognized for unvested restricted stock at December 31, 2006 (millions)				$	1.1
Weighted-average remaining amortization period				2.0 years

(14)	COMMITMENTS AND 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

94

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

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.

During 2003 and 2004 the Group paid an aggregate of $3.2 million, plus interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory tax. In conjunction with making such payments, the Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division to the Group.

The retaliatory tax generally is imposed on foreign insurers when the foreign company’s home state (i.e., its state of incorporation or domicile) has a higher rate of premium tax than the state imposing the tax, in this case New Jersey. The basis for the Group’s protests was that the Division was denying the Group the benefits of New Jersey’s premium tax cap, which limits the premiums tax to the lesser of the Group’s New Jersey premiums or 12.5 percent of the Group’s total premiums received from both New Jersey and out-of-state policyholders. In its protests, the Group argued that the Division’s position was unconstitutional and was based on an incorrect interpretation of New Jersey law. The protests currently are pending with the Division’s Conferences and Appeals branch.

For several years, and concurrent with the processing of the Group’s protests of the retaliatory tax, certain other foreign insurers have been litigating virtually identical issues in New Jersey state courts. As a result of such litigation, the Division has held off on making a determination regarding the Group’s protests until a final judicial determination is made in such cases.

On October 19, 2006, in the case of American Fire & Casualty Company v. New Jersey Division of Taxation (A-134-04), the New Jersey Supreme Court ruled in favor of the foreign insurers, holding that the tax benefits of the premium tax cap afforded to foreign insurers should not be included in calculating the retaliatory tax. Instead, the Court ruled that the retaliatory tax and the premium tax cap must be harmonized to effectuate their respective purposes, thereby preserving the benefits of the premium tax cap for foreign insurers.

The Group expects that the Division shortly will issue a final determination with respect to the Group’s protests based on the opinion issued by the New Jersey Supreme Court. If, as the Group expects, the Division grants the Group’s protests, a portion or all of the retaliatory tax previously paid by the Group will be refunded. Any such refund would be reduced by related Federal income tax. Due to the contingencies involved, the Group has not accrued any refund of the retaliatory tax.

95

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

As of December 31, 2006, the Group occupied office space and leased equipment and vehicles under various operating leases that have remaining noncancelable lease terms in excess of one year. Operating leases extending beyond 2009 represent two five-year lease option extensions relating to the FPIG office building in Rocklin, California. Although these options are cancelable, the Group currently intends on exercising these lease extension options. A summary of minimum future lease commitments, including the options on the FPIG building, as of December 31, 2006 follows:

	Minimum
	Requirements
Year ending December 31:
2007	$	463
2008		411
2009		361
2010		356
2011		356
Thereafter		2,955
	$	4,902

	Rental expenses of approximately $474 and $117 for the years ended December 31, 2006 and 2005, respectively, has been charged to income in the accompanying consolidated statement of earnings.
(15)	RELATED-PARTY TRANSACTIONS
	The Group produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis), the owner of which is also a Board member of the Group. In 2006, 2005, and 2004, premiums written through Davis totaled 4%, 8% and 12%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,187, $1,231 and $1,336 in 2006, 2005, and 2004, respectively.
	Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided equities investment management services to the Group since the year 2000. Fees to Van Rensselaer, Ltd. amounted to $117, $161 and $166 in 2006, 2005 and 2004.
	Thomas, Thomas & Hafer of Harrisburg, PA is a law firm the Company uses for claims handling assistance. The brother of the Chief Executive Officer of the Group is a partner of the firm. Fees to Thomas, Thomas & Hafer amounted to $73, $52 and $16 in 2006, 2005 and 2004, respectively.
(16)	LINE OF CREDIT
	As of December 31, 2006 and 2005, the FPIG owed $3,000 under a $4,000 bank line of credit. The line of credit bears interest at the bank’s base rate or an optional rate based on LIBOR. The effective annual interest rate as of December 31, 2006 and 2005 was 8.25% and 7.25%, respectively. The line of credit includes covenants to maintain certain financial requirements including a minimum A.M. Best rating and minimum statutory surplus. All covenants were in compliance as of December 31, 2006 and 2005. This line of credit was renewed with the same capacity effective December 5, 2006 and with a maturity date of November 15, 2007.

96

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(17) TRUST PREFERRED SECURITIES

The Group had the following Trust Preferred Securities outstanding as of December 31, 2006:

							Maturity
	Issue Date		Amount			Interest Rate	Date
Financial Pacific Statutory Trust I		12/4/2002	$	5,155		LIBOR + 4.00%		12/4/2032
Financial Pacific Statutory Trust II		5/15/2003	$	3,093		7.35% fixed thru 5/15/2008 thereafter converting to floating LIBOR + 4.10%		5/15/2033
Financial Pacific Statutory Trust III		9/30/2003	$	7,740		LIBOR + 4.05%		9/30/2033
Total Trust Preferred Securities			$	15,988
Less: Unamortized issuance costs			$	(446	)
Total			$	15,542

FPIG formed three statutory business trusts for the purpose of issuing Floating Rate Capital Securities (Trust preferred securities) and investing the proceeds thereof in Junior Subordinated Debentures of FPIG. FPIG holds $488 of common stock securities issued to capitalize the Trusts. Trust preferred securities totaling $15,500 were issued to the public.

Financial Pacific Statutory Trust I (Trust I) is a Connecticut statutory business trust. The Trust issued 5,000 shares of the Trust preferred securities at a price of $1,000 per share for $5,000. The Trust purchased $5,155 in Junior Subordinated Debentures from the Group that mature on December 4, 2032. The annual effective rate of interest at December 31, 2006 is 9.37%.

Financial Pacific Statutory Trust II (Trust II) is a Connecticut statutory business trust. The Trust issued 3,000 shares of the Trust preferred securities at a price of $1,000 per share for $3,000. The Trust purchased $3,093 in Junior Subordinated Debentures from the Group that mature on May 15, 2033. The annual effective rate of interest at December 31, 2006 is 7.35%.

Financial Pacific Statutory Trust III (Trust III) is a Delaware statutory business trust. The Trust issued 7,500 shares of the Trust preferred securities at a price of $1,000 per share for $7,500. The Trust purchased $7,740 in Junior Subordinated Debentures from the Group that mature on September 30, 2033. The annual effective rate of interest at December 31, 2006 is 9.42%.

The Group has the right, at any time, so long as there are no continuing events of default, to defer payments of interest on the Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters; but not beyond the stated maturity of the Junior Subordinated Debentures. To date no interest has been deferred. FPIG entered into an interest rate swap agreement to hedge the floating interest rate on the Junior Subordinated Debentures (note 18).

The Trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption. The Group has the right to redeem the Junior Subordinated Debentures after December 4, 2007 for Trust I, after May 15, 2008 for Trust II and after September 30, 2008 for Trust III.

97

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(18) INTEREST RATE SWAP AGREEMENT FOR VARIABLE-RATE DEBT

     The Group had the following Interest Rate Swaps outstanding as of December 31, 2006:

			Notional			Counterparty	Maturity
	Effective Date		Amount		Counterparty Pays	Receives	Date
US Bank (Trust I)		3/14/2003	$	5,000	3 Month LIBOR	3.5025% fixed		12/4/2007
Union Bank of California (Trust III)		10/15/2003	$	7,500	3 Month LIBOR	3.3350% fixed		9/30/2008
Union Bank of California (Trust I)		12/4/2007	$	5,000	3 Month LIBOR	4.7400% fixed		12/4/2012
Union Bank of California (Trust II)		5/15/2008	$	3,000	3 Month LIBOR	4.8000% fixed		5/15/2013
Union Bank of California (Trust III)		9/30/2008	$	7,500	3 Month LIBOR	4.8400% fixed		9/30/2013

The Group has interest-rate related hedging instruments to manage its exposure on its debt instruments. The type of hedging instruments utilized by the Group are interest rate swap agreements (swaps). Interest differentials to be paid or received because of swap agreements are reflected as an adjustment in the consolidated statement of earnings over the swap period. By using hedging financial instruments to hedge exposures to changes in interest rates, the Group exposes itself to credit risk and market risk.

Credit risk is the failure of the counterparty to perform under the terms of the contract. When the fair value of a contract is positive, the counterparty owes the Group, which creates credit risk for the Group. When the fair value of a contract is negative, the Group owes the counterparty and, therefore, it does not possess credit risk. The Group minimizes the credit risk in hedging instruments by entering into transactions with high-quality counterparties whose credit rating is higher than Aa.

Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

The Group is party to interest rate swap agreements to hedge the floating interest rate on the Junior Subordinated Debentures purchased by Trust I, Trust II and Trust III. The variable-rate debt obligations expose the Group to variability in interest payments due to changes in interest rates. Management believes it is prudent to limit the variability of a portion of its interest payments. To meet this objective, management enters into swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These swaps change the variable-rate cash flow exposure on the debt obligations to fixed-rate cash flows. Under the terms of the interest rate swaps, the Group makes fixed interest rate payments and receives variable interest rate payments, thereby creating the equivalent of fixed-rate debt.

As of December 31, 2006 and 2005, the Group was party to interest-rate swap agreements with an aggregate notional principal amount of $28,000. For the year ending December 31, 2006 and 2005, the Group recognized the change in the economic value of the interest rate swap agreements which is recognized in the consolidated statement of earnings as a realized (loss)/gain of $(94) and $122, respectively. The estimated fair value of the interest-rate swap agreements included in other assets was $395 and $489 as of December 31, 2006 and 2005, respectively.

98

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Dollars in thousands)

(19)	FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
	The Group accepts various forms of collateral for issuance of its surety bonds including cash, irrevocable letters of credit and certificates of deposit. The Group’s policy is to record in the accompanying consolidated financial statements only those funds received as cash deposits. The off-balance sheet collateral held by the Group consists solely of irrevocable letters of credit totaling $1,808 and $1,329 as of December 31, 2006 and 2005, respectively.
(20)	QUARTERLY FINANCIAL DATA (unaudited)
	The Group’s unaudited quarterly financial information is as follows:

	First Quarter						Second Quarter					Third Quarter						Fourth Quarter
	2006			2005			2006			2005		2006			2005			2006		2005
				(Unaudited, in thousands, except per share data)
Net premiums written	$	39,695		$	13,161		$	41,234		$	16,780	$	34,809		$	14,171		$	30,053	$	31,154
Net premiums earned		33,537			15,113			33,631			14,862		35,004			15,404			35,501		29,381
Net investment income earned		2,091			743			2,369			740		2,597			770			3,013		2,214
Net realized gains (losses)		307			18			298			80		(505	)		1,175			51		(6	)
Net income		2,650			993			2,895			1,065		2,194			2,061			2,896		2,901
Other comprehensive income (loss)		(1,752	)		(1,509	)		(1,599	)		511		3,264			(817	)		51		(520	)
Comprehensive income (loss)	$	898		$	(516	)	$	1,296		$	1,576	$	5,458		$	1,244		$	2,947	$	2,381
Net income per share
Basic	$	0.44			0.17		$	0.48			0.18	$	0.36			0.35		$	0.48		0.49
Diluted	$	0.43			0.16		$	0.47			0.17	$	0.35			0.34		$	0.46		0.47

99

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

None.

ITEM 9A. CONTROLS AND PROCEDURES.

     (a) Evaluation of Disclosure Controls and Procedures

     Mercer Insurance Group, Inc’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Group’s disclosure controls and procedures as of December 31, 2006, and based on that evaluation they have concluded that these controls and procedures are effective as of that date.

     (b) Changes in Internal Control Over Financial Reporting

     There have been no changes in the Group’s internal control over financial reporting during the fourth quarter of 2006 that have materially affected, or are reasonably likely to materially affect, the Group’s internal control over financial reporting.

     (c) 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 Group. 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, 2006.

     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, 2007	By:	/s/ Andrew R. Speaker
	Andrew R. Speaker
	President and Chief Executive Officer
March 16, 2007	By:	/s/ David B. Merclean
	David B. Merclean
	Senior Vice President of Finance and Chief Financial Officer

100

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 annual report on internal control over financial reporting (Item 9A(c)), that Mercer Insurance Group, Inc. maintained effective internal control over financial reporting as of December 31, 2006, 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, 2006, 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, 2006, 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, 2006 and 2005, 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, 2006, and our report dated March 16, 2007, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP
Philadelphia, Pennsylvania
March 16, 2007

101

ITEM 9B. OTHER INFORMATION.

On March 15, 2007, Mercer Insurance Group, Inc., Mercer Insurance Company and BICUS (collectively, and individually, the “Company”) entered into an Amended and Restated Employment Agreement (the “Amended Agreement”) with David B. Merclean, who is Senior Vice President and Chief Financial Officer of the Company. The Amended Agreement is effective retroactively to October 31, 2004 and supersedes and replaces an Employment Agreement between the Company and Mr. Merclean dated October 31, 2004 (the “Original Agreement”).

The Amended Agreement was entered into for the purpose of correcting a drafting error in the Original Agreement which was only recently discovered. It was intended by the parties at the time of the execution of the Original Agreement that Mr. Merclean would receive compensation and benefits payments for the remainder of the then current term of the agreement in the event of the termination of his employment by the Company without disability or cause or in the event of the termination by Mr. Merclean of his employment for good reason. The Original Agreement provided under such circumstances that compensation and benefits payments would be made for a period of one year. The Amended Agreement corrects the drafting error in the Original Agreement.

The Amended Agreement differs in other minor respects from the Original Agreement, but such differences are not material in nature.

On March 15, 2007, Mercer Insurance Group, Inc., Mercer Insurance Company and BICUS (collectively, and individually, the “Company”) entered into an Amendment No. 1 to Employment Agreement (the “Amendment”) with Paul R. Corkery, who is Senior Vice President and Chief Information Officer of the Company. The Amendment is intended to amend and restate in its entirety Paragraph 3 of an Employment Agreement between the parties dated October 1, 2006 for purposes of extending the term of Mr. Corkery’s employment from March 31, 2008 to March 31, 2010 and for purposes of providing for serial one year extensions, commencing effective March 31, 2008, and on each March 31 thereafter, so as to maintain a constant three year term, unless the Company or Mr. Corkery gives prior notice of nonrenewal.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

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, 2006.

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, 2006.

102

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

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, 2006.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

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, 2006.

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, 2006.

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.
			Report of Independent Registered Public Accounting Firm
			Consolidated Financial Statements:
			Consolidated Balance Sheets as of December 31, 2006 and 2005
			Consolidated Statements of Earnings for Each of the Years in the Three-year Period Ended December 31, 2006
			Consolidated Statements of Stockholders’ Equity for Each of the Years in the Three-year Period Ended December 31, 2006
			Consolidated Statements of Cash Flows for Each of the Years in the Three-year Period Ended December 31, 2006
			Notes to Consolidated Financial Statements
	(2	)	The following consolidated financial statement schedules for the years 2006, 2005 and 2004 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

103

		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.

EXHIBIT INDEX

NUMBER	TITLE
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.)
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.)

104

NUMBER	TITLE
10.2	Employment Agreement, dated as of April 1, 2004, among BICUS Services Corporation, Mercer Insurance Company and Andrew R. Speaker (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.)
10.3	Employment Agreement, dated as of April 1, 2004, among BICUS Services Corporation, Mercer Insurance Company and Paul D. Ehrhardt (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.)
10.4	Amended and Restated Employment Agreement, dated as of March 15, 2007, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and David B. Merclean (filed herewith.)
10.5	Employment Agreement, dated as of October 1, 2006, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and Paul R. Corkery (incorporated by reference herein to the Company’s Quarterly Report on Form 10-Q, SEC File No. 000-25425, for the quarter ended September 30, 2006.)
10.6	Amendment No. 1 to Employment Agreement, dated as of March 15, 2007, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and Paul R. Corkery (filed herewith.)
10.7	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.)
10.8	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.)
10.9	Mercer Insurance Group, Inc. 2004 Stock Incentive Plan, as amended through January 18, 2006 (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, 2005.)
10.10	Mercer Insurance Group, Inc. 401(k) Mirror Plan (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.)
23	Consent of independent registered public accounting firm (filed herewith)

105

NUMBER	TITLE
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)

106

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.
By:	/s/ Andrew R. Speaker	March 16, 2007
Andrew R. Speaker
President and Chief Executive Officer and a Director
By:	/s/ David B. Merclean	March 16, 2007
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	March 16, 2007
Roland D. Boehm
Vice Chairman of the Board of Directors
By:	/s/ H. Thomas Davis	March 16, 2007
H. Thomas Davis
Director
By:	/s/ William V. R. Fogler	March 16, 2007
William V. R. Fogler
Director
By:	/s/ William C. Hart	March 16, 2007
William C. Hart
Director
By:	/s/ George T. Hornyak, Jr.	March 16, 2007
George T. Hornyak, Jr.
Chairman of the Board of Directors
By:	/s/ Samuel J. Malizia	March 16, 2007
Samuel J. Malizia
Director
By:	/s/ Richard U. Niedt	March 16, 2007
Richard U. Niedt
Director
By:	/s/ Andrew R. Speaker	March 16, 2007
Andrew R. Speaker
President and Chief Executive Officer and a Director
By:	/s/ Richard G. Van Noy	March 16, 2007
Richard G. Van Noy
Director

107

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Mercer Insurance Group, Inc. and Subsidiaries:

Under date of March 16, 2007, we reported on the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2006 and 2005, 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, 2006, as contained 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.

The Company adopted Statement of Financial Accounting Standards No. 123 (R), Share Based Payment, effective January 1, 2006.

/s/ KPMG LLP

Philadelphia, Pennsylvania
March 16, 2007

108

Mercer Insurance Group, Inc. and Subsidiaries
Schedule I — Summary of Investments — Other than
Investments in Related Parties as of December 31, 2006

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	$	75,683		74,981		74,981
States, municipalities and political subdivisions		116,361		116,298		116,298
All Other		82,725		82,175		82,175
Total bonds		274,769		273,454		273,454
Preferred stock		1,729		1,731		1,731
Total fixed maturities		276,498		275,185		275,185
Equity securities:
Common stocks:
Banks, trust and insurance companies		1,149		2,518		2,518
Industrial, miscellaneous and all other		8,062		12,273		12,273
Total equity securities		9,211		14,791		14,791
Short-term investments		7,692		7,692		7,692
Total investments	$	293,401		297,668		297,668

See accompanying report of independent registered public accounting firm.

109

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Balance Sheet

December 31, 2006 and 2005

	2006			2005
	(Dollars in thousands)
ASSETS
Investment in common stock of subsidiaries (equity method)	$	118,883			107,492
Investment in preferred stock of subsidiaries (equity method)		2,475			2,475
Cash and cash equivalents		1,554			307
Goodwill		1,797			1,797
Deferred tax asset		302			95
Other assets		722			1,379
Total assets	$	125,733			113,545
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Accounts payable and accrued expenses	$	89			23
Other liabilities		9,805			10,123
Total liabilities		9,894			10,146
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 7,064,233 shares and 7,068,233 shares, outstanding 6,582,232 shares and 6,463,538 shares		—			—
Additional paid-in capital		68,473			67,973
Accumulated other comprehensive income:
Unrealized gains in investments, net of deferred income taxes		2,815			2,851
Retained Earnings		54,629			44,896
Unearned restricted stock compensation		—			(1,654	)
Unearned ESOP shares		(3,757	)		(4,383	)
Treasury stock, 503,513 and 501,563 shares		(6,321	)		(6,284	)
Total stockholders’ equity		115,839			103,399
Total liabilities and stockholders’ equity	$	125,733			113,545

See accompanying report of independent registered public accounting firm.

110

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statement of Earnings

For the Years ended December 31, 2006, 2005 and 2004

	2006			2005			2004
	(In thousands)
Revenue:
Investment income, net of expenses	$	53			547			574
Net realized capital losses		—			(211	)		—
Total revenue		53			336			574
Expenses:
Other expenses		2,602			1,266			972
Total expenses		2,602			1,266			972
Loss before tax benefit		(2,549	)		(930	)		(398	)
Income tax benefit		(633	)		(304	)		(160	)
Loss before equity in loss of subsidiaries		(1,916	)		(626	)		(238	)
Equity in income of subsidiaries		12,551			7,646			3,502
Net income	$	10,635			7,020			3,264

See accompanying report of independent registered public accounting firm.

111

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statements of Cash Flows

For the Years ended December 31, 2006, 2005 and 2004

	2006			2005			2004
	(Dollars in thousands)
Cash flows from operating activities:
Net income	$	10,635			7,020			3,264
Dividends from subsidiaries		1,125			10,000			—
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in undistributed income of subsidiaries		(12,551	)		(7,646	)		(3,502	)
Accretion of discount		—			136			178
ESOP share commitment		1,253			832			781
Net realized investment losses		—			211			—
Amortization of restricted stock compensation		1,398			704			383
Deferred income tax		(169	)		(5	)		(90	)
Other		366			10,017			(1,101	)
Net cash provided by (used in) operating activities		2,057			21,269			(87	)
Cash flows from investing activities:
Purchase of fixed income securities		—			(4,317	)		(23,508	)
Sale and maturity of fixed income securities		—			26,864			436
Sale of short-term investments		—			—			25,495
Purchase of subsidiary		—			(41,108	)		—
Net cash (used in) provided by investing activities		—			(18,561	)		2,423
Cash flows from financing activities:
Tax benefit from stock compensation plans		129			—			—
Dividends to shareholders		(902	)		—			—
Purchase of treasury stock		(37	)		(3,230	)		(3,054	)
Net cash used in financing activities		(810	)		(3,230	)		(3,054	)
Net increase (decrease) in cash and cash equivalents		1,247			(522	)		(718	)
Cash and cash equivalents at beginning of period		307			829			1,547
Cash and cash equivalents at end of period	$	1,554			307			829
Cash paid during the year for:
Interest	$	—			—			—
Income taxes		—			—			—

See accompanying report of independent registered public accounting firm.

112

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, 2006
Commercial lines	$	14,075		240,239		69,865		—		115,116
Personal lines		2,633		10,216		12,065		—		22,557
Total	$	16,708		250,455		81,930		—		137,673
December 31, 2005
Commercial lines	$	8,231		200,992		67,391		—		51,957
Personal lines		2,558		10,687		11,591		—		22,803
Total	$	10,789		211,679		78,982		—		74,760
December 31, 2004
Commercial lines	$	5,327		21,679		22,822		—		32,370
Personal lines		2,687		14,349		11,185		—		23,414
Total		8,014		36,028		34,007		—		55,784

	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, 2006
Commercial lines	$	—		71,992		27,397		9,655		123,484
Personal lines		—		15,705		5,297		3,587		22,307
Total	$	10,070		87,697		32,694		13,242		145,791
December 31, 2005
Commercial lines	$	—		29,841		11,296		6,085		52,311
Personal lines		—		13,543		5,553		4,681		22,955
Total	$	4,467		43,384		16,849		10,766		75,266
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

See accompanying report of independent registered public accounting firm.

113

Mercer Insurance Group, Inc. and Subsidiaries
For the years ended December 31, 2006, 2005 and 2004
Schedule IV- Reinsurance

Column A	Column B		Column C		Column D		Column E		Column F
					Assumed				Percentage
			Ceded 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, 2006		182,633		47,499		2,539		137,673		1.8	%
For the year ended December 31, 2005		93,205		21,141		2,696		74,760		3.6	%
For the year ended December 31, 2004		62,415		8,460		1,829		55,784		3.3	%

See accompanying report of independent registered public accounting firm.

114

Mercer Insurance Group, Inc. and Subsidiaries
For the years ended December 31, 2006, 2005 and 2004
Schedule V- Allowance for Uncollectible Premiums and Other Receivables

	2006			2005			2004
	(Dollars in thousands)
Balance, January 1	$	401		$	103		$	97
Additions		467			389			129
Deletions		(240	)		(91	)		(123	)
Balance, December 31	$	628		$	401		$	103

See accompanying report of independent registered public accounting firm.

115

Mercer Insurance Group, Inc. and Subsidiaries
For the years ended December 31, 2006, 2005 and 2004
Schedule VI — Supplemental Information

Column A

Column B

Column C

Column D

Column E

Column F

Column G

Deferred

Reserve for

Discount

Policy

Losses and

if 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, 2006

16,708

250,455

—

81,930

137,673

10,070

Year ended December 31, 2005

10,789

211,679

—

78,982

74,760

4,467

Year ended December 31, 2004

8,014

36,028

—

34,007

55,784

2,841

	Column H					Column I		Column J		Column K
	Losses and LAE							Paid
	Incurred							Losses and		Net
	Current		Prior			Amortization		Adjustment		Written
	Year		Year			of DPAC		Expenses		Premiums
	(Dollars in thousands)
Year ended December 31, 2006		79,275		8,422			32,694		56,110		145,791
Year ended December 31, 2005		43,921		(537	)		16,849		35,309		75,266
Year ended December 31, 2004		29,024		(886	)		15,075		27,398		59,504

See accompanying report of independent registered public accounting firm.

116

EX-10.4

EXHIBIT 10.4

AMENDED and RESTATED EMPLOYMENT AGREEMENT

AGREEMENT made this 15^th day of March, 2007 (effective retroactively to October 31, 2004), by and among BICUS SERVICES CORPORATION, a Pennsylvania corporation, MERCER INSURANCE GROUP, INC, a Pennsylvania corporation, MERCER INSURANCE COMPANY, a Pennsylvania corporation, and David B. Merclean (“Executive”).

     Executive entered into an Employment Agreement dated October 31, 2004 with Bicus Services Corporation, Mercer Insurance Group, Inc., and Mercer Insurance Company (the “Original Agreement”). The parties recently discovered several drafting errors in the Original Agreement. This Amended and Restated Employment Agreement, which is effective retroactively to October 31, 2004, is intended to correct those drafting errors and to supersede and replace the Original Agreement in its entirety.

     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 of 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.

1

     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 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, , 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.

2

          (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 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

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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 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

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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 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

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(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 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

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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.

     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), except that all such compensation and benefits shall be for the remaining term of this Agreement and, with respect to Subparagraphs 6(b)(2) and (3), an additional pro rated amount shall be paid to him in cash on the last day of the remaining term of this Agreement. Such pro rated amount shall be determined by reference to a fraction, the numerator of which is the number of whole months elapsed during the year in which termination occurs, and the denominator of which is 12.

          (c) Adjustment to Certain Subparagraph (b) Compensation and Benefits. In the event the Executive suffers a Disability during the remaining term of this Agreement 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 remaining term of this Agreement 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

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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 remaining term of this Agreement 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 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), except that all such compensation and benefits shall be for the remaining term of this Agreement and, with respect to Subparagraphs 6(b)(2) and (3), an additional pro rated amount shall be paid to him in cash on the last day of the remaining term of this Agreement. Such pro rated amount shall be determined by reference to a fraction, the numerator of which is the number of whole months elapsed during the year in which termination occurs, and the denominator of which is 12.

          (c) Adjustment to Certain Subparagraph (b) Compensation and Benefits. In the event the Executive suffers a Disability during the remaining term of this Agreement 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

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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 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).

               (2) In the event the Executive dies during the remaining term of this Agreement 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

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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 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

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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 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, 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 10 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

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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 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. During his employment, and if the Executive’s employment terminates under Paragraph 8 or 9 prior to a Change in Control, then for a period of 12 months after the Date of Termination, the Executive agrees he will not, without the written consent in writing of the Board of Directors of the Company, 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, a customer, agent or supplier of the Company, a Subsidiary or any Affiliate. 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 if the Executive’s employment terminates under Paragraph 8 or 9 prior to a Change in Control, then for a period of 12 months after 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

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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.

     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

13

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

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

14

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, 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.

     40. Joinder. Mercer and Mercer Insurance have joined in this Agreement for the purpose of guaranteeing the performance of the Company’s obligations hereunder.

15

     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 GROUP, INC.

By:

Attest:

MERCER INSURANCE COMPANY

By:

Attest:

16

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) Mercer or any Subsidiary or Affiliate of Mercer, or (ii) any Employee Benefit Plan (or any trust forming a part thereof) maintained by Mercer or any Subsidiary or Affiliate) is or becomes the beneficial owner, directly or indirectly, of, Mercer or any Affiliate’s securities representing 19.9% or more of the combined voting power of Mercer 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 Mercer or a Material Subsidiary to another entity, except to an entity controlled directly or indirectly by Mercer or an Affiliate;

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

     (i) the shareholders of 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

     (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 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

17

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) Mercer or any Subsidiary or Affiliate of Mercer, (B) any Employee Benefit Plan (or any trust forming a part thereof) maintained by Mercer or any Subsidiary or Affiliate of Mercer, 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 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 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 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 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 Mercer’s then outstanding securities solely as a result of an acquisition by 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 Mercer’s then outstanding securities by reason of share repurchases by Mercer and thereafter becomes the beneficial owner, directly or indirectly, of any additional voting securities of Mercer, then a Change in Control shall be deemed to have occurred with respect to such Person under Clause (a).

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;

18

     (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.

     “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) requiring the Executive to be based more than 20 miles from his current office location as of the date of this Agreement;

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

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

19

     (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 the 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;

     (vi) requiring the Executive to be based more than 20 miles from 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 seven 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 seven days prior to the 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 Mercer 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.

20

     “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 Group, Inc., a Pennsylvania corporation and the holding company for Mercer Insurance.

     “Mercer Insurance” means Mercer Insurance Company, a Pennsylvania insurance company.

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

     “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 Mercer.

     “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), Mercer’s business directly, by merger or consolidation, or indirectly, by purchase of Mercer’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 Mercer 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 Mercer or any Affiliate at any time after the relevant Date of Termination, notwithstanding the fact that the Executive is not a participant therein prior to such date.

21

EX-10.6

EXHIBIT 10.6

AMENDMENT No. 1
To
EMPLOYMENT AGREEMENT

Paragraph 3 of the Employment Agreement made as of October 1, 2006, by and between BICUS Services Corporation, a Pennsylvania corporation, Mercer Insurance Group, Inc., a Pennsylvania corporation, Mercer Insurance Company, a Pennsylvania corporation, and Paul R. Corkery, is hereby amended and extended in its entirety to read as follows:

3. Term of Agreement. The Executive’s employment under this Agreement shall commence on the date of this Agreement and, except as otherwise provided herein, shall continue until March 31, 2010; provided, however, that commencing on March 31, 2008 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 in the form attached hereto as Exhibit A.

As of January 1, 2007, the annual Base Compensation for Paul R. Corkery pursuant to Paragraph 5 of the aforementioned agreement is $203,846.

In witness whereof, the parties have executed this Notice of Extension as of the date noted below.

Paul R. Corkery

BICUS Service Corporation	Mercer Insurance Group, Inc.
By:	By:
Attest:	Attest:
Mercer Insurance Company
By:
Attest:

Date: March 15, 2007

EX-10.10

MERCER INSURANCE GROUP, INC.
401(k) MIRROR PLAN

Plan Document

© 2003 Executive Benefit Services, Inc.
4140 ParkLake Avenue, Suite 500
Raleigh, NC 27612

MERCER INSURANCE, GROUP, INC.
401(k) MIRROR PLAN

TABLE OF CONTENTS

			Page
Section 1.		Purpose:		1
Section 2.		Definitions:		1
	2.1	“Accrued Benefit”		1
	2.2	“Active Participant” ,		1
	2.3	“Adoption Agreement”		2
	2.4	“Beneficiary”		2
	2.5	“Board”		2
	2.6	“Committee”		2
	2.7	“Compensation”		2
	2.8	“Crediting Date”		2
	2.9	“Deferred Compensation Account”		2
	2.10	“Disability”		2
	2.11	“Education Account”		3
	2.12	“Education Subaccount”		3
	2.13	“Education Recipient”		3
	2.14	“Effective Date”		3
	2.15	“Employee”		3
	2.16	“Employer”		4
	2.17	“Employer Credits”		4
	2.18	“Independent Contractor”		4
	2.19	“In-Service Account”		4
	2.20	“Normal Retirement Date”		4
	2.21	“Participant”		5
	2.22	“Participating Employer”		5
	2.23	“Plan”		5
	2.24	“Plan Administrator”		5
	2.25	“Plan Year”		5
	2.26	“Qualifying Distribution Event”		5
	2.27	“Retire” or “Retirement”		5
	2.28	“Retirement Account”		5
	2.29	“Salary Deferral Agreement”		6
	2.30	“Salary Deferral Credits”		6
	2.31	“Service”		6
	2.32	“Sponsor”		6
	2.33	“Spouse” or “Surviving Spouse”		6
	2.34	“Trust”		6
	2.35	“Trustee”		6
	2.36	“Years of Service”		6

i

			Page
Section 3		Participation:		7
Section 4.		Credits to Deferred Compensation Account:		7
	4.1	Salary Deferral Credits		7
	4.2	Employer Credits		8
	4.3	Deferred Compensation Account		8
Section 5.		Qualifying Distribution Events:		8
	5.1	Death of a Participant		8
	5.2	Disability of a Participant		9
	5.3	Termination of Service		9
	5.4	Retirement		9
Section 6.		Distributions While in Service:		9
	6.1	In-Service Withdrawals		9
	6.2	Financial Hardship Withdrawals		10
	6.3	“Haircut” Withdrawals		11
	6.4	Education Withdrawals		11
Section 7.		Qualifying Distribution Events Payment Options:		12
	7.1	Payment Options		12
	7.2	Prepayment		13
Section 8.		Vesting:		13
Section 9.		Accounts; Deemed Investment; Adjustments to Account:		14
	9.1	Accounts		14
	9.2	Deemed Investments		14
	9.3	Adjustments to Deferred Compensation Account		14
Section 10.		Benefit Exchange:		15
Section 11		Transfer to Qualified Plan:		15
	11.1	Maximize Qualified Plan Deferrals		15
	11.2	Maximize Qualified Plan Match		16
	11.3	Transfer Deferral to Qualified Plan		16
	11.4	Credit Match to Qualified Plan		16
	11.5	Compliance with Qualified Plan		17
Section 12.		Administration by Committee:		17
	12.1	Membership of Committee		17
	12.2	Committee Officers; Subcommittee		17
	12.3	Committee Meetings		17
	12.4	Transaction of Business		18
	12.5	Committee Records		18
	12.6	Establishment of Rules		18
	12.7	Conflicts of Interest		18

ii

			Page
	12.8	Correction of Errors		18
	12.9	Authority to Interpret Plan		19
	12.10	Third Party Advisors		19
	12.11	Compensation of Members		19
	12.12	Expense Reimbursement		19
	12.13	Indemnification		19
Section 13		Contractual Liability; Trust:		20
	13.1	Contractual Liability		20
	13.2	Trust		20
Section 14		Allocation of Responsibilities:		21
	14.1	Board		21
	14.2	Committee		21
	14.3	Plan Administrator		21
Section 15		Benefits Not Assignable; Facility of Payments:		21
	15.1	Benefits not Assignable		21
	15.2	Payments to Minors and Others		22
Section 16.		Beneficiary:		22
Section 17.		Amendment and Termination of Plan:		23
Section 18.		Communication to Participants:		23
Section 19.		Claims Procedure:		24
	19.1	Filing of a Claim for Benefits		24
	19.2	Notification to Claimant of Decision		24
	19.3	Procedure for Review		25
	19.4	Decision on Review		25
	19.5	Action by Authorized Representative of Claimant		25
Section 20.		Miscellaneous Provisions:		26
	20.1	Set off		26
	20.2	Notices		26
	20.3	Lost Distributees		26
	20.4	Reliance on Data		27
	20.5	Receipt and Release for Payments		27
	20.6	Headings		27
	20.7	Continuation of Employment		27
	20.8	Merger or Consolidation; Assumption of Plan		28
	20.9	Construction		28

iii

MERCER INSURANCE, GROUP, INC.
401 (k) MIRROR PLAN

          Section 1. Purpose:

          By execution of the Adoption Agreement, the Employer has adopted the Plan set forth herein to provide a means by which certain management Employees and Independent Contractors of the Employer may elect to defer receipt of current Compensation from the Employer in order to provide Retirement and other benefits on behalf of such Employees and Independent Contractors of the Employer, as selected in the Adoption Agreement. The Plan is not intended to be a tax-qualified retirement plan under Section 401(a) of the Internal Revenue Code (the “Code”). The Plan is intended to be an unfunded plan maintained primarily for the purpose of providing deferred compensation benefits for a select group of management or highly compensated employees under Sections 201(2), 301(a)(3) and 401(a)(l) of the Employee Retirement Income Security Act of 1974 and independent contractors.

          Section 2. Definitions:

          As used in the Plan, including this Section 2, references to one gender shall include the other and, unless otherwise indicated by the context:

          2.1 “Accrued Benefit” means, with respect to each Participant, the balance credited to his Deferred Compensation Account.

          2.2 “Active Participant” means, with respect to any day or date, a Participant who is in Service on such day or date; provided, that a Participant shall cease to be an Active Participant immediately upon a determination by the Committee that the Participant has ceased to be an Employee or Independent Contractor, or that the Participant no longer meets the eligibility requirements of the Plan.

          2.3 “Adoption Agreement” means the written agreement pursuant to which the Employer adopts the Plan. The Adoption Agreement is a part of the Plan as applied to the Employer.

          2.4 “Beneficiary” means the person, persons, entity or entities designated or determined pursuant to the provisions of Section 16 of the Plan.

          2.5 “Board” means the Board of Directors of the Employer, if the Employer is a corporation. If the Employer is not a corporation, “Board” shall mean the Employer.

          2.6 “Committee” means the administrative committee provided for in Section 12.

          2.7 “Compensation” shall have the meaning designated in the Adoption Agreement.

          2.8 “Crediting Date” means the date designated in the Adoption Agreement for crediting the amount of any Salary Deferral Credits to the Deferred Compensation Account of a Participant. Employer Credits may be credited to the Deferred Compensation Account of a Participant on any day that securities are traded on a national securities exchange.

          2.9 “Deferred Compensation Account” means the sum of the amounts credited to the Retirement Account, the In-Service Account and the Education Account of each Participant, as applicable. The Deferred Compensation Account of each Participant shall be adjusted as provided in Section 9.

          2.10 “Disability” means disability as defined in the Adoption Agreement.

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          2.11 “Education Account” means a separate account to be kept for each Participant that can be divided into one or more Education Subaccounts as described in Section 6.4. The Education Account shall be established, adjusted for payments, credited with Salary Deferral Credits, and credited or debited for deemed investment gains or losses in the same manner and at the same time as such adjustments are made to the Deferred Compensation Account under Section 9 and in accordance with the rules and elections in effect under Section 9.

          2.12 “Education Subaccount” means the subaccount of the Education Account which is maintained with respect to an Education Recipient. If the Participant does not designate more than one Education Recipient, the Education Account shall be the Education Subaccount with respect to such Education Recipient.

          2.13 “Education Recipient” means the individual designated by the Participant in the Salary Deferral Agreement with respect to whom the Participant will create an Education Subaccount.

          2.14 “Effective Date” shall be the date designated in the Adoption Agreement as of which the Plan first becomes effective.

          2.15 “Employee” means an individual in the Service of the Employer if the relationship between the individual and the Employer is the legal relationship of employer and employee and if the individual is a highly compensated or management employee of the Employer. An individual shall cease to be an Employee upon the Employee’s termination of Service.

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          2.16 “Employer” means the Employer identified in the Adoption Agreement, and any Participating Employer which adopts this Plan. The Employer may be a corporation, a limited liability company, a partnership or sole proprietorship. All references herein to the Employer shall be applied separately to each such Employer as if the Plan were solely the Plan of that Employer.

          2.17 “Employer Credits” means the amounts credited to the Participant’s Retirement Account by the Employer pursuant to the provisions of Section 4.2.

          2.18 “Independent Contractor” means an individual in the Service of the Employer if the relationship between the individual and the Employer is not the legal relationship of employer and employee. An individual shall cease to be an Independent Contractor upon the termination of the Independent Contractor’s Service. An Independent Contractor shall include a director of the Employer who is not an Employee.

          2.19 “In-Service Account” means a separate account to be kept for each Participant, as described in Section 6.1. The In-Service Account shall be established, adjusted for payments, credited with Salary Deferral Credits, and credited or debited for deemed investment gains or losses in the same manner and at the same time as such adjustments are made to the Deferred Compensation Account under Section 9 and in accordance with the rules and elections in effect under Section 9.

          2.20 “Normal Retirement Date” of a Participant is designated in the Adoption Agreement. The “Retirement Date” of a Participant means the date the Participant attains his Retirement Age.

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          2.21 “Participant” means with respect to any Plan Year an Employee or Independent Contractor who has been designated by the Committee as a Participant and who has entered the Plan or who has an Accrued Benefit under the Plan.

          2.22 “Participating Employer” means any trade or business (whether or not incorporated) which adopts this Plan with the consent of the Employer identified in the Adoption Agreement.

          2.23 “Plan” means The Executive Nonqualified Excess Plan™, as herein set out or as duly amended. The name of the Plan as applied to the Employer shall be designated in the Adoption Agreement.

          2.24 “Plan Administrator” means the person designated in the Adoption Agreement. If the Plan Administrator designated in the Adoption Agreement is unable to serve, the Employer shall be the Plan Administrator.

          2.25 “Plan Year” means the twelve-month period ending on the last day of the month designated in the Adoption Agreement.

          2.26 “Qualifying Distribution Event” means the Participant’s Retirement or the termination of Participant’s Service with the Employer for any reason, including as a result of his death or Disability, as described in Section 5.

          2.27 “Retire” or “Retirement” means Retirement within the meaning of Section 5.4.

          2.28 “Retirement Account” means a separate account to be kept for each Participant, as described in Section 4.3. The Retirement Account shall be established, adjusted for payments, credited with Salary Deferral Credits and Employer Credits, and credited or debited for deemed investment gains or losses in the same manner and at the same time as such

          

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adjustments are made to the Deferred Compensation Account under Section 9 and in accordance with the rules and elections in effect under Section 9.

          2.29 “Salary Deferral Agreement” means a written agreement entered into between a Participant and the Employer pursuant to the provisions of Section 4.1

          2.30 “Salary Deferral Credits” means the amounts credited to the Participant’s Deferred Compensation Account by the Employer pursuant to the provisions of Section 4.1.

          2.31 “Service” means employment by the Employer as an Employee. If the Participant is an Independent Contractor, “Service” shall mean the period during which the contractual relationship exists between the Employer and the Participant.

          2.32 “Sponsor” means Executive Benefit Services, Inc.

          2.33 “Spouse” or “Surviving Spouse” means, except as otherwise provided in the Plan, the legally married spouse or surviving spouse of a Participant.

          2.34 “Trust” means the trust fund established pursuant to Section 13.2, if designated by the Employer in the Adoption Agreement.

          2.35 “Trustee” means the trustee, if any, named in the agreement establishing the Trust and such successor or additional trustee as may be named pursuant to the terms of the agreement establishing the Trust.

          2.36 “Years of Service” means each Plan Year of Service completed by the Participant. For vesting purposes, Years of Service shall be calculated from the date designated in the Adoption Agreement.

          

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          Section 3. Participation;

          The Committee in its discretion shall designate each Employee or Independent Contractor who is eligible to participate in the Plan. An Employee or Independent Contractor designated by the Committee as a Participant who has not otherwise entered the Plan shall enter the Plan and become a Participant as of the date determined by the Committee. A Participant who separates from Service with the Employer and who later returns to Service will not be an Active Participant under the Plan except upon satisfaction of such terms and conditions as the Committee shall establish upon the Participant’s return to Service, whether or not the Participant shall have an Accrued Benefit remaining under the Plan on the date of his return to Service.

          Section 4. Credits to Deferred Compensation Account:

          4.1 Salary Deferral Credits. To the extent provided in the Adoption Agreement, each Active Participant may elect, by entering into a Salary Deferral Agreement with the Employer, to defer his Compensation from the Employer by a dollar amount or percentage specified in the Salary Deferral Agreement. The amount of the Participant’s Salary Deferral Credit shall be credited by the Employer to the Deferred Compensation Account maintained for the Participant pursuant to Section 9. The following special provisions shall apply with respect to the Salary Deferral Credits of a Participant:

     4.1.1 The Employer shall credit to the Participant’s Deferred Compensation Account on each Crediting Date an amount equal to the total Salary Deferral Credit for the period ending on such Crediting Date.

     4.1.2 An election pursuant to Section 4.1 shall be made by the Participant by executing and delivering a Salary Deferral Agreement to the Committee. The Salary Deferral Agreement shall become effective with respect to such Participant as of the first full payroll period commencing on or immediately following the first day of the Plan Year which occurs after the date such Salary Deferral Agreement is received by the Committee; provided, that a Participant who first becomes a Participant in the Plan during a Plan Year may enter into a Salary Deferral Agreement to be effective as of the first payroll period next following the date he enters the Plan. A Participant’s election shall continue

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in effect, unless earlier modified by the Participant, until the Service of the Participant is terminated, or, if earlier, until the Participant ceases to be an Active Participant under the Plan.

     4.1.3 A Participant may unilaterally modify a Salary Deferral Agreement (either to increase or decrease the portion of his future Compensation which is subject to salary deferral within the percentage limits set forth in Section 4.1 of the Adoption Agreement) by providing a written modification of the Salary Deferral Agreement to the Employer. The modification shall become effective as of the first full payroll period commencing on or immediately following the first day of the Plan Year which occurs after the date such written modification is received by the Committee. The Participant may terminate the Salary Deferral Agreement effective as of the date designated in the Adoption Agreement.

     4.1.4 The Committee may from time to time establish policies or rules governing the manner in which Salary Deferral Credits may be made.

          4.2 Employer Credits. If designated by the Employer in the Adoption Agreement, the Employer shall cause the Committee to credit to the Deferred Compensation Account of each Active Participant an Employer Credit as determined in accordance with the Adoption Agreement.

          4.3 Deferred Compensation Account. Unless otherwise designated by the Participant in the Salary Deferral Agreement, all Salary Deferral Credits made pursuant to Section 4.1 shall be credited to the Retirement Account of the Participant. All Employer Credits made pursuant to Section 4.2 shall be made to the Retirement Account of the Participant. The Retirement Account is a part of the Deferred Compensation Account of a Participant and shall be distributed upon a Qualifying Distribution Event.

          Section 5. Qualifying Distribution Events:

          5.1 Death of a Participant. If a Participant dies while in Service, the Employer shall pay a benefit to the Participant’s Beneficiary in the amount designated in the Adoption Agreement. Payment of such benefit shall be made by the Employer pursuant to Section 7. If a Participant dies following his Retirement or termination of Service for any

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reason, including Disability, and before all payments to him under the Plan have been made, the balance of the Participant’s vested Accrued Benefit shall be paid by the Employer to the Participant’s Beneficiary pursuant to Section 7, and such balance shall be determined as of the commencement date of the payments.

          5.2 Disability of a Participant. If a Participant suffers a Disability while in Service prior to his Normal Retirement Date, he shall terminate Service with the Employer as of the date of the establishment of his Disability, whereupon he shall commence receiving payment of his vested Accrued Benefit, determined as of the commencement date of the payments. Such benefit shall be paid by the Employer as provided in Section 7.

          5.3 Termination of Service. If the Service of a Participant with the Employer shall be terminated for any reason other than Retirement, Disability or death, his vested Accrued Benefit shall be paid to him by the Employer as provided in Section 7, and such Accrued Benefit shall be determined as of the commencement date of the payments. If a Participant’s Accrued Benefit is not fully vested at his termination of employment, he shall forfeit that portion of his Accrued Benefit that is not fully vested. If he subsequently returns to Service with the Employer, he shall be treated as a new Participant for purposes of determining the vested portion of his Accrued Benefit.

          5.4 Retirement. A Participant who is in Service on or after his Normal Retirement Date shall be eligible to Retire and commence receiving payment of his Accrued Benefit. Payment of such benefit shall be made by the Employer pursuant to Section 7.

          Section 6. Distributions While in Service:

          6.1 In-Service Withdrawals. If the Employer designates in the Adoption Agreement that in-service withdrawals are permitted under the Plan, a Participant may elect in the Salary Deferral Agreement to withdraw a designated amount from his Deferred

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Compensation Account at the specified time or times designated by the Participant in the Salary Deferral Agreement, and the Participant’s In-Service Account shall be credited with the amount designated for in-service withdrawals. The following special provisions shall apply with respect to the In-Service Account:

     6.1.1 Notwithstanding any provision in this Section 6 to the contrary, if Participant incurs a Qualifying Distribution Event prior to the date on which the entire balance of his In-Service Account has been distributed to him, then the balance in the In-Service Account on the date of the Qualifying Distribution Event shall be distributed to him in the same manner and at the same time as his Deferred Compensation Account is distributed to him under Section 7 and in accordance with the rules and elections in effect under Section 7.

     6.1.2 If permitted by the Employer in the Adoption Agreement, a Participant may defer the date of any withdrawal from the In-Service Account by giving notice of the new withdrawal date to the Committee within the time limits specified in the Adoption Agreement.

          6.2 Financial Hardship Withdrawals. If the Employer designates in the Adoption Agreement that financial hardship withdrawals are permitted under the Plan, a distribution of the Deferred Compensation Account may be made to a Participant on account of financial hardship, subject to the following provisions:

     6.2.1 A Participant may, at any time prior to his Retirement or termination of Service for any reason, including Disability, make application to the Committee to receive a distribution in a lump sum of all or a portion of the vested Accrued Benefit credited to his Deferred Compensation Account (determined as of the date the distribution, if any, is made under this Section 6.2) because of an unforeseeable emergency that results in severe financial hardship to the Participant. A distribution because of an unforeseeable emergency shall not exceed the amount required to meet the immediate financial need created by the unforeseeable emergency and not otherwise reasonably available from other resources of the Participant. Examples of an unforeseeable emergency shall include but shall not be limited to those financial needs arising on account of a sudden or unexpected illness or accident of the Participant or of a dependent of the Participant, loss of the Participant’s property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.

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     6.2.2 The Participant’s request for a distribution on account of financial hardship must be made in writing to the Committee. The request must specify the nature of the financial hardship, the total amount requested to be distributed from the Deferred Compensation Account, and the total amount of the actual expense incurred or to be incurred on account of financial hardship.

     6.2.3 If a distribution under this Section 6.2 is approved by the Committee, such distribution will be made as soon as practicable following the date it is approved. The processing of the request shall be completed as soon as practicable from the date on which the Committee receives the properly completed written request for a distribution on account of a financial hardship. If a Participant’s termination of Service occurs after a request is approved in accordance with this Section 6.2.3, but prior to distribution of the full amount approved, the approval of the request shall be automatically null and void and the benefits which the Participant is entitled to receive under the Plan shall be distributed in accordance with the applicable distribution provisions of the Plan. Only one financial hardship distribution shall be made within any Plan Year.

     6.2.4 The Committee may from time to time adopt additional policies or rules governing the manner in which such distributions may be made so that the Plan may be conveniently administered.

          6.3 “Haircut” Withdrawals. If the Employer designates in the Adoption Agreement that “haircut” withdrawals are permitted under the Plan, a Participant in Service may at his option make one or more withdrawals from his Deferred Compensation Account by written request to the Committee; provided, however, that a Participant who requests a withdrawal under this Section 6.3 shall incur a penalty (the “haircut”) equal to a percentage (not less than 10%), as designated by the Employer in the Adoption Agreement, of the amount withdrawn, and this penalty shall be forfeited from the Deferred Compensation Account of the Participant notwithstanding the provisions of Section 8.

          6.4 Education Withdrawals. If the Employer designates in the Adoption Agreement that education withdrawals are permitted under the Plan, a Participant may elect in the Salary Deferral Agreement for a designated percentage or dollar amount of the Salary Deferral Credits to be credited to the Education Account of the Education Recipient designated by the Participant. If the Participant designates more than one Education Recipient, the

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Education Account shall be divided into Education Subaccounts for each Education Recipient, and the Participant may designate in the Salary Deferral Agreement the percentage or dollar amount of each Salary Deferral Credit to be credited to each Education Subaccount. In the absence of a clear designation, all credits made to the Education Account shall be equally allocated to each Education Subaccount. As soon as practicable after the date designated by the Participant in the Salary Deferral Agreement, the Employer shall pay to the Participant the balance in the Education Subaccount with respect to such Education Recipient in the manner designated by the Participant in the Salary Deferral Agreement and permitted by the Employer in the Adoption Agreement. The following special provisions shall apply with respect to the Education Account:

     6.4.1 Notwithstanding any provision in this Section 6 to the contrary, if a Participant incurs a Qualifying Distribution Event prior to the date on which the entire balance of the Education Account has been distributed to him, then the balance in the Education Account on the date of the Qualifying Distribution Event shall be distributed to him in the same manner and at the same time as his Deferred Compensation Account is distributed to him under Section 7 and in accordance with the rules and elections in effect under Section 7.

     6.4.2 If permitted by the Employer in the Adoption Agreement, a Participant may defer the date of any withdrawal from the Education Account by giving notice of the new withdrawal date to the Committee within the time limits specified in the Adoption Agreement.

     Section 7. Qualifying Distribution Events Payment Options:

             7.1 Payment Options. The Employer shall designate in the Adoption Agreement the payment options available upon a Qualifying Distribution Event. Upon a Participant’s entry into the Plan, the Participant shall elect among these designated payment options the method under which his vested Accrued Benefit or, in the event of his death, any benefit payable as a result, will be distributed; provided, however, that if permitted by the Employer in the Adoption Agreement, a Participant may change the method of payment by

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giving notice of the new payment method to the Committee within the time limits specified in the Adoption Agreement. In the event the Participant fails to make a valid designation of the payment method, the distribution will be made in a single lump sum payment. Notwithstanding any election made by the Participant, the vested Accrued Benefit of the Participant will be distributed in a single lump sum payment if the amount of such benefit does not exceed the dollar limit specified by the Employer in the Adoption Agreement, if applicable.

             7.2 Prepayment. Notwithstanding any other provisions of this Plan, if a Participant or any other person (a “recipient”) is entitled to receive payments under the Plan, the Committee in its sole discretion may direct the Employer to prepay all or any part of the payments remaining to be made to or on behalf of the recipient, or to shorten the payment period. The amount of such prepayment shall be in full satisfaction of the Employer’s obligations hereunder to the recipient and to all persons claiming under or through the recipient with respect to the payments being prepaid. In the event of a partial prepayment, the Committee shall designate which installments are being prepaid and, if applicable, the accounts of the Participant from which such prepayments shall be debited. The Committee’s determinations under this Section 7.2 shall be final and conclusive upon all parties claiming benefits under this Plan.

     Section 8. Vesting:

             A Participant shall be fully vested in the portion of his Deferred Compensation Account attributable to Salary Deferral Credits, and all income, gains and losses attributable thereto. A Participant shall become fully vested in the portion of his Deferred Compensation Account attributable to Employer Credits, and income, gains and losses attributable thereto, in accordance with the vesting schedule and provisions designated by the Employer in the Adoption Agreement.

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             Section 9. Accounts; Deemed Investment; Adjustments to Account:

             9.1 Accounts. The Committee shall establish a book reserve account, entitled the “Deferred Compensation Account,” on behalf of each Participant. The Committee shall also establish a Retirement Account, In-Service Account and Education Account as a part of the Deferred Compensation Account of each Participant, if applicable. The amount credited to the Deferred Compensation Account shall be adjusted pursuant to the provisions of Section 9.3.

             9.2 Deemed Investments. The Deferred Compensation Account of a Participant shall be credited with an investment return determined as if the account were invested in one or more investment funds made available by the Committee. The Participant shall elect the investment funds in which his Deferred Compensation Account shall be deemed to be invested. Such election shall be made in the manner prescribed by the Committee and shall take effect upon the entry of the Participant into the Plan. The investment election of the Participant shall remain in effect until a new election is made by the Participant. In the event the Participant fails for any reason to make an effective election of the investment return to be credited to his account, the investment return shall be determined by the Committee.

             9.3 Adjustments to Deferred Compensation Account. With respect to each Participant who has a Deferred Compensation Account under the Plan, the amount credited to such account shall be adjusted by the following debits and credits, at the times and in the order stated:

     9.3.1 The Deferred Compensation Account shall be debited each business day with the total amount of any payments made from such account since the last preceding business day to him or for his benefit.

     9.3.2 The Deferred Compensation Account shall be credited on each Crediting Date with the total amount of any Salary Deferral Credits and Employer Credits to such account since the last preceding Crediting Date.

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     9.3.3 The Deferred Compensation Account shall be credited or debited on each day securities are traded on a national stock exchange with the amount of deemed investment gain or loss resulting from the performance of the investment funds elected by the Participant in accordance with Section 9.2. The amount of such deemed investment gain or loss shall be determined by the Committee and such determination shall be final and conclusive upon all concerned.

             Section 10. Benefit Exchange:

             If elected by the Employer in the Adoption Agreement, the Employer and the Participant may enter into an agreement under which the Participant’s vested Accrued Benefit may be exchanged for another nonqualified benefit in accordance with rules established by the Committee.

             Section 11. Transfer to Qualified Plan:

             If elected by the Employer in the Adoption Agreement and directed by the Participant in the Salary Deferral Agreement, the Employer shall transfer amounts from the Deferred Compensation Account of the Participant to the account of the Participant under a tax-qualified retirement plan maintained by the Employer and identified in the Adoption Agreement (the “Qualified Plan”) in accordance with the following procedures:

             11.1 Maximize Qualified Plan Deferrals. As soon as administratively feasible after the end of each Plan Year, the Employer shall determine the amount of Salary Deferral Credits made to the Deferred Compensation Account of the Participant for the Plan Year (excluding the amount of deemed investment gain or loss with respect thereto) which is eligible for transfer to the Qualified Plan. Such amount shall be determined so as to permit the maximum allocation to the account of the Participant under the Qualified Plan for the Plan Year without exceeding the limitations applicable to the Qualified Plan (including by way of illustration and not limitation, the limitations under Sections 402(g) and 401(k)(3) of the Code, and any successors thereto).

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             11.2 Maximize Qualified Plan Match. As soon as administratively feasible after the end of each Plan Year, the Employer shall determine the amount of any Employer Credits made as a matching amount to the Deferred Compensation Account of the Participant for the Plan Year (excluding the amount of deemed investment gain or loss with respect thereto) which is eligible for transfer to the Qualified Plan. Such amount shall be determined so as to permit the maximum allocation to the account of the Participant under the Qualified Plan for the Plan Year without exceeding the limitations applicable to the Qualified Plan (including by way of illustration and not limitation, the limitation under Section 401(m)(2) of the Code, and any successors thereto).

             11.3 Transfer Deferral to Qualified Plan. No later than two and one-half months following the end of the Plan Year, the Employer shall debit the amount determined under Section 11.1 from the Deferred Compensation Account of the Participant. If the Participant has directed in the Salary Deferral Agreement that such transfer be made, the Employer shall allocate such amount to the account of the Participant under the Qualified Plan. If the Participant has not directed such transfer, the Employer shall distribute such amount from the Deferred Compensation Account to the Participant.

             11.4 Credit Match to Qualified Plan. No later than two and one-half months following the end of the Plan Year, the Employer shall debit the amount determined under Section 11.2 from the Deferred Compensation Account of the Participant. If the transfer described in Section 11.3 is made, the Employer shall allocate the amount determined under Section 11.2 to the account of the Participant under the Qualified Plan. If such transfer is not made and the Participant receives a distribution of the amount determined under Section 11.1, the Participant shall forfeit the amount determined under Section 11.2.

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             11.5 Compliance with Qualified Plan. In its sole discretion, the Employer may make multiple transfers or distributions under this Section 11 during the Plan Year; provided, however, that no transfers shall be made under this Section 11 if precluded by the terms of the Qualified Plan.

             Section 12. Administration by Committee:

             12.1 Membership of Committee. The Committee shall consist of at least three individuals who shall be appointed by the Board to serve at the pleasure of the Board. Any member of the Committee may resign, and his successor, if any, shall be appointed by the Board. The Committee shall be responsible for the general administration and interpretation of the Plan and for carrying out its provisions, except to the extent all or any of such obligations are specifically imposed on the Board.

             12.2 Committee Officers; Subcommittee. The members of the Committee may elect Chairman and may elect an acting Chairman. They may also elect a Secretary and may elect an acting Secretary, either of whom may be but need not be a member of the Committee. The Committee may appoint from its membership such subcommittees with such powers as the Committee shall determine, and may authorize one or more of its members or any agent to execute or deliver any instruments or to make any payment on behalf of the Committee.

             12.3 Committee Meetings. The Committee shall hold such meetings upon such notice, at such places and at such intervals as it may from time to time determine. Notice of meetings shall not be required if notice is waived in writing by all the members of the Committee at the time in office, or if all such members are present at the meeting.

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             12.4 Transaction of Business. A majority of the members of the Committee at the time in office shall constitute a quorum for the transaction of business. All resolutions or other actions taken by the Committee at any meeting shall be by vote of a majority of those present at any such meeting and entitled to vote. Resolutions may be adopted or other action taken without a meeting upon written consent thereto signed by all of the members of the Committee.

             12.5 Committee Records. The Committee shall maintain full and complete records of its deliberations and decisions. The minutes of its proceedings shall be conclusive proof of the facts of the operation of the Plan.

             12.6 Establishment of Rules. Subject to the limitations of the Plan, the Committee may from time to time establish rules or by-laws for the administration of the Plan and the transaction of its business.

             12.7 Conflicts of Interest. No individual member of the Committee shall have any right to vote or decide upon any matter relating solely to himself or to any of his rights or benefits under the Plan (except that such member may sign unanimous written consent to resolutions adopted or other action taken without a meeting), except relating to the terms of his Salary Deferral Agreement.

             12.8 Correction of Errors. The Committee may correct errors and, so far as practicable, may adjust any benefit or credit or payment accordingly. The Committee may in its discretion waive any notice requirements in the Plan; provided, that a waiver of notice in one or more cases shall not be deemed to constitute a waiver of notice in any other case. With respect to any power or authority which the Committee has discretion to exercise under the Plan, such discretion shall be exercised in a nondiscriminatory manner.

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             12.9 Authority to Interpret Plan. Subject to the claims procedure set forth in Section 18 the Plan Administrator and the Committee shall have the duty and discretionary authority to interpret and construe the provisions of the Plan and to decide any dispute which may arise regarding the rights of Participants hereunder, including the discretionary authority to construe the Plan and to make determinations as to eligibility and benefits under the Plan. Determinations by the Plan Administrator and the Committee shall apply uniformly to all persons similarly situated and shall be binding and conclusive upon all interested persons.

             12.10 Third Party Advisors. The Committee may engage an attorney, accountant, actuary or any other technical advisor on matters regarding the operation of the Plan and to perform such other duties as shall be required in connection therewith, and may employ such clerical and related personnel as the Committee shall deem requisite or desirable in carrying out the provisions of the Plan. The Committee shall from time to time, but no less frequently than annually, review the financial condition of the Plan and determine the financial and liquidity needs of the Plan. The Committee shall communicate such needs to the Employer so that its policies may be appropriately coordinated to meet such needs.

             12.11 Compensation of Members. No fee or compensation shall be paid to any member of the Committee for his Service as such.

             12.12 Expense Reimbursement. The Committee shall be entitled to reimbursement by the Employer for its reasonable expenses properly and actually incurred in the performance of its duties in the administration of the Plan.

             12.13 Indemnification. No member of the Committee shall be personally liable by reason of any contract or other instrument executed by him or on his behalf as a member of the Committee nor for any mistake of judgment made in good faith, and the Employer shall

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indemnify and hold harmless, directly from its own assets (including the proceeds of any insurance policy the premiums for which are paid from the Employer’s own assets), each member of the Committee and each other officer, employee, or director of the Employer to whom any duty or power relating to the administration or interpretation of the Plan may be delegated or allocated, against any unreimbursed or uninsured cost or expense (including any sum paid in settlement of a claim with the prior written approval of the Board) arising out of any act or omission to act in connection with the Plan unless arising out of such person’s own fraud, bad faith, willful misconduct or gross negligence.

             Section 13. Contractual Liability; Trust:

             13.1 Contractual Liability. The obligation of the Employer to make payments hereunder shall constitute a contractual liability of the Employer to the Participant. Such payments shall be made from the general funds of the Employer, and the Employer shall not be required to establish or maintain any special or separate fund, or otherwise to segregate assets to assure that such payments shall be made, and the Participant shall not have any interest in any particular assets of the Employer by reason of its obligations hereunder. To the extent that any person acquires a right to receive payment from the Employer, such right shall be no greater than the right of an unsecured creditor of the Employer.

             13.2 Trust. If so designated in Section 2.34 of the Adoption Agreement, the Employer may establish a Trust with the Trustee, pursuant to such terms and conditions as are set forth in the Trust Agreement. The Trust, if and when established, is intended to be treated as a grantor trust for purposes of the Code. The establishment of the Trust is not intended to cause Participants to realize current income on amounts contributed thereto, and the Trust shall be so interpreted and administered.

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             Section 14. Allocation of Responsibilities:

             The persons responsible for the Plan and the duties and responsibilities allocated to each are as follows:

             14.1 Board.

       (i) To amend the Plan;

       (ii) To appoint and remove members of the Committee; and

       (iii) To terminate the Plan.

             14.2 Committee.

       (i) To designate Participants;

       (ii) To interpret the provisions of the Plan and to determine the rights of the Participants under the Plan, except to the extent otherwise provided in Section 19 relating to claims procedure;

       (iii) To administer the Plan in accordance with its terms, except to the extent powers to administer the Plan are specifically delegated to another person or persons as provided in the Plan;

       (iv) To account for the Accrued Benefits of Participants; and

       (v) To direct the Employer in the payment of benefits.

             14.3 Plan Administrator.

       (i) To file such reports as may be required with the United States Department of Labor, the Internal Revenue Service and any other government agency to which reports may be required to be submitted from time to time; and

       (ii) To administer the claims procedure to the extent provided in Section 19.

             Section 15. Benefits Not Assignable; Facility of Payments:

             15.1 Benefits not Assignable. No portion of any benefit credited or paid under the Plan with respect to any Participant shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, and any attempt so to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the same shall be void, nor shall any

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portion of such benefit be in any manner payable to any assignee, receiver or any one trustee, or be liable for his debts, contracts, liabilities, engagements or torts. Notwithstanding the foregoing, in the event that all or any portion of the benefit of a Participant is transferred to the former spouse of the Participant incident to a divorce, the Committee shall maintain such amount for the benefit of the former spouse until distributed in the manner required by an order of any court having jurisdiction over the divorce, and the former spouse shall be entitled to the same rights as the Participant with respect to such benefit.

             15.2 Payments to Minors and Others. If any individual entitled to receive a payment under the Plan shall be physically, mentally or legally incapable of receiving or acknowledging receipt of such payment, the Committee, upon the receipt of satisfactory evidence of his incapacity and satisfactory evidence that another person or institution is maintaining him and that no guardian or committee has been appointed for him, may cause any payment otherwise payable to him to be made to such person or institution so maintaining him. Payment to such person or institution shall be in full satisfaction of all claims by or through the Participant to the extent of the amount thereof.

             Section 16. Beneficiary:

             The Participant’s Beneficiary shall be the person or persons designated by the Participant on the Beneficiary designation form provided by and filed with the Committee or its designee. If the Participant does not designate a Beneficiary, the Beneficiary shall be his Surviving Spouse. If the Participant does not designate a Beneficiary and has no Surviving Spouse, the Beneficiary shall be the Participant’s estate. The designation of a Beneficiary may be changed or revoked only by filing a new Beneficiary designation form with the Committee or its designee. If a Beneficiary (the “primary Beneficiary”) is receiving or is entitled to receive payments under the Plan and dies before receiving all of the payments due him, the balance to

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which he is entitled shall be paid to the contingent Beneficiary, if any, named in the Participant’s current Beneficiary designation form. If there is no contingent Beneficiary, the balance shall be paid to the estate of the primary Beneficiary. Any Beneficiary may disclaim all or any part of any benefit to which such Beneficiary shall be entitled hereunder by filing a written disclaimer with the Committee before payment of such benefit is to be made. Such a disclaimer shall be made in a form satisfactory to the Committee and shall be irrevocable when filed. Any benefit disclaimed shall be payable from the Plan in the same manner as if the Beneficiary who filed the disclaimer had died on the date of such filing.

             Section 17. Amendment and Termination of Plan:

             The Board may amend any provision of the Plan or terminate the Plan at any time; provided, that in no event shall such amendment or termination reduce any Participant’s Accrued Benefit as of the date of such amendment or termination, nor shall any such amendment affect the terms of the Plan relating to the payment of such Accrued Benefit.

             Notwithstanding the foregoing, the Plan shall be terminated upon the occurrence of one or more of the events designated in the Adoption Agreement. Upon the occurrence of a termination event, the Accrued Benefit of each Participant may become fully vested and payable to the Participant in a lump sum if designated by the Employer in the Adoption Agreement.

             Section 18. Communication to Participants:

             The Employer shall make a copy of the Plan available for inspection by Participants and their beneficiaries during reasonable hours at the principal office of the Employer.

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             Section 19. Claims Procedure:

            The following claims procedure shall apply with respect to the Plan:

             19.1 Filing of a Claim for Benefits. If a Participant or Beneficiary (the “claimant”) believes that he is entitled to benefits under the Plan which are not being paid to him or which are not being accrued for his benefit, he shall file a written claim therefor with the Plan Administrator. In the event the Plan Administrator shall be the claimant, all actions which are required to be taken by the Plan Administrator pursuant to this Section 19 shall be taken instead by another member of the Committee designated by the Committee.

             19.2 Notification to Claimant of Decision. Within 90 days after receipt of a claim by the Plan Administrator (or within 180 days if special circumstances require an extension of time), the Plan Administrator shall notify the claimant of his decision with regard to the claim. In the event of such special circumstances requiring an extension of time, there shall be furnished to the claimant prior to expiration of the initial 90-day period written notice of the extension, which notice shall set forth the special circumstances and the date by which the decision shall be furnished. If such claim shall be wholly or partially denied, notice thereof shall be in writing and worded in a manner calculated to be understood by the claimant, and shall set forth: (i) the specific reason or reasons for the denial; (ii) specific reference to pertinent provisions of the Plan on which the denial is based; (iii) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary; and (iv) an explanation of the procedure for review of the denial and the time limits applicable to such procedures, including a statement of the claimant’s right to bring a civil action under ERISA following an adverse benefit determination on review.

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             19.3 Procedure for Review. Within 60 days following receipt by the claimant of notice denying his claim, in whole or in part, or, if such notice shall not be given, within 60 days following the latest date on which such notice could have been timely given, the claimant shall appeal denial of the claim by filing a written application for review with the Committee. Following such request for review, the Committee shall fully and fairly review the decision denying the claim. Prior to the decision of the Committee, the claimant shall be given an opportunity to review pertinent documents and to submit issues and comments in writing.

             19.4 Decision on Review. The decision on review of a claim denied in whole or in part by the Plan Administrator shall be made in the following manner:

     19.4.1 Within 60 days following receipt by the Committee of the request for review (or within 120 days if special circumstances require an extension of time), the Committee shall notify the claimant in writing of its decision with regard to the claim. In the event of such special circumstances requiring an extension of time, written notice of the extension shall be furnished to the claimant prior to the commencement of the extension. If the decision on review is not furnished in a timely manner, the claim shall be deemed denied as of the close of the initial 60-day period (or the close of the extension period, if applicable).

     19.4.2 With respect to a claim that is denied in whole or in part, the decision on review shall set forth specific reasons for the decision, shall be written in a manner calculated to be understood by the claimant, and shall cite specific references to the pertinent Plan provisions on which the decision is based.

     19.4.3 The decision of the Committee shall be final and conclusive.

             19.5 Action by Authorized Representative of Claimant. All actions set forth in this Section 19 to be taken by the claimant may likewise be taken by a representative of the claimant duly authorized by him to act in his behalf on such matters. The Plan Administrator and the Committee may require such evidence as either may reasonably deem necessary or advisable of the authority to act of any such representative.

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             Section 20. Miscellaneous Provisions:

             20.1 Set off. Notwithstanding any other provision of this Plan, the Employer may reduce the amount of any payment otherwise payable to or on behalf of a Participant hereunder by the amount of any loan, cash advance, extension of credit or other obligation of the Participant to the Employer that is then due and payable, and the Participant shall be deemed to have consented to such reduction.

             20.2 Notices. Each Participant who is not in Service and each Beneficiary shall be responsible for furnishing the Committee or its designee with his current address for the mailing of notices and benefit payments. Any notice required or permitted to be given to such Participant or Beneficiary shall be deemed given if directed to such address and mailed by regular United States mail, first class, postage prepaid. If any check mailed to such address is returned as undeliverable to the addressee, mailing of checks will be suspended until the Participant or Beneficiary furnishes the proper address. This provision shall not be construed as requiring the mailing of any notice or notification otherwise permitted to be given by posting or by other publication.

             20.3 Lost Distributees. A benefit shall be deemed forfeited if the Plan Administrator is unable to locate the Participant or Beneficiary to whom payment is due on or before the fifth anniversary of the date payment is to be made or commence; provided, that the deemed investment rate of return pursuant to Section 9.2 shall cease to be applied to the Participant’s account following the first anniversary of such date; provided further, however, that such benefit shall be reinstated if a valid claim is made by or on behalf of the Participant or Beneficiary for all or part of the forfeited benefit.

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             20.4 Reliance on Data. The Employer, the Committee and the Plan Administrator shall have the right to rely on any data provided by the Participant or by any Beneficiary. Representations of such data shall be binding upon any party seeking to claim a benefit through a Participant, and the Employer, the Committee and the Plan Administrator shall have no obligation to inquire into the accuracy of any representation made at any time by a Participant or Beneficiary.

             20.5 Receipt and Release for Payments. Subject to the provisions of Section 20.1, any payment made from the Plan to or with respect to any Participant or Beneficiary, or pursuant to a disclaimer by a Beneficiary, shall, to the extent thereof, be in full satisfaction of all claims hereunder against the Plan and the Employer with respect to the Plan. The recipient of any payment from the Plan may be required by the Committee, as a condition precedent to such payment, to execute a receipt and release with respect thereto in such form as shall be acceptable to the Committee.

             20.6 Headings. The headings and subheadings of the Plan have been inserted for convenience of reference and are to be ignored in any construction of the provisions hereof.

             20.7 Continuation of Employment. The establishment of the Plan shall not be construed as conferring any legal or other rights upon any Employee or any persons for continuation of employment, nor shall it interfere with the right of the Employer to discharge any Employee or to deal with him without regard to the effect thereof under the Plan.

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             20.8 Merger or Consolidation; Assumption of Plan. No employer-party to the Plan shall consolidate or merge into or with another corporation or entity, or transfer all or substantially all of its assets to another corporation, partnership, trust or other entity (a “Successor Entity”) unless such Successor Entity shall assume the rights, obligations and liabilities of the employer-party under the Plan and upon such assumption, the Successor Entity shall become obligated to perform the terms and conditions of the Plan. Nothing herein shall prohibit the assumption of the obligations and liabilities of the Employer under the Plan by any Successor Entity.

             20.9 Construction. The Employer shall designate in the Adoption Agreement the state according to whose laws the provisions of the Plan shall be construed and enforced, except to the extent that such laws are superseded by ERISA.

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EX-23

EXHIBIT 23

Consent of Independent Registered Public Accounting Firm

The Board of Directors
Mercer Insurance Group, Inc.:

We consent to incorporation by reference in the registration statement (No. 333-123758) on Form S-8 of Mercer Insurance Group, Inc. and subsidiaries of our reports dated March 16, 2007, with respect to the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2006 and 2005, 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, 2006, and all related financial statement schedules, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006 and the effectiveness of internal control over financial reporting as of December 31, 2006, which reports appear in the December 31, 2006 annual report on Form 10-K of Mercer Insurance Group, Inc.

Our reports dated March 16, 2007, with respect the consolidated balance sheets of Mercer Insurance Group Inc, and subsidiaries as of December 31, 2006 and 2005, 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, 2006, and related financial statement schedules contain an explanatory paragraph concerning the Company’s adoption of Statement of Financial Accounting Standards No. 123 (R) , Share Based Payment, effective January 1, 2006.

/s/ KPMG LLP
Philadelphia, Pennsylvania
March 16, 2007

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):

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(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, 2007

/s/ Andrew R. Speaker

Andrew R. Speaker

President and Chief Executive Officer

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EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, David B. Merclean, Senior Vice President of Finance 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):

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(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, 2007

/s/ David B. Merclean

David B. Merclean

Senior Vice President of Finance and Chief Financial Officer

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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 “Group”) on Form 10-K for the period ending December 31, 2006, 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 Group, 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 Group.

/s/ Andrew R. Speaker Andrew R. Speaker

President and Chief Executive Officer

March 16, 2007

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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 “Group”) on Form 10-K for the period ending December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David B. Merclean, Senior Vice President of Finance and Chief Financial Officer of the Group, 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 Group.

/s/ David B. Merclean David B. Merclean

Senior Vice President of Finance and Chief Financial Officer

March 16, 2007

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