FRONT ROYAL INC, S-1/A, 1998-07-29

FRONT ROYAL INC
S-1/A, 1998-07-29
SURETY INSURANCE

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 29, 1998

REGISTRATION NO. 333-57177

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
PRE-EFFECTIVE AMENDMENT NO. 1
TO
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

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FRONT ROYAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
NORTH CAROLINA 6331 56-1719109
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>

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2200 GATEWAY BLVD.
SUITE 205
MORRISVILLE, NC 27560
(919) 469-9795
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------

J. ADAM ABRAM
PRESIDENT AND CHIEF EXECUTIVE OFFICER
2200 GATEWAY BLVD.
SUITE 205
MORRISVILLE, NC 27560
(919) 469-9795
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------

With copies to:

<TABLE>
<S> <C>
KENNETH L. HENDERSON, ESQ. GARY I. HOROWITZ, ESQ.
ROBINSON SILVERMAN PEARCE ARONSOHN & BERMAN LLP SIMPSON THACHER & BARTLETT
1290 AVENUE OF THE AMERICAS 425 LEXINGTON AVENUE
NEW YORK, NEW YORK 10104 NEW YORK, NEW YORK 10017
PHONE (212) 541-2000 PHONE (212) 455-7113
FAX (212) 541-4630 FAX (212) 455-2502
</TABLE>

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APPROXIMATE DATE OF COMMENCEMENT OF THE PROPOSED SALE TO THE PUBLIC: As
soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
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CALCULATION OF REGISTRATION FEE

<TABLE>
<CAPTION>
PROPOSED PROPOSED
TITLE OF EACH CLASS AMOUNT TO BE MAXIMUM OFFERING MAXIMUM AGGREGATE AMOUNT OF
OF SECURITIES TO BE REGISTERED REGISTERED PRICE PER SHARE OFFERING PRICE(1) REGISTRATION FEE
<S> <C> <C> <C> <C>
Common Stock, no par value per
share................................. -- -- $96,800,000 $28,556(2)
</TABLE>

(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457 of the Securities Act of 1933, as amended.

(2) $7,576 of such fee has been paid.

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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH
SECTION 8(a), MAY DETERMINE.
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<PAGE>

EXPLANATORY NOTE

This Registration Statement covers (i) the primary offering of shares of
Common Stock by the Company and the offering of shares of Common Stock by the
Selling Shareholders and (ii) the offering of shares of Common Stock by Wycon
Corporation ('Wycon') and United American Financial Services Corporation
('UnaMark'; and together with Wycon, the 'Alternate Selling Shareholders'). The
Company is registering for sale under the primary Prospectus (the 'Offering
Prospectus') 3,300,000 shares of Common Stock and the 1,700,000 shares of Common
Stock being offered by the Selling Shareholders. The Company is registering
300,000 shares of Common Stock owned by the Alternate Selling Shareholders in an
Alternate Selling Shareholders' Prospectus (the 'Alternate Selling Shareholders'
Prospectus'). The Alternate Selling Shareholders' Prospectus pages, which follow
the Offering Prospectus, contain sections which are to be combined with all of
the sections contained in the Offering Prospectus, with the following
exceptions: the Front Cover Page, the Back Cover Page, the section entitled
'Prospectus Summary--The Offering,' the section entitled 'Use of Proceeds' and
the section entitled 'Principal and Selling Shareholders' contained in the
Offering Prospectus will be replaced with the alternate Front Cover Page, the
alternate Back Cover Page, the alternate section entitled 'Prospectus
Summary--The Alternate Selling Shareholders' Offering,' the alternate section
entitled 'Use of Proceeds' and the alternate section entitled 'Principal
Shareholders,' respectively, each of which is contained in the Alternate Selling
Shareholders' Prospectus pages following the Offering Prospectus. In addition,
the sections entitled 'Concurrent Sales' and 'Alternate Selling Shareholders and
Plan of Distribution' from the Alternate Selling Shareholders' Prospectus pages
following the Offering Prospectus will be added to the Alternate Selling
Shareholders' Prospectus. Furthermore, (i) the section entitled 'Underwriting'
contained in the Offering Prospectus will be deleted from the Alternate Selling
Shareholders' Prospectus and all references to the Underwriting section in the
Alternate Selling Shareholders' Prospectus will have no effect and (ii) all
references to the offering in the Offering Prospectus and the Alternate Selling
Shareholders' Prospectus shall refer to the offering under the Offering
Prospectus.

i
<PAGE>

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT.
A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

SUBJECT TO COMPLETION, DATED JULY 29, 1998
PROSPECTUS
, 1998

5,000,000 SHARES

Front Royal, Inc.

COMMON STOCK

Of the 5,000,000 shares of Common Stock, no par value per share (the
'Common Stock'), of Front Royal, Inc. ('Front Royal' or the 'Company') offered
hereby (the 'Offering'), 3,300,000 shares are being sold by the Company and
1,700,000 shares are being sold by the Selling Shareholders (as defined herein).
The Company will not receive any of the proceeds from the sale of Common Stock
by the Selling Shareholders. See 'Principal and Selling Shareholders.'

Prior to the Offering, there has been no public market for the Common
Stock. It is currently estimated that the initial public offering price will be
between $14.00 and $16.00 per share. See 'Underwriting' for information relating
to the factors considered in determining the initial public offering price.

Application has been made to list the Common Stock on the Nasdaq National
Market under the symbol 'FRYL.' There can be no assurance that such listing
application will be approved.

The Registration Statement, of which this Prospectus is a part, also covers
the offering of 75,000 shares of Common Stock held by Wycon Corporation
('Wycon') and 225,000 shares of Common Stock held by United American Financial
Services Corporation ('UnaMark'). Such shares of Common Stock may be sold
commencing 180 days following the date of this Prospectus.

SEE 'RISK FACTORS' BEGINNING ON PAGE 11 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS PROCEEDS TO
TO THE DISCOUNTS AND TO THE THE SELLING
PUBLIC COMMISSIONS(1) COMPANY(2) SHAREHOLDERS
<S> <C> <C> <C> <C>
Per Share................................. $ $ $ $
Total(3).................................. $ $ $ $
</TABLE>

(1) The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See 'Underwriting.'
(2) Before deducting expenses estimated at $ , which will be paid by the
Company.

(3) The Company and the Selling Shareholders have granted the Underwriters a
30-day option to purchase up to 750,000 additional shares of Common Stock,
at the Price to the Public less Underwriting Discounts and Commissions,
solely to cover over-allotments, if any. If such option is exercised in
full, the total Price to the Public, Underwriting Discounts and Commissions,
Proceeds to the Company and Proceeds to the Selling Shareholders will be
$ , $ , $ and $ , respectively. See 'Underwriting.'

The shares are being offered by the several Underwriters, when, as and if
delivered to and accepted by the Underwriters and subject to various prior
conditions, including their right to reject orders in whole or in part. It is
expected that delivery of share certificates will be made in New York, New York,
on or about , 1998.

DONALDSON, LUFKIN & JENRETTE
BT ALEX. BROWN
WHEAT FIRST UNION
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING,
AND MAY BID FOR AND PURCHASE SHARES OF THE COMMON STOCK IN THE OPEN MARKET. FOR
A DESCRIPTION OF THESE ACTIVITIES, SEE 'UNDERWRITING.'

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FRONT ROYAL, A NORTH CAROLINA CORPORATION, PRIOR TO THE CLOSING OF THE
OFFERING WILL OWN ALL OF THE SHARES OF CAPITAL STOCK OF CERTAIN INSURANCE
COMPANIES DOMICILED IN THE STATES OF OHIO, PENNSYLVANIA, VIRGINIA AND FLORIDA.
THE INSURANCE LAWS OF THOSE STATES REQUIRE PRIOR APPROVAL BY THEIR RESPECTIVE
STATE INSURANCE COMMISSIONERS OF ANY ACQUISITION OF CONTROL OF A DOMESTIC
INSURANCE COMPANY OR OF ANY COMPANY WHICH CONTROLS A DOMESTIC INSURANCE COMPANY.
'CONTROL' IS GENERALLY PRESUMED TO EXIST THROUGH THE OWNERSHIP OF, OR THE
HOLDING OF PROXIES WITH RESPECT TO 10.0% (5.0% IN FLORIDA) OR MORE OF THE VOTING
SECURITIES OF A DOMESTIC INSURANCE COMPANY OR OF ANY COMPANY WHICH CONTROLS A
DOMESTIC INSURANCE COMPANY. ACCORDINGLY, ANY PURCHASE RESULTING IN A PURCHASER'S
HOLDING THE POWER TO VOTE 10.0% (5.0% IN FLORIDA) OR MORE OF THE OUTSTANDING
SHARES OF COMMON STOCK WOULD REQUIRE PRIOR APPROVAL BY THE INSURANCE
COMMISSIONERS OF THE ABOVE-REFERENCED STATES. SEE 'RISK FACTORS-- ANTI-TAKEOVER
CONSIDERATIONS, INCLUDING POSSIBILITY OF FUTURE ISSUANCE OF PREFERRED STOCK.'

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

AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
'Commission'), Washington, D.C., a Registration Statement on Form S-1 under the
Securities Act of 1933, as amended (the 'Securities Act'), with respect to the
Common Stock offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and such
Common Stock, reference is hereby made to such Registration Statement and the
exhibits and schedules thereto. Statements contained in this Prospectus as to
the contents of any contract or any other document are not necessarily complete,
and in each instance reference is made to the copy of such contract or document
filed as an exhibit to the Registration Statement, each such statement being
qualified in all respects by such reference. The Registration Statement,
including the exhibits and schedules thereto, may be inspected and copied at the
public reference facilities maintained by the Commission at its principal office
located at 450 Fifth Street, N.W., Washington, D.C. 20549, the New York Regional
Office located at 7 World Trade Center, 13th Floor, New York, New York 10048,
and the Chicago Regional Office located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can be
obtained from the Public Reference Section of the Commission, at 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates and from the
Commissions website, at http://www.sec.gov.

The Company intends to furnish its shareholders with annual reports
containing audited financial statements examined and reported upon by
independent certified public accountants and with quarterly reports containing
unaudited interim financial information for each of the first three fiscal
quarters of each fiscal year.

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2
<PAGE>
PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and the historical and pro
forma financial statements, including the notes thereto, appearing elsewhere in
this Prospectus. Unless otherwise specified, all financial information is
presented in accordance with generally accepted accounting principles ('GAAP').
Financial information presented in accordance with statutory accounting
practices ('SAP') is identified as such. Unless the context otherwise requires,
all references in this Prospectus to: (i) 'Front Royal' or the 'Company' refer
to Front Royal, Inc. and, depending on the context, its subsidiaries on a
consolidated basis; (ii) 'Colony' refers to Colony Holdings, Inc. and its
subsidiaries including Colony Insurance Company ('Colony Insurance') and its
subsidiary, Front Royal Insurance Company ('FRIC'); (iii) 'Rockwood' refers to
Rockwood Casualty Insurance Company and its subsidiary, Somerset Casualty
Insurance Company; (iv) 'Redwoods' refers to The Redwoods Group, Inc.; (v)
'Preferred National' refers to Preferred National Insurance Company and the
'Preferred National Acquisition' refers to the announced acquisition by the
Company of all of the capital stock of Preferred National as well as certain
assets and liabilities of Wycon Corporation, United American Financial Services
Corporation ('UnaMark') (the business of which will become a part of Redwoods)
and Americlaim Adjustment Corp.; (vi) 'Subsidiaries' refers to Colony, Rockwood
and Redwoods; and (vii) 'Insurance Subsidiaries' refers to Colony and Rockwood.
Unless otherwise indicated, the information contained in this Prospectus assumes
that: (i) the underwriters over-allotment option (the 'Over-Allotment Option')
is not exercised; (ii) the Recapitalization, as defined in 'The
Recapitalization,' has been completed; (iii) the Preferred National Acquisition
has not been completed; and (iv) the initial public offering price is $15.00 per
share. The financial statements beginning on page F-1 do not reflect the
Recapitalization. Certain terms used herein are defined in 'Glossary of Selected
Insurance Terms.'

THE COMPANY

GENERAL

Front Royal is an insurance holding company which acquires and operates
property and casualty insurance companies that underwrite specialty coverages.
The Company's strategy is to acquire companies with particular marketing,
underwriting and claims expertise in their markets, which enables them to
achieve superior underwriting results. Since commencing operations in 1992, the
Company has acquired Front Royal Insurance Company in May 1992, Colony in
December 1994, Rockwood in December 1996 and Redwoods in January 1998. In March
1998, the Company announced the Preferred National Acquisition, which it expects
to complete in July 1998. See 'Business--General.'

The Subsidiaries provide commercial liability, professional liability and
other insurance to targeted types of businesses, primarily on an excess and
surplus lines ('E&S') basis, and workers' compensation insurance for non-union
coal mines and other specialized risk classes. The Company's primary operating
objective is to achieve consistent profits from its core business of
underwriting insurance, as evidenced by an average SAP combined ratio (as
defined in 'Glossary of Selected Insurance Terms') from 1995 through 1997 of
98.8%. The Company pursues this goal by focusing on niche markets in which it
has particular expertise, adhering to disciplined underwriting and claims
practices and utilizing various distribution channels, including wholesale
agents, retail agents and direct marketing, depending on which channel most
effectively reaches the Company's targeted customers in each market. The Company
manages the Subsidiaries on a decentralized basis to enable them to respond
effectively to changing conditions in the markets in which they operate, while
consolidating investment, financial, actuarial and other support functions to
achieve operating efficiencies. The Company believes that generally there are
fewer companies competing in the specialty markets it pursues than in the
standard lines markets because the specialty markets are relatively small and
require specialized underwriting and targeted distribution.

3
<PAGE>

premiums grew from $49.9 million in 1996 to $100.2 million in 1997, primarily as
a result of acquiring Rockwood. See 'Business--Colony--Lines of Business' and
'Business--Rockwood--Lines of Business' for Colony's and Rockwood's historical
gross written premiums, respectively. The Company's net operating income/(loss)
(excluding after-tax realized gains) has grown from $(800,000) in 1992 to $3.0
million in 1995 and $10.6 million in 1997. Pro forma 1997 gross written premiums
and net operating income, assuming the Preferred National Acquisition had been
completed on January 1, 1997, were $146.4 million and $12.8 million,
respectively. In 1995, 1996 and 1997, the Company achieved an average return on
equity of 26.3%, 24.1% and 20.8%, respectively. From 1995 through 1997, the
Company's average SAP combined ratio was 98.8%.

DESCRIPTION OF THE SUBSIDIARIES AND PREFERRED NATIONAL

Colony. Colony provides commercial liability, commercial property,
products liability and environmental liability coverages to commercial
enterprises, including restaurants, artisan contractors, day-care centers and
manufacturers, and professional liability coverages for health care providers
(other than physicians) and other professionals. Colony operates primarily on an
E&S basis, which the Company believes better permits Colony to focus on insureds
who generally cannot purchase insurance from standard lines insurers due to the
perceived risks related to their businesses. E&S carriers operate in accordance
with provisions of state insurance laws which permit greater flexibility in
pricing and structuring coverages than is given to standard lines carriers.
Policies written on an E&S basis are generally not supported by state sponsored
insurance guarantee funds. See 'Business--Regulation--General.' Colony offers
its coverages through 133 wholesale agent offices (representing 69 agencies)
located throughout the U.S. These agents, in turn, solicit and receive premiums
from over 30,000 retail agents. Colony is an admitted insurer in nine states and
is approved as a non-admitted insurer in 44 states. Colony has an 'A-' rating
from A.M. Best. A.M. Best determines its ratings based upon factors concerning
policyholders and not upon factors concerning investors. Such ratings are
subject to change and do not constitute recommendations to buy, sell or hold
securities. See 'Business--Colony' and 'Business-- Ratings.'

Preferred National. The Company announced the Preferred National
Acquisition in March 1998 and expects that it will be completed in July 1998.
Preferred National focuses on many of the same coverages and risk classes as
does Colony. In addition, Preferred National offers surety, property and inland
marine coverages not offered by Colony. Approximately 60% of Preferred
National's business is written on an admitted basis in Florida. The Company
believes that Preferred National, which will be managed by Colony's management
team, will enhance Colony's business by increasing the scale of Colony's
operations and by broadening the scope of the Company's product offerings.
Preferred National offers coverage through 154 wholesale agent offices, 40 of
which also have an appointment with Colony. Preferred National's largest
wholesale agent is UnaMark, a captive agency the business of which will be
acquired in the Preferred National Acquisition and thereafter operate as a
division of Redwoods. Through UnaMark and its other wholesale agents, the
Company believes that Preferred National has access to over 20,000 retail
agents. Preferred National's surety business is produced directly through retail
agents. A substantial portion of the professional liability business written by
Preferred National is produced through four risk purchasing groups that have
direct communications with accountants, lawyers, title agents and dentists.
Preferred National is an admitted insurer in Florida and Illinois and is
approved as a non-admitted insurer in 36 states. Preferred National is rated
'B++' by A.M. Best. See 'Business--Preferred National' and 'Business--Ratings.'

Rockwood. Rockwood primarily writes specialty workers' compensation
insurance for non-union coal mines, other mining businesses and small premium or
specialty commercial accounts. Rockwood operates principally in Pennsylvania,
Maryland and, to a lesser extent, in four other states. Rockwood also offers
commercial coverages, generally for insureds covered by Rockwoods workers'
compensation policies, including general liability, property, automobile and
surety. Rockwood offers its coverages through 659 independent agents and
brokers. Rockwood is an admitted insurer in six states and has a 'B++' rating
from A.M. Best. See 'Business--Rockwood' and 'Business--Ratings.'

4
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The following table shows the gross written premiums of the Insurance
Subsidiaries and Preferred National in 1997:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------
GROSS WRITTEN PERCENT
PREMIUMS OF TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Colony................................................................ $ 50,562 34.5%
Preferred National.................................................... 46,133 31.6
Rockwood.............................................................. 49,684 33.9
------------- --------
Total.......................................................... $ 146,379 100.0%
------------- --------
------------- --------
</TABLE>

The following table compares the SAP combined ratios of Colony and
Preferred National to the property and casualty insurance industry as a whole
and the SAP combined ratios of Rockwood to the workers' compensation industry as
a whole for the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
SAP COMBINED RATIOS:
Colony................................................... 99.6% 97.2% 98.4% 117.8% 109.3%
Preferred National....................................... 98.7% 81.7% 105.5% 103.1% 76.2%
Property and Casualty Insurance Industry (1)............. 101.6% 105.8% 106.5% 108.4% 106.9%
Rockwood................................................. 102.0% 102.3%(2) 100.6% 105.5% 111.8%
Workers' Compensation Insurance Industry (1)............. N/A 99.7% 97.0% 101.4% 108.8%
</TABLE>

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(1) Source: A.M. Best.
(2) Excludes loss reserve redundancies of $23.8 million recognized prior to its
acquisition by the Company. The actual combined ratio, including these
redundancies, was 64.0%.

Redwoods. The Company acquired Redwoods in January 1998. Redwoods, which
was a start-up business when acquired by the Company, is a managing general
underwriter which provides brokerage, underwriting and claims management
services to insurance companies. Redwoods produces business for the Insurance
Subsidiaries and for third party insurers not affiliated with the Company. The
Company acquired Redwoods in anticipation of acquiring substantially all of the
assets and liabilities of UnaMark, which in 1997 produced approximately 36.0% of
Preferred National's gross written premiums. Following the anticipated
completion of the Preferred National Acquisition, UnaMark will operate as a
division of Redwoods. See 'Business--Redwoods.'

BUSINESS STRATEGY

Focus on Specialty Insurance Markets. The Company believes that it can
continue to operate profitably and earn attractive returns on its capital by
focusing on specialty insurance markets in which it has particular marketing,
underwriting and claims expertise and in which generally there are fewer
competitors than in standard lines markets. The Company manages the Subsidiaries
on a decentralized basis to enable them to respond effectively to changing
conditions in the markets in which they operate, while consolidating investment,
financial, actuarial and other support functions to achieve operating
efficiencies. The Subsidiaries utilize various distribution channels, including
wholesale agents, retail agents and direct marketing, depending on which channel
most effectively reaches their targeted customers in each market.

Acquire Additional Specialty Insurance Businesses. The Company has
achieved significant growth and profitability by pursuing its acquisition
strategy. The Company intends to pursue additional acquisitions of specialty
insurance businesses which have particular expertise in profitable markets. The
Company seeks acquisitions which are accretive to its earnings per share and
book value per share, as have been all of the insurance company acquisitions the
Company has completed to date.

Achieve Superior Underwriting Results. The Company seeks to achieve
consistent underwriting profitability through disciplined underwriting, pricing
and claims management. The Company pays incentive compensation to the senior
management of each Insurance Subsidiary primarily based on underwriting
profitability. In addition to standard commissions, the Company provides
incentives to its agents to produce

5
<PAGE>
profitable business through a contingent commission structure which is
substantially tied to underwriting profitability.

Expand Existing Insurance Operations. The Company intends to grow the
businesses of its Subsidiaries through enhanced product offerings, additional
coverages, geographic expansion and increased penetration in its existing
markets. The Company believes that agents and other customers generally find it
most efficient to transact business with a limited number of insurers who
provide most or all of the products they require. The Company, therefore,
focuses on continually enhancing the quality and broadening the scope of its
products in order to better serve the needs of agents and customers.

Manage Capital Actively. The Company actively manages its capital
structure in order to maximize returns to its stockholders. The Company expects
to finance its future acquisitions with a combination of debt and equity and
does not seek to raise or retain more capital than it believes it can properly
deploy. In 1997, the Company operated at a ratio of net written premiums to
surplus of 1.2:1. On a pro forma basis for the three months ended March 31,
1998, the Company operated at a ratio of net written premiums (on an annualized
basis) to surplus of 1.4:1. As of March 31, 1998, the Company had a ratio of
total debt to total capitalization of 35.9%. The Company plans to use a portion
of the net proceeds from the Offering to repay a substantial portion of its
existing indebtedness. The Company has received a commitment for a $50.0 million
revolving bank credit facility (the 'Credit Facility') to support future
acquisitions. The Company intends to enter into the Credit Facility shortly
after completion of the Offering. See 'Use of Proceeds' and 'Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources.'

PREFERRED NATIONAL ACQUISITION

On March 6, 1998, the Company executed a definitive agreement to purchase
the stock of Preferred National and substantially all of the assets and business
of UnaMark, Wycon and Americlaim Adjustment Corp. ('Americlaim'), affiliates of
Preferred National, for a total purchase price of $35.0 million in cash, subject
to adjustment, 300,000 shares of Common Stock and warrants to purchase 630,000
shares of Common Stock at an exercise price of $16.67 per share, which warrants
will be exercisable for seven and one-half years following the closing of the
Preferred National Acquisition (the 'Preferred National Warrants'). The cash
portion of the purchase price is subject to adjustment based on Preferred
National's levels of GAAP book value, SAP surplus, and cash and invested assets
as of the month end immediately prior to closing. While the Company believes
that completion of the Preferred National Acquisition is highly probable, and
will occur in July 1998, there can be no assurance when or if the transaction
will be completed. See 'Business--Preferred National.'

SIGNIFICANT EQUITY OWNERSHIP OF EXECUTIVE OFFICERS

The Company's executive officers currently beneficially own approximately
6.5% of the Common Stock and will beneficially own 4.5% of the Common Stock
after completion of the Offering. The significant equity ownership of the
Company by its officers demonstrates their commitment to the Company's future
success and aligns their interests with those of other shareholders. J. Adam
Abram, the Company's President and Chief Executive Officer, has indicated an
interest in purchasing approximately $250,000 of additional shares of Common
Stock in the Offering, which, if purchased, will result in his beneficial
ownership of 4.0% of the Common Stock, assuming completion of the Offering. See
'Principal and Selling Shareholders.'

CORPORATE INFORMATION

The Company is a North Carolina corporation whose corporate offices are
located at 2200 Gateway Boulevard, Suite 205, Morrisville, North Carolina 27560.
The Company's telephone number is (919) 469-9795. Colony's principal offices are
located in Richmond, Virginia, and Rockwood's principal offices are located in
Rockwood, Pennsylvania. See 'Business--Facilities.' As of July 24, 1998, the
Company had approximately 190 employees. See 'Business--Employees.'

6
<PAGE>

RECENT OPERATING RESULTS

The following table sets forth unaudited historical operating results for
the Company and its subsidiaries on a consolidated basis without giving effect
to the Preferred National Acquisition or, unless otherwise stated, the
Recapitalization. Operating results for the six months ended June 30, 1998, are
not necessarily indicative of results that may be expected for the entire year
ending December 31, 1998.

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
Total revenue.................................................................. $48,402 $55,917
Net income available to common shareholders.................................... 4,209 4,128
Net income per share--diluted.................................................. $ 0.36 $ 0.37
SAP combined ratio............................................................. 99.5% 100.8%
Shareholders' equity........................................................... $49,772 $38,061
Book value per share........................................................... $ 5.31 $ 4.09

Adjusted Per Share Data(1)
Net income per share--diluted................................................ $ 0.60 $ 0.62
Book value per share......................................................... $ 9.10 $ 7.51
</TABLE>

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

(1) Assumes the Recapitalization, including the conversion of the Company's
Series A Redeemable Convertible Preferred Stock, no par value (the 'Series A
Preferred Stock') into Common Stock, has occurred.

The Company's revenues have declined for the six months ended June 30, 1998
compared to the six months ended June 30, 1997, primarily as a result of
reductions in workers' compensation premium rates promulgated by Pennsylvania.
The Company believes that the reductions in workers' compensation premium rates
will be offset by the benefits of workers' compensation reform legislation in
Pennsylvania. These reforms significantly lowered both medical reimbursement
costs and wage indemnity costs to workers' compensation insurers. The decrease
in the combined ratio for the six months ended June 30, 1998 compared to the six
months ended June 30, 1997 reflects the effect of these reforms, among other
factors.

RISK FACTORS

No assurances can be given that the Company's objectives or strategies will
be achieved. Prospective investors should consider carefully the factors
discussed in detail elsewhere in this Prospectus under the caption 'Risk
Factors.'

7
<PAGE>
THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company............................ 3,300,000 shares
Common Stock offered by the Selling Shareholders............... 1,700,000 shares
Common Stock to be outstanding after the Offering(1)........... 10,775,555 shares
Use of Proceeds(2)............................................. The net proceeds to the Company from the
Offering, after deducting underwriting discounts
and commissions and estimated offering expenses,
are estimated to be approximately $45.2 million.
The Company expects to use the net proceeds from
the Offering to repay existing bank debt, to pay
accrued dividends on the Series A Preferred
Stock and for general corporate purposes. The
Company will not receive any of the proceeds
from the sale of shares of Common Stock by the
Selling Shareholders. See 'Use of Proceeds.'
Proposed Nasdaq National Market Symbol......................... FRYL
</TABLE>

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

(1) Includes 300,000 shares of Common Stock to be issued in connection with the
Preferred National Acquisition. See 'Business--Preferred National.' Assumes
no exercise of outstanding stock options and warrants. As of the date of
this Prospectus, there are outstanding options and warrants to purchase
945,826 shares of Common Stock at a weighted average price of $4.70 per
share, excluding certain price adjustment warrants which the Company does
not expect will be exercised. Does not include an aggregate of 1,500,000
shares of Common Stock reserved for future issuance under the Company's
employee stock plans. See 'Capitalization,' 'Description of Capital Stock,'
'Management--Stock Option Plans' and Note 12 of Notes to the Front Royal,
Inc. and Subsidiaries Consolidated Financial Statements.

(2) The Company has received a commitment letter for the Credit Facility, which
it anticipates will close shortly following the Offering. The Credit
Facility will be available for, among other things, future acquisitions.

<PAGE>
SUMMARY HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL DATA

The following tables set forth certain summary historical financial
information for the Company and certain unaudited pro forma financial
information. Such pro forma financial information gives effect to the Preferred
National Acquisition and the Recapitalization as if they had occurred on the
dates and for the periods indicated herein, and gives effect to the pro forma
adjustments described in the notes to the unaudited pro forma financial
statements appearing elsewhere in this Prospectus. The pro forma financial
information is not necessarily indicative of the results that actually would
have occurred had the Preferred National Acquisition been consummated on the
dates indicated or that may be obtained in the future. See 'Pro Forma Condensed
Combined Financial Statements.'

The historical operating results data, per share data and balance sheet
data for the Company are derived from the consolidated audited financial
statements of the Company for the three year period ended December 31, 1997. The
historical operating results data, per share data and balance sheet data set
forth below for the three months ended March 31, 1997 and 1998 are derived from
unaudited financial statements. The unaudited financial statements include all
adjustments, consisting of normal recurring accruals only, which the Company
considers necessary for a fair presentation of the financial position and the
results of operations for these periods. Operating results for the three months
ended March 31, 1998 are not necessarily indicative of results that may be
expected for the entire year ending December 31, 1998.

All historical operating results data, per share data and balance sheet
data set forth below should be read in conjunction with the consolidated
financial statements of the Company, combined financial statements of Preferred
National, together with related notes and other financial information of the
Company and Preferred National, respectively, included in this Prospectus.

The unaudited pro forma financial data presented do not reflect any future
events that may occur after the Preferred National Acquisition has been
consummated. The Company believes that, on a combined basis, the Company and
Preferred National can be operated less expensively. However, for the purposes
of the unaudited pro forma financial data presented herein, these anticipated
expense savings have not been reflected.

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, YEARS ENDED DECEMBER 31,
------------------------------ ------------------------------------------
PRO PRO
FORMA FORMA
1998(1) 1998 1997 1997(1) 1997 1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA(2):
Revenues:
Gross written premiums.................. $ 32,881 $ 22,968 $ 27,407 $146,379 $100,246 $ 49,948 $ 43,571
Net written premiums.................... 28,460 19,879 24,200 128,480 88,031 43,404 37,655
Net earned premiums..................... 29,105 20,167 24,308 119,102 90,523 42,115 36,537
Net investment income................... 4,788 4,265 4,266 19,097 17,984 5,867 5,449
Net realized capital gains/(losses)..... 44 4 42 (477) (480) (1) 838
Other income............................ 509 56 27 3,643 331 631 726
-------- -------- -------- -------- -------- -------- --------
Total revenues........................ 34,446 24,492 28,643 141,365 108,358 48,612 43,550
Losses and expenses:
Loss and loss adjustment expenses....... 17,562 12,187 15,791 73,352 56,196 26,110 22,566
Policy acquisition costs amortized...... 7,869 5,763 6,457 30,511 25,829 12,729 11,133
Other underwriting expenses............. 2,132 1,171 956 7,829 3,471 2,074 2,076
Interest expense........................ 1,013 881 1,155 4,410 3,883 2,029 1,645
Dividends to policyholders.............. 737 737 1,130 3,603 3,603 -- --
Other expenses.......................... 1,093 206 40 6,176 1,806 538 1,314
-------- -------- -------- -------- -------- -------- --------
Total losses and expenses............. 30,406 20,945 25,529 125,881 94,788 43,480 38,734
-------- -------- -------- -------- -------- -------- --------
Income before income taxes................ 4,040 3,547 3,114 15,484 13,570 5,132 4,816
Income tax expense........................ 1,325 1,133 791 2,954 2,211 621 1,264
-------- -------- -------- -------- -------- -------- --------
Net income................................ 2,715 2,414 2,323 12,530 11,359 4,511 3,552
Dividends to preferred shareholders....... -- 271 271 -- 1,085 -- --
-------- -------- -------- -------- -------- -------- --------
Net income available to common
shareholders............................ $ 2,715 $ 2,143 $ 2,052 $ 12,530 $ 10,274 $ 4,511 $ 3,552
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
Net operating income(3)................... $ 2,686 $ 2,140 $ 2,025 $ 12,840 $ 10,586 $ 4,512 $ 3,007
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
</TABLE>

9
<PAGE>

ADJUSTED PER SHARE DATA(4):
Net income per share--diluted............. $ 0.33 $ 0.30 $ 0.31 $ 1.56 $ 1.47 $ 1.17 $ 0.93
Net operating income per share--diluted... $ 0.33 $ 0.30 $ 0.30 $ 1.60 $ 1.51 $ 1.17 $ 0.78
Book value per share(5)................... $ 9.23 $ 8.78 $ 7.20 $ 8.93 $ 8.47 $ 7.07 $ 5.08

BALANCE SHEET DATA (AT END OF PERIOD)(6):
Cash and invested assets.................. $317,470 $279,513 $261,626 $317,752 $280,629 $253,555 $ 89,162
Total assets.............................. 416,471 357,325 343,909 414,320 356,315 339,987 113,527
Senior bank debt.......................... 41,571 35,295 38,000 42,820 36,545 38,000 13,384
Shareholders' equity...................... 68,998 47,498 34,083 66,762 45,262 33,154 17,409
Book value per share(5)................... $ 9.23 $ 5.07 $ 3.83 $ 8.93 $ 4.83 $ 3.73 $ 3.05

SAP AND OTHER DATA(2):
Loss ratio................................ 60.4% 60.5% 65.0% 63.0% 63.9% 61.8% 61.5%
Expense ratio............................. 35.9 34.2 30.8 34.6 32.8 35.4 36.9
Dividend ratio............................ 2.9 4.2 4.7 3.2 4.2 -- --
-------- -------- -------- -------- -------- -------- --------
Combined ratio............................ 99.2% 98.9% 100.5% 100.8% 100.9% 97.2% 98.4%
======== ======== ======== ======== ======== ======== ========
Ratio of net written premiums to SAP
surplus(7).............................. 1.4x 1.0x 1.4x 1.6x 1.2x 0.7x 1.4x
SAP surplus (at end of period)............ $ 81,914 $ 76,149 $ 68,716 $ 79,169 $ 74,417 $ 65,852 $ 26,150
Return on equity(7)(8).................... 16.7% 15.6% 18.9% 21.7% 20.8% 24.1%(9) 26.3%
</TABLE>

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

(1) Assumes the Recapitalization, including the conversion of the Series A
Preferred Stock into Common Stock, has occurred. Also assumes that the
Preferred National Acquisition had occurred on January 1, 1997 for purposes
of income statement presentation and March 31, 1998 and December 31, 1997,
respectively, for all balance sheet amounts presented. The Company believes
that, on a combined basis, the Company and Preferred National can be
operated less expensively. However, for the purposes of the unaudited
pro forma financial data presented herein, these anticipated expense
savings have not been reflected.

(2) Includes operations of Rockwood from January 1, 1997.

(3) Net operating income is equal to net income available to common shareholders
excluding after-tax realized gains or losses at a 35.0% marginal tax rate.

(4) Reflects the Recapitalization for all periods presented.

(5) Excludes the exercise of all warrants and options then exercisable.

(6) Includes assets and liabilities of Rockwood from December 31, 1996.

(7) Interim period amounts are presented on an annualized basis.

(8) Calculated based on the average of the beginning and ending shareholders'
equity for the period.

(9) Excludes $28.6 million of equity raised on December 31, 1996, in connection
with the acquisition of Rockwood. Absent this adjustment, the average return
on equity for 1996 would have been 13.7%.

10
<PAGE>
RISK FACTORS

In addition to the other information in the Prospectus, the following risk
factors should be considered carefully by prospective investors in evaluating
the Company before purchasing the Common Stock offered hereby.

CERTAIN RISKS AFFECTING THE INSURANCE INDUSTRY

Factors affecting the sectors of the insurance industry in which the
Company operates may subject the Company to significant fluctuations in
operating results. These factors include competition, catastrophic losses and
general economic conditions, including interest rate changes, as well as
legislative initiatives, the frequency of litigation and the size of judgments.
The property and casualty insurance market is influenced by many factors,
including state insurance laws, market conditions for property and casualty
insurance and state assigned risk and residual market plans. Additionally, an
economic downturn in the states in which the Company operates could result in
less demand for property and casualty insurance. Downturns in the financial
prospects of industries targeted by the Company could also result in less demand
for the Company's products. The impact of these factors can dramatically affect
demand for the Company's products, insurance capacity, pricing and claims
experience and, consequently, the Company's business, results of operations or
financial condition.

Historically, the financial performance of the property and casualty
insurance industry has tended to fluctuate in cyclical patterns of soft markets
followed by hard markets. Although an individual insurance company's financial
performance depends in part upon its own specific business characteristics, the
profitability of most property and casualty insurance companies tends to follow
this cyclical market pattern. At present, the property and casualty insurance
industry is experiencing a prolonged soft market, and the extension of current
market conditions could have an adverse effect on the Company's business,
results of operations or financial condition. There can be no assurance that a
hard market will emerge or, if it does emerge, that it will have a favorable
impact on the Company. See 'Management's Discussion and Analysis of Financial
Condition and Results of Operations.'

RISKS OF RAPID GROWTH AND CHANGES IN MIX OF BUSINESS

The Company has grown rapidly over the last few years. The Company believes
that a substantial portion of its future growth will depend on its ability,
among other things, to: (i) identify and acquire on favorable terms insurance
companies or books of business which the Company believes can be operated
profitably; (ii) increase its business through continued marketing efforts;
(iii) expand its business in states where it presently does business and into
additional states; and (iv) expand its business by offering additional products
and programs. Such future growth is contingent on various factors, including the
availability of adequate capital, the Company's ability to target, acquire and
integrate insurance companies or lines of business which the Company believes
can be operated profitably, the Company's ability to hire and train additional
personnel, regulatory requirements and rating agency considerations. As the
Company's mix of business and territories changes, there can be no assurance
that the Company will be able to maintain its profit margins or other operating
results. There is no assurance that the Company will be successful in expanding
its business, that the existing infrastructure will be able to support such
additional expansion or that such new business will be profitable. See '--Risks
Associated with Acquisitions' and 'Business.'

RISKS OF WRITING ON A NON-ADMITTED BASIS

Colony writes virtually all of its business as an approved non-admitted
carrier, and has nine admitted licenses. Preferred National also writes a
material portion of its business in states other than Florida and Illinois, as
an approved non-admitted carrier. Increasingly, there is regulatory and market
pressure to write business that has historically been written on a non-admitted
basis on an admitted basis. The principal difference between writing on an
admitted basis and a non-admitted basis is that as a non-admitted carrier, a
company is subject to less regulation regarding the wording of its insurance
policies and the prices it charges for insurance. When writing on a non-admitted
basis, Colony and Preferred National are generally exempt from assessments made
to support the guaranty funds maintained by certain state regulatory
authorities. These assessments can be substantial. Over time, the Company
expects that more of its traditional business will be written on an admitted
basis, and the Company has a strategy to increase the number of states in which
it is admitted. However, if the market moves more rapidly than anticipated
toward admitted carriers to the detriment of approved non-admitted carriers,
Colony's and Preferred National's business may be adversely affected.

11
<PAGE>
COMPETITION

The Company competes in the property and casualty insurance business with
numerous domestic and international insurers. Many of the Company's existing or
potential competitors are larger, have considerably greater financial and other
resources, have more licenses, have more experience in the insurance industry
and offer a broader line of insurance products than the Company. The Company may
compete with new entrants in the future. Competition is based on many factors,
including the perceived market strength of the insurer, pricing and other terms
and conditions, services provided, the speed of claims payment, the reputation
and experience of the insurer and ratings assigned by independent rating
organizations. Although the Company's business strategy is to achieve an
underwriting profit by identifying niche markets and specialty coverages which
it believes have relatively fewer competitors than in standard lines, it
nevertheless encounters competition from carriers engaged in insuring risks in
broader lines of business which encompass the Company's niche and specialty
markets. Competition is expected to increase as the Company expands its
operations. Larger carriers may have lower expense ratios allowing them to price
their products more competitively than the Company. Ultimately, this competition
could affect the Company's ability to attract business at rates likely to
generate underwriting profits, which could have a material adverse effect on the
Company. See 'Business--Competition.'

The competitive environment for Colony and Preferred National has been
affected as many reinsurers have elected to bypass primary companies such as
Colony and Preferred National and make arrangements to work directly with
wholesale agents. As a result, Colony and Preferred National sometimes compete
with reinsurers and reinsurance intermediaries for business from wholesale
agents. Management regards this trend as a competitive threat to carriers such
as Colony and Preferred National. The Company responds in part by structuring
incentive compensation arrangements with its agents. However, if this trend
continues it could have a material adverse effect on the Company.

Rockwood, which writes on an admitted basis, also has very few admitted
licenses and often competes with carriers that are part of groups which own
several admitted carriers that have broad licensure. This allows those
competitors more rate flexibility than Rockwood currently enjoys because these
competitors can have various members of their group file different rates for
workers compensation insurance and then channel business to the member of its
group which has the appropriate rate filed for the business being underwritten.
In many cases, Rockwood has only one rate filed and is unable to react as
flexibly as its competitors. This can cause Rockwood to lose desirable business
to competitors. In addition, Rockwood's rating from A.M. Best is lower than the
A.M. Best rating of many of its competitors.

RISK THAT LOSS RESERVES MAY NOT BE ADEQUATE

The liabilities for unpaid losses and loss adjustment expenses ('LAE') are
estimated by management utilizing methods and procedures which it believes are
reasonable and in compliance with regulatory requirements. The reserves held by
the Insurance Subsidiaries are reviewed annually by independent actuaries.
Nevertheless, reserve estimates are subject to the impact of loss development
and changes in claims severity, as well as numerous other factors, such as
judicial and legislative trends and actions, economic factors and estimates of
future trends in claims frequency. Most or all of these factors are not directly
quantifiable, particularly on a prospective basis. Although management believes
the estimated liabilities for losses and LAE are reasonable, the subsequent
development of these liabilities may not conform to the assumptions used in
making these estimates. Accordingly, actual results may vary significantly from
the estimated amounts included in the Company's financial statements. Any
variation of actual from estimated liabilities could have a material adverse
effect on the Company. Such adjustments, to the extent they occur, are reported
in the period recognized. See 'Management's Discussion and Analysis of Financial
Condition and Results of Operations,' 'Business--Reserves,' and Note 6 of the
Notes to the Consolidated Financial Statements included elsewhere in this
Prospectus.

The Company has owned and supervised the operation of the Insurance
Subsidiaries for less than their entire operating history and has not yet
acquired Preferred National. The Insurance Subsidiaries and Preferred National
are responsible as a matter of law and contractual obligation for losses which
arise from policies written by prior management personnel who are no longer
employed by the Company. There can be no assurance that adjustments to reserves
may not be required in the future.

Rockwood uses a 4.0% discount factor when establishing its reserves for
workers' compensation business (Rockwood does not discount its reserves on any
of its other lines and Colony does not discount any of its reserves). Such
discounting is a common practice among workers' compensation insurers; however,
it does
12
<PAGE>
expose the Company to additional risk. Essentially, Rockwood has set its
reserves using an assumption that the Company will be able to consistently earn
a 4.0% rate of return on its workers' compensation reserves, and has assumed
that these additional revenues will be available to supplement those reserves.
If the Company is unable to earn a consistent return of 4.0% or if the Company
were required to use a lower discount rate, or to cease discounting, Rockwood
would have to raise its reserve levels. This could have a material adverse
effect on earnings in a future year.

The Company has performed extensive reviews of its records to identify
insured accounts for which unintended environmental exposure and exposure for
asbestos-related illnesses might exist. As a result of this review, the Company
identified three insured accounts with policy terms of up to five years (the
latest of which expired in 1987) where an asbestos-related exposure exists. In
addition, the Company has three insured accounts (with policy terms of up to
seven years) in which claims have been asserted arising out of alleged exposure
to lead-based paint. Reserves for such environmental and asbestos-related
exposures cannot be estimated with traditional loss reserving techniques. Case
reserves (and the costs of related litigation) have been established based on
information that has been developed on known claimants. In addition, incurred
but not yet reported ('IBNR') reserves have been established to cover additional
exposure on both known and unasserted claims. Those reserves are reviewed and
updated continually by management and outside actuaries. In establishing
liabilities for claims for environmental exposure and asbestos-related
illnesses, management considers facts currently known, the current state of the
law and litigation arising from coverage issues. However, courts and
legislatures have, in the past, attempted to expand coverage and liability.
Although the Company believes that this amount should be limited by the very
small number of identified insured accounts, limited policy terms, already
partially exhausted policy limits, and the existence of significant applicable
reinsurance, there can be no assurance that adjustments to such environmental
and asbestos-related reserves may not be required in the future. At March 31,
1998 asbestos-related reserves were $2.6 million on a gross basis and $500,000
net of reinsurance.

RISKS ASSOCIATED WITH ACQUISITIONS

Following the Offering, the Company will continue to pursue acquisitions of
insurance companies and lines of business that can be acquired on acceptable
terms and which the Company believes can be operated profitably. Some of these
acquisitions could be material in size and scope. The Company's future growth
depends, in large part, upon the successful implementation of this strategy.
While the Company will continually be searching for acquisition opportunities,
there can be no assurance that the Company will be successful in identifying
suitable acquisitions. If any potential acquisition opportunities are
identified, there can be no assurance that the Company will consummate such
acquisitions, including the Preferred National Acquisition, or, if any such
acquisition does occur, including the Preferred National Acquisition, that it
will be successful in enhancing the Company's business or be accretive to either
the Company's profitability or book value. The Company may in the future face
increased competition for acquisition opportunities which may inhibit its
ability to consummate suitable acquisitions. In addition, to the extent that the
Company's acquisition strategy results in the acquisition of businesses, such
acquisitions could pose a number of special risks, including the diversion of
management's attention, the assimilation of the operations and personnel of the
acquired companies, the integration of acquired assets with existing assets,
adverse short-term effects on reported operating results, the amortization of
acquired intangible assets and the loss of key employees.

The Company may, in the future, issue additional Common Stock in connection
with one or more acquisitions, which may dilute its shareholders, including
investors in the Offering. Common Stock and options to purchase Common Stock
will be issued in connection with the Preferred National Acquisition. See
'Business--Preferred National.' Additionally, with respect to future
acquisitions, the Company's shareholders may not have an opportunity to review
the financial statements of the entity being acquired or to vote on such
acquisitions.

RISKS ASSOCIATED WITH RATINGS

Increased public and regulatory concerns with the financial stability of
insurers have resulted in greater emphasis by agents and policyholders upon
insurance company ratings, resulting in a potential competitive advantage for
carriers with higher ratings. Colony's rating from A.M. Best was recently raised
from 'B++' to 'A-' and each of Rockwood and Preferred National currently has a
'B++' rating from A.M. Best. A.M. Best determines its ratings based upon factors
concerning policyholders and not upon factors concerning investors. Such ratings
are subject to change and do not constitute recommendations to buy, sell or hold
securities. There

13
<PAGE>
can be no assurance that such ratings or future changes therein will not affect
the Company's competitive position. There can be no assurance that Colony,
Rockwood or Preferred National will maintain their ratings, and any downgrade
could have a material adverse effect on their respective operations. See
'--Competition' and 'Business--Ratings.'

DEPENDENCE UPON KEY PERSONNEL

The Company's business involves the identification and completion of future
acquisitions, the development and innovative underwriting of insurance coverage
for niche markets and the continuing evaluation of the programs insured. The
Company depends upon its executive management, including executive management of
Colony and Rockwood, to perform such services. The loss of any of these
individuals or a reduction in the time devoted by such persons to the Company's
business could have a material adverse effect on the Company's business. The
Company does not have key-man life insurance on any of its executive officers,
other than John P. Yediny. The Company's future success will depend in part upon
its ability to attract and retain highly qualified personnel. The Company faces
competition for such personnel from other companies, many of which have
significantly greater resources than the Company. There can be no assurance that
the Company will be able to attract and retain the necessary personnel on
acceptable terms. See 'Business' and 'Management.'

RISKS ASSOCIATED WITH REINSURANCE

To moderate the impact of severe or frequent losses, the Insurance
Subsidiaries and Preferred National cede (i.e., transfer) a portion of their
gross written premiums to reinsurers in exchange for the reinsurers' agreements
to share covered losses with such Insurance Subsidiaries. This also allows the
Company to write more direct insurance and at greater limits than it otherwise
could. Although reinsurance makes the assuming reinsurer liable to the extent of
the risk ceded, the ceding insurance company is not relieved of its primary
liability to its insureds and, therefore, bears a credit risk with respect to
its reinsurers. Although the Insurance Subsidiaries and Preferred National place
reinsurance with reinsurers they believe to be financially sound, there can be
no assurance that such reinsurers will pay all reinsurance claims on a timely
basis, if at all. At March 31, 1998, the Company and Preferred National had net
reinsurance recoverables and prepaid reinsurance balances of approximately $28.0
million and $6.3 million, respectively. Further, although the Company has
reinsurance it believes to be adequate, there can be no assurance it will
continue to be able to obtain such reinsurance on satisfactory terms. The
Company may choose in the future to re-evaluate the amount of risk it cedes to
reinsurers. See 'Business-- Reinsurance.'

RISKS ASSOCIATED WITH BINDING AUTHORITY OF AGENTS

In 1997, Colony underwrote approximately 71.5% of its commercial policies
on a binding authority basis. In the event that a wholesale agent exceeds its
authority by binding Colony on a risk which does not comply with Colony's
underwriting guidelines, Colony is at risk for that policy until it receives the
policy and effects a cancellation or modification. Colony generally requires its
agents to deliver all policies to Colony within 30 days of the date written.
There can be no assurance that the wholesale agents will bind Colony within the
limits of Colony's underwriting guidelines or deliver policies to Colony in a
timely manner. As a result, Colony may be bound by a policy which does not
comply with its underwriting guidelines and may incur loss and LAE related to
that policy. Although Colony requires its agents to maintain errors and
omissions insurance coverage with limits of at least $500,000, there can be no
assurance that such insurance is in place, or, if in place, that it will be
adequate. Although Preferred National's agents currently have more limited
binding authority than Colony's agents, Preferred National is subject to the
same risks associated with binding authority as Colony. In the future, the
Company may provide greater binding authority to Preferred National's agents.
See 'Business--Colony-- Marketing and Distribution' and 'Business--Preferred
National--Marketing and Distribution.'

RISKS ASSOCIATED WITH REGULATION

The Company is subject to regulation under applicable insurance statutes,
including insurance holding company statutes, of the various states in which the
Insurance Subsidiaries write insurance. Insurance regulation is intended to
provide safeguards for policyholders rather than to protect shareholders of
insurance companies or their holding companies. Regulators oversee matters
relating to trade practices, policy forms and coverage interpretation, claims
practices, mandated participation in shared markets, including guaranty funds,
types and amounts of investments, reserve adequacy, insurer solvency, minimum
amounts of capital and surplus,

14
<PAGE>
transactions with related parties, changes in control and payment of dividends.
The rates that the Insurance Subsidiaries can charge for certain lines of
admitted business are also subject to regulation and, therefore, may not keep
pace with inflation. Any changes in these laws and regulations, or the failure
of the Company to comply with such laws, could materially adversely affect the
Company's operations. As a writer of admitted coverages, Preferred National is
subject to assessments from the Guaranty Fund in Florida, the amounts of which
can be substantial. An approved non-admitted carrier in New Jersey, Preferred
National is subject to assessments from a similar fund in New Jersey. See
'Business--Regulation.'

RISKS OF CONCENTRATION OF BUSINESS

Rockwood's business is heavily concentrated in workers' compensation
insurance in Pennsylvania and is further concentrated in coal-mining operations.
This makes Rockwood vulnerable to changes affecting the economy of Pennsylvania
or to economic cycles in which the coal business in Pennsylvania is depressed.
By concentrating a substantial portion of its business in mining operations,
Rockwood is exposed to substantial losses due to accidents and occupational
disease. Preferred National's business is heavily concentrated in commercial and
multi-peril insurance in Florida. This makes Preferred National vulnerable to
changes affecting the economy of Florida. By concentrating a substantial portion
of its business in property insurance, Preferred National is exposed to
substantial losses due to natural disaster, including hurricanes. The Company
attempts to moderate these risks by the purchase of reinsurance and by
underwriting and pricing accounts with these risks in mind. However, there can
be no assurance that these precautions are adequate and that the Company will
not be exposed to greater than anticipated losses arising from the hazardous
nature of the business conducted by its insureds. See 'Business--Preferred
National' and 'Business--Rockwood.'

DEPENDENCE UPON AGENTS AND RELATIONSHIPS WITH RISK PURCHASING GROUPS

Colony, Preferred National and Rockwood each depend upon outside agents to
produce their business. The renewal rights of all of such business written are
owned by the agents, and not by the Company. While Colony, Preferred National
and Rockwood believe that their relationships with their agents are generally
excellent, there can be no assurance that agents will not move business
currently written by the Company to another carrier. If renewal rates were to
drop significantly at Colony, Rockwood or Preferred National as a result of
agents moving this business, the earnings of the Company could be adversely
affected. The Company had one agency relationship (Burns & Wilcox, Limited)
which produced more than 10% of its 1997 gross written premiums. This agency
produced approximately $12.9 million (12.8%) of 1997 gross written premiums.
Preferred National had no agency other than UnaMark (as discussed below) produce
more than 10% of its 1997 gross written premiums.

Approximately $11.8 million (23.5%) and $12.9 million (25.4%) of Colony's
gross written premiums for the years ended December 31, 1996 and 1997,
respectively, were derived from Burns & Wilcox, Limited which currently sells
Colony's products in 26 of its offices. Approximately $14.9 million (21.5%) and
$13.0 million (26.2%) of Rockwood's gross written premiums were derived from two
agents for the years ended December 31, 1996 and 1997, respectively. The loss of
any of these agents could have a material adverse effect on the Company. See
'Business--Colony--Marketing and Distribution' and
'Business--Rockwood--Marketing and Distribution.'

Approximately 36.0% of Preferred National's business in 1997 was produced
by UnaMark, which, in turn, receives premiums from retail agents. If UnaMark's
(or, following the Preferred National Acquisition, Redwoods') relations with
retail agents were to deteriorate, resulting in reduced premium flow, it could
have an adverse impact on Preferred National. Approximately 46.0% of Preferred
National's gross written premiums in 1997 was produced by wholesale agents other
than UnaMark. The largest amount of premiums produced by any single agent other
than UnaMark represented 3.0% of Preferred National's 1997 premiums.

Forty agent offices represent both Colony and Preferred National. The
deterioration of these relationships could have an adverse effect on the
Company's performance. See 'Business--Preferred National.'

Approximately $5.4 million (11.6%) of Preferred National's gross written
premiums in 1997 was associated with professional liability insurance. Most of
this business arises out of Preferred National's relationship with four risk
purchasing groups. These risk purchasing groups are not required to endorse
insurance policies written by Preferred National and could endorse a
competitor's product. If this occurred, Preferred National might suffer a loss
of a substantial portion of this business.

15
<PAGE>

RISKS ASSOCIATED WITH HOLDING COMPANY STRUCTURE; DIVIDEND RESTRICTIONS

Because Front Royal is a holding company, its cash flows will depend, to a
significant degree, on the ability of the Subsidiaries to pay dividends to Front
Royal. In addition, Front Royal relies on dividends from its Subsidiaries to pay
operating expenses, debt service, taxes and other payments which may include
dividends on the Common Stock, if any. The jurisdictions of incorporation of the
Insurance Subsidiaries and Preferred National place limitations on the amount of
dividends or other distributions payable by insurance companies in order to
protect their solvency. There is no assurance Front Royal will be able to obtain
dividends from the Insurance Subsidiaries in the future. The payment of
dividends and distributions by the Insurance Subsidiaries also may affect the
Insurance Subsidiaries' ratings. See 'Business--Regulation.'

RISKS ASSOCIATED WITH YEAR 2000 COMPLIANCE

Many existing application software products in the marketplace were
designed to accommodate only a two-digit date position which represents the year
(e.g., '95' is stored on the system and represents the year 1995). As a result,
the year 1999 ('99') could be the maximum date value these systems will be able
to process accurately. To the extent the Company's systems are not fully year
2000 compliant or the Company's computer systems must interact with the computer
systems of other entities which are not year 2000 compliant, there can be no
assurance that potential systems interruptions or the resulting costs necessary
to remediate systems and to compensate for any losses would not have a material
adverse effect on the Company's business, financial condition, results of
operations, cash flows and business prospects. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations.'

Although the Company has not received any claims based on losses resulting
from the year 2000 issues, there can be no assurance that insureds will not
suffer losses of this type and seek compensation under the Company's policies.
If any claims are made, the Company's obligations, if any, will depend on the
facts and circumstances of the claim and provisions of the policy. At this time,
the Company is unable to determine whether the adverse impact, if any, in
connection with the foregoing circumstances would be material to the Company.

NO PRIOR PUBLIC MARKET AND POSSIBLE VOLATILITY OF PRICE

Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market for the Common
Stock will develop or be sustained after the Offering. The stock market
generally, and securities of insurance companies in particular, have from time
to time experienced significant price and volume fluctuations that are unrelated
to the operating performance of any particular company. The Company believes
factors such as quarterly fluctuations in results of operations, announcements
of new products and acquisitions by the Company or by its competitors, changes
in earnings estimates by research analysts, changes in accounting treatment or
principles and other factors may cause the market price of the Common Stock to
fluctuate, perhaps substantially. These fluctuations, as well as general
economic, political and market conditions, may adversely affect the market
prices of the Common Stock. See '--Certain Risks Affecting the Insurance
Industry' and 'Management's Discussion and Analysis of Financial Condition and
Results of Operations.' The initial public offering price of the Common Stock
will be determined by negotiations among the Company and the Underwriters and
may not be indicative of the prices that may prevail for the Common Stock in the
public market, and is not necessarily related to the Company's asset value, net
worth, results of operations or any other established criteria of value. See
'Underwriting.'

DILUTION

The initial public offering price of the Common Stock offered hereby is
substantially higher than the net tangible book value of the currently
outstanding Common Stock (giving effect to the Preferred National Acquisition).
Therefore, purchasers of the Common Stock offered hereby will experience
immediate and substantial dilution in the net tangible book value of the Common
Stock in the amount of $6.02 per share (40.1%). See 'Dilution.'

Purchasers of Common Stock in the Offering may experience dilution in the
future as a result of Common Stock issued in connection with future acquisitions
or for other purposes. See 'Business--Business Strategy.' Common Stock and
options to purchase Common Stock will be issued in connection with the Preferred
National Acquisition. See 'Business--Preferred National.'

16
<PAGE>

PREFERENCE TO BE GRANTED TO HOLDERS OF CLASS C COMMON STOCK

Pursuant to the Recapitalization, simultaneously with the consummation of
the Offering, the existing classes of the Company's Common Stock will be
exchanged for one class of Common Stock. Currently, the holders of the Company's
Class C Common Stock, no par value, ('Class C Common Stock') are entitled to a
$4.00 per share ($6.67, adjusted to reflect the Reverse Split) liquidation
preference which they will lose once their Class C Common Stock is exchanged for
Common Stock. Pursuant to the Recapitalization, the Company, following
negotiations with the holders of the Class C Common Stock, agreed, as part of
the Recapitalization, to enter into an agreement with the holders of the Class C
Common Stock to grant them a contractual liquidation preference substantively
similar to the one they will be losing in the Recapitalization. Such liquidation
preference will not be transferrable and will not be attached to the Common
Stock issued to the holders of the Class C Common Stock pursuant to the
Recapitalization. See 'The Recapitalization.' Pursuant to such liquidation
preference, if the Company is liquidated, and the amount to be distributed to
all shareholders as a result of such liquidation, including the current holders
of the Class C Common Stock, is less than $6.67 per share, the current holders
of the Class C Common Stock, to the extent they still hold Common Stock at the
time of such liquidation, will be entitled to receive $6.67 per share of Common
Stock prior to any other shareholders receiving any amount pursuant to such
liquidation. Therefore, to the extent current holders of Class C Common Stock
still own Common Stock at the time of any liquidation of the Company, the right
of other holders of Common Stock to receive funds from such liquidation may be
subordinated to the rights of the current Class C Common Stock to receive their
contractual liquidation preference. Immediately prior to the Offering, there
will be 3,248,300 shares of Class C Common Stock issued and outstanding which
will be converted into 1,948,980 shares of Common Stock in the Recapitalization.
See 'The Recapitalization' and 'Capitalization.'

DIVIDEND POLICY

The Company has never declared or paid a cash dividend on its Common Stock
and currently does not expect to pay cash dividends. See 'Dividend Policy.'

ANTI-TAKEOVER CONSIDERATIONS, INCLUDING POSSIBILITY OF FUTURE ISSUANCE OF
PREFERRED STOCK

Upon consummation of the Offering, the Company's Second Amended and
Restated Articles of Incorporation (the 'Amended Articles of Incorporation')
will authorize the Board of Directors to issue up to 5,000,000 shares of
Preferred Stock and to fix the rights and preferences thereof without
shareholder approval. Issuance of shares of Preferred Stock could have the
effect of delaying or preventing a change of control of the Company otherwise
desired by the shareholders. See 'Description of Capital Stock--Preferred
Stock.'

The North Carolina Business Corporation Act (the 'Business Corporation
Act') contains a 'Shareholder Protection Act' which, with certain exceptions,
requires approval of certain business combinations between a North Carolina
corporation and any beneficial holder of more than 20.0% of the voting shares of
the corporation by the holders of at least 95.0% of the voting shares of the
corporation. Certain North Carolina public corporations are also subject to 'The
North Carolina Control Share Acquisition Act,' which provides that shares
acquired in a transaction that would cause the acquiring person's voting
strength to meet or exceed any of three thresholds (20.0%, 33.3% or a majority)
of voting power, depending on the circumstances of the transaction, have no
voting rights unless granted by a majority vote of all the outstanding shares of
the corporation (not including interested shares) entitled to vote for the
election of directors. The provisions of the Shareholder Protection Act and The
North Carolina Control Share Acquisition Act were designed to deter certain
takeovers of North Carolina corporations. See 'Description of Capital
Stock--Statutory Provisions.' The Company has 'opted out' of the North Carolina
Share Acquisition Act. Within 90 days of the closing of the Offering, the
Company's Board of Directors will amend the Company's Fourth Amended and
Restated Bylaws (the 'Amended Bylaws') to 'opt out' of the Shareholder
Protection Act.

In addition, under applicable state insurance laws and regulations, no
person may acquire control of the Company, or any of the Insurance Subsidiaries,
unless such person has filed a statement containing specified information with
appropriate regulatory authorities and approval for such acquisition has been
obtained. Under applicable laws and regulations, any person acquiring, directly
or indirectly, or holding proxies with respect to, 10.0% (5.0% in Florida) or
more of the voting stock of any other person is presumed to have acquired
control of such person. Accordingly, any purchase resulting in the purchaser
owning 10.0% (5.0% in Florida) or more of the outstanding Common Stock of Front
Royal, in the Offering or otherwise, would require prior approval by

17
<PAGE>
applicable regulatory authorities. Such prior approval requirement also would
apply to an acquisition of proxies to vote 10.0% (5.0% in Florida) or more of
the outstanding Common Stock of Front Royal and, therefore, in a proxy contest,
could delay or prevent a stockholder from acquiring such proxies. See
'Business--Regulation.'

The Amended Articles of Incorporation and Amended Bylaws also contain
provisions which (i) create a staggered Board of Directors consisting of three
classes, with each class serving terms of three years in staggered succession;
(ii) fix the size of the Board of Directors at a minimum of 7 and a maximum of
11 directors, with the authorized number of directors initially set at 11, with
the Board of Directors having the sole power and authority to increase or
decrease the number of directors, and provide that any vacancy on the Board of
Directors may be filled for the unexpired term (or for a new term in the case of
an increase in the size of the Board) only by a vote of a majority of the
remaining directors then in office; (iii) provide that a director may be removed
by the shareholders of the Company only for cause by a vote of holders of
66 2/3% of the Company's voting stock; (iv) eliminate the right of the
shareholders of the Company to call a special meeting of the shareholders at the
time the Company becomes a 'public corporation' under the Business Corporation
Act; (v) require the affirmative vote of 66 2/3% of the Company's voting stock
in order to amend or repeal certain provisions of the Amended Articles of
Incorporation and the Amended Bylaws; and (vi) provide for certain procedural
mechanisms regarding, among other things, shareholder proposals. Such provisions
are designed to deter certain types of takeovers. See 'Description of Capital
Stock--Certain Articles of Incorporation and Bylaw Provisions.'

SHARES ELIGIBLE FOR FUTURE SALE

The sale of a substantial number of shares of Common Stock, or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Common Stock. In addition, any such sale or perception could make
it more difficult for the Company to sell equity securities or equity related
securities in the future at a time and price that the Company deems appropriate.
Upon consummation of the Offering, the Company will have a total of 10,775,555
shares of Common Stock outstanding, of which the 5,000,000 shares of Common
Stock sold in the Offering, the 300,000 shares of Common Stock to be issued in
connection with the Preferred National Acquisition which are being registered
pursuant to the Registration Statement of which this Prospectus is a part and an
additional 2,590,601 shares currently outstanding will be eligible for immediate
sale in the public market without restriction, unless they are held by
'affiliates' of the Company within the meaning of Rule 144 under the Securities
Act or are subject to the lock-up described below, and of which 2,884,954 shares
will be 'restricted' securities within the meaning of Rule 144 under the
Securities Act. Additionally, the Company has granted options to certain
directors and officers and employees of the Company to purchase an aggregate of
450,000 shares of Common Stock and there are currently outstanding warrants
exercisable into 1,125,826 shares of Common Stock including the Preferred
National Warrants but excluding certain price adjustment warrants. The Company,
certain officers, directors, major shareholders and the entities who will
receive the 300,000 shares of Common Stock to be issued in connection with the
Preferred National Acquisition who hold an aggregate of 5,444,326 shares of
Common Stock and options and warrants to purchase 1,012,493 shares of Common
Stock, have agreed that they will not without the prior written consent of
Donaldson, Lufkin & Jenrette Securities Corporation ('DLJ'), directly or
indirectly offer, sell, contract to sell, grant any option to purchase or
otherwise dispose of any shares of Common Stock or any other equity security of
the Company, or any securities convertible into or exercisable or exchangeable
for, or warrants, options or rights to purchase or acquire, Common Stock or any
other equity security of the Company, or enter into any agreement to do any of
the foregoing, for a period of 180 days from the date of this Prospectus. As a
result of the foregoing, 6,456,819 shares of Common Stock will become eligible
for resale following such 180 day period, subject to such additional
restrictions to the extent applicable and subject to Rule 144. No prediction can
be made as to the effect, if any, that future sales of shares of Common Stock,
or the availability of shares for future sales, will have on the market price of
the Common Stock from time to time or the Company's ability to raise capital
through an offering of its equity securities. See 'Principal and Selling
Shareholders,' 'Description of Capital Stock,' 'Shares Eligible for Future Sale'
and 'Underwriting.'

18
<PAGE>
USE OF PROCEEDS

The net proceeds to the Company from the Offering, after deducting
underwriting discounts and commissions and estimated offering expenses, are
estimated to be approximately $45.2 million (approximately $ million
assuming the Over-Allotment Option is exercised in full). The Company expects to
use approximately $42.9 million of the net proceeds from the Offering to repay
in full the Company's term loan, including accrued interest, with certain
lenders, including First Union National Bank ('First Union') which acts as agent
and as a lender (the 'Term Loan'). The remaining net proceeds will be used by
the Company to pay approximately $1.8 million of accrued dividends on the Series
A Preferred Stock and for general corporate purposes.

Pending such uses, the net proceeds may be invested in short-term
income-producing investments such as investment grade commercial paper,
government and government agency securities, money market funds that invest in
government securities, certificates of deposit and interest-bearing bank
accounts. See 'Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources.'

The Term Loan had a principal amount as of July 24, 1998 of $33.2 million.
The Term Loan bears interest at a maximum rate of 8.65%, and is due and payable
in installments which conclude on December 1, 2003. The Term Loan was incurred
to finance a portion of the acquisition of Rockwood (the 'Rockwood
Acquisition'), refinance an outstanding senior term loan and repay or prepay
certain other indebtedness of the Company, and may be increased by up to $9.0
million to fund a portion of the purchase price of the Preferred National
Acquisition. The Company has received a commitment letter from First Union for
the $50.0 million Credit Facility, which it anticipates will close shortly
following the Offering. The Credit Facility will be available for, among other
things, future acquisitions. See 'Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources.'

The Company will not receive any of the net proceeds from the sale of
Common Stock by the Selling Shareholders. See 'Principal and Selling
Shareholders.'

DIVIDEND POLICY

Since its inception, the Company has not paid any dividends on the Common
Stock and currently does not expect to pay cash dividends. Any decision as to
the future payment of dividends will depend on the results of operations and
financial position of the Company and such other factors as the Company's Board
of Directors, in its discretion, deems relevant.

As an insurance holding company, Front Royal will depend on dividends and
other payments from its subsidiaries for the payment of cash dividends to its
shareholders. In the case of the Insurance Subsidiaries, such payments are
restricted by the insurance laws of each such Insurance Subsidiary's state of
domicile, and insurance regulators have authority in certain circumstances to
prohibit payments of dividends and other amounts by the Insurance Subsidiaries
that would otherwise be permitted without regulatory approval. Additionally, the
Company anticipates that the Credit Facility will contain certain restrictions
on, but not prohibit, the payment of dividends. See 'Risk Factors--Risks
Associated with Holding Company Structure; Dividend Restrictions,' 'Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources' and 'Business--Regulation.'

19
<PAGE>
THE RECAPITALIZATION

As at the date of this Prospectus, the Company has outstanding three
classes of common stock and one series of redeemable convertible preferred
stock. See 'Capitalization.' Simultaneously with the consummation of the
Offering: (i) the Company will convert each outstanding share of its existing
Class A Common Stock, no par value ('Class A Common Stock'), Class B Common
Stock, no par value ('Class B Common Stock'), and Class C Common Stock
(collectively, the 'Existing Common Stock'), into shares of Common Stock on the
basis of one share of Existing Common Stock for one share of Common Stock
(collectively, the 'Common Stock Conversion'); (ii) the existing shares of
Series A Preferred Stock will be converted into shares of Common Stock, and the
Series A Preferred Stock will be retired (the 'Preferred Stock Conversion') and
(iii) the Company will effect a three for five reverse stock split (the 'Reverse
Split'). The Common Stock Conversion, the Preferred Stock Conversion and the
Reverse Split are referred to collectively herein as the 'Recapitalization.' In
connection with the Recapitalization, the Board of Directors adopted, and the
shareholders have approved, a Plan of Recapitalization (the 'Plan of
Recapitalization') and concurrently with the closing of the Offering the Company
will adopt the Amended Articles of Incorporation to, among other things, reflect
the Recapitalization. Therefore, following the Offering, the Common Stock will
be the only class of common stock authorized and outstanding and all options and
warrants will convert into Common Stock. See 'Capitalization' and 'Description
of Capital Stock.'

The holders of the currently outstanding Class C Common Stock are entitled,
among other things, to elect two members of the Company's Board of Directors, to
approve, as a class, certain corporate transactions and, in the event of a
liquidation of the Company or similar transaction, to receive from the proceeds
available to holders of all common stock an amount equal to the greater of $4.00
per share of Class C Common Stock ($6.67, adjusted to reflect the Reverse Split)
or the pro rata amount distributable to all common shareholders assuming all
three classes of common stock were a single class. Under the terms of the Plan
of Recapitalization and a separate agreement entered into for the benefit of the
existing holders of Class C Common Stock pursuant to the Plan of
Recapitalization, in the event of a liquidation of the Company the existing
holders of the Class C Common Stock will continue to be entitled to an effective
liquidation preference of $6.67 per share for their shares of Common Stock
received in exchange for the Class C Common Stock. This right to receive a
minimum liquidating distribution as a preference over other holders of Common
Stock does not attach to the shares of Common Stock issued in exchange for the
Class C Common Stock and cannot be transferred by any of the existing holders of
Class C Common Stock. In the event any of the existing holders of Class C Common
Stock transfers any of the Common Stock to which the preference relates, the
liquidation preference will terminate as to the shares so transferred. As a
result of the Recapitalization, the holders of the Class C Common Stock will no
longer have the right to elect any specific number of members of the Board of
Directors or to vote as a separate class on any corporate transactions. Upon the
completion of Recapitalization and the Offering, the current holders of Class C
Common Stock will hold 1,948,980 shares of Common Stock.

20
<PAGE>
CAPITALIZATION

The following table sets forth: (i) the actual consolidated capitalization
of the Company at March 31, 1998 without giving effect to the Recapitalization;
(ii) the pro forma capitalization after giving effect to the Preferred National
Acquisition without giving effect to the Recapitalization and; (iii) the pro
forma capitalization as adjusted after giving effect to the Preferred National
Acquisition, the Recapitalization and the Offering.

<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------------------------------
PRO FORMA FOR
PREFERRED NATIONAL PRO FORMA
ACTUAL ACQUISITION AS ADJUSTED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Senior bank debt.................................................... $35,295 $ 41,571 $ --
Series A Redeemable Convertible Preferred Stock, no par value . 15,500 15,500 --
155,000 shares authorized; 155,000 shares outstanding, actual;
155,000 shares outstanding, pro forma for Preferred National
Acquisition; and no shares outstanding, pro forma as adjusted.
Shareholders' equity:
Common Stock:
Common Stock, no par value .................................... -- -- 94,025
30,000,000 shares authorized; no shares outstanding, actual;
no shares outstanding, pro forma for Preferred National
Acquisition; and 10,775,555 shares outstanding, pro forma as
adjusted.
Class A Common Stock, no par value ............................ 13,740 19,740(1) --
5,859,144 shares outstanding, actual; 6,359,144 shares
outstanding, pro forma for Preferred National Acquisition;
and no shares outstanding, pro forma as adjusted.
Class B Common Stock, no par value ............................ 557 557 --
268,482 shares outstanding, actual; 268,482 shares
outstanding, pro forma for Preferred National Acquisition;
and no shares outstanding, pro forma as adjusted.
Class C Common Stock, no par value ............................ 12,993 12,993 --
3,248,300 shares outstanding, actual; 3,248,300 shares
outstanding, pro forma for Preferred National Acquisition;
and no shares outstanding, pro forma as adjusted.
Retained earnings................................................. 16,956 16,956 16,956
Accumulated other comprehensive income............................ 3,418 3,418 3,418
Notes receivable from officers.................................... (166) (166) (166)
------- ------------------ --------------
Total common shareholders' equity and redeemable convertible
preferred stock........................................... 62,998 68,998 114,233
------- ------------------ --------------
Total capitalization.................................... $98,293 $110,569 $114,233
------- ------------------ --------------
------- ------------------ --------------
</TABLE>

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

(1) The pro forma amounts for the Preferred National Acquisition assume an
aggregate purchase price based on a value of $9.00 per share of Class A
Common Stock ($15.00 per share of Common Stock giving effect to the
Recapitalization).

21
<PAGE>
DILUTION

The net tangible book value of the Company at March 31, 1998 was
approximately $61.7 million or $7.45 per share of Common Stock. Net tangible
book value per share represents the amount of total tangible assets less total
liabilities, divided by the sum of (i) the number of shares of issued and
outstanding Common Stock, (ii) the number of shares of Common Stock issuable
upon conversion of the Company's outstanding redeemable preferred stock and
(iii) the number of shares of Common Stock issuable upon exercise of outstanding
stock options and warrants to purchase Common Stock. After giving effect to the
Preferred National Acquisition, the Recapitalization and the sale of the
3,300,000 shares of Common Stock offered hereby at an initial public offering
price of $15.00 per share and after deducting the underwriting discounts and
commissions and estimated offering expenses payable by the Company, the net
tangible book value of the Company, as of March 31, 1998, would have been
approximately $106.6 million or $8.98 per share. This represents an immediate
increase in net tangible book value of $1.53 per share to existing shareholders
and an immediate decrease of $6.02 per share to new investors purchasing Common
Stock in the Offering. The following table illustrates this per share dilution:

<TABLE>
<CAPTION>
Assumed initial public offering price(1)................................ $ 15.00
<S> <C> <C>
Net tangible book value per share of Common Stock at March 31, 1998... $7.45
Increase per share attributable to new shareholders................... $7.55
Net tangible book value per share of Common Stock after the Offering.... $ 8.98
-------------
Dilution per share to new investors..................................... $ 6.02
-------------
-------------
</TABLE>

- ------------------
(1) Before deducting estimated underwriting discounts and commissions and
estimated expenses of the Offering payable by the Company.

The following table summarizes on a pro forma basis, as of March 31, 1998,
the differences between existing shareholders and new investors with respect to
the number of shares purchased from the Company, the total consideration paid to
the Company and the average price paid per share by existing shareholders and
new investors, after giving effect to the Preferred National Acquisition, the
Recapitalization and the sale of the 3,300,000 shares of Common Stock offered
hereby.

<TABLE>
<CAPTION>
SHARES OWNED TOTAL CONSIDERATION(1)
---------------------- ----------------------
NUMBER PERCENT AMOUNT PERCENT AVERAGE
PER SHARE
---------
<S> <C> <C> <C> <C> <C>
Existing shareholders........................... 7,475,555 69.4% $48,790,257 49.6% $ 6.53
New investors................................... 3,300,000 30.6 49,500,000 50.4% 15.00
----------- ------- ----------- -------
Total......................................... 10,755,555 100.0% $98,290,257 100.0%
----------- ------- ----------- -------
----------- ------- ----------- -------
</TABLE>

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

(1) Before deducting estimated underwriting discounts and commissions and
estimated expenses of the Offering payable by the Company.

22
<PAGE>
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

The following unaudited Pro Forma Condensed Combined Balance Sheet as of
March 31, 1998 and the unaudited Pro Forma Condensed Combined Statements of
Income for the three months ended March 31, 1998 and for the year ended December
31, 1997 (the 'Pro Forma Financial Statements') are based upon the financial
statements of the Company and of Preferred National, which are included herein.
See 'Index to Financial Statements.'

The Pro Forma Condensed Combined Balance Sheet as of March 31, 1998 is
presented as if the Preferred National Acquisition had occurred on March 31,
1998. The Pro Forma Condensed Combined Statements of Income for the three months
ended March 31, 1998 and the year ended December 31, 1997 are presented as if
the Preferred National Acquisition had occurred on January 1, 1997. The Pro
Forma Financial Statements give effect to the Preferred National Acquisition
under the purchase method of accounting in accordance with Accounting Standards
Board Opinion No. 16 and to the Recapitalization.

The Pro Forma Financial Statements are presented for comparative purposes
only and are not necessarily indicative of what the actual financial position of
the Company would have been at March 31, 1998 had the Preferred National
Acquisition occurred on January 1, 1997 nor indicative of the results of
operations in future periods. The Pro Forma Financial Statements should be read
in conjunction with, and are qualified in their entirety by, the respective
unaudited financial statements and notes thereto of the Company and of Preferred
National for the three months ended March 31, 1998 and the respective historical
financial statements and notes thereto of the Company and of Preferred National
for the year ended December 31, 1997.

The Pro Forma Financial Statements presented do not reflect future events
that may occur after the Preferred National Acquisition has been consummated.
The Company believes that on a combined basis, the Company and Preferred
National can be operated less expensively. However, for the purposes of the Pro
Forma Financial Statements presented herein, these savings have not been
reflected because their realization cannot be assured.

23
<PAGE>
PRO FORMA CONDENSED COMBINED BALANCE SHEET
MARCH 31, 1998
(UNAUDITED)

<TABLE>
<CAPTION>
FRONT PREFERRED PRO
ROYAL NATIONAL PRO FORMA FORMA
HISTORICAL HISTORICAL ADJUSTMENTS RESULTS
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Investments............................................ $ 277,945 $ 61,094 $ (28,000)(A1) $311,885
846(H)
Cash................................................... 1,568 3,873 2,000(A4) 5,585
(500)(I)
(1,356)(L)
Reinsurance recoverable on unpaid and paid losses and
loss adjustment expenses............................. 25,535 3,938 -- 29,473
Deferred federal income tax............................ 9,307 767 525(D) 10,599
Deferred policy acquisition costs...................... 8,666 4,489 -- 13,155
Intangible assets, net................................. 5,788 -- 6,304(B) 12,092
Other assets........................................... 28,516 6,036 (870)(I) 33,682
---------- ---------- ----------- --------
Total assets...................................... $ 357,325 $ 80,197 $ (21,051) $416,471
---------- ---------- ----------- --------
---------- ---------- ----------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Reserve for losses and loss adjustment expenses........ $ 197,093 $ 24,997 $ -- $222,090
Unearned premiums...................................... 35,378 19,567 -- 54,945
Accrued policyholders' dividends....................... 5,919 -- -- 5,919
Accrued preferred stock dividend....................... 1,356 -- (1,356)(L) --
Other liabilities...................................... 19,285 2,163 500(C) 22,948
1,500(C)
(500)(I)
Senior bank debt....................................... 35,296 -- 6,275(A4) 41,571
---------- ---------- ----------- --------
Total liabilities................................. 294,327 46,727 6,419 347,473
Series A Redeemable Convertible Preferred Stock........ 15,500 -- (15,500)(L) --
Common shareholders' equity:
Common Stock......................................... -- -- 48,790(L) 48,790
Common Stock--Class A................................ 13,740 3,501 4,500(A2) --
1,500(A3)
(23,241)(L)
Common Stock--Class B................................ 557 -- (557)(L) --
Common Stock--Class C................................ 12,993 -- (12,993)(L) --
Additional paid-in capital........................... -- 23,160 349(K) --
(23,509)(L)
Notes receivable from officers....................... (166) -- -- (166)
Retained earnings.................................... 16,956 6,725 (349)(K) 16,956
(6,376)(L)
Accumulated other comprehensive income............... 3,418 84 (84)(L) 3,418
---------- ---------- ----------- --------
Total common shareholders' equity................. 47,498 33,470 (11,970) 68,998
---------- ---------- ----------- --------
62,998 33,470 (27,470) 68,998
---------- ---------- ----------- --------
Total liabilities, redeemable convertible
preferred stock and common shareholders'
equity.......................................... $ 357,325 $ 80,197 $ (21,051) $416,471
---------- ---------- ----------- --------
---------- ---------- ----------- --------
</TABLE>

See Notes to the (Unaudited) Pro Forma Condensed Combined Financial Statements.

24
<PAGE>
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)

<TABLE>
<CAPTION>
FRONT PREFERRED PRO
ROYAL NATIONAL PRO FORMA FORMA
HISTORICAL HISTORICAL ADJUSTMENTS RESULTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<S> <C> <C> <C> <C>
Revenues:
Net premiums earned.............................................. $ 20,167 $8,938 $ -- $29,105
Net investment income............................................ 4,265 964 (441)(E) 4,788
Net realized gains on investments................................ 4 40 -- 44
Other income..................................................... 56 453 -- 509
---------- ---------- ----------- -------
Total revenues................................................ 24,492 10,395 (441) 34,446
Losses and expenses:
Net losses and loss adjustment expenses.......................... 12,187 5,375 -- 17,562
Policy acquisition costs amortized............................... 5,763 2,106 -- 7,869
Other underwriting expenses...................................... 1,171 961 -- 2,132
Dividends to policyholders....................................... 737 -- -- 737
Interest expense................................................. 881 -- 132(F) 1,013
Other operating costs and expenses............................... 207 833 53(B) 1,093
---------- ---------- ----------- -------
Total losses and expenses..................................... 20,946 9,275 185 30,406
---------- ---------- ----------- -------
Income before federal income taxes................................. 3,546 1,120 (626) 4,040
Federal income tax expense/(benefit)............................... 1,133 274 (82)(G) 1,325
---------- ---------- ----------- -------
Net income/(loss).................................................. 2,413 846 (544) 2,715
Dividends to preferred shareholders................................ 271 -- (271)(L) --
---------- ---------- ----------- -------
Net income available to common shareholders........................ $ 2,142 $ 846 $ (273) $ 2,715
---------- ---------- ----------- -------
---------- ---------- ----------- -------
Net income per share--basic........................................ $ 0.36
-------
-------
Net income per share--diluted...................................... $ 0.33
-------
-------
Weighted average common shares outstanding......................... 7,476
Weighted average common and common stock equivalent shares
outstanding...................................................... 8,218
</TABLE>

See Notes to the (Unaudited) Pro Forma Condensed Combined Financial Statements.

25
<PAGE>
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)

<TABLE>
<CAPTION>
FRONT PREFERRED PRO PRO
ROYAL NATIONAL FORMA FORMA
HISTORICAL HISTORICAL ADJUSTMENTS RESULTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned........................................... $ 90,523 $ 28,579 $ -- $119,102
Net investment income......................................... 17,984 2,877 (1,764)(E) 19,097
Net realized gains/(losses) on investments.................... (480) 3 -- (477)
Other income.................................................. 331 3,312 -- 3,643
---------- ---------- ----------- --------
Total revenues........................................... 108,358 34,771 (1,764) 141,365
---------- ---------- ----------- --------
Losses and expenses:
Net losses and loss adjustment expenses....................... 56,196 17,156 -- 73,352
Policy acquisition costs amortized............................ 25,829 4,682 -- 30,511
Other underwriting expenses................................... 3,471 4,358 -- 7,829
Dividends to policyholders.................................... 3,603 -- -- 3,603
Interest expense.............................................. 3,883 -- 527(F) 4,410
Other operating costs and expenses............................ 1,806 4,160 210(B) 6,176
---------- ---------- ----------- --------
Total losses and expenses................................ 94,788 30,356 737 125,881
---------- ---------- ----------- --------
Income before federal income taxes.............................. 13,570 4,415 (2,501) 15,484
Federal income tax expense/(benefit)............................ 2,211 812 (69)(G) 2,954
---------- ---------- ----------- --------
Net income/(loss)............................................... 11,359 3,603 (2,432) 12,530
Dividends to preferred shareholders 1,085 -- (1,085)(L) --
---------- ---------- ----------- --------
Net income available to common shareholders..................... $ 10,274 $ 3,603 $(1,347) $ 12,530
---------- ---------- ----------- --------
---------- ---------- ----------- --------
Net income per share--basic..................................... $ 1.71
--------
--------
Net income per share--diluted................................... $ 1.56
--------
--------
Weighted average common shares outstanding...................... 7,325
Weighted average common and common stock equivalent shares
outstanding................................................... 8,017
</TABLE>

See Notes to the (Unaudited) Pro Forma Condensed Combined Financial Statements.

26
<PAGE>
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)

EXPLANATION OF PRO FORMA ADJUSTMENTS

A. This pro forma adjustment reflects the issuance of Common Stock and related
warrants, debt and the payment of cash in connection with the acquisition of
Preferred National resulting in:

<TABLE>
<CAPTION>
RECORDED
VALUE
----------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
1. Payment of cash from internal sources........................................... $ 28,000
2. Issuance of 300,000 shares of Common Stock at $15.00 per share.................. 4,500
3. Issuance of warrants to purchase 630,000 shares of Common Stock at an exercise
price of $16.67 per share....................................................... 1,500
4. Record the increase to the Company's credit facility for the portion of the cash
purchase price above the $28.0 million raised from internal sources ($4.3
million), assumed transaction costs of $0.5 million, and estimated assimilation
costs of $1.5 million (See Note J).............................................. 6,275
----------------
Total recorded purchase price (See Notes H and I)............................... $ 40,275
----------------
----------------
</TABLE>

B. To record goodwill of approximately $6.3 million and related amortization
over 30 years.

C. To accrue $0.5 million of assumed transaction costs and $1.5 million of
estimated assimilation costs (See Note J).

D. To record deferred federal income taxes at the federal statutory rate of
35.0%.

E. To record decrease in investment income as a result of cash paid by Front
Royal to purchase Preferred National based on the approximate yield of the
investment portfolio of 6.3%.

F. To record interest expense on the incremental borrowings under the credit
facility at an annual rate of 8.4%.

G. To adjust Preferred National's effective federal income tax rate to 35.0%
and to record federal income tax on all pro forma adjustments at the federal
statutory rate of 35.0%.

H. For purposes of calculating the Pro Forma Financial Statements, the Company
has assumed a July 1998 closing date. In order to estimate Preferred
National's net assets at June 30, 1998, the Company used recorded net income
for the three month period ended March 31, 1998 as an addition to March 31,
1998 net assets to approximate the June 30, 1998 amounts.

I. The cash portion of the purchase price in the Preferred National Acquisition
is subject to adjustment based on Preferred National's levels of GAAP book
value, SAP surplus and cash and invested assets at July 31, 1998. Based on
the March 31, 1998 GAAP financial statements of Preferred National as
adjusted (see Note H above), management has estimated the cash portion of
purchase price to be $32.3 million. The Pro Forma Condensed Combined Balance
Sheet excludes certain assets and liabilities that the Company is not
acquiring.

J. Pursuant to EITF 95-3, the Company has included in the Pro Forma Condensed
Combined Balance Sheet, a pro forma adjustment of $1.5 million relating to
assimilation costs. It is anticipated that the assimilation plan will be
finalized shortly after the Preferred National Acquisition is consummated
and will be completed within one year from that date. Any adjustments to the
$1.5 million accrual for assimilation costs will result in an adjustment to
the Preferred National purchase price.

K. To record undistributed retained earnings of Wycon and UnaMark as paid-in
capital.

L. To record the Recapitalization and reflect payment of all accrued dividends
on the Series A Preferred Stock.

27
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The following tables set forth certain selected historical financial
information for the Company. The historical operating results data, per share
data and balance sheet data for the Company are derived from the consolidated
audited financial statements of the Company for the five year period ended
December 31, 1997. The historical operating results data, per share data and
balance sheet data set forth below for the three months ended March 31, 1997 and
1998 are derived from unaudited financial statements. The unaudited financial
statements include all adjustments, consisting of normal recurring accruals
only, which the Company considers necessary for a fair presentation of the
financial position and the results of operations for these periods. Operating
results for the three months ended March 31, 1998 are not necessarily indicative
of results that may be expected for the entire year ending December 31, 1998.

All historical operating results data, per share data and balance sheet
data set forth below should be read in conjunction with the consolidated
financial statements, related notes and other financial information of the
Company and Preferred National, respectively, included in this Prospectus.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
-------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA(1):
Revenues:
Gross written premiums............ $ 22,968 $ 27,407 $100,246 $ 49,948 $ 43,571 $ 1,171 $ 844
Net written premiums.............. 19,879 24,200 88,031 43,404 37,655 1,054 564
Net earned premiums............... 20,167 24,308 90,523 42,115 36,537 916 508
Net investment income............. 4,265 4,266 17,984 5,867 5,449 317 230
Net realized capital
gains/(losses).................. 4 42 (480) (1) 838 (171) --
Other income...................... 56 27 331 631 726 459 299
-------- -------- -------- -------- -------- -------- --------
Total revenues.................. 24,492 28,643 108,358 48,612 43,550 1,521 1,037
Losses and expenses:
Loss and loss adjustment
expenses........................ 12,187 15,791 56,196 26,110 22,566 593 193
Policy acquisition costs
amortized....................... 5,763 6,457 25,829 12,729 11,133 275 169
Other underwriting expenses....... 1,171 956 3,471 2,074 2,076 498 474
Interest expense.................. 881 1,155 3,883 2,029 1,645 595 499
Dividends to policyholders........ 737 1,130 3,603 -- -- -- --
Other expenses.................... 206 40 1,806 538 1,314 1,351 1,050
-------- -------- -------- -------- -------- -------- --------
Total losses and expenses....... 20,945 25,529 94,788 43,480 38,734 3,312 2,385
-------- -------- -------- -------- -------- -------- --------
Income/(loss) before income taxes... 3,547 3,114 13,570 5,132 4,816 (1,791) (1,348)
Income tax expense/(benefit)........ 1,133 791 2,211 621 1,264 (378) --
-------- -------- -------- -------- -------- -------- --------
Net income/(loss)................... 2,414 2,323 11,359 4,511 3,552 (1,413) (1,348)
Dividends to preferred
shareholders...................... 271 271 1,085 -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Net income/(loss) available to
common shareholders............... $ 2,143 $ 2,052 $ 10,274 $ 4,511 $ 3,552 $ (1,413) $ (1,348)
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
Net operating income/(loss)(2)...... $ 2,140 $ 2,025 $ 10,586 $ 4,512 $ 3,007 $ (1,302) $ (1,348)
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
PER SHARE DATA:
Net income/(loss) per
share--basic...................... $ 0.23 $ 0.23 $ 1.13 $ 0.79 $ 0.62 $ (0.63) $ (1.47)
Net income/(loss) per
share--diluted.................... $ 0.18 $ 0.18 $ 0.88 $ 0.70 $ 0.56 $ (0.63) $ (1.47)
Net operating income/(loss) per
share-- diluted................... $ 0.18 $ 0.18 $ 0.91 $ 0.70 $ 0.47 $ (0.58) $ (1.47)
Weighted average common shares
outstanding....................... 9,376 8,890 9,125 5,724 5,711 2,249 919
Weighted average common and common
stock equivalent shares
outstanding....................... 13,197 12,647 12,861 6,446 6,396 2,249 919

ADJUSTED PER SHARE DATA(3):
Net income/(loss) per
share--diluted.................... $ 0.30 $ 0.31 $ 1.47 $ 1.17 $ 0.93 $ (1.05) $ (2.45)
Net operating income/(loss) per
share-- diluted................... $ 0.30 $ 0.30 $ 1.51 $ 1.17 $ 0.78 $ (0.96) $ (2.45)
Book value per share(4)............. $ 8.78 $ 7.20 $ 8.47 $ 7.07 $ 5.08 $ 2.82 $ (0.51)
</TABLE>

28
<PAGE>

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
-------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET DATA (AT END OF
PERIOD)(5):
<S> <C> <C> <C> <C> <C> <C> <C>
Cash and invested assets............ $279,513 $261,626 $280,629 $253,555 $ 89,162 $ 76,799 $ 4,531
Total assets........................ 357,325 343,909 356,315 339,987 113,527 105,178 7,654
Senior bank debt.................... 35,295 38,000 36,545 38,000 13,384 13,315 6,463
Shareholders' equity/(deficit)...... 47,498 34,083 45,262 33,154 17,409 9,598 (316)
Book value per share(4)............. $ 5.07 $ 3.83 $ 4.83 $ 3.73 $ 3.05 $ 1.69 $ (0.30)

SAP AND OTHER DATA:
Loss ratio.......................... 60.5% 65.0% 63.9% 61.8% 61.5% 64.8% 48.5%
Expense ratio....................... 34.2 30.8 32.8 35.4 36.9 58.8 84.1
Dividend ratio...................... 4.2 4.7 4.2 -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Combined ratio...................... 98.9% 100.5% 100.9% 97.2% 98.4% 123.6% 132.6%
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
Ratio of net written premiums to SAP
surplus(6)........................ 1.0x 1.4x 1.2x 0.7x 1.4x 0.0x 0.1x
SAP surplus (at end of period)...... $ 76,149 $ 68,716 $ 74,417 $ 65,852 $ 26,150 $ 22,741 $ 4,233
Return on equity(6)(7).............. 15.6% 18.9% 20.8% 24.1%(8) 26.3% (30.4%) (1,078.4%)
</TABLE>

- ------------------
(1) Includes operations of Rockwood from January 1, 1997.

(2) Net operating income is equal to net income/(loss) available to common
shareholders excluding after-tax realized gains or losses at a 35.0%
marginal tax rate.

(3) Reflects the Recapitalization for all periods presented.

(4) Excludes the exercise of all warrants and options then exercisable.

(5) Includes assets and liabilities of Rockwood from December 31, 1996.

(6) Interim period amounts are presented on an annualized basis.

(7) Calculated based on average of the beginning and ending shareholders' equity
for the period.

(8) Excludes $28.6 million of equity raised on December 31, 1996, in connection
with the acquisition of Rockwood. Absent this adjustment, the average return
on equity for 1996 would have been 13.7%.

29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto included elsewhere in
this Prospectus. Unless otherwise stated, the information set forth in this
section does not reflect the Recapitalization.

GENERAL

Front Royal was organized in September 1990 as a holding company to acquire
and operate property and casualty insurance companies that profitably underwrite
specialty coverages. The results reported below have been affected by a series
of acquisitions. These acquisitions (together with various other capital and
financing transactions made during this period) have significantly affected the
capital structure and results of operations of the Company. Additionally,
because information regarding Rockwood (which was acquired by the Company in
December 1996) and Preferred National (which is anticipated to be acquired by
the Company in July 1998) are not presented for all periods, period-to-period
results may not be comparable. See 'Business--General.'

In December 1994, the Company acquired Colony for a cash purchase price of
$15.8 million. Immediately following its acquisition by Front Royal, Colony had
statutory surplus of $22.7 million. During the first three full years after the
acquisition, Colony's reported net income (SAP) was $3.3 million, $3.5 million
and $3.8 million for 1995, 1996 and 1997, respectively. See Note 5 of the Notes
to the Consolidated Financial Statements.

In December 1996, Front Royal acquired Rockwood for a total consideration
of $60.5 million. Immediately following its acquisition by Front Royal, Rockwood
had statutory surplus of $39.9 million. During its first year after the Rockwood
Acquisition, Rockwood reported net income (SAP) of $6.7 million. See Note 5 of
the Notes to the Consolidated Financial Statements.

On March 6, 1998, the Company executed a definitive agreement to purchase
the stock of Preferred National, substantially all of the assets and business of
UnaMark and certain other assets and liabilities for a total purchase price of
$35.0 million in cash, subject to adjustment, 500,000 shares of Common Stock
(300,000 adjusted for the Reverse Split) and the Preferred National Warrants.
The cash portion of the purchase price is subject to adjustment based on
Preferred National's levels of GAAP book value, SAP surplus, and cash and
invested assets as of the month end immediately prior to the closing.

Simultaneously with the consummation of the Offering, the Company will
complete the Recapitalization, pursuant to which it will effect the Common Stock
Conversion, the Preferred Stock Conversion and the Reverse Split. In connection
with the Recapitalization, the Company has adopted the Amended Articles of
Incorporation and Amended Bylaws, each of which will become effective
concurrently with the closing of the Offering. See 'The Recapitalization.'

The difference between SAP and GAAP information is immaterial for all
periods presented except for the pro forma combined ratio for the year ended
December 31, 1997, which includes a SAP expense ratio of 34.6% that is 2.8%
lower than the corresponding GAAP expense ratio of 37.4%. This is wholly
attributable to the significant premium growth at Preferred National. As a
result the GAAP combined ratio is higher by this same 2.8%.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 1998 AND 1997.

Gross Written Premiums for the Company decreased $4.4 million (16.1%) from
$27.4 million for the three-month period ended March 31, 1997 to $23.0 million
for the three-month period ended March 31, 1998.

Colony's gross written premiums decreased $1.0 million (7.9%) from $12.6
million for the three-month period ended March 31, 1997 to $11.6 million for the
three-month period ended March 31, 1998, primarily as a result of increased
competition in Colony's contract lines of business (which comprised 65.3% of
Colony's 1998 first quarter gross written premiums). The remaining lines of
business for Colony grew $300,000 (8.1%) from

30
<PAGE>
$3.7 million for the three-month period ended March 31, 1997 to $4.0 million for
the three-month period ended March 31, 1998.

Rockwood's gross written premiums declined $3.4 million (23.0%) from $14.8
million for the three-month period ended March 31, 1997 to $11.4 million for the
three-month period ended March 31, 1998. This decrease was generally a result of
reductions in workers' compensation premium rates promulgated by the
Commonwealth of Pennsylvania (also experienced during fiscal year 1997). The
Company believes that the reductions in workers' compensation premium rates will
be offset by the benefits of workers' compensation reform legislation in
Pennsylvania. These reforms significantly lowered both medical reimbursement
costs and wage indemnity costs to workers' compensation insurers.

The decrease in the Company's net written premiums and net earned premiums
were generally proportional to the decline in gross written premiums.

Net Investment Income for the Company remained stable at $4.3 million for
each of the three-month periods ended March 31, 1997 and 1998. The underlying
cash and invested assets for the Company increased $17.9 million (6.8%) from
$261.6 million at March 31, 1997 to $279.5 million at March 31, 1998. This was
offset by a decrease in yields, reflecting a decrease in the overall interest
rate environment. The gross yield on the Insurance Subsidiaries' portfolio
decreased from 6.6% for the three months ended March 31, 1997 to 6.0% for the
three-month period ended March 31, 1998.

Loss and Loss Adjustment Expenses for the Company decreased by $3.6 million
(22.8%) from $15.8 million for the three-month period ended March 31, 1997 to
$12.2 million for the three-month period ended March 31, 1998. The SAP loss
ratio for the Insurance Subsidiaries decreased from 65.0% for the three months
ended March 31, 1997 to 60.5% for the three months ended March 31, 1998.
Colony's SAP loss ratio of 61.3% for the three months ended March 31, 1997
approximated the 61.4% ratio for the three months ended March 31, 1998.
Rockwood's SAP loss ratio decreased from 68.2% for the three-month period ended
March 31, 1997 to 59.6% for the three-month period ended March 31, 1998.
Rockwood's results reflect the benefits of reform legislation relating to
workers' compensation claims enacted by the Commonwealth of Pennsylvania. See
'Business-- Rockwood--Claims.'

Policy Acquisition Costs Amortized for the Company decreased $700,000
(10.8%), from $6.5 million for the three-month period ended March 31, 1997 to
$5.8 million for the three-month period ended March 31, 1998. Policy acquisition
costs, which consist principally of agents' commissions and premium taxes, are
amortized over the period in which the related premiums are earned, generally 12
months.

Policy acquisition costs amortized for Colony were $3.4 million for the
three months ended March 31, 1998 and remained relatively unchanged from that of
the corresponding period in the prior year.

Policy acquisition costs amortized for Rockwood decreased $500,000 (17.2%),
from $2.9 million for the three-month period ended March 31, 1997 to $2.4
million for the three-month period ended March 31, 1998. This decrease is
generally proportional to the decrease in premiums written as noted above.

As a writer of workers' compensation insurance utilizing an independent
retail agency sales force, Rockwood generally pays lower commissions than does
Colony, which uses a wholesale agency sales force. Average commissions paid by
Rockwood on its workers' compensation insurance premiums range between 4.0% and
10.0% of gross written premiums (other lines range from approximately 15.0% to
20.0%). Commissions paid by Colony vary depending upon the type of business and
generally range from 17.5% to 22.5% of gross written premium.

Other Underwriting Expenses for the Company increased by $200,000 (20.0%),
from $1.0 million for the three-month period ended March 31, 1997 to $1.2
million for the three-month period ended March 31, 1998. The addition of
Redwoods accounted for approximately $100,000 of this increase.

The SAP expense ratio for the Insurance Subsidiaries increased from 30.8%
for the three months ended March 31, 1997 to 34.2% for the three months ended
March 31, 1998. Colony's SAP expense ratio increased from 37.5% for the
three-month period ended March 31, 1997 to 40.0% for the three-month period
ended March 31, 1998. This increase was principally attributable to salary costs
for additional experienced underwriting

31
<PAGE>

and administrative personnel hired by Colony and the decrease in premiums noted
above. Rockwood's SAP expense ratio increased from 25.4% for the three-month
period ended March 31, 1997 to 28.7% for the three-month period ended March 31,
1998. This increase was attributable to the decrease in premiums noted above.

The SAP combined ratio for the Insurance Subsidiaries decreased from 100.5%
for the three months ended March 31, 1997 to 98.9% for the three months ended
March 31, 1998. Colony's SAP combined ratio increased from 98.8% for the
three-month period ended March 31, 1997 to 101.4% for the three-month period
ended March 31, 1998. Despite this increase, Colony's SAP combined ratio is
below the published SAP combined ratio for the entire property and casualty
industry of 101.6%, as reported by A.M. Best. Rockwood's SAP combined ratio
decreased from 102.3% for the three-month period ended March 31, 1997 to 97.1%
for the three-month period ended March 31, 1998 (including a dividend ratio of
8.7% and 8.8%, respectively).

Interest Expense for the Company decreased $300,000 (25.0%), from $1.2
million for the three-month period ended March 31, 1997 to $900,000 for the
three-month period ended March 31, 1998. This is primarily attributable to a
decrease in the weighted average outstanding debt for the Company. Weighted
average outstanding debt decreased by $2.7 million (7.1%) from $38.0 million for
the three-month period ended March 31, 1997 to $35.3 million for the three-month
period ended March 31, 1998. In February 1997, the Company purchased an interest
rate contract for the entire balance of the Term Loan (reduced periodically to
reflect principal payments made) which limits the maximum interest rate payable
on this debt to 8.65% (see Note 9 of the Notes to the Consolidated Financial
Statements).

Dividends to Policyholders are payments made by Rockwood to certain
workers' compensation policyholders with whom the Company has negotiated
profit-sharing arrangements. Such dividends decreased $400,000 (36.4%), from
$1.1 million for the three-month period ended March 31, 1997 to $700,000 for the
three-month period ended March 31, 1998. This decrease is related to the
decrease in earned premiums noted above on the participating policies written by
Rockwood. Colony does not write such participating policies.

Income Tax Expense for the Company increased $300,000 (37.5%) from $800,000
for the three-month period ended March 31, 1997 to $1.1 million for the
three-month period ended March 31, 1998 as a result of higher pre-tax earnings
and a higher tax rate (31.9% versus 25.4%, respectively). The tax rate for the
quarter ended March 31, 1997 was affected by the recognition of deferred tax
assets through a reduction of the related valuation allowance. Deferred tax
assets, other than the deferred tax asset related to net operating loss
carryforwards, were fully recognized at December 31, 1997. See '--Deferred
Income Taxes.'

Net Income for the Company increased $100,000 (4.3%) from $2.3 million for
the three-month period ended March 31, 1997 to $2.4 million for the three-month
period ended March 31, 1998 despite the increase in the tax rate noted above.
Basic and diluted earnings per share remained constant at $0.23 per share and
$0.18 per share respectively.

YEARS ENDED DECEMBER 31, 1997 AND 1996.

Gross Written Premiums for the Company increased $50.3 million (100.8%),
from $49.9 million for the year ended December 31, 1996, to $100.2 million for
the year ended December 31, 1997. This increase was primarily the result of the
Rockwood Acquisition in December 1996.

Colony's gross written premiums increased $600,000 (1.2%), from $49.9
million for the year ended December 31, 1996, to $50.5 million for the year
ended December 31, 1997. This increase was primarily concentrated in its
contract and specialty underwriting business.

Rockwood's gross written premiums decreased $19.7 million (28.4%) from
$69.4 million for the year ended December 31, 1996 to $49.7 million for the year
ended December 31, 1997. This decrease was primarily due to a reduction in
workers' compensation premium rates promulgated by the Commonwealth of
Pennsylvania during the first quarter of 1997 and to the termination of a
fronting agreement for a discontinued line of business (i.e., private passenger
automobile insurance) in 1996, which accounted for $9.5 million (13.7%) of the
decrease in gross written premiums from the prior year. Rockwood ceded 100.0% of
such private passenger automobile business as of December 31, 1996 and,
accordingly, retained no risk or net earned premium associated with this line.
However, the Company remains contingently liable should the reinsurer be unable
to meet its obligations.

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<PAGE>
The Company believes the reductions in workers' compensation premium rates
will be offset by the benefits of workers' compensation reform legislation in
Pennsylvania. These reforms significantly lowered both medical reimbursement
costs and wage indemnity costs to workers' compensation insurers.

Net Written Premiums for the Company increased $44.6 million (102.8%) from
$43.4 million for the year ended December 31, 1996 to $88.0 million for the year
ended December 31, 1997. This increase was primarily due to the addition of
Rockwood's premiums to the Company's totals during 1997.

Colony's net written premium decreased $700,000 (1.6%), from $43.4 million
for the year ended December 31, 1996 to $42.7 million for the year ended
December 31, 1997. Colony's net written premium growth lags its growth in gross
written premium because some of the lines of business experiencing the highest
rates of growth are reinsured on a quota-share basis pursuant to which the
Company retains a smaller percentage of the premiums written. After a period of
time, Colony has historically moved seasoned business to an excess of loss
treaty under which more of the premium and related risk are retained.

Rockwood's net written premium decreased $8.9 million (16.4%), from $54.2
million for the year ended December 31, 1996 to $45.3 million for the year ended
December 31, 1997. This reduction was primarily a result of the premium rate
adjustments described above.

Net Earned Premiums for the Company increased $48.4 million (115.0%), from
$42.1 million for the year ended December 31, 1996 to $90.5 million for the year
ended December 31, 1997. This increase was primarily due to the addition of
Rockwood's premiums to the Company's totals during 1997.

Colony's net earned premium increased $1.4 million (3.3%), from $42.1
million for the year ended December 31, 1996 to $43.5 million for the year ended
December 31, 1997.

Rockwood's net earned premium decreased $5.5 million (10.5%), from $52.5
million for the year ended December 31, 1996 to $47.0 million for the year ended
December 31, 1997. Rockwood sustained a smaller percentage drop in earned
premiums than in gross or net written premium primarily because of premiums
earned on policies written in the previous year.

Net Investment Income for the Company increased $12.1 million (205.1%),
from $5.9 million for the year ended December 31, 1996 to $18.0 million for the
year ended December 31, 1997. This increase was primarily the result of the
addition of investment income from Rockwood, which contributed $10.3 million to
investment income during the year ended December 31, 1997. Gross yield on the
Insurance Subsidiaries' portfolio increased from 6.1% for the year ended
December 31, 1996 to 6.3% for the year ended December 31, 1997.

Cash and invested assets for the Company increased $27.0 million (10.6%),
from $253.6 million at December 31, 1996 to $280.6 million at December 31, 1997.
The December 31, 1996, balance of cash and invested assets included an amount
for Rockwood of $158.0 million. Since this balance was included in the Company's
assets only from the date of Rockwood's acquisition (i.e., December 31, 1996),
net investment income for the year ended December 31, 1996, excludes any amounts
attributable to Rockwood's cash and invested assets.

Other Income for the Company decreased $300,000 (50.0%), from $600,000 for
the year ended December 31, 1996 to $300,000 for the year ended December 31,
1997. This decrease primarily reflects a decline in the net amount of the
Company's amortization of negative goodwill. As of December 31, 1996, prior to
the Rockwood acquisition, the Company had $3.6 million of net negative goodwill.
The amount of amortization for the year ended December 31, 1996, relating to
this negative goodwill was $400,000. In 1997, such negative goodwill
amortization was substantially offset by amortization of the costs associated
with the Rockwood Acquisition.

Loss and Loss Adjustment Expenses for the Company increased by $30.1
million (115.3%), from $26.1 million for the year ended December 31, 1996, to
$56.2 million for the year ended December 31, 1997. The SAP loss ratio for the
Company increased from 61.8% for the year ended December 31, 1996 to 63.9% for
the year ended December 31, 1997. The SAP loss ratio for the Insurance
Subsidiaries (assuming Rockwood had been purchased by the Company on January 1,
1996) increased from 43.7% for the year ended December 31, 1996 to 63.9% for the
year ended December 31, 1997. Colony's SAP loss ratio increased from 61.8% for
the year ended December 31, 1996 to 62.4% for the year ended December 31, 1997.
Rockwood's SAP loss ratio increased from

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<PAGE>
29.1% for the year ended December 31, 1996 to 65.3% for the year ended December
31, 1997. The 1996 SAP loss ratio for Rockwood included the recognition of loss
reserve redundancies of $23.8 million (excluding $3.8 million for the effect of
discounting) prior to its acquisition by the Company. Excluding these loss
reserve redundancies, Rockwood's SAP loss ratio would have been 67.3% for the
year ended December 31, 1996. Management believes that the decrease in the SAP
loss ratio from 67.3% for 1996 to 65.3% for 1997 reflects the effects of reform
legislation relating to workers' compensation claims enacted by the Commonwealth
of Pennsylvania. See 'Business--Rockwood--Claims.'

Policy Acquisition Costs Amortized for the Company increased $13.1 million
(103.1%), from $12.7 million for the year ended December 31, 1996 to $25.8
million for the year ended December 31, 1997, as a result of the Rockwood
Acquisition. Policy acquisition costs, which consist principally of agents'
commissions and premium taxes, are amortized over the period in which the
related premiums are earned, generally 12 months.

Colony's policy acquisition costs amortized increased $1.1 million (8.7%),
from $12.7 million for the year ended December 31, 1996 to $13.8 million for the
year ended December 31, 1997. This increase was related to the increase in net
earned premiums noted above.

Rockwood's policy acquisition costs amortized decreased $100,000 (0.8%),
from $12.1 million for the year ended December 31, 1996, to $12.0 million for
the year ended December 31, 1997. This slight decrease, in spite of a 10.5%
decrease in net earned premiums, is attributable to the fact that the decrease
in net earned premiums was due primarily to a rate decrease without a
corresponding decrease in policy acquisition costs other than commissions.

Other Underwriting Expenses for the Company increased $1.4 million (66.7%),
from $2.1 million for the year ended December 31, 1996, to $3.5 million for the
year ended December 31, 1997. This increase was again primarily attributable to
the Rockwood Acquisition.

Colony's other underwriting expenses increased $100,000 (4.8%), from $2.1
million for the year ended December 31, 1996, to $2.2 million for the year ended
December 31, 1997. This increase was consistent with Colony's increase in net
earned premiums.

Rockwood's other underwriting expenses decreased $300,000 (18.8%), from
$1.6 million for the year ended December 31, 1996, to $1.3 million for the year
ended December 31, 1997. This decrease was consistent with Rockwood's decrease
in net earned premiums.

The SAP expense ratio for the Company decreased from 35.4% for the year
ended December 31, 1996 to 32.8% for the year ended December 31, 1997. The SAP
expense ratio for the Insurance Subsidiaries (assuming Rockwood had been
purchased by the Company on January 1, 1996) increased from 29.8% for the year
ended December 31, 1996 to 32.8% for the year ended December 31, 1997. Colony's
SAP expense ratio, including commissions, increased from 35.4% for the year
ended December 31, 1996, to 37.2% for the year ended December 31, 1997. This
increase was principally attributable to salary costs for additional experienced
underwriting and administrative personnel hired by Colony. Rockwood's SAP
expense ratio, including commissions, increased from 25.4% for the year ended
December 31, 1996, to 28.6% for the year ended December 31, 1997. This increase
was attributable to an increase in allocated corporate overhead and the decrease
in premiums noted above.

The SAP combined ratio for the Company increased from 97.2% for the year
ended December 31, 1996 to 100.9% for the year ended December 31, 1997. The SAP
combined ratio for the Insurance Subsidiaries (assuming Rockwood had been
purchased by the Company on January 1, 1996) increased from 78.8% for the year
ended December 31, 1996 to 100.9% for the year ended December 31, 1997.
Excluding the adjustment to Rockwood's loss reserves noted above, the SAP
combined ratio for the Insurance Subsidiaries (assuming Rockwood had been
purchased by the Company on January 1, 1996) increased from 100.0% for the year
ended December 31, 1996 to 100.9% for the year ended December 31, 1997. Colony's
SAP combined ratio increased from 97.2% for the year ended December 31, 1996, to
99.6% for the year ended December 31, 1997. Despite the increase, Colony's SAP
combined ratio was below the last published combined ratio for the entire
property and casualty industry for 1996 of 105.8%, as reported by A.M. Best.
Rockwood's SAP combined ratio for the year ended December 31, 1997 (including a
dividend ratio of 8.1%) was 102.0%.

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<PAGE>

Interest Expense for the Company increased $1.9 million (95.0%), from $2.0
million for the year ended December 31, 1996, to $3.9 million for the year ended
December 31, 1997. The 1996 interest expense included a $500,000 charge relating
to unamortized discount on subordinated debt which was repaid in December 1996.
Of the total for the year ended December 31, 1997, $3.4 million was attributable
to interest on the Term Loan. The weighted average outstanding debt for the
Company for the year ended December 31, 1996, increased by $24.7 million
(196.0%) from $12.6 million for the year ended December 31, 1996, to $37.3
million for the year ended December 31, 1997.

Dividends to Policyholders by Rockwood decreased $2.7 million (42.9%) from
$6.3 million for the year ended December 31, 1996, to $3.6 million for the year
ended December 31, 1997. This decrease was attributable to the allocable amount
of profit sharing in Rockwood's $23.8 million reduction in management's estimate
of the amount of ultimate claims expense for certain policy years recorded in
1996. Colony does not write participating policies.

Other Expenses for the Company increased $1.3 million (260.0%), from
$500,000 for the year ended December 31, 1996, to $1.8 million for the year
ended December 31, 1997. This increase was primarily attributable to $800,000 of
consulting services (principally legal and accounting) incurred relating to
preparation of an offering document in 1997.

Income Tax Expense for the Company increased $1.6 million (266.7%) from
$600,000 for the year ended December 31, 1996 to $2.2 million for the year ended
December 31, 1997 primarily as a result of the increase in income before federal
income taxes. The 1997 effective tax rate of 16.3% was lower than prevailing
federal rates primarily due to the recognition of deferred tax assets through a
reduction in the related valuation allowance. The valuation allowance was
reduced in recognition of the Company's taxable earnings in 1997. See
'--Deferred Income Taxes.'

Net Income for the Company increased $6.9 million (153.3%), from $4.5
million for the year ended December 31, 1996, to $11.4 million for the year
ended December 31, 1997. Basic earnings per share increased $0.34 (43.0%), from
$0.79 for the year ended December 31, 1996 to $1.13 for the year ended December
31, 1997. Diluted earnings per share increased $0.18 (25.7%), from $0.70 for the
year ended December 31, 1996 to $0.88 for the year ended December 31, 1997.

YEARS ENDED DECEMBER 31, 1996 AND 1995.

General. Front Royal acquired Rockwood on December 31, 1996, in a
transaction accounted for as a purchase. Accordingly, no Rockwood income or
expense is included in the Company's consolidated financial statements for 1996.

Gross Written Premiums for the Company increased $6.3 million (14.4%), from
$43.6 million for the year ended December 31, 1995 to $49.9 million for the year
ended December 31, 1996. This increase was primarily due to growth in Colony's
contract business for which gross written premiums increased $5.4 million
(17.8%), from $30.4 million for the year ended December 31, 1995 to $35.8
million for the year ended December 31, 1996. Colony's gross written premiums
from its specialty-line business, which was effectively started at the beginning
of 1996, grew during this period to $1.0 million.

The increase in the Company's net written premiums and net earned premiums
were generally proportional to the increase in gross written premiums.

Net Investment Income for the Company increased $500,000 (9.3%), from $5.4
million for the year ended December 31, 1995 to $5.9 million for the year ended
December 31, 1996. The gross yield on Colony's portfolio was 6.1% for the year
ended December 31, 1996 as compared to 6.2% for the year ended December 31,
1995. The decline in yield was primarily the result of a generally lower
interest rate environment. Cash and invested assets for the Company of $253.6
million at December 31, 1996, included $158.0 million for Rockwood. The
remaining $95.6 million of cash and invested assets represented a $6.4 million
(7.2%) increase over the December 31, 1995 balance of $89.2 million.

Loss and Loss Adjustment Expenses for the Company increased $3.5 million
(15.5%), from $22.6 million for the year ended December 31, 1995 to $26.1
million for the year ended December 31, 1996. Colony's SAP loss

35
<PAGE>
ratio increased from 61.6% for the year ended December 31, 1995 to 61.8% for the
year ended December 31, 1996.

Policy Acquisition Costs Amortized for the Company increased $1.6 million
(14.4%), from $11.1 million for the year ended December 31, 1995 to $12.7
million for the year ended December 31, 1996. Such increase was consistent with
the increase in premiums reported above.

Colony's SAP expense ratio decreased from 36.9% for the year ended December
31, 1995 to 35.4% for the year ended December 31, 1996. Colony's SAP combined
ratio also decreased from 98.4% for the year ended December 31, 1995 to 97.2%
for the year ended December 31, 1996.

Interest Expense for the Company increased $400,000 (25.0%), from $1.6
million for the year ended December 31, 1995 to $2.0 million for the year ended
December 31, 1996. The 1996 interest amount included a $500,000 charge relating
to unamortized discount on $2.5 million of subordinated debt which was paid in
December 1996. The remaining $1.5 million in interest expense for the year ended
December 31, 1996 represented a decrease of 6.3% from 1995.

The Company's average outstanding debt for the year ended December 31, 1995
was $14.1 million. The Company's average outstanding debt for the year ended
December 31, 1996 (excluding the Term Loan) was $12.8 million representing a
9.2% decrease over the prior year.

Other Expenses for the Company decreased $800,000 (61.5%), from $1.3
million for the year ended December 31, 1995 to $500,000 for the year ended
December 31, 1996. This decrease was primarily attributable to expenses related
to redundant costs of FRIC's offices and personnel which were consolidated into
Colony for the year ended December 31, 1996 and expense accruals for such
consolidation taken for the year ended December 31, 1995.

Income Tax Expense for the Company decreased $700,000 (53.8%), from $1.3
million for the year ended December 31, 1995 to $600,000 for the year ended
December 31, 1996. The decrease was due primarily to the recognition of a
greater amount of deferred tax assets through a reduction in the related
valuation allowance based on an increased taxable income for the year ended
December 31, 1996. The effective tax rate for the year ended December 31, 1996
of 12.1% was lower than the prevailing federal rate as a result of the
recognition of those deferred tax benefits. See '--Deferred Income Taxes.'

Net Income for the Company increased $900,000 (25.0%), from $3.6 million
for the year ended December 31, 1995 to $4.5 million for the year ended December
31, 1996. Basic earnings per share increased $0.17 (27.4%), from $0.62 for the
year ended December 31, 1995 to $0.79 for the year ended December 31, 1996.
Diluted earnings per share increased $0.14 (25.0%), from $0.56 for the year
ended December 31, 1995 to $0.70 for the year ended December 31, 1996.

LIQUIDITY AND CAPITAL RESOURCES

Front Royal is a holding company, the principal assets of which are the
common stock of the Subsidiaries. Front Royal's cash flows depend primarily on
dividends and other payments from the Subsidiaries. The Subsidiaries' sources of
funds consist primarily of premiums, investment income and proceeds from sales
and maturities of investments. Funds are used by the Subsidiaries principally to
pay claims and operating expenses and to purchase investments. In addition, the
Subsidiaries pay dividends and other distributions to Front Royal. Front Royal
uses these funds to pay operating expenses, debt service on the Term Loan, taxes
and other payments. See 'Risk Factors--Risks Associated with Holding Company
Structure; Dividend Restrictions.'

Cash provided by operating activities was $9.3 million and ($200,000) for
the three months ended March 31, 1997 and March 31, 1998, respectively. At March
31, 1998, the Company held cash of $1.6 million and investments of $277.9
million. Additionally, the Company had long-term debt of $38.0 million and $35.3
million as of March 31, 1997 and 1998, respectively.

Cash provided by operating activities was $7.0 million, $7.4 million and
$25.1 million for the fiscal years ended December 31, 1995, 1996 and 1997,
respectively. The significant increase in cash provided by operating activities
for the year ended December 31, 1997 was primarily attributable to the Rockwood
Acquisition. In

36
<PAGE>

addition to $2.9 million of cash and $277.7 million of investments at December
31, 1997, the Company had long-term debt of $36.5 million.

The Company believes that it has sufficient liquidity to meet its
anticipated insurance obligations, as well as its operating and capital
expenditure needs. The Company's investment strategy emphasizes quality,
liquidity, and diversification. With respect to liquidity, the Company considers
liability durations, specifically for its loss reserves, when determining
investment maturities. In addition, the Company staggers maturities to produce a
pattern of cash flows for the purpose of anticipating its liability schedules,
loss payments, and reinvestment opportunities. Of the Company's investments in
fixed maturity securities at March 31, 1998, 98.6% are in securities rated by
the National Association of Insurance Commissioners (the 'NAIC') as Class I. As
of March 31, 1998, Front Royal had $93.2 million (33.3%) of its total cash and
invested assets and 42.1% of its bond portfolio designated as held-to-maturity.
The held-to-maturity portfolio is carried in the Company's financial statements
at amortized cost. See 'Business--Investments.'

The Company does invest in mortgage-backed securities, including
collateralized mortgage obligations. These instruments can experience more than
average volatility in value in response to fluctuations in interest rates. The
Company believes it has moderated these risks by concentrating apaproximately
48% of its mortgage backed securities in planned amortization class bonds or
agency pass-through certificates with 15 year or shorter maturity. The average
life of which is less sensitive to changes in interest rates. See
'Business--Investments.'

To date, the Company has funded acquisitions and other major capital
transactions through debt financing and the private placement of equity
securities. On December 31, 1996, in connection with the Rockwood Acquisition,
the Company entered into the Term Loan. The proceeds of the Term Loan were used
to refinance a then-existing $8.7 million term loan with First Union, to finance
a portion of the Rockwood Acquisition and to repay or prepay various other
indebtedness incurred in connection with previous acquisitions. The balance of
the Term Loan at July 24, 1998 was approximately $33.2 million ($35.3 million
and $36.5 million at March 31, 1998 and December 31, 1997, respectively). The
Term Loan will be repaid in full, from the proceeds of the Offering.

The Company has received a commitment from First Union for the Credit
Facility. Under the terms of the commitment, the Company will be able to borrow
and reborrow up to $50.0 million from time to time for working capital and
general corporate purposes, including acquisitions, with the amount available
being reduced on a quarterly basis beginning after the second anniversary of the
closing until the facility is reduced to zero at maturity in 2004. Advances
under the Credit Facility will bear interest at the lenders' base rate, or at a
margin of 0.75% to 1.0% above LIBOR, at the Company's option. Loans are to be
guaranteed by the Company's subsidiaries and are to be secured by a pledge of
the stock of Front Royal's direct and indirect subsidiaries. Closing of the
Credit Facility, which the Company anticipates will take place shortly following
the closing of the Offering, is subject to negotiation of definitive
documentation, customary closing conditions, and the receipt by the Company of
at least $40.0 million of net proceeds from the Offering.

IMPACT OF INFLATION

Inflation can have a significant impact on property and casualty insurers
because premium rates are established before the amount of loss and loss
adjustment expenses are known. The Company attempts to anticipate increases from
inflation in establishing rates, subject to limitations imposed for competitive
pricing. The Company does not believe inflation has had a material impact on the
Company's business, results of operations or financial condition to date.

The Company also considers inflation when estimating liabilities for loss
and loss adjustment expenses, particularly for claims having a long period
between occurrence and settlement. The liabilities for loss and loss adjustment
expenses are management's estimates of the ultimate net cost of underlying
claims and expenses and, for the workers' compensation portion of the business
only, are discounted for the time value of money. In times of high inflation,
the normally higher yields on investments may partially offset higher claims and
expenses. See 'Risk Factors--Risk that Loss Reserves May Not Be Adequate.'

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<PAGE>
DEFERRED INCOME TAXES

The Company had income tax net operating loss ('NOL') carryforwards of
approximately $3.8 million at December 31, 1997. The utilization of these NOLs
is limited to $435,000 per year under Section 382 of the Internal Revenue Code.
In addition, Front Royal's tax returns have not been examined by the Internal
Revenue Service ('IRS') and the availability of the NOLs could be challenged by
the IRS upon review of the Company's returns through 1997. Because of the
limitations on the use of these NOLs and evaluation of related risk factors, the
Company has limited recognition of the benefits to amounts actually used or
scheduled to be used in the Company's income tax returns. Accordingly, the tax
benefit related to those NOLs of $1.3 million has been fully reserved by the
Company. The Company has determined that no valuation allowance is required for
the other components of its deferred tax asset because realization of such
amounts is evidenced as more likely than not based on taxable earnings in the
carryback period and the Company's trend of taxable earnings. Prior to 1995, the
Company had produced operating losses and accumulated an unused net operating
loss for income tax purposes. Colony was acquired on December 30, 1994, and had
produced a net loss in 1994, and a sizable underwriting loss in 1993. Because of
the Company's past operating losses, and the unfavorable operating results
produced by Colony prior to its acquisition, the Company determined that the
valuation allowance for the deferred tax asset at December 31, 1995 should be
established at a level to limit recognition of net deferred tax assets to an
amount approximately equal to the amount of current income taxes paid for 1995.
Such taxes would be available for recovery in the event of future losses. Thus,
the net deferred tax asset at December 31, 1995 of $1.0 million was
approximately equal to the current income taxes paid by the Company for 1995.

Rockwood was acquired on December 31, 1996 and was responsible for the
addition of $6.4 million to the Company's deferred tax asset on that date. No
allowance was made for the Rockwood portion of the deferred tax asset, because
Rockwood had consistently produced income in 1996 and prior years, and was
expected to continue to do so. With respect to the deferred tax assets at
December 31, 1996 attributable to companies other than Rockwood, the Company
continued to follow the practice established in 1995. The deferred tax valuation
allowance was decreased to recognize a net deferred tax asset approximately
equal to the cumulative current income taxes paid for 1995 and 1996. Such taxes
would be available for recovery in the event of future losses. Thus the net
deferred tax asset at December 31, 1996, attributable to the non-Rockwood
entities of $2.7 million, was approximately equal to the cumulative current
income taxes paid by the Company for 1995 and 1996.

At December 31, 1997, the Company considered separately the deferred tax
assets related to temporary differences, other than the NOL's discussed above,
and concluded that no valuation allowance was necessary. This decision was made
because the taxes paid and recoverable by the Company's component members in the
two year carry back period, exceeded such deferred tax assets, and because of a
positive assessment of the prospects for future earnings.

OTHER

In 1997, the Financial Accounting Standards Board ('FASB') issued Statement
No. 130, Reporting Comprehensive Income ('Statement 130'), effective for years
beginning after December 15, 1997. The new rules require companies to display
items of other comprehensive income either below the total for net income on the
income statement, on the statement of changes in shareholders' equity or in a
new, separate statement of comprehensive income. The Company would then disclose
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the balance
sheet.

The adoption of Statement 130 did not affect results of operations or
financial position of the Company. Currently, the Company has no other
comprehensive income, as defined, other than unrealized gains or losses on
available-for-sale securities which have been disclosed separately in the equity
section of the balance sheet.

In June 1997, the FASB issued Statement No. 131, Disclosures about Segments
of an Enterprise and Related Information ('Statement 131'), effective for years
beginning after December 15, 1997. Statement 131 requires that a public company
report financial and descriptive information about its reportable operating
segments pursuant to criteria that differ from current accounting practice.
Operating segments, as defined, are components of an enterprise about which
separate financial information is available that is evaluated regularly by
senior management in deciding how to allocate resources and in assessing
performance. The adoption of Statement 131 will not affect results of operations
or financial position of the Company.

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<PAGE>

In 1997, the Accounting Standards Executive Board issued Statement of
Position 97-3, Accounting by Insurance and Other Enterprises for Insurance
Related Assessments ('SOP 97-3'), effective for years beginning after December
15, 1998. SOP 97-3 provides guidance on when an insurance or other enterprise
should recognize a liability for assessments related to insurance activities,
including those by state guaranty funds and workers' compensation funds. The
provisions of this statement will have little effect on Colony because it does
not apply to business written on a non-admitted basis. Rockwood currently
provides for guarantee fund assessments on a basis similar to that prescribed by
the statement, and therefore, this statement, will not have a significant effect
on results of operations or financial position.

The codification of SAP has been officially approved by the NAIC. It is
uncertain at this time whether or how states will adopt the new accounting
guidance. The Company has not yet quantified the impact such changes would have
on the statutory capital and surplus or results of operations of the
Subsidiaries. The impact of adopting this new comprehensive statutory basis of
accounting may, however, materially impact statutory capital and surplus.

YEAR 2000 COMPLIANCE

The Company has developed a plan to modify its information technology to be
ready for the year 2000 and has purchased, where necessary, year 2000 compliant
software and begun converting critical data processing systems. The Company
currently expects the project to be substantially complete by early 1999 and to
cost approximately $1.5 million, of which approximately $800,000 has been
incurred as of December 31, 1997. This estimate excludes the costs to upgrade
and replace systems in the normal course of business. The Company currently does
not expect this project to have a significant effect on its operations.

While the foregoing represents the Company's best current estimates
regarding its year 2000 compliance program, no assurance can be given that such
program will be completed on time or that its costs will be in line with current
estimates. If, for whatever reason, such program is not completed on time, the
consequences could have a material adverse effect on the Company. See 'Risk
Factors--Risks Associated with Year 2000 Compliance.'

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<PAGE>
BUSINESS

GENERAL

The Subsidiaries provide commercial liability, professional liability and
other insurance to targeted types of businesses, primarily on an E&S basis, and
workers' compensation insurance for non-union coal mines and other specialized
risk classes. The Company's primary operating objective is to achieve consistent
profits from its core business of underwriting insurance, as evidenced by an
average SAP combined ratio from 1995 through 1997 of 98.8%. The Company pursues
this goal by focusing on niche markets in which it has particular expertise,
adhering to disciplined underwriting and claims practices and utilizing various
distribution channels, including wholesale agents, retail agents and direct
marketing, depending on which channel most effectively reaches the Company's
targeted customers in each market. The Company manages the Subsidiaries on a
decentralized basis to enable them to respond effectively to changing conditions
in the markets in which they operate, while consolidating investment, financial,
actuarial and other support functions to achieve operating efficiencies. The
Company believes that generally there are fewer companies competing in the
specialty markets it pursues than in the standard lines markets because the
specialty markets are relatively small and require specialized underwriting and
targeted distribution.

The Company's acquisition strategy has resulted in significant growth, and
its operating strategy, which emphasizes disciplined underwriting over premium
growth, has produced consistent underwriting profitability. The Company's gross
written premiums were $500,000 in 1992, $800,000 in 1993 and $1.2 million in
1994. In 1995, primarily as a result of acquiring Colony, gross written premiums
grew to $43.6 million. Gross written premiums grew from $49.9 million in 1996 to
$100.2 million in 1997, primarily as a result of acquiring Rockwood. See
'--Colony--Lines of Business' and '--Rockwood--Lines of Business' for Colony's
and Rockwood's historical gross written premiums, respectively. The Company's
net operating income/(loss) (excluding after-tax realized gains) has grown from
$(800,000) in 1992 to $3.0 million in 1995 and $11.7 million in 1997. Pro forma
1997 gross written premiums and net operating income, assuming the Preferred
National Acquisition had been completed on January 1, 1997, were $146.4 million
and $12.8 million, respectively. In 1995, 1996 and 1997, the Company achieved an
average return on equity of 26.3%, 24.1% and 20.8%, respectively. From 1995
through 1997, the Company's average SAP combined ratio was 98.8%.

The difference between SAP and GAAP information is immaterial for all
periods presented except for the pro forma combined ratio for the year ended
December 31, 1997 which includes a SAP expense ratio of 34.6% that is 2.8% lower
than the corresponding GAAP expense ratio of 37.4%. This is wholly attributable
to the significant premium growth at Preferred National. As a result, the GAAP
combined ratio is higher by this same 2.8%.

DESCRIPTION OF THE SUBSIDIARIES AND PREFERRED NATIONAL

40
<PAGE>
risk classes as does Colony. In addition, Preferred National offers surety,
property and inland marine coverages not offered by Colony. Approximately 60% of
Preferred National's business is written on an admitted basis in Florida. The
Company believes that Preferred National, which will be managed by Colony's
management team, will enhance Colony's business by increasing the scale of
Colony's operations and by broadening the scope of the Company's product
offerings. Preferred National offers coverage through 154 wholesale agent
offices, 40 of which also have an appointment with Colony. Preferred National's
largest wholesale agent is UnaMark, a captive agency the business of which will
be acquired in the Preferred National Acquisition and thereafter operate as a
division of Redwoods. Through UnaMark and its other wholesale agents, the
Company believes that Preferred National has access to over 20,000 retail
agents. Preferred National's surety business is produced directly through retail
agents. A substantial portion of the professional liability business written by
Preferred National is produced through four risk-purchasing groups that have
direct communications with accountants, lawyers, title agents and dentists.
Preferred National is an admitted insurer in Florida and Illinois and is
approved as a non-admitted insurer in 36 states. Preferred National is rated
'B++' by A.M. Best. See '--Preferred National.'

The following table shows the gross written premiums of the Insurance
Subsidiaries and Preferred National in 1997:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------
GROSS WRITTEN PERCENT
PREMIUMS OF TOTAL
(DOLLARS IN THOUSANDS)

<S> <C> <C>
Colony................................................................ $ 50,562 34.5%
Preferred National.................................................... 46,133 31.6
Rockwood.............................................................. 49,684 33.9
------------- --------
Total.......................................................... $ 146,379 100.0%
------------- --------
------------- --------
</TABLE>

41
<PAGE>
BUSINESS STRATEGY

Manage Capital Actively. The Company actively manages its capital
structure in order to maximize returns to its stockholders. The Company expects
to finance its future acquisitions with a combination of debt and equity and
does not seek to raise or retain more capital than it believes can properly be
deployed. In 1997, the Company operated at a ratio of net written premiums to
surplus of 1.2:1. On a pro forma basis for the three months ended March 31,
1998, the Company operated at a ratio of net written premiums (on an annualized
basis) to surplus of 1.4:1. As of March 31, 1998, the Company had a ratio of
total debt to total capitalization of 35.9%. The Company plans to use a portion
of the net proceeds from the Offering to repay a substantial portion of its
existing indebtedness. The Company has received a commitment for the $50.0
million Credit Facility to support future acquisitions. The Company intends to
enter into the Credit Facility shortly after completion of the Offering. See
'Use of Proceeds' and 'Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources.'

COLONY

General. Colony provides commercial liability, commercial property,
products liability and environmental liability coverages to commercial
enterprises, including restaurants, artisan contractors, day-care centers and
manufacturers, and professional liability coverages for health care providers
(other than physicians) and other professionals. Colony operates primarily on an
E&S basis and focuses on insureds who generally cannot purchase insurance from
standard lines insurers due to the perceived risks related to their businesses.
Colony is an admitted insurer in nine states and is approved as a non-admitted
insurer in 44 states.

Lines of Business. Colony believes that in order to be a preferred carrier
for its agents, it must be able to efficiently and routinely handle a wide
variety of risks. These include risk classes as diverse as small contractors,
restaurants and taverns, a variety of manufacturers, pest-control operators, and
other service businesses.

In addition to these core products, Colony offers its agents a variety of
specialty products. These products, which are tailored to respond to specific
market niches, help to distinguish Colony from other E&S markets which do not
offer similar lines or whose policies are not as customized as Colony's to the
specific needs of the insureds. Examples of some of these products include
environmental liability insurance, specific professional

42
<PAGE>
liability coverage for health care providers other than physicians, specialty
mono-line property coverage, and coverage for oil and gas lease operators. Of
Colony's 56 total products at March 31, 1998, 25 were new products (or
significant refinements) developed within the previous 18 months.

Colony currently divides its business into four broad categories: contract
business, brokerage business, environmental business and specialty business.

The following table sets forth gross written premiums for Colony by line of
business for the periods set forth below (all amounts presented below are on a
SAP basis; the differences between GAAP and SAP amounts are not material):

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, YEARS ENDED DECEMBER 31,
---------------------------------------- ----------------------------------------------------
1998 1997 1997 1996 1995
------------------ ------------------ ------------------ ------------------ --------
GROSS PERCENT GROSS PERCENT GROSS PERCENT GROSS PERCENT GROSS
WRITTEN OF WRITTEN OF WRITTEN OF WRITTEN OF WRITTEN
PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Contract business.......... $ 7,580 65.3% $ 8,878 70.7% $36,130 71.5% $35,826 71.7% $30,423
Brokerage business......... 2,712 23.4 2,760 22.0 10,242 20.3 11,200 22.4 11,048
Environmental business..... 598 5.2 473 3.8 1,974 3.9 1,918 3.9 2,087
Specialty business......... 717 6.1 444 3.5 2,163 4.2 988 2.0 28
Other(1)................... -- -- 2 -- 53 0.1 16 -- (15)
-------- ------- -------- ------- -------- ------- -------- ------- --------
Total...................... $11,607 100.0% $12,557 100.0% $50,562 100.0% $49,948 100.0% $43,571
-------- ------- -------- ------- -------- ------- -------- ------- --------
-------- ------- -------- ------- -------- ------- -------- ------- --------

PERCENT
OF
TOTAL

<S> <C>
Contract business.......... 69.8%
Brokerage business......... 25.4
Environmental business..... 4.8
Specialty business......... --
Other(1)................... --
-------
Total...................... 100.0%
-------
-------
</TABLE>

- ------------------
(1) For the three months ended March 31, 1998, the amounts presented exclude
$657,000 of workers' compensation premiums written by Colony and reinsured
100.0% by Rockwood.

Contract Business. Contract business principally consists of general
liability policies written for commercial enterprises which are produced,
underwritten, priced and bound by one of Colony's wholesale agents in
accordance with specific guidelines developed by Colony's underwriting
staff and set forth in Colony's underwriting manual. After this business is
written by agents, the contracts are sent to Colony's offices where they
are re-underwritten by Colony's underwriting staff. All claims handling
authority with respect to this business remains with Colony and no
reinsurance is placed by agents. The enterprises insured through Colony's
contract business tend to be smaller, independently owned businesses, where
the business owner is often a key employee of the insured business.
Contract business policies are commonly written for restaurants, artisan
contractors, day-care centers, garages and convenience stores. The low
average annual premium (less than $2,000), combined with the perceived
risks related to these businesses, has traditionally caused standard
insurance companies to avoid writing these types of risks. Colony believes
that, properly screened and priced, these accounts can be profitable.

Brokerage Business. Brokerage business principally consists of
general liability and products liability coverage, where the product will
be used in an industrial setting. Brokerage business is submitted to Colony
by the same wholesale agents who produce contract business, and by some
wholesale agents appointed only for this category of business. Brokerage
business is distinguished from contract business by the fact that the
underwriting authority on these policies remains solely with Colony and not
with the agents. Brokerage business may fall into the same risk classes as
contract business, but because of the more complex nature or larger size of
the account it may be treated as brokerage business rather than contract
business. A substantial portion of Colony's brokerage business is written
for industrial contractors, fabricators and manufacturers. While many of
the risks underwritten as brokerage business might be deemed hazardous by
standard carriers, the Company believes that its specialized underwriting
knowledge and discipline enables it to distinguish among such risks and
earn an underwriting profit insuring such risks. Typical annual premiums
for Colony's brokerage business are between $7,500 and $12,500, which fall
beneath the minimum premium requirements of many larger competitors.

Environmental Business. Environmental business consists of insurance
policies covering environmental risks. Environmental business is produced
and underwritten in the same fashion as brokerage business; however,
environmental business may occasionally be produced by retail agents in
addition to wholesale agents. Colony currently writes several products in
this class, including contractors' pollution liability, errors and omission
insurance for small environmental consultants; pollution legal liability
insurance for property owners and lenders, underground and above-ground
petroleum storage tank insurance, first and third-party pollution cleanup
coverage, environmental liability insurance for dry cleaners and
environmental cleanup coverage for agri-

43
<PAGE>

chemical dealers. Over time, Colony has developed an expertise underwriting
these types of risks. The manager of this business has a Masters Degree in
Environmental Science and extensive experience with another specialist in
the environmental insurance field. Coverages are written on a claims-made
basis, generally with policy limits applying to both defense and cleanup
costs. The average annual premium for this type of business is
approximately $2,300. Since l996, Colony has expanded its offerings in this
area, and environmental business is currently one of the Company's targeted
growth areas. Between the first quarter of 1997 and the first quarter of
1998, Colony's environmental business gross written premiums grew by 26.4%.

Specialty Business. Specialty business consists of professional
liability coverages written for classes which Colony has identified as
underserved by traditional underwriters of professional liability
coverages. Specialty business is produced and underwritten in the same
fashion as brokerage business. A major emphasis for Colony in this category
has been health care providers other than physicians. Colony offers
coverage to small convalescent homes, artificial limb fitters, dental labs,
alcohol detoxification facilities and other health care providers working
away from a physician's office or clinic. Specialty business also includes
coverages written for computer consultants, insurance agents and exercise
facilities. Colony believes that, properly screened and priced, these
accounts can be profitable. The average annual premiums in this class is
approximately $3,500. Specialty business is currently one of the Company's
targeted growth areas. Between the first quarter of 1997 and the first
quarter of 1998, Colony's specialty business gross written premiums grew by
61.5%.

Marketing and Distribution. Colony markets its products through a select
group of wholesale agents who have demonstrated that they can consistently
produce quality business for the Company. These agents, in turn, generally
obtain premium from independent, or 'retail,' agents who do not have direct
access to insurance carriers willing to write specialty insurance. When retail
agents encounter a specialty risk, they generally approach a wholesale agent who
has access to companies willing to accept these risks. Colony utilizes this
distribution system because it believes wholesale agents represent the most
effective method of collecting risks from retail agents. The 133 wholesale agent
offices with which Colony maintains relationships service over 30,000 retail
agents. Instead of having infrequent contacts with each of these retail agents,
Colony maintains close relationships with a much more limited number of
wholesale agents.

Colony's wholesale agents cover the cost of marketing to the retail agents
in their area, and handle agent inquiries about coverage, pricing and
administrative matters. In addition, for Colony's contract business, wholesale
agents review applications, price business (based on schedules from Colony),
bind the coverage and issue Colony's policies.

The Company selects its wholesale agents based upon management's review of
the experience and performance record of the agents in charge of each office.
While many of Colony's agents have more than one office, Colony evaluates each
office as if it were a separate agency. Often, Colony appoints some but not all
offices owned by an agency for specialized lines of business. Colony may
designate only a specific employee of the agent as having underwriting authority
under the agreement. The Company seeks agents with written business plans that
are consistent with the Company's own strategy and underwriting objectives.
Agents must be able to demonstrate an ability to competently underwrite both the
quality and quantity of business sought by Colony. Colony requires its agents to
maintain in-force errors and omissions insurance coverage with limits of not
less than $500,000. Not all agents appointed by Colony are granted authority to
produce contract, brokerage, environmental and specialty business. The Company
evaluates the ability of an agent to produce these lines on an individual basis.
Agents who are unable to produce consistently profitable business, or who
produce unacceptably low volumes of business, are terminated. Colony's
underwriters regularly visit with agents in their offices in order to review
policies produced by that agency, discuss products offered by the Company and
market to these agents.

Colony's largest single agent, Burns & Wilcox, Limited, has 31 offices
nationwide, but Colony has approved and contracted with only 26 of those
offices. This agent produced 23.5% and 25.4% of Colony's business in 1996 and
1997, respectively. No more than 5.1% of Colony's business comes from any one
single office of this agent. Three of Colony's top five producers are
independently owned agencies and, other than Colony's top producer, no other
agency produced more than 6.0% of Colony's business in 1996 or 1997. Colony is
seeking selectively to add agents in order to expand its presence in existing
territories and to take advantage of particular knowledge developed by certain
agents.

The Company believes that the economics of the wholesale distribution
system are such that wholesale agents are reducing the number of companies with
which they do business in order to make their operations more cost

44
<PAGE>
efficient. The Company believes that it has a reputation for excellent service
to agents, and that this reputation will allow Colony to expand its share of its
agents' business as agents reduce the total number of carriers with which they
do business.

Underwriting. Colony's underwriting staff consists of 17 underwriters who
have an average of over 12 years of underwriting experience. Colony believes
that it has assembled an underwriting staff that is highly skilled in
underwriting the types of coverage provided by Colony. This staff develops all
of Colony's underwriting policies and manuals and meets regularly with members
of Colony's marketing and claims departments.

Colony's contract business is underwritten by Colony's wholesale agents and
is re-underwritten by Colony's underwriting staff after policies are received by
Colony. Colony's brokerage, environmental and specialty business is underwritten
exclusively by Colony's underwriting staff.

The authority granted to Colony's wholesale agents is limited. Colony has
developed detailed underwriting manuals which are provided to its agents. The
agents that write contract business receive applications on behalf of Colony,
price business (based on schedules from Colony), bind the coverages, and issue
Colony policies. Colony has carefully constructed its manual in such a way as to
cause its agents to contact the Company before issuing all but the most routine
policies. In this way, the Company's underwriting staff is able to guide agents
in advance of issuing a policy and mistakes are reduced. The applications
received by the agent and the policies and endorsements issued by them are
reviewed in each case by a Colony underwriter. If necessary, Colony has the
option to cancel or modify coverage at any time, typically within 45 to 75 days
of the original issuance of the policy. The Company also annually conducts a
series of two and three-day training seminars for its agents. The Company
believes these seminars contribute to its agents having an understanding of
Colony's underwriting criteria.

The following table sets forth the recent accident year experience for
Colony as compared to industry results.

COMPARISON OF COLONY AND INDUSTRY RATIOS(1)

<TABLE>
<CAPTION>
ACCIDENT COLONY TOTAL INDUSTRY TOTAL VARIANCE TO INDUSTRY
YEAR ALL LINES(2) ALL LINES(3) FAVORABLE/(UNFAVORABLE)
<S> <C> <C> <C>
1990 76.5% 82.3% 5.8%
1991 64.1 81.1 17.0
1992 72.4 88.1 15.7
1993 69.5 79.5 10.0
1994 61.4 81.1 19.7
1995 58.6 78.9 20.3
1996 62.8 78.3 15.5
1997 67.4 72.8 5.4
</TABLE>

- ------------------
(1) Accident year loss ratios include allocated and unallocated loss adjustment
expenses.
(2) Results are from Colony's 1997 Annual Statement, Schedule P--Analysis of
Losses and Loss Expenses.
(3) Source: A.M. Best.

Claims. Colony's claims department consists of 13 claims professionals who
have an average of 12 years of claims experience in the property and casualty
industry. The Vice President of claims is an attorney with 33 years of claims
experience in large commercial and medium-sized specialty insurance companies
and has been employed by Colony for the past six years.

Colony's business generally results in three types of claims: bodily injury
liability, property damage liability and first party property losses. The claims
staff is organized so as to bring specialized knowledge and skills in each of
the three types of claims.

Colony believes that the key to effective claims management is timely and
thorough claims investigation (which Colony believes results in accurate
reserves), improved defenses and proper settlements. Colony seeks to complete
all investigations and adjust reserves appropriately within 30 days of receipt
of a claim. Within 60 days of receiving a claim, senior management reviews each
case to ensure that the front-line adjuster has recognized and is addressing the
key issues in the case and has adjusted the reserve to the appropriate amount.
Colony keeps the settlement authority of its front-line adjusters low to ensure
the practice of having two or more members of the department participate in the
decision whether to settle or defend. In addition, cases with unusual damage,
liability or policy interpretation issues are subjected to peer review on a
weekly basis, and members of the underwriting staff participate in this process.
Prior to any scheduled mediation or trial of a claim, claims personnel conduct
further peer review to make sure all issues and exposures have been fully
analyzed.
45
<PAGE>
Litigation expense is Colony's second largest component of overall claims
costs. The Company believes that effective management of litigation avoids
delays and associated additional costs. Early mediation is utilized to narrow
the issues and streamline the problem solving process.

The claims department also contributes to Colony's operations through its
interaction with the underwriting staff. Information on changes in the business
and legal environment that pose either a risk or opportunity for a new or
refined insurance product is also sent to the underwriters. The claims staff
participates on a regular basis in the drafting of policy forms to help ensure
that the language clearly describes the underwriter's intent.

PREFERRED NATIONAL

General. On March 6, 1998, the Company executed a definitive agreement to
purchase the stock of Preferred National, substantially all of the assets and
business of UnaMark and certain other assets and liabilities for a total
purchase price of $35.0 million in cash, subject to adjustment, 300,000 shares
of Common Stock and the Preferred National Warrants. The cash portion of the
purchase price is subject to adjustment based on Preferred National's levels of
GAAP book value, SAP surplus, and cash and invested assets as of the month end
immediately prior to closing. While the Company believes that completion of the
Preferred National Acquisition is highly probable, and will occur in July 1998,
there can be no assurance when or if the transaction will be completed.

The Company believes that Preferred National will enhance Colony by adding
to the scale of Colony's operations and by broadening the scope of the Company's
offerings. Preferred National focuses on many of the same coverages and risk
classes as does Colony. In addition, Preferred National offers surety, property
and inland marine coverages not offered by Colony. Approximately 60% of
Preferred National's business is written on an admitted basis in Florida.
Preferred National is rated 'B++' by A.M. Best.

Following the Preferred National Acquisition, Preferred National will be
managed by Colony's management team, which will be responsible for all
underwriting and claims management activities. The Company anticipates that the
same policies and operating philosophy currently applied to Colony will be
applied to Preferred National. See '--Colony--Underwriting' and
'--Colony--Claims.' Preferred National currently operates from offices located
in Coral Springs, Florida and Hightstown, New Jersey, and Front Royal intends to
maintain these facilities.

Formed in 1989, Preferred National commenced material operations in 1996.
Preferred National is a wholly-owned subsidiary of Preferred National Financial
Corporation, which also owns Britamco Underwriters, Inc., a former syndicate on
the Illinois Insurance Exchange ('Britamco'). Britamco is now in runoff, having
ceased writing insurance in 1997. Many of the policies written by Britamco were
renewed on expiration by Preferred National. Front Royal will not acquire
Britamco or assume any liabilities associated with business written by Britamco
as part of the Preferred National Acquisition.

Lines of Business. Approximately 60% of Preferred National's business
originates in Florida and is written on an admitted basis. In 1997, Preferred
National wrote $46.1 million in gross written premium. Preferred National
divides its business into four major segments: commercial multi-peril; other
general liability; professional liability coverages; and surety. In 1998,
Preferred National hired an experienced inland marine insurance underwriter and
began to offer inland marine insurance, which it had not previously
underwritten.

46
<PAGE>
The following table sets forth gross written premiums for Preferred
National by line of business for the periods set forth below (all amounts
presented below are on a SAP basis; the differences between GAAP and SAP amounts
are not material):

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31,
---------------------------------------------------------- ---------------------------
1998 1997 1997
--------------------------- --------------------------- ---------------------------
GROSS WRITTEN PERCENT OF GROSS WRITTEN PERCENT OF GROSS WRITTEN PERCENT OF
PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Commercial multi-peril.......... $5,528 55.8% $6,944 55.0% $25,824 56.0%
Other general liability......... 2,130 21.5 3,378 26.8 11,087 24.0
Professional liability.......... 1,306 13.2 1,275 10.0 5,362 11.6
Surety.......................... 766 7.7 848 6.7 3,282 7.1
Other........................... 182 1.8 179 1.5 578 1.3
------------- ---------- ------------- ---------- ------------- ----------
Total...................... $9,912 100.0% $12,624 100.0% $46,133 100.0%
------------- ---------- ------------- ---------- ------------- ----------
------------- ---------- ------------- ---------- ------------- ----------
</TABLE>

Commercial Multi-Peril Policies. These policies cover both property
and liability risks for small businesses. Classes sought out by Preferred
National include restaurants and taverns, strip shopping centers, apartment
buildings, condominiums, and small office facilities. In 1997, $25.8
million (56.0%) of Preferred National's gross written premiums was from
commercial multi-peril insurance. In recent years, Preferred National has
successfully underwritten property risks in Florida, where the Company
believes there are greater opportunities to profitably underwrite property
coverages than exist in other areas of the country which are less subject
to hurricane activities.

Other General Liability. Preferred National writes liability
insurance for artisan contractors, liquor liability coverages for bars,
liability coverage for beauty salons and fitness clubs, insurance for
contractors working at marinas and employment practices liability coverage.
Other general liability coverages accounted for $11.1 million (24.0%) of
gross written premiums in 1997.

Professional Liability Coverages. Preferred National sells
professional liability insurance to lawyers, accountants, dentists and
title agents. In 1997, this line accounted for $5.4 million (11.6%) of
gross written premiums for Preferred National. A substantial portion of the
professional liability insurance written by Preferred National is
distributed through risk purchasing groups which communicate directly to
their members. Preferred National's policies are endorsed by the American
Society of Accountants, Inc., the National Society of Dental Practitioners,
Inc., the North American Title Organization, Inc. and the National Lawyers
Risk Management Association, Inc. An affiliate of Preferred National serves
as program administrator for these associations. The Company believes that
there is an opportunity to expand the amount of professional liability
business distributed directly through these risk purchasing groups.

Surety. Preferred National writes surety policies for small and
mid-sized contractors, primarily in Florida. In 1997, surety underwriting
generated $3.3 million (7.1%) in gross written premiums for Preferred
National.

Marketing and Distribution. Preferred National offers its products through
wholesale agents. Of the 154 agent offices representing Preferred National, 40
also have an appointment with Colony. Preferred National's largest wholesale
agent is UnaMark, a captive agency the business of which will be acquired by the
Company in the Preferred National Acquisition. Through UnaMark and its other
agents, the Company believes that Preferred National has access to over 20,000
retail agents. Preferred National also distributes insurance through retail
agents who produce its surety business and through four risk-purchasing groups
which have direct communications with insureds who purchase Preferred National's
professional liability coverages. Preferred National is admitted in Florida and
Illinois and is approved as a non-admitted insurer in 36 states.

Direct marketing through the four risk purchasing groups referenced above
generated $4.9 million of gross written premiums in 1997, or 10.7% of the total.
Retail agents, appointed for the purpose of producing surety business, produced
$3.3 million of gross written premiums, or 7.2% of gross written premiums for
1997. The balance of Preferred National's premiums in 1997 were produced by
independent wholesale agents.

47
<PAGE>

Of Preferred National's 10 largest wholesale agents (excluding UnaMark), no
agent accounted for more than 3.0% of total premiums collected.

ROCKWOOD

General. Rockwood, which concentrates on writing specialty workers'
compensation insurance, is licensed to write insurance in Pennsylvania,
Maryland, Delaware, West Virginia, Virginia and Indiana. Most of Rockwood's
business is concentrated in Pennsylvania, where Rockwood is domiciled.

Rockwood and its predecessor companies have been writing specialty workers'
compensation insurance for coal mining operations in Pennsylvania for over 40
years. Front Royal acquired Rockwood in December 1996 for $60.5 million, in part
because of the depth of Rockwood's knowledge of this market niche.

Lines of Business. Rockwood separates its business into three broad
workers' compensation categories: workers' compensation for coal mines; workers'
compensation for small premium or specialty commercial accounts; and workers'
compensation for other mining business. In addition, Rockwood writes lesser
amounts of general liability, commercial automobile, commercial multi-peril,
property and surety business, primarily for the same accounts for which it
writes workers' compensation insurance.

The following table sets forth gross written premiums for Rockwood by line
of business for the periods set forth below (all amounts presented below are on
a SAP basis; the differences between GAAP and SAP amounts are not material):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------
1998 1997
--------------------- ---------------------
GROSS PERCENT GROSS PERCENT
WRITTEN OF WRITTEN OF
PREMIUMS TOTAL PREMIUMS TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Workers' compensation Coal
mining...................... $4,217 37.1% $6,517 43.9%
Commercial.................. 4,124 36.3 5,396 36.3
Other mining................ 442 3.9 447 3.0
Other lines................... 2,579 22.7 2,490 16.8
--------- ---------- --------- ----------
Total continuing business..... 11,362 100.0 14,850 100.0
Discontinued business(1)...... -- -- -- --
--------- ---------- --------- ----------
Total....................... $11,362 100.0% $14,850 100.0%
--------- ---------- --------- ----------
--------- ---------- --------- ----------

<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------

1997 1996 1995
-------------------- --------------------- ---------------------
GROSS PERCENT GROSS PERCENT GROSS PERCENT
WRITTEN OF WRITTEN OF WRITTEN OF
PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS TOTAL

<S> <C> <C> <C> <C> <C> <C>
Workers' compensation Coal
mining...................... $19,871 40.0% $22,957 33.1% $23,007 35.5%
Commercial.................. 17,715 35.6 22,567 32.5 25,654 39.6
Other mining................ 2,584 5.2 3,140 4.5 3,638 5.6
Other lines................... 9,563 19.2 11,191 16.1 12,051 18.7
-------- ---------- --------- ---------- --------- ----------
Total continuing business..... 49,733 100.0 59,855 86.2 64,350 99.4
Discontinued business(1)...... -- -- 9,543 13.8 382 0.6
-------- ---------- --------- ---------- --------- ----------
Total....................... $49,733 100.0% $69,398 100.0% $64,732 100.0%
-------- ---------- --------- ---------- --------- ----------
-------- ---------- --------- ---------- --------- ----------
</TABLE>

- ------------------
(1) Consists of private passenger auto insurance premiums which are 100.0%
reinsured.

Workers' Compensation--Coal Mining. Workers' compensation
(principally for non-union coal mining operations) is the most distinctive
aspect of Rockwood's business. In 1996, the Pennsylvania Coal Mine
Compensation Rating Bureau reported that Rockwood wrote 44.2% of the total
workers' compensation written premiums for coal mining operations in
Pennsylvania (self-insured companies are not included in this measure). The
second largest writer in this category wrote 25.7% of the total written
premiums. The Company believes that Rockwood's history of evaluating the
quality of mines in this region and its expertise in writing this type of
business, together with its central location in the coal mining region in
western Pennsylvania, gives it a competitive advantage for writing workers'
compensation for coal mining operations. The Company further believes that
Rockwood's expertise in this type of business, including its rigorous
inspection and underwriting process, makes this type of business an
attractive niche for the Company. Rockwood has developed underwriting
techniques which it believes protect the Company against occupational
disease and safety exposures which cause most insurers to avoid these
risks. Over time, as Rockwood continues to grow both its commercial
business and other mining business, the Company expects that the coal
mining related portion of Rockwood's business will represent a smaller
percentage of the total premium written by Rockwood.

Workers' Compensation--Commercial. Rockwood has developed substantial
expertise in writing workers' compensation insurance for small commercial
accounts with an average annual premium of approximately $2,500. These
accounts are often small businesses which typically fall below the minimum

48
<PAGE>
premium requirements of larger workers' compensation insurance carriers and
are difficult for agents to place. Moreover, agents have relatively little
incentive to shop aggressively to place these accounts because the average
commission paid is very low. Rockwood provides a ready market for this
business if the account meets Rockwood's underwriting standards. Because
there is less competition for accounts of this size, Rockwood believes that
it is able to charge an adequate price for these risks. Rockwood's policy
is to inspect virtually all of these risks during the initial policy term,
which allows Rockwood to confirm the information provided at the time of
underwriting and to adjust premiums, cancel coverage, or not renew the
policy if the information provided was incorrect.

Workers' Compensation--Other Mining Business. Rockwood has also
applied its detailed knowledge of the issues involved in writing workers'
compensation insurance for coal mining operations to evaluate and write
insurance for mining operations other than coal mines. These include
aggregate mines, limestone quarries, sand and gravel operations and
mining-related transportation operations. Like coal mines, these types of
operations are considered hazardous by most writers of workers'
compensation insurance. Rockwood has found that the same rigorous
underwriting process applied to its coal mining operations can be utilized
to make the underwriting of other mining operations attractive to the
Company. The Company believes that the fact that these operations are
hazardous is balanced by the ability of Rockwood to charge premiums
developed for the entire hazardous class while insuring operations the
Company believes are safer than average. The Company believes that
Rockwood's expertise in this area will allow Rockwood to implement its
long-term plan of expanding this business prudently into other states and
reducing its reliance on the coal-mining industry for its profits.

Other Lines. Rockwood's other lines consist primarily of commercial
automobile insurance written for mining operations, general liability
insurance written for insureds where Rockwood also typically writes the
workers compensation insurance and surety business written for mining
operations. Rockwood also writes multi-peril, inland marine and umbrella
liability policies. In most cases, where Rockwood writes a coverage other
than workers' compensation, it also writes workers' compensation for that
enterprise.

Marketing and Distribution. Rockwood produces its business through 659
independent agents and brokers, 15 of whom are responsible for the majority of
Rockwood's workers' compensation insurance for coal mining operations. These
producers generally are selected on the basis of their ability to access
profitable workers' compensation business that is often overlooked by larger
competitors. Rockwood pays commissions which are competitive with other
insurance carriers offering similar products and also believes that it delivers
prompt, efficient and professional support services. Personal contact with its
agency force is maintained by four field representatives through regular visits
to each producer's office. Approximately $14.9 million (21.5%) and $13.0 million
(26.2%) of Rockwood's gross written premiums were derived from two agents for
the years ended December 31, 1996 and 1997, respectively.

Underwriting. Rockwood's underwriting staff, which is comprised of 12
individuals who have an average of 19 years of underwriting experience at
Rockwood, makes all underwriting decisions. Rockwood also has its own
experienced engineering department which makes extensive evaluations of mining
operations before they are underwritten by Rockwood. Rockwood's strict
underwriting guidelines require that each mining operation insured by Rockwood
is inspected annually, and many are reviewed more frequently. Rockwood's
management believes that its detailed knowledge of mining operations, bolstered
by these inspections, plays an important role in their ability to make informed
underwriting decisions. Further, Rockwood physically inspects substantially all
non-mining business for which it writes workers' compensation insurance prior to
the first renewal of the account.

49
<PAGE>

The following table sets forth the recent accident year experience for
Rockwood as compared to the workers' compensation insurance industry:

COMPARISON OF ROCKWOOD AND INDUSTRY LOSS RATIOS(1)

<TABLE>
<CAPTION>
WORKERS' COMPENSATION(2) ALL LINES
----------------------------------------------- -----------------------------------------------
VARIANCE VARIANCE
TO INDUSTRY TO INDUSTRY
ACCIDENT FAVORABLE/ FAVORABLE/
YEAR ROCKWOOD(3) INDUSTRY(4) (UNFAVORABLE) ROCKWOOD(3) INDUSTRY(4) (UNFAVORABLE)
<S> <C> <C> <C> <C> <C> <C>
1990 81.1% 94.6% 13.5% 69.6% 82.3% 12.7%
1991 63.0 99.3 36.3 60.6 81.1 20.5
1992 63.1 97.1 34.0 58.3 88.1 29.8
1993 52.8 84.0 31.2 60.3 79.5 19.2
1994 53.3 73.4 20.1 75.3 81.1 5.8
1995 71.4 67.7 (3.7) 76.2 78.9 2.7
1996 70.2 69.5 (0.7) 74.2 78.3 4.1
1997 71.4 N/A N/A 72.3 72.8 0.5
</TABLE>

- ------------------
(1) Accident year loss ratios include allocated and unallocated loss adjustment
expenses.
(2) Represents approximately 80.8% of Rockwood's gross written premium on its
continuing business for 1997.
(3) Results are from Rockwood's 1997 Schedule P--Analysis of Losses and Loss
Expenses.
(4) Source: A.M. Best.

Claims. Rockwood's claims staff, consisting of 19 individuals who have an
average of 16 years claims management experience at Rockwood, retains complete
authority for handling claims arising from policies issued by Rockwood. The
staff is supervised by an attorney who has 22 years of claims experience in the
insurance industry, including 20 years at Rockwood.

Workers' compensation insurance provides compensation to workers who are
injured or become ill as a result of their employment. These policies provide
for payment of the cost of medical bills associated with covered injuries or
illnesses. In addition, if a claimant suffers lost wages as a result of a
covered work-related injury or illness, the workers' compensation carrier makes
indemnity payments to such worker. Death benefits may also be paid to an injured
worker's family.

Rockwood believes that proper handling of workers' compensation claims
includes at least three steps: (i) determination of a claimant's eligibility for
medical benefits and wage indemnity payments; (ii) ascertaining the appropriate
medical treatment for an injured or ill claimant, and providing appropriate,
cost-effective treatment of covered medical expenses; and (iii) returning the
claimant to work as soon as the claimant is medically capable of resuming work.
Rockwood has organized its claims handling process to effectively and
efficiently address each of these tasks.

Rockwood's policy is to initiate a review of each claim within 24 hours of
receiving notice thereof. This review is conducted by a member of the claims
staff, who develops basic information to determine whether the claim is covered
under the policy terms. In the case of a workers' compensation claim, a typical
investigation will include direct contact with the claimant, the claimant's
employer, and the medical service provider. If the adjuster develops information
which suggests the claim may not be covered, additional investigation is
commenced. This process may include ordering additional medical exams,
surveillance, interviewing witnesses and reviewing police reports. Rockwood's
policy is to promptly pay all sums due under its policies, and to vigorously
contest claims it judges to be unwarranted or not covered by its policies.

Medical cost containment is a key to Rockwood's success as a workers'
compensation carrier. Rockwood has authority under Pennsylvania law (where the
majority of its workers' compensation business is written) to require claimants
to utilize employer-approved physicians during the first 90 days of a claim.
Rockwood has contracted with a variety of preferred provider organizations to
get access to highly qualified physicians at favorable costs to Rockwood. As a
matter of Pennsylvania law, workers' compensation companies are not required to
pay more than a specified percent above the cost schedules approved by Medicare
for medical

50
<PAGE>
treatments. Rockwood reviews the treatment its claimants receive to assure they
are being appropriately treated, consistent with the approach most likely to
permit a rapid recovery and return to work. Rockwood's medical reviews are
supervised by a registered nurse. Complex cases or cases involving traumatic
injuries are referred immediately to a surgeon who serves on a consulting basis
as Rockwood's medical director. All medical bills are reviewed to assure that
Rockwood has received the appropriate discounts.

Rockwood's claims staff has, as one of its primary goals, the rapid return
to work of each claimant. At the outset of each claim which involves both
medical and indemnity payments, Rockwood develops a strategy designed to chart a
course to 'close the claim file.' To help implement these strategies Rockwood
remains in contact with injured or ill claimants and their medical providers
during the entire period of their recovery and works with employers to modify
the workers' duties during a period of convalescence.

In the event that a worker suffers a total disability, Rockwood's policy is
to attempt to reach a total settlement of indemnity and medical claims
associated with the claim. Final settlements permit Rockwood to eliminate the
uncertainty associated with setting appropriate reserves for long-term medical
care and indemnity payments. The authority to make final settlements on total
disability claims was granted in 1996 to Pennsylvania Workers' Compensation
insurers as part of a broad reform of workers' compensation insurance laws in
Pennsylvania.

Rockwood conducts a complete file review on each claim every six months.
This review process is designed to encourage progress on claims resolution, and
to assure that reserves set on each open claim are appropriate and adequate. In
addition to the six-month review, open claim files are audited annually by
Rockwood's claims audit unit.

Rockwood's operations contributed approximately $4.3 million to the
Company's favorable prior year loss reserve development in 1997. Rockwood's
stand-alone 1996 statement of operations reflects $23.8 million of favorable
prior year loss reserve development. The Company attributes the favorable
development in recent years largely to the effect of Pennsylvania Act 44,
enacted in September 1993 ('Act 44'), which significantly changed workers'
compensation insurance in Pennsylvania. These changes included introduction of
managed care and a system of medical reimbursement based upon the Medicare
system. The changes had the effect of lowering medical costs to workers'
compensation carriers. Rockwood began to see the favorable effects of Act 44 on
medical costs in 1994 and 1995 and began to cautiously adjust its reserve
estimates to give effect to the lower costs. Rockwood's SAP loss ratio declined
from 86.1% in 1993 to 81.9% in 1994 and 68.4% in 1995. By mid-1996, with ten
quarters of post Act 44 loss experience available, Rockwood revised its
estimates of the ultimate net cost of all reported and unreported losses
incurred through December 31, 1996, and adjusted the estimates downward by
approximately $23.8 million. Rockwood also reduced its provision for losses and
loss adjustment expenses occurring in the current year from 87.3% of earned
premiums in 1994 and 84.3% of earned premiums in 1995 to 71.5% of earned
premiums in 1996 and 72.3% of earned premiums in 1997. See
'--Reserves.'

REDWOODS

Redwoods is a managing general underwriter of specialty commercial
insurance products. Redwoods, which does not bear risk itself, has the capacity
to provide brokerage, underwriting and claims management services to insurance
carriers, including the Insurance Subsidiaries and third-party carriers. In
general, Redwoods' business can be divided into two categories--the premium
produced for Preferred National, and the premium produced for the Insurance
Subsidiaries and for third-party carriers.

Redwoods, a start-up company, was purchased by Front Royal on January 1,
1998 for $50,000. Front Royal made the acquisition in anticipation of acquiring
substantially all of the assets and business of UnaMark, a general agent
affiliated with Preferred National. UnaMark has active relationships with
approximately 600 independent agents who have access to Preferred National
through UnaMark. Approximately 36.0% of all Preferred National's premiums in
1997 were produced by UnaMark. Following the Preferred National Acquisition, the
UnaMark business will be conducted through a separate division of Redwoods to be
named Redwoods Underwriters. Preferred National will compensate Redwoods
Underwriters as a general agent on terms no less favorable than could be
obtained from independent third parties.

51
<PAGE>
Front Royal intends for Redwoods to produce business for carriers unrelated
to Front Royal as well as for the Insurance Subsidiaries and Preferred National.
In this way, Redwoods can generate fee income for Front Royal while serving to
provide the Company with more information regarding insurance distribution
channels.

During 1998, and prior to the Preferred National Acquisition, Redwoods has
initiated two programs in which it produces and underwrites insurance for
third-party carriers unrelated to Front Royal. Redwoods is compensated on a
fee-for-service and/or commission basis for producing this business. In one of
these two programs, one of the Insurance Subsidiaries will also reinsure a
portion of the premium written by Redwoods for the third-party carrier. Redwoods
plans to create additional relationships with third-party carriers interested in
serving as issuing carriers for Redwoods' programs. The Insurance Subsidiaries
may bear a portion of the risk on certain of these programs.

In those instances where an Insurance Subsidiary bears risk, the Company
could earn both fee income and risk bearing income from Redwoods' programs. In
addition, by creating opportunities for Front Royal to participate in taking a
limited amount of risk on new programs, Redwoods can serve as a vehicle for the
Company's insurance product development.

Redwoods began to earn income and fees in the second quarter of 1998.

RESERVES

The Company's policy is to have reserves set by the management of each of
its subsidiaries. The individual subsidiaries set case reserves for each
reported claim as promptly as possible after receiving notice of the claim and
developing sufficient information to form a judgement about the probable
ultimate loss and loss adjustment expense associated with that claim.

In addition, management of both Colony and Rockwood independently establish
reserves on an aggregate basis to provide for IBNR claims. The Company's
independent actuarial consultant annually reviews the provisions for such IBNR
and the reserves taken as a whole.

Colony does not discount its loss reserves. Rockwood, on the other hand,
because of the long periods over which workers' compensation losses are paid,
discounts its reserves related to these workers' compensation claims for both
GAAP and SAP financial reporting purposes. The discount rate at December 31,
1997 and 1996 of 4.0% has been determined in accordance with the regulations of
the Pennsylvania Insurance Department (which allows a discount of up to 6.0%).
The amount of the discount for the Company's reserves at December 31, 1997 was
$15.1 million.

The estimates of reserves are subject to change based on the effect of
trends in the severity and frequency of losses and are continually reviewed. As
part of this process, the Company reviews historical data and considers various
factors, including legal developments, changes in social attitudes, inflation
and economic conditions. As experience develops and other data becomes
available, these estimates are revised, as required, resulting in increases or
decreases to existing reserves. Adjustments are reflected in results of
operations in the period in which they are made and may deviate substantially
from prior estimates. The establishment of reserves is an inherently subjective
process and, therefore, the historical gross or net redundancies or deficiencies
are not indicative of the likelihood or amount of future redundancies or
deficiencies. The Company's reserve estimates change as more information becomes
available about the frequency or severity of claims.

The following table shows the development and payment of loss and loss
adjustment expenses for the Company over the period from its inception to
December 31, 1997. The table includes reserves for all subsidiaries only after
they were acquired by the Company.

Except for the last 18 lines, the table on the following page presents the
development of the reserve for unpaid losses and LAE, net of reinsurance, for
1992 (inception) through 1997. The last 18 lines present that type of
development on a 'gross-of-reinsurance' basis for the periods following adoption
of FASB Statement 113 as of January 1, 1993. The top line of the table shows the
estimated reserve for unpaid losses and LAE reported at the December 31 balance
sheet date, net of reinsurance recoverables on unpaid claims. That net reserve
represents the estimated amount of losses and LAE for claims occurring in all
prior years that are unpaid as of that balance sheet date, including losses that
had been incurred but not yet reported to the Company. The upper portion of the
table shows the re-estimated amounts of the previously reported reserve based on
experience as of

52
<PAGE>

the end of each succeeding year. The estimate is increased or decreased as more
information becomes known about the frequency or severity of the claims
incurred.

The amounts on the 'Net Cumulative (Deficiency)/Redundancy' line represent
the aggregate change in the estimates over all prior years. For example, the
1994 reserve has developed an approximate $3.0 million redundancy over three
years. That amount has been included in operations over the last three years.
The effects on income caused by changes in estimates of the reserve for losses
and LAE for the past three years are shown in a subsequent three-year loss and
LAE reserve reconciliation schedule.

The lower section of the table shows the cumulative amounts paid with
respect to the previously reported reserve as of the end of each succeeding
year. For example, through December 31, 1997 the Company had paid a net $29.2
million of the $37.4 million of losses and LAE reserves as of December 31, 1994
(re-estimated as of December 31, 1997); thus, $8.2 million of losses incurred
through 1994 remain unpaid as of the current financial statement date, December
31, 1997.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1992 1993 1994 1995 1996 1997
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Reserve for
unpaid losses
and loss
adjustment
expenses, net
of
reinsurance
recoverables(1)... $ 115 $ 334 $40,397 $44,160 $162,339 $172,788

Discount on
net
reserves... -- -- -- -- 15,509 15,061
------- ------- ------- ------- -------- --------

Net reserve,
gross of
discount... $ 115 $ 334 $40,397 $44,160 $177,848 $187,849

Net reserve
re-estimated
as of(2):
One year
later.... $ 104 $ 378 $40,093 $43,212 $169,870
Two years
later.... 85 409 39,628 40,134
Three years
later.... 165 219 37,440
Four years
later.... 91 235
Five years
later.... 107
------- ------- ------- ------- --------
Net
cumulative
redundancy... $ 8 $ 99 $ 2,957 $ 4,026 $ 7,978

Cumulative
amount of
reserve
paid, net
of reserve
recoveries(3),
through:
One year
later.... $ 11 $ 72 $13,161 $15,055 $ 32,097
Two years
later.... 30 97 23,591 24,727
Three years
later.... 50 113 29,153
Four years
later.... 58 159
Five years
later.... 103

Net reserve,
gross of
discount--December
31........... $ 334 $40,397 $44,160 $177,848 $187,849
Discount on net
reserve--December
31........... -- -- -- (15,509) (15,061)
------- ------- ------- -------- --------
Net reserve,
net of
discount--December
31........... 334 40,397 44,160 162,339 172,788
Reinsurance
recoverable,
net of
discount..... 267 12,707 12,073 25,736 22,543
------- ------- ------- -------- --------
Gross reserve,
net of
discount--December
31........... $ 601 $53,104 $56,233 $188,075 $195,331
------- ------- ------- -------- --------

Net reserve
re-estimated,
net of
discount--1
year later... $ 378 $40,093 $43,212 $154,363
Reinsurance
recoverable,
net of
discount,
re-estimated... 394 21,158 15,872 24,778
------- ------- ------- --------
Gross reserve
re-estimated,
net of
discount--1
year later... $ 772 $61,251 $59,084 $179,139
------- ------- ------- --------

Net reserve
re-estimated,
net of
discount--2
years
later........ $ 409 $39,628 $40,134
Reinsurance
recoverable,
net of
discount,
re-estimated... 363 24,238 15,853
------- ------- -------
Gross reserve
re-estimated,
net of
discount--2
years
later........ $ 772 $63,866 $55,987
------- ------- -------

Net reserve
re-estimated,
net of
discount--3
years
later........ $ 219 $37,440
Reinsurance
recoverable,
net of
discount,
re-estimated... 318 24,038
------- -------
Gross reserve
re-estimated,
net of
discount--3
years
later........ $ 537 $61,478
------- -------

Net reserve
re-estimated,
net of
discount--4
years
later........ $ 235
Reinsurance
recoverable,
net of
discount,
re-estimated... 393
-------
Gross reserve
re-estimated,
net of
discount--4
years
later........ $ 628
-------
Gross
cumulative
(deficiency)/redundancy... $ (27) $(8,374) $ 246 $ 8,936
------- ------- ------- --------
------- ------- ------- --------
</TABLE>

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

(1) This represents unpaid losses and LAE for claims arising in the current year
and all prior years that were unpaid as of the date indicated, including
IBNR reserves.

(Footnotes continued on next page)

53
<PAGE>
(Footnotes continued from previous page)

(2) Reflects the amounts of unpaid losses and LAE that the Company would have
originally established based on experience as of the end of each succeeding
year. These amounts were calculated as the sum of the cumulative paid
amounts described in (3) below, plus the amounts of unpaid losses and LAE
re-evaluated at the end of each succeeding year-end.

(3) Reflects the amounts of paid losses and LAE subsequent to the year in which
the original reserves were established.

As shown on the table on the preceding page, a deficiency has emerged for
the gross reserves as of December 31, 1994. This is due, in part, to the fact
that prior to 1995, the Company's management focused on recording adequate net
IBNR reserves, but generally underestimated the ceded portion of IBNR reserves
(as well as applicable reinsurance recoverables).

Approximately $4.3 million of the favorable development of prior year
reserves in 1997 is attributable to Rockwood. The Company attributes Rockwood's
favorable development largely to the effect of Act 44 (enacted September 1993)
and Act 57 (enacted August 1996), which significantly changed workers'
compensation insurance in Pennsylvania. These changes included introduction of
managed care and a system of medical reimbursement based upon the Medicare
system. The changes had the effect of lowering medical costs to workers'
compensation carriers. The exact savings produced by this legislation will not
be known for many years, and as such, it may spur favorable development on the
current reserves well into the future. To be prudent, Rockwood management
recognizes the savings from these acts only as they become evident in the data.

In evaluating the information in the foregoing table, it should be noted
that each amount includes the effects of all changes in amounts for prior
periods. For example, the amount of the deficiency related to losses settled in
1997 but incurred in 1992 is included in the cumulative redundancy amount for
years 1992 through 1996. The table does not present accident or policy year
development data, to which readers may be more accustomed. Conditions and trends
that have affected the development of the liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.

54
<PAGE>

The following table provides a reconciliation of the beginning and ending
reserve balances for losses and LAE, net of reinsurance, for 1997, 1996 and 1995
to the gross amounts reported on the balance sheet for the Company.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Reserve for losses and LAE, net of related reinsurance
recoverables, at beginning of year............................... $162,339 $ 44,160 $ 40,397
Add:
Provision for losses and LAE for claims occurring in the current
year, net of reinsurance...................................... 63,725 27,058 22,870
Increase (decrease) in incurred losses and LAE for claims
occurring in prior years, net of reinsurance.................. (7,978) (948) (304)
Provision for discount on claims occurring in the current year... (3,014) -- --
Provision for discount on claims occurring in prior years........ 3,463 -- --
-------- -------- --------
Incurred losses and LAE during the current year, net of
reinsurance and discount.................................... 56,196 26,110 22,566
-------- -------- --------
Deduct:
Losses and LAE payments for claims, net of reinsurance, occurring
during:
Current year.................................................. (13,650) (6,325) (5,642)
Prior years................................................... (32,097) (15,055) (13,161)
-------- -------- --------
Total paid.................................................... (45,747) (21,380) (18,803)
-------- -------- --------
Add: Reserves related to acquisitions, net of discount............. -- 113,449 --
-------- -------- --------
Reserve for losses and LAE, net of related reinsurance
recoverables, at end of year..................................... 172,788 162,339 44,160
Add: Reinsurance recoverables on unpaid losses and LAE at end of
year ($14,356 in 1996 related to acquisitions)................... 22,543 25,736 12,073
-------- -------- --------
Reserve for losses and LAE, gross of reinsurance recoverables on
unpaid losses and LAE, at end of year............................ $195,331 $188,075 $ 56,233
-------- -------- --------
-------- -------- --------
</TABLE>

REINSURANCE

General. The Company's policy is for management of each Insurance
Subsidiary to purchase reinsurance for that subsidiary, subject to review by
Front Royal.

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

In formulating its reinsurance programs, the Company is selective in its
choice of reinsurers and considers numerous factors, the most important of which
are the financial stability of the reinsurer, its history of responding to
claims and its overall reputation. In an effort to minimize its exposure to the
insolvency of its reinsurers, the Company evaluates the acceptability and
reviews the financial condition of each reinsurer annually.

55
<PAGE>
The Company's seven largest recoverables from its reinsurers at December
31, 1997 are as follows:

<TABLE>
<CAPTION>
A.M. BEST
AMOUNT RATING
(IN THOUSANDS)
<S> <C> <C>
General Reinsurance Corporation........................................ $7,339 A++
Reliance Insurance Company............................................. 2,857 A-
North Star Reinsurance Corporation..................................... 1,625 NR-3(1)
Chartwell Reinsurance Co............................................... 1,442 A
Kemper Reinsurance Company............................................. 1,361 A
American Reinsurance Co................................................ 1,173 A++
Federal Insurance Company.............................................. 1,166 A++
</TABLE>

- ------------------
(1) Denotes a reinsurer that is part of the A++ rated General Reinsurance group.

Colony. Colony maintains the following excess of loss reinsurance
contracts:

Casualty and Property:

Excess of loss casualty and property. This treaty provides Colony
with $750,000 in coverage for each occurrence above Colony's retention
of $250,000 per occurrence. This coverage is purchased primarily to
reinsure Colony's contract and brokerage business.

Property catastrophe reinsurance. This treaty provides Colony with
95.0% of $3.5 million in coverage resulting from any one catastrophe
above an attachment level of the greater of $600,000 or 10.0% of the
subject earned premium.

Clash Protection:

Clash coverage for casualty business. This treaty provides Colony
with $2.0 million in excess of a $1.0 million attachment point. Clash
protection coverage is generally purchased to provide coverage for
multiple insureds arising from a single occurrence.

Colony also maintains the following quota-share reinsurance
treaties, to reinsure its specialty, environmental and umbrella
liability books:

Specialty and environmental business. This treaty provides 80.0%
quota-share reinsurance for the first $1.0 million in such coverage
written by Colony.

Umbrella and excess general liability. This treaty provides
quota-share reinsurance for 95.0% of the first $1.0 million and 100.0%
of any excess limits of between $1.0 million and $5.0 million written by
Colony.
Colony also purchases individual risk facultative reinsurance from time
to time.

Preferred National.

Surety Bond Quota Share Reinsurance:

In May 1994, Preferred National entered into a surety bond quota
surplus share reinsurance agreement with Winterthur Reinsurance
Corporation of America under which Preferred National retains all bonds
less than $100,000. For bonds $100,000 or greater but not more than $3.0
million, Preferred National retains the pro rata share as defined below
and cedes the remainder to the reinsurer as follows:

<TABLE>
<CAPTION>
COMPANY REINSURER'S
BOND AMOUNT RETENTION PARTICIPATION
<S> <C> <C>
$ 0 -- $ 99,999................................... 100.0% 0.0%
$ 100,000 -- $ 199,999..................................... 90.0% 10.0%
$ 200,000 -- $ 299,999..................................... 75.0% 25.0%
$ 300,000 -- $ 399,999..................................... 65.0% 35.0%
$ 400,000 -- $ 499,999..................................... 55.0% 45.0%
$ 500,000 -- $1,000,000.................................... 40.0% 60.0%
$1,000,001 -- $1,500,000................................... 35.0% 65.0%
$1,500,001 -- $3,000,000................................... 30.0% 70.0%
</TABLE>

56
<PAGE>

Preferred National receives a ceding commission with a contingent
commission representing a portion of the net profit, if any, generated
on this business.

Commercial Liability Excess of Loss:

This treaty provides Preferred National with $750,000 in coverage
for each occurrence above Preferred National's retention of $250,000 per
occurrence.

Property Per Risk Excess of Loss:

This treaty provides Preferred National with $1.5 million in
coverage for each risk above Preferred National's retention of $500,000
per risk.

Property Catastrophe Excess of Loss:

This treaty provides Preferred National with 95% of $30.0 million
in coverage resulting from any one catastrophe above an attachment level
of $5.0 million.

Facultative Reinsurance:

Preferred National cedes property and liability business to various
reinsurers on a facultative basis.

Rockwood. Rockwood maintains the following excess of loss reinsurance
contracts:

Workers' Compensation Related Reinsurance Contracts:

Workers' compensation for underground mining operations. This
treaty provides Rockwood with $24.6 million per occurrence in coverage
above Rockwood's $400,000 retention level subject to a maximum recovery
of $1.0 million per person.

Workers' compensation excluding underground mining
operations. This treaty provides Rockwood with $29.6 million in
coverage above the Company's $400,000 retention level subject to a
maximum recovery of $1.0 million per person. All workers' compensation
for mining risks other than underground mines are covered under this
arrangement.

Workers' compensation per person coverage. This treaty provides
Rockwood with per person coverage of $5.0 million for workers'
compensation claims in excess of a $1.0 million attachment level.
Rockwood purchases this layer of reinsurance principally to protect the
Company in the event that a covered workers' compensation claim for any
individual exceeds $1.0 million.

Other Casualty Coverage:

Automobile liability and general liability and first party auto
medical. This treaty provides Rockwood with $600,000 in coverage per
occurrence above a $400,000 retention level maintained by the Company.
Rockwood purchases this coverage principally to provide protection
against first party medical claims and third party liability claims on
or in its commercial automobile book. This treaty also applies to
Rockwood's general liability writings.

Clash protection for automobile and general liability workers'
compensation, employers' liability, and Pennsylvania first party
benefits. This treaty provides Rockwood with $3.0 million in coverage
above a $1.0 million attachment point.

Property Coverage:

Fire and inland marine. This treaty provides Rockwood with
$900,000 in coverage per risk in excess of a $100,000 retention level.
Rockwood writes some property coverages as part of 'package policies'
and also covers equipment used in some of the mining operations insured
by Rockwood.

Fire and inland marine and physical damage excluding collision per
event catastrophe coverage. This treaty provides Rockwood with $4.5
million in excess of a $500,000 attachment point per catastrophe. This
treaty provides an additional layer of protection for Rockwood's
property and inland marine business.

Automobile physical damage. This treaty provides Rockwood with
$950,000 in coverage above Rockwood's $50,000 retention level. Rockwood
purchases this coverage to protect against physical damage claims on its
commercial automobile business.

Rockwood also maintains quota share treaties to reinsure its
umbrella liability insurance business and its surety business.

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<PAGE>
Umbrella Liability:

When Rockwood writes the underlying coverage, this treaty provides
90.0% reinsurance for the first $1.0 million in umbrella liability
underwritten by Rockwood and 100.0% reinsurance for amounts between $1.0
million and $5.0 million. If Rockwood has not written the underlying
coverage, Rockwood retains 20.0% of the first $1.0 million in coverage.

Surety:

Rockwood maintains a 50.0% quota-share treaty for its surety
business.

INVESTMENTS

Investment income is the primary source of earnings for the Company. The
Company collects premiums and holds a portion of these funds in reserves until
claims are paid. While the Company holds the reserves, it invests these funds.
In the years that the Company makes an underwriting profit, it is able to retain
all investment income. Underwriting losses require the Company to dedicate a
portion of its investment income to cover insurance claims and expenses
associated with writing insurance.

The Company's investments are restricted as a matter of regulatory law. The
Company's policy is to invest primarily in high quality debt instruments.
Investment policy is set by the Investment Committee of the Board of Directors.
The Company employs independent professional managers to invest in accordance
with the policies established by the Board of Directors.

Investment income, net of expenses, for 1996 and 1997 totaled $5.9 million
and $18.0 million, respectively. The totals for 1996 do not include any
investment income from Rockwood, which was acquired by Front Royal on December
31, 1996. Investment income for the three-month period ended March 31, 1998, was
$4.3 million. As of March 31, 1998, the Company held cash and investments of
$279.5 million. See Note 2 of Notes to the Consolidated Financial Statements
included elsewhere in this Prospectus for a detail of those investments by type
and expected maturity.

The following table sets forth the classifications of the Company's
investments at March 31, 1998:

<TABLE>
<CAPTION>
MARCH 31, 1998
--------------------------------------
FAIR CARRYING PERCENT OF
VALUE VALUE CARRYING VALUE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities:
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government
agencies.......................................................... $ 54,538 $ 54,538 19.5%
Mortgage-backed securities.......................................... 44,130 44,130 15.8
Corporate securities................................................ 27,459 27,459 9.8
Other securities.................................................... 2,037 2,037 0.7
-------- -------- -------
Total available-for-sale............................................ 128,164 128,164 45.8
-------- -------- -------
Held-to-maturity:
Mortgage-backed securities.......................................... 41,044 40,714 14.6
State and municipal securities...................................... 26,166 25,126 9.0
U.S. Treasury securities and obligations of U.S. government
agencies.......................................................... 11,911 11,745 4.2
Corporate securities................................................ 15,892 15,568 5.6
-------- -------- -------
Total held-to-maturity............................................ 95,013 93,153 33.4
-------- -------- -------
Total fixed securities............................................ 223,177 221,317 79.2
-------- -------- -------
Equity investments:
Closed-end bond funds............................................... 12,413 12,413 4.4
Common stocks....................................................... 5,616 5,616 2.0
Preferred stocks.................................................... 746 746 0.3
-------- -------- -------
Total equity investments............................................ 18,775 18,775 6.7
-------- -------- -------
Short-term investments................................................... 37,853 37,853 13.5
-------- -------- -------
Total investments................................................... 279,805 277,945 99.4
Cash..................................................................... 1,568 1,568 0.6
-------- -------- -------
Total cash and investments.......................................... $281,373 $279,513 100.0%
-------- -------- -------
-------- -------- -------
</TABLE>

58
<PAGE>

As of March 31, 1998, the Company's investment portfolio of $277.9 million
contained $84.8 million (30.5%) of mortgage-backed securities. All of these
securities are rated Class I by the NAIC and are primarily issued by government
and government-related agencies, are publicly traded and have market values
obtained from an external pricing service. Changes in estimated cash flows due
to changes in prepayment assumptions from the original purchase assumptions are
revised based on current interest rates and the economic environment.

Mortgage-backed securities ('MBSs'), including collateralized mortgage
obligations, are subject to prepayment risks that vary with, among other things,
interest rates. During periods of declining interest rates, MBSs generally
prepay faster as the underlying mortgages are prepaid and refinanced by the
borrowers in order to take advantage of the lower rates. As a result, during
periods of falling interest rates, proceeds from such prepayments generally must
be reinvested at lower prevailing yields. In addition, MBSs that have an
amortized cost that is greater than par (i.e., purchased at a premium) may incur
a reduction in yield or a loss as a result of such prepayments. Conversely,
during periods of rising interest rates, the rate of prepayments generally
slows. MBSs that have an amortized value that is less than par (i.e., purchased
at a discount) may incur a decrease in yield as a result of a slower rate of
prepayments. In order to mitigate these risks in part, approximately 48.2% of
the MBSs held by the Company at March 31, 1998 were either a category of MBSs
known as planned amortization class bonds or agency pass-through certificates
with 15-year or shorter final maturities, the average life of which is less
sensitive to fluctuations in interest rates. The remainder of the MBSs held by
the Company are primarily agency pass-through certificates with 30-year final
maturities.

At March 31, 1998 and December 31, 1997, the Company's fixed maturity
securities portfolio was composed approximately 98.6% and approximately 98.7%,
respectively, of bonds which were rated NAIC Class I. The Company, through its
subsidiaries, owned one bond rated less than NAIC Class II at such dates.

The following table sets forth the composition of the Company's portfolio
of fixed maturity securities by rating as of March 31, 1998:

<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------
CARRYING PERCENTAGE
VALUE OF TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Ratings:
NAIC-SVO Class I (1)................................................ $218,256 98.6%
NAIC-SVO Class II (2)............................................... 2,564 1.2
NAIC-SVO Class III or lower......................................... 497 0.2
-------- ----------
Total............................................................ $221,317 100.0%
-------- ----------
-------- ----------
</TABLE>

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

(1) Equates to Standard & Poor's rating of AAA, AA or A.

(2) Equates to Standard & Poor's rating of BBB.

59
<PAGE>
The following table sets forth the classifications of Preferred National's
investment portfolio as of March 31, 1998:

<TABLE>
<CAPTION>
MARCH 31, 1998
-------------------------------------
PERCENT OF
FAIR CARRYING TOTAL CARRYING
VALUE VALUE VALUE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities:
Available-for-sale:
U.S. Treasury securities and obligations of U.S. government agencies... $20,398 $ 20,398 31.9%
Mortgage-backed securities............................................. 11,284 11,284 17.6
Corporate securities................................................... 26,197 26,197 40.9
------- -------- ------
Total fixed securities................................................. 57,879 57,879 90.4
------- -------- ------
Short-term investments...................................................... 3,215 3,215 5.0
------- -------- ------
Total investments...................................................... 61,094 61,094 95.4
Cash........................................................................ 2,919 2,919 4.6
------- -------- ------
Total cash and investments............................................. $64,013 $ 64,013 100.0%
------- -------- ------
------- -------- ------
</TABLE>

As of March 31, 1998, Preferred National's investment portfolio of $61.1
million contained $11.3 million (18.5%) of mortgage-backed securities. All of
these securities are rated Class I by the NAIC and are primarily issued by
government and government-related agencies, are publicly traded and have market
values obtained from an external pricing service.

COMPETITION

The Company competes in the property and casualty insurance business with
numerous domestic and international insurers. Many of the Company's existing or
potential competitors are larger, have considerably greater financial and other
resources, have more licenses, have more experience in the insurance industry
and offer a broader line of insurance products than the Company. The Company may
compete with new entrants in the future. Competition is based on many factors,
including the perceived market strength of the insurer, pricing and other terms
and conditions, services provided, the speed of claims payment, the reputation
and experience of the insurer and ratings assigned by independent rating
organizations. Although the Company's business strategy is to achieve an
underwriting profit by identifying niche markets and specialty coverages which
it believes have limited competition, it nevertheless encounters competition
from carriers engaged in insuring risks in broader lines of business which
encompass the Company's niche and specialty markets. Competition is expected to
increase as the Company expands its operations. Larger carriers may have lower
expense ratios allowing them to price their products more competitively than the
Company. Ultimately, this competition could affect the Company's ability to
attract business at rates likely to generate underwriting profits, which could
have a material adverse effect on the Company.

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<PAGE>
The competitive environment for Colony and Preferred National has also been
affected as many reinsurers have elected to bypass primary companies such as
Colony and Preferred National and make arrangements to work directly with
wholesale agents. As a result, Colony and Preferred National sometimes compete
with reinsurers and reinsurance intermediaries for business from wholesale
agents. Management regards this trend as a competitive threat to carriers such
as Colony and Preferred National. The Company responds in part by structuring
incentive compensation arrangements with its agents. However, if this trend
continues it could have a material adverse effect on the Company.

RATINGS

A.M. Best has assigned an 'A-' (Excellent) rating to Colony and a 'B++'
(Very Good) rating to each of Rockwood and Preferred National. A.M. Best's
ratings are based upon an evaluation of a company's: (i) financial strength
(leverage/capitalization, capital structure/holding company, quality and
appropriateness of reinsurance program, adequacy of loss/policy reserves,
quality and diversification of assets, and liquidity); (ii) operating
performance (profitability, revenue composition, and management experience and
objectives); and (iii) market profile (market risk, competitive market position,
spread of risk, and event risk). An 'A-' rating is assigned to companies which
have on balance, in A.M. Best's opinion, excellent financial strength, operating
performance and market profile when compared to the standards established by
A.M. Best, and have a strong ability to meet their ongoing obligations to
policyholders. A 'B++' rating is assigned to companies which have on balance, in
A.M. Best's opinion, very good financial strength, operating performance and
market profile when compared to the standards established by A.M. Best, and have
a good ability to meet their ongoing obligations to policyholders. 'A-' and
'B++' are A.M. Best's fourth and fifth highest rating classifications,
respectively, out of 15 ratings. A.M. Best determines its ratings based upon
factors concerning policyholders and not upon factors concerning investors. Such
ratings are subject to change and do not constitute recommendations to buy, sell
or hold securities.

REGULATION

General. As a general rule, an insurance company must be licensed to
transact insurance business in each jurisdiction in which it operates, and
almost all significant operations of a licensed insurer are subject to
regulatory scrutiny. Licensed insurance companies are generally known as
'admitted' insurers. Most states provide a limited exemption from licensing for
insurers issuing insurance coverages that generally are not available from
admitted insurers. These coverages are referred to as 'excess and surplus lines'
insurance and these insurers are generally known as 'excess and surplus lines'
or 'non-admitted' insurers.

The Company is subject to regulation under the insurance statutes and
regulations, including insurance holding company statutes, of the various states
in which it does business. These statutes are generally designed to protect the
interests of insurance policyholders, as opposed to the interests of
shareholders, and they relate to most aspects of an insurance company's
business, and include such matters as the standards of solvency which must be
met and maintained; underwriting standards; the licensing of insurers and their
agents; the nature and limitations of investments; deposits of securities for
the benefit of policyholders; approval of policy forms and premium rates (with
respect to admitted lines); periodic examination of the affairs of insurance
companies; annual and other reports required to be filed on the financial
condition of insurers or for other purposes; establishment and maintenance of
reserves for unearned premiums and losses; transactions with affiliates;
dividends; changes in control; and requirements regarding numerous other
matters. All insurance companies must file annual statements with certain state
regulatory agencies and are subject to regular and special financial
examinations by those agencies. The last regulatory financial examination of:
(i) Rockwood was completed by

61
<PAGE>
the Pennsylvania Insurance Department in 1996, covering the two-year period
ended December 31, 1994; (ii) Colony Insurance was completed by the Virginia
Bureau of Insurance in 1996, covering the three-year period ended December 31,
1994; and (iii) FRIC was completed by the Ohio Department of Insurance in 1996,
covering the three-year period ended December 31, 1994. No material deficiencies
were noted in any of these financial examinations. Insurance regulatory
authorities have broad administrative powers to regulate trade practices and in
that connection to restrict or rescind licenses to transact business and to levy
fines and monetary penalties against insurers and insurance agents found to be
in violation of applicable laws and regulations.

The Insurance Subsidiaries are licensed as admitted insurers in a total of
10 states and the District of Columbia and as approved non-admitted insurers in
43 states and two jurisdictions. Preferred National is licensed as an admitted
insurer in two states and an approved non-admitted broker in 36 states. All
insurance is written through licensed agents and brokers. In states in which the
Company operates on a non-admitted basis, general agents and their retail
insurance brokers generally are required to certify that a certain number of
licensed admitted insurers had been offered and declined to write a particular
risk prior to placing that risk with the Company.

Insurance Holding Company Laws. Pennsylvania, Ohio, Virginia and Florida
have laws governing insurers and insurance holding companies. The statutes
generally require insurers and insurance holding companies to register and file
reports concerning their capital structure, ownership, financial condition and
general business operations. Under the statutes, a person must generally obtain
approval to acquire, directly or indirectly, 10.0% (5.0% in Florida) or more of
the outstanding voting securities of an insurance holding company such as Front
Royal. The insurance department's determination of whether to approve any such
acquisition is based on a variety of factors, including an evaluation of the
acquirer's financial condition, the competence of its management and whether
competition would be reduced. All transactions within a holding company's group
affecting an insurer must be fair and reasonable, and the insurer's
policyholders' surplus following any such transaction must be both reasonable in
relation to its outstanding liabilities and adequate for its needs. Notice to
applicable regulators is required prior to the consummation of certain
transactions affecting the Insurance Subsidiaries. See 'Risk
Factors--Anti-Takeover Considerations, Including Possibility of Future Issuance
of Preferred Stock.'

Dividend Restrictions. As an insurance holding company, Front Royal
depends primarily on dividends and other permitted payments from the Insurance
Subsidiaries to provide cash for the payment of operating expenses, debt service
on the Term Loan, taxes and other payments. The payment of dividends to Front
Royal by the Insurance Subsidiaries is subject to state regulations, primarily
the insurance laws of Pennsylvania, Ohio, Virginia and Florida. Generally these
laws provide that, unless prior approval is obtained, shareholder dividends of a
property and casualty insurance company in any consecutive 12 month period shall
not exceed the greater of (the lesser of in Virginia) 100.0% of its statutory
net income (excluding net realized capital gains in Virginia) of the prior year
or 10.0% of its statutory policyholders' surplus as of the preceding December
31. The maximum annual dividends payable by the Insurance Subsidiaries without
prior approval in 1998 is approximately $9.8 million. Colony paid no dividends
and Rockwood paid approximately $4.9 million of dividends to Front Royal in
1997. Insurance regulators have broad powers to prevent reduction of statutory
surplus to inadequate levels, and there is no assurance that dividends of the
maximum amounts calculated under any applicable formula would be permitted.

Insurance Guaranty Funds. To ensure the protection of the insurance
consumer, as well as the general public, states have created insurance guaranty
funds (also known as security funds). These funds exist to pay claims of
insolvent insurance companies and are maintained by assessments levied against
admitted insurance companies operating in a particular state in proportion to
business written in the state.

The primary guaranty fund affecting Rockwood is the Pennsylvania Workers'
Compensation Security Fund which represented 59.2% (amounting to $319,000) of
Rockwood's 1997 guaranty fund charges incurred. By statute, the maximum annual
assessment that can be levied by this fund is 1.0% of each company's direct
workers' compensation business. Colony, as an E&S carrier, is excluded from
guaranty fund assessments.

As a writer of admitted coverages, Preferred National is subject to
assessments from the Guaranty Fund in Florida, the amounts of which can be
substantial. An approved non-admitted carrier in New Jersey, Preferred National
is subject to assessments from a similar fund in New Jersey.

62
<PAGE>
ADDITIONAL LEGISLATION OR REGULATIONS

General. New regulations and legislation are proposed from time to time to
limit damage awards, to bring the industry under regulation by the federal
government, to control premiums, policy terminations and other policy terms and
to impose new taxes and assessments. Difficulties with insurance availability
and affordability have increased legislative activity at both the federal and
state levels. Some state legislatures and regulatory agencies have enacted
measures, particularly in personal lines, to limit mid-term cancellations by
insurers and require advance notice of renewal intentions.

In addition to state-imposed insurance laws and regulations, the
Subsidiaries are subject to the general SAP and reporting formats established by
the NAIC. The NAIC also promulgates model insurance laws and regulations
relating to the financial and operational regulation of insurance companies.
These model laws and regulations generally are not directly applicable to an
insurance company unless and until they are adopted by applicable state
legislatures or departments of insurance. However, the NAIC model laws and
regulations have become increasingly important in recent years, due primarily to
the NAIC's state regulatory accreditation program. Under this program, states
which have adopted certain required model laws and regulations and meet various
staffing and other requirements are 'accredited' by the NAIC. There is a certain
degree of pressure on individual states to become accredited by the NAIC.
Because the adoption of certain model laws and regulations is a prerequisite to
accreditation, the NAIC's initiatives have taken on a greater level of practical
importance in recent years.

All states have adopted the NAIC's financial reporting form, which is
typically referred to as the NAIC 'annual statement,' and most states generally
defer to the NAIC with respect to SAP. In this regard, the NAIC has a
substantial degree of practical influence and is able to accomplish certain
quasi-legislative initiatives through amendments to the NAIC annual statement
and applicable accounting practices and procedures. For instance, in recent
years, the NAIC has required all insurance companies to have an annual statutory
financial audit and an annual actuarial certification as to loss and LAE
reserves by including such requirements within the annual statement
instructions.

Risk-Based Capital Requirements. The NAIC has promulgated risk-based
capital ('RBC') requirements for property/casualty insurance companies to
evaluate the adequacy of statutory capital and surplus in relation to investment
and insurance risks, such as asset quality, asset and liability duration
matching, loss reserve adequacy and other business factors. The RBC information
is used by state insurance regulators as an early warning tool to identify, for
the purpose of initiating regulatory action, insurance companies that
potentially are inadequately capitalized. In addition, the formula defines new
minimum capital standards that will supplement the current system of fixed
minimum capital and surplus requirements on a state-by-state basis. Regulatory
compliance is determined by a ratio (the 'Ratio') of the enterprise's regulatory
total adjusted capital, as defined by the NAIC, to its authorized control level
RBC, as defined by the NAIC. Generally, a Ratio in excess of 200.0% of
authorized control level RBC (the 'company action level') requires no corrective
actions by insurance companies or regulators. As of December 31, 1997, the Ratio
for each of the Subsidiaries was significantly in excess of this company action
level.

Recent Pennsylvania Regulation. In 1993, Pennsylvania enacted Act 44 which
significantly changed many aspects of the Pennsylvania Workers' Compensation
Act. The most significant effect of Act 44 was that it introduced a system of
medical reimbursement based on the Medicare system. Under Act 44, payments for
medical services are generally to be made at no more than 113.0% of the
applicable Medicare reimbursement rate (subject to annual cost-of-living
adjustments) and prescription drugs at no more than 110.0% of the average
wholesale price of the product. Additionally, among other things, Act 44 adopted
a 'loss cost' approach for rate making, whereby rates for worker's compensation
insurance in Pennsylvania are set by the Pennsylvania Compensation Rating Bureau
based on the experience of insurance companies generally. Companies apply these
rates modified by their own cost factors, judgment and the three-year loss
experience of their accounts to develop the premium charged.

In June 1996, Pennsylvania enacted Act 57 which further reformed the
Pennsylvania workers' compensation system. This act, among other things: (i)
allows insurance companies to offset benefits payable to insureds by social
security, severance pay and employer-funded retirement programs; (ii) revised
calculation of the average weekly wage to an average based on the highest three
of the last four quarters; (iii) implemented a new medical

63
<PAGE>
impairment rating system based on American Medical Association Guidelines; and
(iv) clarified job availability requirements.

EMPLOYEES

As of July 24, 1998, the Company had approximately 190 employees, four of
whom are employed by Front Royal, 80 of whom are employed by Colony, 105 of whom
are employed by Rockwood and one of whom is employed by Redwoods. The Chairman
of the Board of Directors of the Company and certain directors devote a portion
of their time to the management of Front Royal, without additional compensation,
except that two directors have entered into consulting agreements with the
Company pursuant to which they receive $40,000 and $24,000, respectively, per
year for their management advice. See 'Management--Compensation Agreements.' The
Company is not a party to any collective bargaining agreements and believes that
its employee relations are good.

FACILITIES

The Company's executive offices are located in approximately 3,000 square
feet of office space in Morrisville, North Carolina, which the Company subleases
(along with certain administrative services) for approximately $9,000 per month.
Such sublease permits the Company to terminate the lease upon 90-day written
notice.

The Company's insurance operations are located in Richmond, Virginia and
Rockwood, Pennsylvania. Colony operates out of the Richmond office which
occupies approximately 29,000 square feet of which approximately 5,000 square
feet is subleased to an unrelated third party. The lease for this space expires
in 2001 and is renewable for a period of up to eight years with rental rates
contingent upon those of the original lease term. The net annual rent under this
lease is approximately $313,000.

The Rockwood office contains approximately 35,000 square feet. The Company
has the option to purchase the property (which includes this 35,000-square-foot
facility) at any time during its 15-year lease agreement that expires in
December 2011, for a scheduled price which equals all of the remaining fixed
payments discounted at 8.5%, including a required payment of $2.5 million at the
end of the lease term. If the Company fails to exercise such option, the lessor
may require the Company to purchase the property for $2.5 million at the
conclusion of the lease. For a description of the lease terms and certain other
agreements with an affiliate of the landlord, see 'Certain Transactions.'

The Company believes that its facilities are adequate for its current
needs.

LEGAL PROCEEDINGS

The Company is subject to routine legal proceedings in the normal course of
operating its insurance business. The Company is not involved in any legal
proceedings which reasonably could be expected to have a material adverse effect
on the Company's business, results of operations or financial condition.

64
<PAGE>
MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The following tables set forth certain information about the current
directors and executive officers of the Company. All directors of the Company
serve one-year terms. Unless otherwise set forth below, all positions are with
Front Royal. Following completion of the Offering the Company's Board of
Directors will be classified into three classes, each serving staggered
three-year terms. See 'Description of Capital Stock--Certain Certificate of
Incorporation and Bylaw Provisions.'

<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Richard W. Wright.............................. 64 Chairman of the Board
J. Adam Abram.................................. 42 President, Chief Executive Officer and Director
Gregg T. Davis................................. 40 Chief Financial Officer and Chief Operating
Officer
John K. Latham................................. 51 President and Chief Executive Officer, Colony
Insurance and Colony Management Services
John P. Yediny................................. 49 President and Chief Executive Officer, Rockwood
Kevin A. Trapani............................... 42 President and Chief Executive Officer, Redwoods
Philip S. Kift................................. 49 Vice President Claims and General Counsel,
Rockwood
Dale H. Pilkington............................. 42 Senior Vice President, Underwriting, Colony
Insurance and Front Royal Insurance Company
and Colony Management Services
Edward J. Desch................................ 57 Vice President and Chief Financial Officer,
Colony Insurance and Colony Management
Services
Matthew Bronfman............................... 38 Director
Alan N. Colner................................. 43 Director
Joel L. Fleishman.............................. 64 Director
Robert V. Hatcher, Jr.......................... 68 Director
Ira M. Lubert.................................. 48 Director
Lawrence G. McMichael.......................... 44 Director
Wilson Wilde................................... 70 Director
Lewis P. Wilkinson............................. 49 Director
James L. Zech.................................. 40 Director
</TABLE>

Richard W. Wright has served as Chairman of the Board of the Company since
its inception. From 1993 to 1996, Mr. Wright served as a consultant for
Jefferson Pilot Corp. on strategic planning and operational matters related to
acquisitions. From 1993 to 1995, Mr. Wright served as special consultant to the
Insurance Commissioner of Kentucky regarding the Kentucky Central Life Insurance
Company. From 1986 to July 1991, Mr. Wright served as Chief Executive Officer of
People's Security Life Insurance Company. Mr. Wright founded the Wright Group, a
consulting firm in 1986 and has served as its President since inception.

J. Adam Abram, one of the founders of Front Royal, has served as its
President, Chief Executive Officer and a director since its inception. From 1990
to April 1997, Mr. Abram served as Chairman of Front Royal Environmental
Services, Inc., a former Front Royal subsidiary, and its predecessor company.
Mr. Abram has

65
<PAGE>
been Chairman of the Boards of Directors of Colony, FRIC, Rockwood, Redwoods and
Colony Management since their respective acquisitions.

Gregg T. Davis has served as Chief Operating Officer and Chief Financial
Officer of Front Royal since 1994. From 1988 to 1994, Mr. Davis was Vice
President-Finance, Treasurer and Chief Financial Officer of Hunter Environmental
Services, Inc. Mr. Davis is a certified public accountant who previously spent
six years at Ernst & Young LLP. He has been a member of the Boards of Directors
of Colony, FRIC, Rockwood, Redwoods and Colony Management since their
acquisition.

John K. Latham has served as the President and Chief Executive Officer of
Colony Insurance and Colony Management (formerly the Waite Hill Insurance Group)
since 1991. Mr. Latham has served as a director of Rockwood since the Rockwood
Acquisition. He has also served as a member of the Board of Directors of the
National Association of Professional Surplus Line Offices, LTD. ('NAPSLO') for
four years and is presently Treasurer of this association of surplus lines,
agents and companies. From 1989 to 1991, Mr. Latham served as Executive Vice
President and Chief Operating Officer of Markel Services, Inc., a wholesale
brokerage operation owned by Markel Corporation. Mr. Latham also served as a
Vice President of General Reinsurance Corporation for 14 years.

John P. Yediny has served as President and Chief Executive Officer of
Rockwood since December 1996, has served as a director of Colony Insurance since
1996, and has served as a director of FRIC since 1996. Mr. Yediny previously
served as Senior Executive Vice President and Chief Operating Officer of
Rockwood from June 1994 to December 1996 and as President and Chief Operating
Officer of Rockwood and its predecessor companies from 1984 to 1994 and has been
in charge of all underwriting functions from 1988 to the present. Mr. Yediny has
worked at Rockwood, or its predecessors, since 1970.

Kevin A. Trapani has served as President and Chief Executive Officer of
Redwoods, which he founded in May 1997. He has also served as a director of
Redwoods, Colony Insurance, FRIC and Rockwood since January 1998. From 1996 to
1997, Mr. Trapani served as President of the Guilford Specialty Group, Inc. and
Executive Vice President of the Burlington Insurance Group, Inc. From 1993 to
1996, he served as Senior Vice President and Chief Underwriting Officer of the
Coregis Insurance Group. Mr. Trapani served as Vice President of the Commercial
Division of Great American Insurance Company from 1987 to 1993. From 1985 to
1987, Mr. Trapani served as Director of Sales & Marketing of Medigroup, Inc.

Philip S. Kift, Esq. has served as Vice President--Claims and General
Counsel of Rockwood since September 1990 and as its Assistant Secretary since
January 1997. Mr. Kift has worked at Rockwood, and its predecessors, since June
1978.

Dale H. Pilkington has served as Senior Vice President of Underwriting of
Colony Insurance, FRIC and Colony Management Services since 1995. From June 1985
to March 1993, Mr. Pilkington was a partner in Pilkington Brothers Insurance
Services, a specialty retail insurance operation in the state of Florida. He was
previously a specialty and excess underwriter with Crump Companies and with
General Reinsurance Corporation.

Edward J. Desch has served as the Vice President and Chief Financial
Officer of Colony Insurance, FRIC and Colony Management, since December 1994 and
has served as Vice President of Front Royal Environmental Insurance Management,
Inc. since December 1996. From May 1992 to December 1994, he served as Vice
President and Controller of the Waite Hill Insurance Group, which included
Colony, Hamilton and Cardinal Insurance Companies. He previously served as a
public accountant and Executive Vice President and General Manager of Virginia
Farm Bureau Insurance Companies.

Matthew Bronfman has served as a director of Front Royal since June 1994.
Mr. Bronfman founded Perfumes Isabell, Inc. in 1996 and has served as its Chief
Executive Officer since its inception. From 1981 to 1983, Mr. Bronfman served as
an analyst at Goldman Sachs & Co. and from 1985 to 1987 served as a development
executive at Cadillac-Fairview Corp. Ltd. From 1991 to 1994, Mr. Bronfman served
as Chairman and Chief Executive Officer of Sterling Cellular Company. From 1987
through 1993, Mr. Bronfman directed an investment group which acquired five
companies and developed extensive real estate holdings.

66
<PAGE>

Alan N. Colner has served as a director of Front Royal since December 1996.
Since August 1996, he has served as Managing Director, Private Equity
Investments at Moore Capital Management, Inc. ('Moore'). Before joining Moore,
he was a Managing Director of Corporate Advisors, L.P., the general partner of
Corporate Partners, a private equity fund affiliated with Lazard Freres & Co.,
LLC. Mr. Colner was a director of LaSalle Re Limited from October 1993 to May
1996. Before joining Corporate Partners in 1988, he was an investment banker at
Shearson Lehman Brothers and Lehman Brothers Kuhn Loeb.

Joel L. Fleishman has served as a director of Front Royal since July 1996.
Since 1993 Mr. Fleishman has served as President of Atlantic Philanthropic
Services Company. He was the founding Director of the Terry Sanford Institute
for Public Policy at Duke University in 1971. Mr. Fleishman has been a tenured
professor at Duke University Law School since 1975.

Robert V. Hatcher, Jr. has served as a director of Front Royal since 1992.
Mr. Hatcher has also served on the Board of Directors of Media General, Inc.
since 1991 and has served on the Board of Directors of EXEL Limited and
Pro-Active Therapy, Inc. since June 1993. Since 1968, Mr. Hatcher worked at
Johnson & Higgins of Virginia, Inc., and he served as its Chairman of the Board
and Chief Executive Officer from 1982 to 1992.

Ira M. Lubert has served as a director of Front Royal since 1993. Mr.
Lubert has served as Managing Director of TL Ventures since 1990 and as Managing
Director of Radnor Venture Partners since 1988. He has served as a director of
The Score Board since 1996, RMS Technologies since 1995 and Alphatronix, Inc.
since 1988.

Lawrence G. McMichael has been nominated to the Board of Directors by the
holders of the Series A Preferred Stock, and he will be elected in August 1998.
He has been a partner at Dilworth Paxson LLP since 1985 and currently chairs the
Insurance Law Group. He is also a member of the Board of Directors of American
General Holdings, Inc., an insurance holding company headquartered in Chicago,
Illinois. Mr. McMichael earned a J.D. from Duke University School of Law. He has
been a member of the Pennsylvania Bar since 1978. He is a member of the Bars of
the U.S. Supreme Court, the U.S. Courts of Appeals for the Third Circuit and
Eleventh Circuit, the U.S. District Courts for the Eastern, Middle and Western
Districts of Pennsylvania and the Pennsylvania Supreme Court. Mr. McMichael has
been a lecturer on the faculty of the Pennsylvania Bar Institute in the areas of
both insurance and litigation.

Wilson Wilde has served as a director of Front Royal since 1995 and
currently is Chairman Emeritus of The Hartford Steam Boiler Inspection and
Insurance Company ('HSB'). From May 1994 to April 21, 1998, Mr. Wilde served as
Chairman of the Executive Committee of HSB. From September 1993 to May 1994, he
served as Chairman and Chief Executive Officer of HSB and from 1971 to September
1993, he served as President and Chief Executive Officer of HSB. From 1972 to
October 1995, he served as a director of Shawmut National Corporation (now Fleet
Financial Group, Inc.) and, prior to such time, from 1984 to February 1997 as a
director of Phoenix Home Life Mutual Company and from July 1986 to the present
as a director of PXRE Corporation. From April 1997 to the present, he has served
as a member of the Phoenix Home Life Directors' Advisory Counsel.

Lewis P. Wilkinson has served as a director of Front Royal since 1992. Mr.
Wilkinson also founded and served as President of Strategic Venture Services,
Inc., a venture capital advisory firm, since 1993. From 1987 to 1995, Mr.
Wilkinson served as a director of HazWaste Industries, Inc., a provider of
environmental engineering, remediation and laboratory services. From 1987 to
1993, Mr. Wilkinson served as a general partner in Atlantic Venture Management
Co., L.P., an affiliate of Wheat First Securities.

James L. Zech has served as a director of Front Royal since December 1996.
Mr. Zech founded High Ridge Capital, LLC, in August 1995 and has served as its
President since that time. From July 1992 to August 1995, he served as a
Managing Director in the Corporate Finance Division of S. G. Warburg & Co., Inc.
Mr. Zech was a member of the insurance group of DLJ from 1988 to 1992.

67
<PAGE>
BOARD COMMITTEES

The standing committees of the Board of Directors are the Acquisition
Committee, the Audit Committee, the Investment Committee and the Compensation
Committee.

The Acquisition Committee is responsible for reviewing all potential
acquisition targets and the related strategic issues. It is comprised of Messrs.
Abram, Lubert, Wright and Zech.

The Audit Committee is responsible for appointing the external auditors,
reviewing the results of audits, planning for such audits and reviewing internal
reports and internal controls. The members of this committee are Messrs. Wright,
Colner, Fleishman and Wilkinson.

The Investment Committee is responsible for investment policy and selection
of outside investment managers. The members of this committee are Messrs.
Wright, Abram, Bronfman and Colner.

The Compensation Committee is responsible for overall compensation of the
Company's employees, particularly for its officers, and for administration of
the Company's Stock Option Plans (as hereinafter defined). This committee is
comprised of Messrs. Wright, Hatcher, Lubert, Wilde and Zech.

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following summary compensation table sets forth the aggregate
compensation earned by the Company's Chief Executive Officer and the Company's
six most highly compensated executive officers other than the Chief Executive
Officer (including the President of Colony Insurance and the President of
Rockwood) (collectively, the 'Named Executive Officers') during the fiscal year
ended December 31, 1997:

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION(1) SECURITIES ALL OTHER
------------------------------ UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($)(2) OPTIONS/SARS ($)(3)
<S> <C> <C> <C> <C> <C>
J. Adam Abram
President and Chief Executive Officer, Front
Royal............................................... 1997 $ 275,000 $ 209,239 50,700 $4,750
Gregg T. Davis
Chief Financial Officer, Front Royal................ 1997 $ 168,000 $ 127,826 15,000 $4,750
John K. Latham
President, Colony................................... 1997 $ 208,000 $ 80,000 24,000 $4,750
John P. Yediny
President, Rockwood................................. 1997 $ 161,888 $ 77,457 24,000 --
Philip S. Kift
Vice President, Claims, Rockwood.................... 1997 $ 96,708 $ 27,166 7,500 --
Dale H. Pilkington
Senior Vice President, Underwriting, Colony......... 1997 $ 101,667 $ 20,000 8,400 $3,000
Edward J. Desch
Vice President, Chief Financial Officer, Colony..... 1997 $ 106,250 $ 24,000(4) 7,500 $3,757
</TABLE>

- ------------------
(1) Excludes certain perquisites and other amounts which for any Named Executive
Officer did not exceed the lesser of either $50,000 or 10.0% of the total
amount of salary and annual bonus reported for such Named Executive Officer.
(2) Bonuses were earned in 1997, but paid in 1998.
(3) Represents the Company's matching 401(k) contributions.
(4) Of such amount, $3,000 represents one time bonus earned and awarded in 1997.

68
<PAGE>
Option/SAR Grants in Last Fiscal Year. The following table sets forth
certain information with respect to stock option grants to the Named Executive
Officers during the year ended December 31, 1997:

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS(1)(2) VALUE
----------------------------------------------------------- AT ASSUMED ANNUAL
% OF TOTAL RATES
NUMBER OF OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR
UNDERLYING EMPLOYEES EXERCISE OPTION TERM(3)
OPTION IN FISCAL PRICE PER --------------------
NAME GRANTED YEAR SHARE ($/SH) EXPIRATION DATE 5.0% 10.0%
<S> <C> <C> <C> <C> <C> <C>
J. Adam Abram..................... 50,700 16.7% $ 8.33 12/31/07 $265,708 $673,356
Gregg T. Davis.................... 15,000 4.9% $ 8.33 12/31/07 $ 78,612 $199,218
John K. Latham.................... 24,000 7.9% $ 8.33 12/31/07 $125,779 $318,748
John P. Yediny.................... 24,000 7.9% $ 8.33 12/31/07 $125,779 $318,748
Philip S. Kift.................... 7,500 2.5% $ 8.33 12/31/07 $ 39,306 $ 99,609
Dale H. Pilkington................ 8,400 2.8% $ 8.33 12/31/07 $ 44,023 $111,562
Edward J. Desch................... 7,500 2.5% $ 8.33 12/31/07 $ 39,306 $ 99,609
</TABLE>

- ------------------
(1) All options were granted with an exercise price equal to or above the fair
market value of the Common Stock at the date of grant as determined by the
Company's Board of Directors.
(2) All options granted in 1997 vest and become exercisable in equal annual
installments on each December 31 of the years 1998, 1999, 2000 and 2001.
(3) In accordance with the rules of the Commission, the amounts shown on this
table reflect hypothetical gains that could be achieved for the respective
options if exercised at the end of the option term. These gains are based on
assumed rates of stock appreciation of 5.0% and 10.0%, compounded annually
from the date the respective options were granted to their expiration date.
The gains shown are net of the option exercise price, but do not include
deductions for taxes or other expenses associated with the exercise. Actual
gains, if any, on stock option exercises will depend on the future
performance of the Common Stock and the date on which the options are
exercised.

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values. The following table sets forth certain information with respect to the
value of unexercised options held by the Named Executive Officers at December
31, 1997. None of the Named Executive Officers exercised any options during the
year ended December 31, 1997.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT DECEMBER 31, 1997 IN-THE-MONEY OPTIONS
AT DECEMBER 31, 1997(1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
<S> <C> <C> <C> <C>
J. Adam Abram.............................................. 63,000 50,700 $ 407,500 $ 84,500
Gregg T. Davis............................................. 23,250 21,750 $ 130,000 $ 47,500
John K. Latham............................................. 6,000 42,000 $ 20,000 $ 100,000
John P. Yediny............................................. -- 24,000 -- $ 40,000
Philip S. Kift............................................. -- 7,500 -- $ 12,500
Dale H. Pilkington......................................... 1,500 12,900 $ 5,000 $ 29,000
Edward J. Desch............................................ 1,500 12,000 $ 5,000 $ 27,500
</TABLE>

- ------------------
(1) Based upon a fair market value of the Common Stock so determined by the
Company's management on December 31, 1997.

COMPENSATION AGREEMENTS

Front Royal has entered into an Employment Agreement dated December 31,
1997 (the 'Abram Agreement'), with J. Adam Abram, pursuant to which Mr. Abram
serves as President and Chief Executive Officer of Front Royal. The term of the
Abram Agreement commenced on December 31, 1997 and is for a period of three
years from such date, subject to automatic renewal for additional periods of
three years unless terminated

69
<PAGE>

by either party within 90 days prior to the end of the then current term. The
Abram Agreement provides for an annual base salary of $275,000, which base
salary may be increased at the discretion of the Company's Board of Directors,
and provides that Mr. Abram may also receive cash bonuses and other compensation
at the discretion of the Board of Directors.

Front Royal has entered into an Employment Agreement dated December 31,
1997 (the 'Davis Agreement'), with Gregg T. Davis, pursuant to which Mr. Davis
serves as Chief Financial Officer and Chief Operating Officer of Front Royal.
The term of the Davis Agreement commenced on December 31, 1997 and is for a
period of three years from such date, subject to automatic renewal for
additional periods of three years unless terminated by either party within 90
days of the end of the then current term. The Davis Agreement provides for an
annual base salary of $176,400, which base salary may be increased at the
discretion of the Company's Board of Directors, and provides that Mr. Davis may
also receive cash bonuses and other compensation at the discretion of the Board
of Directors.

Colony Management has entered into an Employment Agreement dated December
31, 1997 (the 'Latham Agreement'), with John K. Latham, pursuant to which Mr.
Latham serves as President of Colony Management. The term of the Latham
Agreement commenced on December 31, 1997 and is for a period of three years from
such date, subject to automatic renewal for additional periods of three years
unless terminated by either party within 90 days of the end of the then current
term. The Latham Agreement provides for an annual base salary of $208,000, which
base salary may be increased at the discretion of the Company's Board of
Directors, and provides that Mr. Latham may also receive cash bonuses and other
compensation at the discretion of the Board of Directors.

Rockwood has entered into an Employment Agreement dated December 31, 1996
(the 'Yediny Agreement'), with John P. Yediny, pursuant to which Mr. Yediny
serves as President and Chief Executive Officer of Rockwood. The term of the
Yediny Agreement commenced on December 31, 1996 and is for a period of three
years from such date, subject to automatic annual renewal unless earlier
terminated by either party. The Yediny Agreement initially provided for an
annual base salary of $150,000, which amount is currently $195,000. Such base
salary may be increased at the discretion of the Company's Board of Directors,
and provides that Mr. Yediny may also receive cash bonuses and other
compensation at the discretion of the Board of Directors.

Redwoods has entered into an Employment Agreement dated December 31, 1997
(the 'Trapani Agreement'), with Kevin A. Trapani, pursuant to which Mr. Trapani
serves as President of Redwoods. The term of the Trapani Agreement commenced
January 5, 1998 and is for a period of one year from such date, subject to
automatic renewal unless earlier terminated by either party. The Trapani
Agreement provides for an annual base salary of $200,000, which base salary may
be increased at the discretion of the Company's Board of Directors, and provides
that Mr. Trapani may also receive cash bonuses and other compensation at the
discretion of the Board of Directors.

The Abram Agreement, the Davis Agreement, the Latham Agreement, the Yediny
Agreement and the Trapani Agreement are collectively referred to herein as the
'Employment Agreements.' The Employment Agreements allow for termination of the
respective employee at any time with or without cause. Under the Employment
Agreements, if the respective employee is unable to perform his duties on
account of illness or other incapacity and such Employment Agreement is
terminated, or if such employee is terminated without cause then, except for Mr.
Yediny and Mr. Trapani, such employee, or his legal representative, shall
receive from the employer an amount (net of any payments or benefits they are
entitled to under disability insurance or similar plans) equal to 18 months,
which amount may be extended up to an additional 18 months (if the employee
complies with certain non-compete provisions) of additional base salary from the
date of such termination, and shall continue to receive employee and fringe
benefits throughout the 12 months following such date. In such circumstance Mr.
Yediny receives 24 months of additional base salary and employee and fringe
benefits following termination and Mr. Trapani receives an amount of base salary
and employee and fringe benefits based on his length of service or whether a
change of control has occurred prior to his termination. Pursuant to the
Employment Agreements, if the respective employee dies, is terminated with
cause, other than because the employee or the employer has not met certain
specified performance targets, or voluntarily terminates the Employment
Agreement, the employer shall have no further obligation to such employee. The
Employment Agreements also provide for medical insurance and other fringe
benefits generally available to other senior

70
<PAGE>

executive officers of each respective employer and contain confidentiality and
current and post-termination non-competition and non-solicitation provisions.

The Company has also entered into consulting agreements with each of
Richard W. Wright, the Company's Chairman of the Board, and Lewis P. Wilkinson,
a director of the Company. The consulting agreement with Mr. Wright requires Mr.
Wright to provide his services to the Company for 40 hours each month for an
annual fee of $40,000. The consulting agreement with Mr. Wilkinson requires Mr.
Wilkinson to provide his services to the Company for one day per week for a
monthly fee of $2,000. Such agreements can be terminated on 90 days written
notice by either party.

STOCK OPTION PLANS

In May 1992, the Board of Directors adopted, and the shareholders approved,
the 1992 Stock Option Plan (the '1992 Plan'). The 1992 Plan allows for the grant
of incentive stock options ('ISOs') (within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the 'Code')) and non-qualified stock
options ('NQSOs') to executive officers or key employees of, or consultants to,
the Company or any 'subsidiary' or 'parent' corporation as defined in the Code.
The purpose of the 1992 Plan was to assist the Company in recruiting and
retaining key employees and consultants. The total number of shares of Common
Stock with respect to which options will be granted under the 1992 Plan is
150,000, subject to certain adjustments. Pursuant to the 1992 Plan, ISOs may not
be exercisable for terms in excess of 10 years from the date of grant; however,
NQSOs are not subject to such restriction. In addition, no options or SARs may
be granted under the 1992 Plan after May 2002. The exercise price of ISOs
granted under the 1992 Plan may not be less than the fair market value per share
on the date of grant, as determined by the Compensation Committee of the Board
of Directors; provided, however, that if an optionee owns more than 10.0% of the
Common Stock at the time the individual is granted an ISO, the option price per
share cannot be less than 110.0% of the fair market value per share and the term
of the option cannot exceed five years. All options available for grant under
the 1992 Plan have been granted.

In November 1996, the Board of Directors adopted, and in December 1996 the
shareholders approved, the 1996 Incentive Plan (the '1996 Plan' and together
with the 1992 Plan, the 'Stock Option Plans'). The 1996 Plan allows for the
grant of ISOs, NQSOs, SARs (which must be associated with specific ISOs or NSQOs
and must be granted at the same time as such option), reload options (which may
only be awarded concurrently with an ISO or NSQO), share purchase awards and
restricted share awards (collectively '1996 Plan Awards') to directors and
employees of, and consultants and advisors to, the Company. The purpose of the
1996 Plan is to attract, retain and motivate exemplary key employees,
consultants and directors. As initially adjusted the total number of shares of
Common Stock with respect to which 1996 Plan Awards may be granted under the
1996 Plan is 300,000, subject to certain adjustments. Pursuant to the 1996 Plan,
1996 Plan Awards may not be exercisable for terms in excess of 10 years from the
date of grant. In addition, no 1996 Plan Awards may be granted under the 1996
Plan after November 7, 2006. The exercise price of ISOs and reload options
granted under the 1996 Plan may not be less than the fair market value per share
on the date of grant, as determined by the Compensation Committee; provided,
however, that if an optionee owns more than 10.0% of the Common Stock at the
time the individual is granted any option, the option price per share cannot be
less than 110.0% of the fair market value per share and the term of the option
cannot exceed five years.

The shares of Common Stock subject to and available under the 1992 Plan and
the 1996 Plan may consist, in whole or in part, of authorized but unissued
Common Stock or treasury stock not reserved for any other purpose. Any shares of
Common Stock subject to an option that terminates, expires or lapses for any
reason, and any shares purchased pursuant to an option and subsequently
repurchased by the Company pursuant to the terms of the option, shall again be
available for grant under such plans. Each of the 1992 Plan and the 1996 Plan is
administered by the Compensation Committee of the Board of Directors which is
composed solely of two or more 'Non-Employee Directors' within the meaning of
paragraph (b)(3) of Rule 16b-3 promulgated under the Exchange Act, which
determines, in its discretion, among other things, the recipients of grants, the
type of option or award granted, and the number of shares of Common Stock to be
subject to such options or awards.

As of July 24, 1998, the Company had granted options under the 1992 Plan
exercisable into 150,000 shares of Common Stock to three individuals. The
exercise prices of such options range from $3.33 to $8.33 per share

71
<PAGE>

and such options are exercisable through 2007 and expire at various times from
2002 to 2007. As of June 12, 1998, the Company had granted options under the
1996 Plan exercisable into 300,000 shares of Common Stock to 47 individuals. The
exercise prices of 1996 Plan Awards range from $6.67 to $8.33 per share and such
options are exercisable through 2007 and expire at various times from 2003 to
2007.

On July 2, 1998, the Board of Directors adopted, and on July 23 the
Company's shareholders approved, an amendment to the 1996 Plan to increase the
shares of Common Stock with respect to which 1996 Plan Awards may be granted
from 300,000 to 1,800,000.

The Company's Board of Directors is considering the adoption of a new
compensation program for the Company's and its subsidiaries' senior employees.
It is anticipated that the new compensation program will involve the granting of
options and restricted shares under various terms.

DIRECTOR COMPENSATION

Directors who are not employees or officers of the Company or associated
with the Company receive $1,000 for each Board of Directors meeting attended. In
addition all directors are reimbursed for certain expenses in connection with
attendance at Board of Directors and committee meetings. Other than with respect
to reimbursement of expenses, directors who are employees or officers of the
Company or who are associated with the Company do not receive additional
compensation for service as a director.

Directors also receive non-qualified options pursuant to the Stock Option
Plans. See '--Stock Option Plans.'

LIMITATIONS ON LIABILITY AND INDEMNIFICATION

Front Royal's Amended Articles of Incorporation, which will be in effect
upon the consummation of the Offering, will eliminate, to the fullest extent
permitted by the Business Corporation Act, the personal liability of each
director to the Company or its shareholders for monetary damages for breach of
duty as a director. These provisions in the Amended Articles of Incorporation
will not change a director's duty of care, but will eliminate the individual's
monetary liability for certain violations of that duty, including violations
based on grossly negligent business decisions that may include decisions
relating to attempts to change control of the Company. The provision will not
affect the availability of equitable remedies for a breach of the duty of care,
such as an action to enjoin or rescind a transaction involving a breach of
fiduciary duty; in certain circumstances, however, equitable remedies may not be
available as a practical matter. Under the Business Corporation Act, the
limitation of liability provision is ineffective against liabilities for: (i)
acts or omissions that the director knew or believed at the time of the breach
to be clearly in conflict with the best interests of the Company; (ii) unlawful
distributions described in Business Corporation Act Section 55-8-33; (iii) any
transaction from which the director derived an improper personal benefit; or
(iv) acts or omissions occurring prior to the date the provision became
effective. The provision also in no way affects a director's liability under the
federal securities laws.

Also, to the fullest extent permitted by the Business Corporation Act, the
Company's Amended Bylaws, which will be in effect upon the consummmation of the
Offering provide, in addition to the indemnification of directors and officers
otherwise provided by the Business Corporation Act, for indemnification of the
Company's current or former directors, officers, and employees against any and
all liability and litigation expense, including reasonable attorneys' fees,
arising out of their status or activities as directors, officers and employees,
except for liability or litigation expense incurred on account of activities
that were at the time known or believed by such director, officer or employee to
be clearly in conflict with the best interests of the Company.

The Company maintains director and officer liability insurance with respect
to liabilities arising out of certain matters, including matters arising under
the Securities Act.

At present, there is no pending litigation or proceeding involving any
director or officer, employee or agent of the company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding which may result in a claim for such indemnification.

72
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information regarding beneficial
ownership of the Common Stock of: (i) each of the Company's directors; (ii) the
Named Executive Officers; (iii) the Company's executive officers and directors
as a group; and (iv) all persons known by the Company to be the beneficial owner
of more than 5.0% of the outstanding Common Stock of the Company immediately
prior to the Offering, giving pro forma effect to the Recapitalization, and
immediately after the Offering, giving pro forma effect to the Recapitalization
and the sale of Common Stock offered hereby. See 'Management.'

The table also sets forth the number of shares of Common Stock being
offered by the Selling Shareholder and the number and percentage of outstanding
shares to be owned by each person and group after adjustment for completion of
the Offering. The Selling Shareholders' shares of Common Stock are being offered
and sold pursuant to this Prospectus by the Selling Shareholders. The Company
has agreed to register the public offering of such shares of Common Stock under
the Securities Act and to pay all expenses in connection therewith, and such
shares of Common Stock have been included in the Registration Statement of which
this Prospectus forms a part. See 'Underwriting.' Except as set forth below,
none of the Selling Shareholders nor their affiliates has ever held any position
or office with the Company and, except as noted below, none of the Selling
Shareholders or their affiliates has had any other material relationship with
the Company. The Company will not receive any of the proceeds from the sale of
their shares of Common Stock.

<CAPTION>
J. Adam Abram (4) .................................. 420,403 5.6% -- 420,403 3.9%
Front Royal, Inc.
2200 Gateway Boulevard, Suite 205
Morrisville, NC 27560
<S> <C> <C> <C> <C> <C>
Gregg T. Davis (5) ................................. 35,754 * -- 35,754 *
Front Royal, Inc.
2200 Gateway Boulevard, Suite 205
Morrisville, NC 27560
John K. Latham (6) ................................. 22,581 * -- 22,581 *
Colony Management Services, Inc.
9201 Forest Hill Avenue, Suite 200
Richmond, VA 23235
Philip S. Kift (7) ................................. 1,080 * -- 1,080 *
Rockwood Casualty Insurance Company
654 Main Street
Rockwood, PA 15557
Dale H. Pilkington (8) ............................. 2,369 * -- 2,369 *
Colony Management Services, Inc.
9201 Forest Hill Avenue, Suite 200
Richmond, VA 23235
Edward J. Desch (9) ................................ 1,500 * -- 1,500 *
Colony Management Services, Inc.
9201 Forest Hill Avenue, Suite 200
Richmond, VA 23235
John P. Yediny (10) ................................ 9,000 * -- 9,000 *
Rockwood Casualty Insurance Company
654 Main Street
Rockwood, PA 15557
</TABLE>

73
<PAGE>

<TABLE>
<CAPTION>
AMOUNT AND
BENEFICIAL NATURE OF
OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO AFTER THE
THE OFFERING(1)(2) SHARES OF OFFERING(1)(2)(3)
-------------------- COMMON STOCK ---------------------
SHARES PERCENT OFFERED SHARES PERCENT
------------
<S> <C> <C> <C> <C> <C>
Richard W. Wright (11) ............................. 60,594 * -- 60,594 *
The Wright Group
1500 Forest Avenue, Suite 114
Richmond, VA 23229
Matthew Bronfman (12) .............................. 416,084 5.6% -- 416,084 3.9%
Perfumes Isabell, Inc.
30 West 26th Street, 2nd Floor
New York, NY 10010
Robert V. Hatcher, Jr. (13) ........................ 13,658 * -- 13,658 *
8401 Patterson Avenue, Suite 106
Richmond, VA 23229
Ira M. Lubert (14) ................................. -- * -- -- *
IL Management, Inc.
101 West Main Street
Moorestown, NJ 08057
Lewis P. Wilkinson (15) ............................ 35,898 * -- 35,898 *
Lewis P. Wilkinson IRA
509 St. Christopher Road
Richmond, VA 23226
Wilson Wilde (16) .................................. 17,525 * -- 17,525 *
The Hartford Steam Boiler Insurance
& Inspection Company
One State Street
Hartford, CT 06102-3001
Joel L. Fleishman (17) ............................. 3,750 * -- 3,750 *
Duke University
Box 90522
Durham, NC 27708-0522
Lawrence McMichael ................................. -- * -- -- *
Dilworth Paxson LLP
3200 Mellon Bank Center
1735 Market Street
Philadelphia, PA 19103
Alan N. Colner (18) ................................ -- * -- -- *
Moore Capital Management, Inc.
1251 Avenue of the Americas, 53rd Floor
New York, NY 10020
James L. Zech (19) ................................. 763,500 10.2% -- 763,500 7.1%
High Ridge Capital LLC
4 Stamford Plaza
Stamford, CT 06912
Charles M. Lederman (20) ........................... 1,669,999 22.0% 99,881 1,570,118 14.4%
FWH, Inc.
502 West Office Center Drive
Fort Washington, PA 19034
</TABLE>

74
<PAGE>

<TABLE>
<CAPTION>
AMOUNT AND
BENEFICIAL NATURE OF
OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO AFTER THE
THE OFFERING(1)(2) SHARES OF OFFERING(1)(2)(3)
-------------------- COMMON STOCK ---------------------
SHARES PERCENT OFFERED SHARES PERCENT
------------
<S> <C> <C> <C> <C> <C>
Atlantic Venture Partners .......................... 483,292 6.5% 241,552 241,740 2.2%
380 Knollwood Street, Suite 410
Winston-Salem, NC 27103
Technology Leaders, L.P. (21) ...................... 888,484 11.8% 425,658 462,826 4.3%
IL Management, Inc.
101 West Main Street
Moorestown, NJ 08057
FWH, Inc. .......................................... 1,350,000 18.6% 674,737 675,263 6.2%
502 West Office Center Drive
Fort Washington, PA 19034
High Ridge Capital, LLC ............................ 763,500 10.2% -- 763,500 7.1%
4 Stamford Plaza, 15th Floor
108 Elm Street
Stamford, CT 06912-0043
Moore Global Investments, Ltd./Remington Investment % %
Strategies, L.P (22) ............................. 742,500 9.9 -- 742,500 6.9
1251 Avenue of the Americas, 53rd Floor
New York, NY 10020
Stephen Weicholz (2)(23) ........................... 930,000 11.5% -- 930,000 8.2%
2100 University Drive, Suite 900
Coral Springs, FL 33071
All directors and executive officers ............... 1,804,290 23.8% -- 1,804,290 16.6%
as a group (4) through (20) and (24)
Additional Selling Shareholders:
Edwin Andrews....................................... 5,000 * 1,200 3,800 *
FRA, LLC............................................ 48,206 * 2,999 45,207 *
Dorothy Kretchmer................................... 65,665 * 15,954 49,711 *
Prima Partners(25).................................. 75,000 1.0% 9,371 65,629 *
Cindi Resha......................................... 1,200 * 600 600 *
Sirrom Capital, LLC(26)............................. 210,275 2.8% 105,096 105,179 1.0%
Anna Teitelbaum..................................... 5,454 * 450 5,004 *
Thomas Tuffy........................................ 10,142 * 2,549 7,593 *
Virginia Capital Management, Inc.(27)............... 371,468 5.0% 119,953 251,515 2.3%
</TABLE>

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

* Less than 1.0%

(1) All shares are beneficially owned and sole voting and investment power is
held by the persons named, except as otherwise noted. See 'Description of
Capital Stock.'

(2) Percentage ownership amounts reflect the issuance of 300,000 shares of
Common Stock to Wycon and UnaMark and the Preferred National Warrants to
Wycon and Americlaim pursuant to the Preferred National Acquisition. Mr.
Stephen Weicholz controls each of Wycon, UnaMark and Americlaim. See
'Business-- Preferred National.'

(Footnotes continued on next page)

75
<PAGE>

(Footnotes continued from previous page)

(3) In each case reflects the sale of Common Stock included in the Offering.
See 'Principal and Selling Shareholders.'

(4) Includes 70,725 shares of Common Stock issuable upon exercise of warrants
and options granted by Front Royal to Mr. Abram, 50,725 shares of Common
Stock owned by Rosalind Abram, the wife of Mr. Abram, 78,009 shares of
Common Stock owned by MBA Ventures, a partnership in which Mr. Abram is the
only general partner, and 83,383 shares of Common Stock owned by Jane M.
Abram Family Limited Partnership of which Mr. Abram is managing general
partner, as to all of which Mr. Abram is the beneficial owner. Excludes
57,000 shares of Common Stock issuable upon exercise of options granted by
Front Royal to Mr. Abram which are not exercisable within 60 days from the
date of this Prospectus and 1,771 shares of Common Stock issuable upon
exercise of warrants which are not exercisable until June 1, 2001.

(5) Includes 23,250 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Davis. Excludes 21,750 shares of Common Stock
issuable upon exercise of options granted by Front Royal to Mr. Davis which
are not exercisable within 60 days from the date of this Prospectus and 649
shares of Common Stock issuable upon exercise of warrants which are not
exercisable until June 1, 2001.

(6) Includes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Latham. Excludes 42,000 shares of Common
Stock issuable upon exercise of options granted by Front Royal to Mr.
Latham which are not exercisable within 60 days from the date of this
Prospectus and 590 shares of Common Stock issuable upon exercise of
warrants which are not exercisable until June 1, 2001.

(7) Excludes 7,500 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Kift which are not exercisable within 60 days
from the date of this Prospectus and 85 shares of Common Stock issuable
upon exercise of warrants which are not exercisable until June 1, 2001.

(8) Includes 1,500 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Pilkington. Excludes 12,900 shares of Common
Stock issuable upon exercise of options granted by Front Royal to Mr.
Pilkington which are not exercisable within 60 days from the date of this
Prospectus and 24 shares of Common Stock issuable upon exercise of warrants
which are not exercisable until June 1, 2001.

(9) Includes 1,500 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Desch. Excludes 12,000 shares of Common Stock
issuable upon exercise of options granted by Front Royal to Mr. Desch which
are not exercisable within 60 days after the date of this Prospectus.

(10) Excludes 1,650 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Shari Yediny, the wife of Mr. Yediny (who is also
an employee of the Company), which are not exercisable within 60 days from
the date of the Prospectus, 24,000 shares of Common Stock issuable upon
exercise of options granted by Front Royal to Mr. Yediny which are not
exercisable within 60 days from the date of this Prospectus and 708 shares
of Common Stock issuable upon exercise of warrants which are not
exercisable until June 1, 2001.

(11) Includes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Wright, 4,200 shares of Common Stock held in
trust by Mr. Wright as trustee for his grandchildren and 3,575 shares of
Common Stock held by Jean Wright, the wife of Mr. Wright, as to all of
which Mr. Wright claims beneficial ownership. Excludes 12,000 shares of
Common Stock issuable upon exercise of options granted by Front Royal to
Mr. Wright which are not exercisable within 60 days of the date of this
Prospectus.

(12) Includes 9,000 shares of Common Stock owned by Mr. Bronfman's children, and
319,809 shares of Common Stock owned by the Matthew Bronfman Pour-Off
Trust, as to all of which Mr. Bronfman claims beneficial ownership.
Excludes 6,000 shares of Common Stock issuable upon exercise of warrants
which are not exercisable within 60 days of the date of this Prospectus,
131,637 shares of Common Stock owned by the Matthew Bronfman 1990 Long Term
Trust and 17,826 shares of Common Stock issuable upon exercise of warrants
granted by Front Royal to the Matthew Bronfman 1990 Long Term Trust, as to
all of which Mr. Bronfman disclaims beneficial ownership.

(Footnotes continued on next page)

76
<PAGE>

(Footnotes continued from previous page)

(13) Excludes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Hatcher which are not exercisable within 60
days from the date of this Prospectus and 118 shares of Common Stock
issuable upon exercise of warrants which are not exercisable until June 1,
2001.

(14) Excludes 6,000 shares of Common Stock issued upon exercise of options
granted by Front Royal to Mr. Lubert which are not exercisable within 60
days after the date of this Prospectus and 851,647 shares of Common Stock
owned by Technology Leaders, L.P., of which Mr. Lubert is Managing
Director, as to which he disclaims beneficial ownership.

(15) Includes 6,000 shares of Common Stock held in an IRA trust for the benefit
of Mr. Wilkinson as to which Mr. Wilkinson claims beneficial ownership.
Excludes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Wilkinson which are not exercisable within 60
days from the date of this Prospectus, 1,290 shares of Common Stock owned
by a trust for the benefit of Mr. Wilkinson's son, and 283 shares of Common
Stock issuable upon exercise of warrants which are not exercisable until
June 1, 2001.

(16) Excludes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Wilde which are not exercisable within 60
days from the date of this Prospectus and 885 shares of Common Stock
issuable upon exercise of warrants which are not exercisable until June 1,
2001.

(17) Excludes 6,000 shares of Common Stock issuable upon exercise of options
granted by Front Royal to Mr. Fleishman which are not exercisable within 60
days from the date of this Prospectus and 295 shares of Common Stock
issuable upon exercise of warrants which are not exercisable until June 1,
2001.

(18) Mr. Colner is Managing Director, Private Equity Investments of the
investment advisor to each of Moore Global Investments, Ltd. ('MGI') and
Remington Investment Strategies, L.P. ('Remington'), and does not have
voting or investment power with respect to the shares of Common Stock owned
by MGI or Remington. Excludes 6,000 shares of Common Stock issuable upon
exercise of options granted by Front Royal to Mr. Colner which are not
exercisable within 60 days after the date of this Prospectus. Pursuant to
an agreement between Mr. Colner and the investment advisor for each of MGI
and Remington, all economic interest in options granted to Mr. Colner by
the Company will accrue to the benefit of MGI and Remington.

(19) Includes 763,500 shares of Common Stock owned by High Ridge Capital, Inc.,
of which Mr. Zech is President and ultimate beneficial owner, as to which
he claims beneficial ownership. Excludes 6,000 shares of Common Stock
issuable upon exercise of options granted by Front Royal to Mr. Zech which
are not exercisable within 60 days after the date of this Prospectus.

(20) Includes 120,000 shares of Common Stock issuable upon exercise of warrants
from Front Royal to Mr. Lederman, 1,350,000 shares of Common Stock owned by
FWH Inc. ('FWH'), of which Mr. Lederman is President, Chief Executive
Officer and ultimate beneficial owner, and 199,999 shares of Common Stock
owned by Premier Auto Insurance Company, of which Mr. Lederman is President
('Premier'), as to all of which he claims beneficial ownership. Excludes
6,000 shares of Common Stock issuable upon exercise of options granted by
Front Royal to Mr. Lederman which are not exercisable within 60 days after
the date of this Prospectus. Mr. Lederman was a director of the Company
from December 1996 through July 1998.

(21) Includes 36,841 shares of Common Stock issuable upon exercise of warrants
issued by Front Royal, 336,469 shares of Common Stock owned by Technology
Leaders FR Corp. and 147,475 shares of Common Stock owned by Technology
Leaders Offshore CV, as to all of which Technology Leaders, L.P. claims
beneficial ownership.

(22) Moore Capital Management, Inc., a Connecticut corporation, is vested with
investment discretion with respect to portfolio assets held for the account
of MGI, the holder of 631,140 shares of Common Stock. Moore Capital
Advisors, L.L.C., a New York limited liability company, is the sole general
partner of Remington, the holder of 111,360 shares of Common Stock. Mr.
Louis M. Bacon is the majority shareholder of Moore Capital Management,
Inc. and is the majority equity holder of Moore Capital Advisors, L.L.C. As
a result, Mr. Bacon, though he disclaims beneficial ownership of such
shares, may be deemed to be the beneficial owner of the aggregate shares
held by MGI and Remington.

(Footnotes continued on next page)

77
<PAGE>

(Footnotes continued from previous page)

(23) Includes 630,000 shares of Common Stock issuable upon exercise of the
Preferred National Warrants granted by Front Royal to Wycon and Americlaim
pursuant to the Preferred National Acquisition.

(24) The directors and officers group includes Messrs. Abram, Davis, Latham,
Yediny, Desch, Pilkington, Kift, Wright, Bronfman, Fleishman, Hatcher,
Lubert, Colner, Zech, Wilkinson and Wilde.

(25) Excludes 1,585 shares of Common Stock issuable upon exercise of warrants
which are not exercisable until June 1, 2001.

(26) Includes 144,275 shares of Common Stock issuable upon exercise of warrants
granted by Front Royal to Sirrom Capital, L.L.C. Sirrom Capital, L.L.C. has
notified the Company that it wishes to exercise and sell warrants
representing 72,109 shares of Common Stock.

(27) Excludes 351 shares of Common Stock issuable upon exercise of warrants
which are not exercisable until June 1, 2001. Includes 17,832 shares of
Common Stock issuable upon exercise of warrants granted by Front Royal to
Virginia Capital Management, Inc.

78
<PAGE>
CERTAIN TRANSACTIONS

The Company has entered into employment agreements with certain of its
executive officers and consulting agreements with certain of its directors. See
'Management--Compensation Agreements.' Additionally, the Company has granted
options to certain of its officers and directors. All such grants were approved
by the Company's Board of Directors and the Company believes that the exercise
price of each such option represented the fair market value of the underlying
Common Stock on the date of grant. See 'Management--Stock Option Plans' and
'Principal and Selling Shareholders.'

In connection with the Rockwood Acquisition, Colony Insurance and Fort
Washington Holdings, Inc. ('Fort Washington'),an entity affiliated with Charles
M. Lederman, who became a director of the Company in connection with the
Rockwood Acquisition and resigned as a director in July 1998, entered into an
Option Agreement pursuant to which Fort Washington was granted an option,
exercisable prior to June 30, 1997, to purchase all of the outstanding capital
stock of Hamilton, a wholly-owned subsidiary of Colony Insurance, for an
aggregate purchase price of $4.5 million. In June 1997, Fort Washington
exercised such option and the transaction was completed after receiving
regulatory approval on December 31, 1997. Management believes that this
transaction was on terms no less favorable to the Company than could be obtained
from independent third parties.

Pursuant to the Rockwood Acquisition, Premier, a company of which Mr.
Lederman is a controlling shareholder, issued a $2.5 million secured promissory
note in favor of the Company (which was repaid in full by July 1997) and FWH,
the parent company of Premier, acquired the Series A Preferred Stock. Management
believes that these transactions were on terms no less favorable to the Company
than could be obtained from independent third parties.

In connection with the Rockwood Acquisition, on December 31, 1996, the
Company issued 31,750 Units (defined below) to 27 individuals and entities and
on August 25, 1997 the Company issued an additional 733 Units to 11 individuals
and entities in private placements. The purchase price for each 'Unit' was $400
and each Unit consisted of 100 shares of Class C Common Stock, 100 purchase
price adjustment rights and one Warrant to purchase 7.874 shares of Class A
Common Stock. Certain directors and executive officers purchased securities in
this transaction upon the same terms as all other purchasers. Of such officers
and directors who purchased securities in this transaction, only J. Adam Abram,
Matthew Bronfman and Wilson Wilde, each a director, purchased in excess of
$60,000 worth of such securities. See 'Principal and Selling Shareholders.' The
Company loaned an aggregate of $200,000 to J. Adam Abram, Gregg T. Davis and
John K. Latham, each of whom is an executive officer of the Company, which
amounts were used by these individuals to purchase securities in this
transaction. These notes have an interest rate of 6.5%, mature on December 31,
2001, are secured by the stock purchased with the proceeds and require mandatory
prepayment of 25.0% of the net after-tax amount of any cash bonus paid to these
officers. The balance of such notes as of June 12, 1998 was approximately
$112,000.

Rockwood (prior to its acquisition by the Company) paid Rockwood Asset
Management, Inc. ('RAM'), an entity in which Mr. Lederman, a director of the
Company from December 1996 through July 1998, is a controlling shareholder,
$841,000, $636,000 and $319,000 during 1996, 1995 and 1994, respectively, under
agreements for: (i) the lease of Rockwood's main office facilities; (ii) the
lease of certain computer equipment; (iii) a software license; and (iv) an
installment purchase of office equipment. In connection with the Rockwood
Acquisition, the Company entered into a new lease with RAM (see
'Business--Facilities') and also entered into several agreements with former
owners and affiliates of Rockwood, including certain non-solicitation and non-
compete agreements, for periods of up to ten years. The agreements require
aggregate payments of $565,000 per year through 2001 and $390,000 per year from
2002 through 2006. The net present value of such agreements is recorded as an
intangible asset with a corresponding liability recorded in other liabilities.

In early 1995, the Company issued 51,648 shares of Class A Common Stock at
$2.50 per share in connection with the conversion of $129,122 of principal and
accrued interest on outstanding subordinated debt to certain shareholders. Of
such shares, approximately 25,000 were issued to J. Adam Abram. See 'Principal
and Selling Shareholders.'

The share amounts in this section do not give effect to the
Recapitalization.

79
<PAGE>
DESCRIPTION OF CAPITAL STOCK

GENERAL

Upon consummation of the Offering and completion of the Recapitalization,
the Company's authorized capital stock will consist of 30,000,000 shares of
Common Stock, no par value per share, and 5,000,000 shares of Preferred Stock,
no par value per share (the 'Preferred Stock'). The discussions of the Common
Stock and Preferred Stock here and elsewhere in this Prospectus are qualified in
their entirety by reference to: (i) the Amended Articles of Incorporation of
Front Royal, a copy of which has been filed as an exhibit to the Registration
Statement of which this Prospectus is a part; and (ii) the applicable North
Carolina law. See 'The Recapitalization' and 'Capitalization.'

COMMON STOCK

Holders of Common Stock will be entitled to one vote for each share held on
all matters submitted to a vote of shareholders and will not have cumulative
voting rights. Shareholders casting a plurality of votes of the shareholders
entitled to vote in an election of directors will be able to elect all of the
directors standing for election. Holders of Common Stock will be entitled to
receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available therefor, subject to any preferential
dividend rights of Preferred Stock that may be issued at such future time or
times. Upon the liquidation, dissolution or winding-up of the Company, the
holders of Common Stock will be entitled to receive ratably the net assets of
the Company after the payment of all debts and other liabilities and subject to
the prior rights of Preferred Stock that may be outstanding at such time.
Holders of Common Stock will have no preemptive, subscription, redemption or
conversion rights. The outstanding shares of Common Stock will be, and the
shares of Common Stock offered by the Company in the Offering will be, when
issued and paid for, fully paid and nonassessable. The rights, preferences and
privileges of holders of Common Stock are subject to the rights of the holders
of shares of any series of Preferred Stock which the Company may designate and
issue in the future.

As of July 24, 1998, giving pro forma effect to the Preferred National
Acquisition and the Recapitalization, there were 7,475,555 shares of Common
Stock outstanding held of record by approximately 80 shareholders. After giving
effect to the issuance of the 3,300,000 shares of Common Stock offered by the
Company hereby, and the closing of the Preferred National Acquisition there will
be 10,775,555 shares of Common Stock outstanding upon the closing of the
Offering.

PREFERRED STOCK

The Board of Directors will have the authority to issue the Preferred Stock
in one or more series and to fix the rights, preferences, privileges and
restrictions thereof, including dividend rights, conversion rights, voting
rights, terms of redemption, redemption prices, liquidation preferences and the
number of shares constituting any series or the designation of such series,
without further vote or action by the shareholders. The issuance of Preferred
Stock may have the effect of delaying, deferring or preventing a change in
control of the Company without further action by the shareholders and may
adversely affect the voting and other rights of the holders of Common Stock. The
issuance of Preferred Stock with voting and conversion rights may adversely
affect the voting power of the holders of Common Stock, including the loss of
voting control of others. At present, the Company has no plans to issue any of
the Preferred Stock.

WARRANTS

Class A Warrants. As of the date of this Prospectus, the Company has
outstanding Class A Common Stock Purchase Warrants ('Class A Warrants') to
purchase 495,825 shares of Common Stock, subject to adjustment. Of the Class A
Warrants: (i) 13,500 were issued in May 1992, have an exercise price of $3.33
per share, and have no expiration date; (ii) 36,450 were issued in December
1994, have an exercise price of $4.17 per share, are currently exercisable and
expire in December 1999; (iii) 126,250 were issued in September 1994 (the
'September 1994 Warrants'), have an exercise price of $0.017 per share, are
currently exercisable and expire in September 1999; (iv) 79,624 were issued in
December 1994 (the 'December 1994 Warrants'), have an exercise price of $0.017
per share, are currently exercisable and expire in September and December of
1999; and (v) 240,000 were issued in December 1996, have an exercise price of
$4.17 per share, are currently exercisable and expire on the later of December
31, 2001 or two years after the Company's initial public offering. The

80
<PAGE>
September 1994 Warrants and the December 1994 Warrants are subject to periodic
adjustments if not exercised by certain dates and contain certain registration
rights with respect to the underlying shares of Common Stock.

Class C Warrants. As of the date of this Prospectus, the Company has
outstanding warrants (the 'Class C Warrants') to purchase an aggregate 153,463
shares of Common Stock at an exercise price of $0.017 per share, subject to
adjustment. Of the Class C Warrants: (i) warrants to purchase an aggregate of
150,000 shares of common stock were issued on December 31, 1996; and (ii)
warrants to purchase an aggregate of 3,463 shares of Common Stock were issued on
August 25, 1997. The Class C Warrants may be exercised by the holders thereof at
the earliest to occur of (i) June 1, 2001; (ii) the sale by the Company of all
or substantially all of its assets; (iii) the date on which, immediately prior
to the date of such transaction as a result of one or a series of related
transactions, the holders of the then issued and outstanding Common Stock
beneficially own in the aggregate, less than 55.0% of the issued and outstanding
voting securities of the Company (or the successor to the Company if such
transaction was a merger or consolidation in which the Company was not the
surviving entity), determined on a fully diluted basis; or (iv) the date on
which the members who comprised the Board of Directors on December 31, 1996
cease for any reason to comprise at least a majority of the Board of Directors,
provided, that, any person who becomes a director subsequent to such date whose
election, or nomination for election by the Company's shareholders, was approved
by a vote of at least a majority of the directors comprising the Board of
Directors on December 31, 1996 shall be, for all purposes of this definition,
considered as though such person were a member of the Board of Directors on such
date (each of (ii) to (iv) above, a 'Trigger Event'). The Class C Warrants
expire on December 31, 2006.

The Class C Warrants may be redeemed at the option of the Company, at a
redemption price of $0.017 per Class C Warrant, at any time (i) after December
31, 2000, if the book value per share of the Company is greater than $12.08,
subject to adjustment; or (ii) if at the end of each of the three immediately
preceding fiscal quarters the book value per share of the Company is greater
than $12.92, subject to adjustment. The Company shall have the right to redeem
such number of the Class C Warrants as is equal to (i) in the case of a
redemption following December 31, 2000, the number of Class C Warrants
represented by each Warrant certificate multiplied by 2.0% times each $0.01 by
which the book value per share of the Company exceeds $12.08, and (ii) in the
case of any redemption prior to December 31, 2000, all the Class C Warrants. All
of the computations above shall be adjusted to reflect any stock dividends and
any stock splits or combinations or similar transactions taking place after the
original issue date of the Class C Warrants through the end of the above
referenced fiscal quarters or December 31, 2000.

The Class C Warrants may also be redeemed at the option of the Company at a
price equal to $0.017 per Class C Warrant if, at the end of the fiscal quarter
immediately prior to the effective date of any Trigger Events the book value per
share of the Company is greater than (i) $12.08 less the book value per share of
the Company at December 31, 1996, divided by (ii) 16 and multiplied by (iii) the
number of fiscal quarters from January 1, 1997 through such effective date, as
adjusted.

Preferred National Warrants. In connection with the Preferred National
Acquisition, the Company will issue the Preferred National Warrants, which will
have an exercise price of $16.67 per share and be exercisable for seven and
one-half years from the closing of the Preferred National Acquisition. See
'Business--Preferred National.'

All Warrants. The Class A Warrants, the Class C Warrants and the Preferred
National Warrants may be exercised upon surrender of the certificates therefor
on or prior to their expiration or any redemption date at the offices of the
Company upon, among other things, the payment of the exercise price for the
number of such warrants being exercised. Additionally, the Class A Warrants,
Class C Warrants and the Preferred National Warrants contain provisions that
protect the holders thereof against dilution by adjustment of the exercise price
in certain events, such as stock dividends, stock splits, mergers, the sale of
substantially all of the Company's assets and for other extraordinary events and
for sales of securities for a consideration less than the then current market
price of the Common Stock. The Company is not required to issue fractional
shares of Common Stock and, in lieu thereof, is required to make a cash payment
based upon the current market value of such fractional shares. The holders of
the Class A Warrants, Class C Warrants and Preferred National Warrants do not by
virtue of their ownership thereof possess any rights as a shareholder of the
Company unless and until their respective warrants are exercised.

81
<PAGE>
REGISTRATION RIGHTS

In connection with the Rockwood Acquisition, the Company entered into an
Amended and Restated Registration Rights Agreement, dated as of December 31,
1996, as amended on August 25, 1997 (the 'Amended and Restated Registration
Rights Agreement'), with certain of its then Class A Common Stock, Class B
Common Stock, Class C Common Stock, Class A Warrant and Class C Warrant holders
(the 'Holders'). The Company also entered into a Shareholder and Registration
Rights Agreement dated as of December 31, 1996 (the 'Preferred Registration
Rights Agreement') with Fort Washington, PIC Insurance Group, Inc. Charles M.
Lederman and Timothy I. McCarthy, Sr. (collectively, the 'Preferred Holders')
pursuant to which the Preferred Holders were granted the same registration
rights as the Holders under the Amended and Restated Registration Rights
Agreement. Upon the closing of the Preferred National Acquisition the person
and/or entities to whom shares of Common Stock and the Preferred National
Warrants are issued will become parties to and Holders under the Amended and
Restated Registration Rights Agreement. The Amended and Restated Registration
Rights Agreement and the Preferred Registration Rights Agreement are referred to
herein as the 'Registration Rights Agreement.' The Holders and the Preferred
Holders are referred to herein as the 'Registration Rights Holders.'

Pursuant to the Registration Rights Agreement the Registration Rights
Holders have the following rights with respect to 'Registrable Securities' held
by them: (i) 'piggyback' registration rights to any registration by the Company
of any of the Company's equity securities, other than offerings registered on
Form S-4 or S-8; and (ii) 'demand' registration rights which are exercisable:
(a) on four separate occasions upon the receipt by the Company of written notice
from the Registration Rights Holders holding at least 15.0% of the Common Stock
(such percentage based upon the number of shares outstanding at December 31,
1996 on a fully diluted basis), that such holders desire to offer or cause to be
offered for public sale at least 10.0% of the shares of Common Stock (such
percentage based upon the number of shares outstanding at December 31, 1996 on a
fully diluted basis), and the fulfillment of certain other conditions; and (b)
once every 12-months for a period of 10 years, commencing on the date on which
the Company becomes eligible to use Form S-3, but only if such registration can
be effected on Form S-3, upon written request by the holders of at least 15.0%
of the securities held by the Registration Rights Holders (such percentage based
upon the number of shares outstanding at December 31, 1996 on a fully diluted
basis) and upon the good faith estimation by the Board of Directors that the
market value of the securities requested to be registered exceeds $500,000.

Shares of Common Stock cease to be 'Registrable Securities' (i) upon the
consummation of any sale of such shares pursuant to an effective registration
statement under the Securities Act or Rule 144 under the Securities Act or (ii)
at such time as such Registrable Securities become eligible for sale under Rule
144(k) under the Securities Act.

Immediately following the Offering, the Registration Rights Holders will
have the foregoing registration rights with respect to 3,184,954 shares of
Common Stock and with respect to an additional 1,279,288 shares of Common Stock
issuable upon exercise of the Class A Warrants and the Class C Warrants
described above. See 'Shares Eligible for Future Sale.'

STATUTORY PROVISIONS

The Business Corporation Act contains a 'Shareholder Protection Act' which,
with certain exceptions discussed below, requires approval of certain business
combinations between a North Carolina corporation and any beneficial holder of
more than 20.0% of the voting shares of the corporation by the holders of at
least 95.0% of the voting shares of the corporation. Business combinations
subject to this approval requirement include any merger or consolidation of the
corporation with or into any other corporation, the sale or lease of all or any
substantial part of the corporation's assets to, or any payment, sale or lease
to the corporation or any subsidiary thereof in exchange for securities of the
corporation of any assets (except assets having an aggregate fair market value
of less than $5.0 million) of any other entity. The principal exception to the
special voting requirement applies to business combinations that satisfy various
complex statutory provisions, including provisions relating to the fairness of
the price and the constituency of the Board of Directors. In addition, the
special voting requirement shall not be applicable to any corporation if, for
example: (i) the corporation was not a public corporation at the time such other
entity acquired in excess of 10.0% of the voting shares; (ii) the corporation
adopted an amendment to its bylaws within 90 days of becoming a public company
or incorporated a provision in its original articles of incorporation providing
that the provisions shall not apply to it in accordance with the statute; or
(iii) the business combination in question was the subject of an existing
agreement of the corporation

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on April 23, 1987. Within 90 days of the closing of the Offering, the Company's
Board of Directors will cancel the Amended Bylaws to 'opt out' of the
Shareholder Protection Act.

Certain North Carolina public corporations are also subject to 'The North
Carolina Control Share Acquisition Act.' This law provides that shares acquired
in a transaction that would cause the acquiring person's voting strength to meet
or exceed any of three thresholds (20.0%, 33.3% or a majority) of voting power,
depending on the circumstances of the transaction, have no voting rights unless
granted by a majority vote of all the outstanding shares of the corporation (not
including Interested Shares) entitled to vote for the election of directors.
'Interested Shares' means the shares of a corporation beneficially owned by (i)
any person who has acquired or proposes to acquire control shares in a control
share acquisition; (ii) any officer of the corporation; or (iii) any employee of
the covered corporation who is also a director of the corporation. This
provision empowers an acquiring person to require the North Carolina corporation
to hold a special meeting of shareholders to consider the matter within 50 days
and, if so requested, no sooner than 30 days of its request. The Company has
'opted out' of The North Carolina Control Share Acquisition Act.

These provisions were designed to deter certain takeovers of North Carolina
corporations.

CERTAIN ARTICLES OF INCORPORATION AND BYLAW PROVISIONS

The Amended Articles of Incorporation and Amended Bylaws contain provisions
that could make the acquisition or control of the Company by means of a tender
offer, open market purchases, proxy contest or otherwise more difficult. These
provisions are as follows:

Classified Board of Directors. The Amended Articles of Incorporation
provide for the Board of Directors to be divided into three classes of directors
serving staggered three-year terms. The Company believes that a classified Board
of Directors will help to assure the continuity and stability of the board and
the Company's business strategies and policies as determined by the Board of
Directors. The classified board provision could have the effect of making the
removal of incumbent directors more time-consuming and difficult, therefore
discouraging a third party from making a tender offer or otherwise attempting to
obtain control of the Company, even though such an attempt might be beneficial
to the Company and its shareholders. Thus, the classified board provision could
increase the likelihood that incumbent directors will retain their positions.

Number of Directors; Removal; Filling Vacancies. The Amended Articles of
Incorporation and Amended Bylaws provide that the number of directors will be
fixed from time to time by the Board of Directors. Moreover, directors may be
removed only for cause and only upon the affirmative vote of holders of at least
66 2/3% of the voting power of the then outstanding shares of any class or
series of capital stock of the Company entitled to vote generally in the
election of directors (the 'Voting Stock') voting as a class. This provision,
when coupled with the provisions of the Amended Articles of Incorporation
authorizing the Board of Directors to fill vacant directorships, will preclude
shareholders from removing incumbent directors without the affirmative vote of
at least a substantial majority of the Voting Stock and filling the vacancies
created by such removal with their own nominees.

Special Meetings. The Amended Bylaws provide that special meetings of
shareholders can be called pursuant to a resolution adopted by a majority of the
entire Board of Directors, by the Chairman of the Board of Directors or by
holders of at least 10% of the Voting Stock entitled to cast votes at such
meeting. Once the Company becomes a 'public corporation' as defined in the
Business Corporation Act, the shareholders will no longer have the right to call
special meetings.

Advance Notice Provisions for Shareholder Proposals and Shareholder
Nominations of Directors. The Amended Bylaws establish an advance notice
procedure with regard to the nomination, other than by or at the direction of
the Board of Directors or a committee thereof, of candidates for election as
directors (the 'Nomination Procedure') and with regard to other matters to be
brought by stockholders before an annual meeting of shareholders of the Company
(the 'Business Procedure'). Under the Business Procedure, a shareholder seeking
to have any business conducted at an annual meeting must give prior written
notice, in proper form, to the Company. The requirements as to the form and
timing of that notice are specified in the Amended Bylaws. If the Chairman of
the Board or other officer presiding at a meeting determines that other business
was not properly brought before such meeting in accordance with the Business
Procedure, such business will not be conducted at such meeting. The Nomination
Procedure requires that a shareholder give prior written notice, in proper form,
of a planned nomination for the Board of Directors. The requirements as to the
form and

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timing of that notice are specified in the Amended Bylaws. If the Chairman of
the Board determines that a person was not nominated in accordance with the
Nomination Procedure, such person will not be eligible for election as a
director. Although the Amended Bylaws do not give the Board of Directors any
power to approve or disapprove shareholder nominations for the election of
directors or of any other business desired by shareholders to be conducted at an
annual or any other meeting, the Amended Bylaws (i) may have the effect of
precluding a nomination for the election of directors or precluding the conduct
of business at a particular annual meeting if the proper procedures are not
followed or (ii) may discourage or deter a third party from conducting a
solicitation of proxies to elect its own slate of directors or otherwise
attempting to obtain control of the Company and its shareholders. The Company's
procedures with respect to all shareholder proposals and the nomination of
directors will be conducted in accordance with Section 14 of the Securities
Exchange Act of 1934, as amended, and the rules promulgated thereunder.

Preferred Stock. As described above, the Board of Directors will be
authorized to provide for the issuance of shares of Preferred Stock, in one or
more series, and to fix by resolution of the Board of Directors and to the
extent permitted by the Business Corporation Act, the terms and conditions of
each such series. The Company believes that the availability of the Preferred
Stock issuable in series will provide it with increased flexibility in
structuring possible future financings and acquisitions and in meeting other
corporate needs which might arise. Although the Board of Directors has no
present intention of doing so, it could issue a series of Preferred Stock that
could, depending on its terms, either impede or facilitate the completion of a
merger, tender offer of other takeover attempt.

Certain Amendments. The Amended Articles of Incorporation and Amended
Bylaws contain provisions requiring the affirmative vote of the holders of at
least 66 2/3% of the Voting Stock to amend certain provisions of the Amended
Articles of Incorporation and Amended Bylaws, including the provisions relating
to the election, quorum, term, classification of directors, the indemnification
of officers and directors and the calling of special meetings.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is First Union.

SHARES ELIGIBLE FOR FUTURE SALE

The sale of a substantial number of shares of Common Stock, or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Common Stock. In addition, any such sale or perception could make
it more difficult for the Company to sell equity securities or equity related
securities in the future at a time and price that the Company deems appropriate.
Upon consummation of the Offering, the Company will have a total of 10,775,555
shares of Common Stock outstanding, of which the 5,000,000 shares of Common
Stock sold in the Offering, the 300,000 shares of Common Stock to be issued in
connection with the Preferred National Acquisition which are being registered
pursuant to the Registration Statement of which this Prospectus forms a part and
an additional 2,590,601 shares currently outstanding will be eligible for
immediate sale in the public market without restriction, unless they are held by
'affiliates' of the Company within the meaning of Rule 144 under the Securities
Act, and of which 2,884,954 shares will be 'restricted' securities within the
meaning of Rule 144 under the Securities Act. Additionally, the Company has
granted options to certain directors and officers of the Company to purchase an
aggregate of 450,000 shares of Common Stock and there are currently warrants
exercisable into 1,125,826 shares of Common Stock, including the Preferred
National Warrants but excluding certain price adjustment warrants. Certain
officers, directors, major shareholders and the entities who will receive the
300,000 shares of Common Stock to be issued in connection with the Preferred
National Acquisition, who hold an aggregate of 5,444,326 shares of Common Stock
and such options and warrants to purchase 1,012,493 shares of Common Stock, have
agreed that they will not without the prior written consent of DLJ directly or
indirectly offer, sell, contract to sell, grant any option to purchase or
otherwise dispose of any shares of Common Stock or any other equity security of
the Company, or any securities convertible into or exercisable or exchangeable
for, or warrants, options or rights to purchase or acquire, Common Stock or any
other equity security of the Company, or enter into any agreement to do any of
the foregoing, for a period of 180 days from the date of this Prospectus. As a
result of the foregoing, 6,456,819 shares of Common Stock will become eligible
for resale following such 180 day period, subject to such additional
restrictions to the extent

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applicable and subject to Rule 144. See 'Principal and Selling Shareholders,'
'Description of Capital Stock' and 'Underwriting.'

In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of restricted shares from the Company
or any 'affiliate' of the Company, as that term is defined under the Securities
Act, the acquiror or subsequent holder thereof is entitled to sell within any
three-month period a number of shares that does not exceed the greater of 1.0%
of the then outstanding Common Stock or the average weekly trading volume of the
Common Stock during the four calendar weeks preceding the date on which notice
of the sale is filed with the Commission. Sales under Rule 144 also are subject
to certain manner of sale provisions, notice requirements and the availability
of current public information about the Company. If two years have elapsed since
the date of acquisition of restricted shares from the Company or from any
'affiliate' of the Company, and the acquiror or subsequent holder thereof is
deemed not to have been an 'affiliate' of the Company at any time during the
three months preceding a sale, such person would be entitled to sell such shares
in the public market under Rule 144(k) without regard to the volume limitations,
manner of sale provisions, public information requirements or notice
requirements.

No prediction can be made as to the effect, if any, that future sales of
shares, or the availability of shares for future sale, will have on the market
price prevailing from time to time. Sales of substantial amounts of Common
Stock, or the perception that such sales could occur, may affect adversely
prevailing market prices of the Common Stock.

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

The following is a general discussion of certain United States federal
income and estate tax consequences of the purchase, ownership and dispositon of
Common Stock by a Non-U.S. Holder. As used herein the term 'Non-U.S. Holder'
means any person or entity that is not a United States Holder ('U.S. Holder'). A
U.S. Holder is any beneficial owner of Common Stock that is (i) a citizen or
resident of the United States, (ii) a corporation or partnership created or
organized in or under the laws of the United States or any political subdivision
thereof, (iii) an estate the income of which is subject to U.S. federal income
taxation regardless of its source and (iv) a trust which is subject to the
supervision of a court within the United States and the control of a United
States person as described in section 7701(a)(30) of the Internal Revenue Code
of 1986, as amended (the 'Code'). This discussion does not address all aspects
of United States federal income and estate taxes and does not deal with foreign,
state and local consequences that may be relevant to such Non-U.S. Holders in
light of their personal circumstances. Furthermore, this discussion is based on
provisions of the Code, existing and proposed regulations promulgated thereunder
and administrative and judicial interpretations thereof, as of the date hereof,
all of which are subject to change. EACH PROSPECTIVE PURCHASER OF COMMON STOCK
IS ADVISED TO CONSULT A TAX ADVISOR WITH RESPECT TO CURRENT AND POSSIBLE FUTURE
TAX CONSEQUENCES OF ACQUIRING, HOLDING AND DISPOSING OF COMMON STOCK AS WELL AS
ANY TAX CONSEQUENCES THAT MAY ARISE UNDER THE LAWS OF ANY U.S. STATE,
MUNICIPALITY OR OTHER TAXING JURISDICTION.

DIVIDENDS

Dividends paid to a Non-U.S. Holder of Common Stock generally will be
subject to withholding of United States federal income tax at a 30% rate or such
lower rate as may be specified by an applicable income tax treaty. However,
dividends that are effectively connected with the conduct of a trade or business
by the Non-U.S. Holder within the United States and, where a tax treaty applies,
are attributable to a United States permanent establishment of the Non-U.S.
Holder, are not subject to the withholding tax, but instead are subject to
United States federal income tax on a net income basis at applicable graduated
individual or corporate rates. Certain certification and disclosure requirements
must be complied with in order to be exempt from withholding under such
effectively connected income exemption. Any such effectively connected dividends
received by a foreign corporation may, under certain cicumstances, be subject to
an additional 'branch profits tax' at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty.

Under current law, dividends paid to an address outside the United States
are presumed to be paid to a resident of such country (unless the payer has
knowledge to the contrary) for purposes of the withholding tax discussed above
and, under the current interpretation of United States Treasury regulations, for
purposes of determining the applicability of a tax treaty rate. Under recently
finalized United States Treasury regulations (the 'Final Regulations'), a
Non-U.S. Holder of Common Stock who wishes to claim the benefit of an applicable
treaty rate (and avoid back-up withholding as discussed below) for dividends
paid after December 31, 1999, will be required to satisfy applicable
certification and other requirements.

A Non-U.S. Holder of Common Stock eligible for a reduced rate of United
States withhholding tax pursuant to an income tax treaty may obtain a refund of
any excess amounts withheld by filing an appropriate claim for refund with the
Internal Revenue Service (the 'IRS').

GAIN ON DISPOSITION OF COMMON STOCK

A Non-U.S. Holder generally will not be subject to United States federal
income tax with respect to gain recognized on a sale or other disposition of
Common Stock unless (i) the gain is effectively connected with a trade or
business of the Non-U.S. Holder in the United States, and, where a tax treaty
applies, is attributable to a United States permanent establishment of the
Non-U.S. Holder (ii) in the case of a Non-U.S. Holder who is an individual and
holds the Common Stock as a capital asset, such holder is present in the United
States for 183 or more days in the taxable year of the sale or other disposition
and certain other conditions are met, or (iii) the Company is or has been a
'U.S. real property holding corporation' for United States federal income tax
purposes.

An individual Non-U.S. Holder described in clause (i) above will be subject
to tax on the net gain derived from the sale under graduated United States
federal income tax rates. An individual Non-U.S. Holder described

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in clause (ii) above will be subject to a flat 30% tax on the gain derived from
the sale, which may be offset by United States source capital losses (even
though the individual is not considered a resident of the United States). If a
Non-U.S. Holder that is a foreign corporation falls under clause (i) above, it
will be subject to tax on its gain under regular graduated United States federal
income tax rates and, in addition, may be subject to the branch profits tax
equal to 30% of its effectively connected earnings and profits within the
meaning of the Code for the taxable year, as adjusted for certain items, unless
it qualifies for a lower rate under an applicable income tax treaty.

The Company is not and does not anticipate becoming a 'U.S. real property
holding corporation' for United States federal income tax purposes. If the
Company is or becomes a U.S. real property holding corporation, so long as the
Common Stock continues to be regularly traded on an established securities
market, only a Non-U.S. Holder who holds or held (at any time during the shorter
of the five year period preceding the date of disposition or the holder's
holding period) more than five percent of the Common Stock will be subject to
U.S. federal income tax on the disposition of the Common Stock.

Special Rules may apply to certain Non-U.S. Holders, such as 'controlled
foreign corporations', 'passive foreign investment companies' and 'foreign
personal holding companies', that are subject to special treatment under the
Code. Such entities should consult their own tax advisors to determine the U.S.
federal, state, local and other tax consequences that may be relevant to them.

FEDERAL ESTATE TAX

Common Stock held by an individual Non-U.S. Holder at the time of death
will be included in such holder's gross estate for United States federal estate
tax purposes, unless an applicable estate tax treaty provides otherwise.

INFORMATION REPORTING AND BACKUP WITHHOLDING

The Company must report annually to the IRS and to each Non-U.S. Holder the
amount of dividends paid to such holder and the tax withheld with respect to
such dividends, regardless of whether withholding was required. Copies of the
information returns reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the Non-U.S. Holder
resides under the provisions of an applicable income tax treaty.

Under current law, backup withholding at the rate of 31% generally will not
apply to dividends paid to a Non-U.S. Holder at an address outside the United
States (unless the payer has knowledge that the payee is a U.S. person). Under
the Final Regulations, however, a Non-U.S. Holder will be subject to backup
withholding unless applicable certification requirements are met.

Payment of the proceeds of a sale of Common Stock within the United States
or conducted through certain U.S. related financial intermediaries is subject to
both backup withholding and information reporting unless the beneficial owner
certifies under penalties of perjury that it is a Non-U.S. Holder (and the payor
does not have actual knowledge that the beneficial owner is a United States
person) or the holder otherwise establishes an exemption.

Any amounts withheld under the backup withholding rules may be allowed as a
refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the IRS.

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UNDERWRITING

Subject to the terms and conditions contained in an Underwriting Agreement
dated , 1998 (the 'Underwriting Agreement'), the Underwriters
named below, who are represented by DLJ, BT Alex. Brown Incorporated and Wheat
First Securities, Inc. (the 'Representatives'), have severally agreed to
purchase from the Company and the Selling Shareholders the respective number of
shares of Common Stock set forth opposite their names below.

<TABLE>
<CAPTION>
NUMBER OF
THE UNDERWRITERS SHARES
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation........................................
BT Alex. Brown Incorporated................................................................
Wheat First Securities, Inc................................................................
---------
---------
Total.................................................................................
</TABLE>

The Underwriting Agreement provides that the obligations of the several
Underwriters to pay for and accept delivery of the shares of Common Stock
offered hereby are subject to approval of certain legal matters by their counsel
and to certain other conditions. The Underwriters are obligated to purchase and
accept delivery of all the shares of Common Stock offered hereby (other than
those covered by the over-allotment option described below) if any are
purchased.

The Underwriters initially propose to offer the shares of Common Stock in
part directly to the public at the initial public offering price set forth in
the cover page of this Prospectus and in part to certain dealers (including the
Underwriters) at such price less a concession not in excess of $ per
share. The Underwriters may allow, and such dealers may re-allow, to certain
other dealers, a concession not in excess of $ per share. After the
initial offering of the Common Stock, the offering price and other selling terms
may be changed by the Representatives at any time without notice. The
Underwriters do not intend to confirm sales to any accounts over which they
exercise discretionary authority.

The Company and the Selling Shareholders have granted to the Underwriters
an option, exercisable within 30 days after the date of this Prospectus, to
purchase, from time to time, in whole or in part, up to an aggregate of 750,000
additional shares of Common Stock at the initial public offering price less
underwriting discounts and commissions. The Underwriters may exercise such
option solely to cover over-allotments, if any, made in connection with the
Offering. To the extent that the Underwriters exercise such option, each
Underwriter will become obligated, subject to certain conditions, to purchase
its pro rata portion of such additional shares based on such Underwriter's
percentage underwriting commitment as indicated in the preceding table.

The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, or to contribute to payments that the Underwriters may be
required to make in respect thereof.

Each of the Company, its executive officers and directors and certain
shareholders of the Company (including the Selling Shareholders) has agreed,
subject to certain exceptions, not to (i) offer, pledge, sell, contract to sell,
sell any option or contract to purchase, purchase any option or contract to
sell, grant any option, right or warrant to purchase or otherwise transfer or
dispose of, directly or indirectly, any shares of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock or (ii) enter
into any swap or other arrangement that transfers all or a portion of the
economic consequences associated with the ownership of any Common Stock
(regardless of whether any of the transactions described in clause (i) or (ii)
is to be settled by the delivery of Common Stock, or such other securities, in
cash or otherwise) for a period of 180 days after the date of this Prospectus
without the prior written consent of DLJ. Notwithstanding the foregoing, during
such period (i) the Company may grant stock options pursuant to the Company's
existing stock option plan and (ii) the Company may issue shares of Common Stock
upon the exercise of an option or warrant

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or the conversion of a security outstanding on the date hereof. In addition,
during such period, the Company has also agreed not to file any registration
statement with respect to, and each of its executive officers and directors and
certain stockholders of the Company (including the Selling Shareholders) has
agreed not to make any demand for, or exercise any right with respect to, the
registration of any shares of Common Stock or any securities convertible into or
exercisable or exchangeable for Common Stock without DLJ's prior written
consent.

Prior to the Offering there has been no public market for any of the
Company's securities. Accordingly, the offering price of the Common Stock was
determined by negotiation between the Company and the Representatives. Factors
considered in determining such price, in addition to prevailing market
conditions, included the history of and the prospects for the Company and the
industry in which the Company competes, an assessment of the Company's
management, the Company's capital structure and such other factors as were
deemed relevant.

An affiliate of Wheat First Securities, Inc. is the agent and a lender
under the Term Loan, which is being paid off with the proceeds of the Offering,
and has issued a commitment letter for the Credit Facility.

Therefore, the Offering is being conducted in accordance with Rule
2710(c)(8) of the Conduct Rules of the National Association of Securities
Dealers, Inc. (the 'NASD') which provides that, among other things, when a NASD
member, such as Wheat First Securities, Inc., participates in the underwriting
of securities of a company where a NASD member or an affiliate of a NASD member
is receiving more than 10% of the proceeds of the offering, the initial public
offering price can be no higher than that recommended by a 'qualified
independent underwriter' meeting certain standards. In accordance with this
requirement, DLJ is serving in such role and will recommend a price in
compliance with the requirements of Rule 2720(c)(3) of such Conduct Rules. In
connection with the Offering, DLJ in its role as qualified independent
underwriter has performed due diligence investigations and reviewed and
participated in the preparation of this Prospectus and the Registration
Statement of which this Prospectus forms a part.

Application has been made to list the Common Stock on Nasdaq under the
symbol 'FRYL.' There can be no assurance that such listing application will be
approved.

Other than in the United States, no action has been taken by the Company,
the Selling Shareholders or the Underwriters that would permit a public offering
of the shares of Common Stock offered hereby in any jurisdiction where action
for that purpose is required. The shares of Common Stock offered hereby may not
be offered or sold, directly or indirectly, nor may this Prospectus or any other
offering material or advertisements in connection with the offer and sale of any
such shares of Common Stock be distributed or published in any jurisdiction,
except under circumstances that will result in compliance with the applicable
rules and regulations of such jurisdiction. Persons into whose possession this
Prospectus comes are advised to inform themselves about and to observe any
restrictions relating to the Offering of the Common Stock and the distribution
of this Prospectus. This Prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any shares of Common Stock offered hereby in any
jurisdiction in which such an offer or a solicitation is unlawful.

In connection with the Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock. Specifically, the Underwriters may overallot the Offering,
creating a syndicate short position. The Underwriters may bid for and purchase
shares of Common Stock in the open market to cover such syndicate short position
or to stabilize the price of the Common Stock. In addition, the underwriting
syndicate may reclaim selling concessions from syndicate members and selected
dealers if they repurchase previously distributed Common Stock in syndicate
covering transactions, in stabilizing transactions or otherwise. These
activities may stabilize or maintain the market price of the Common Stock above
independent market levels. The Underwriters are not required to engage in these
activities, and may end any of these activities at any time.

DLJ will set aside up to 5.0% of the shares of the Offering for sale to
officers and directors of the Company and others.

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LEGAL MATTERS

Certain legal matters will be passed upon for the Company by Robinson
Silverman Pearce Aronsohn & Berman LLP, New York, New York, and for the
Underwriters by Simpson Thacher & Bartlett, New York, New York. Robinson
Silverman Pearce Aronsohn & Berman LLP and Simpson Thacher & Bartlett may rely
as to matters of North Carolina law on the opinion of Brooks Pierce McLendon
Murphy & Leonard, Greensboro, North Carolina.

Herbert Teitelbaum, who is a member of Robinson Silverman Pearce Aronsohn &
Berman LLP, beneficially owns 12,000 shares of Common Stock and warrants which
are exercisable into an additional 5,942 shares of Common Stock. Mr.
Teitelbaum's wife owns 43,108 shares of Common Stock, as to all of which shares
Mr. Teitelbaum disclaims beneficial ownership.

EXPERTS

The consolidated financial statements and schedules of Front Royal and
subsidiaries and the consolidated statements of operations and cash flows of
Rockwood and subsidiaries appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, to the
extent indicated in their reports thereon also appearing elsewhere herein and in
the Registration Statement. Such consolidated financial statements have been
included herein in reliance upon such reports given upon the authority of such
firm as experts in auditing and accounting.

The combined financial statements of Preferred National Insurance Company
and Affiliates as of December 31, 1997 and for the year then ended included in
this Prospectus and Registration Statement have been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report appearing herein,
and are included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.

The consolidated financial statements of Rockwood and subsidiaries at
December 31, 1995 and 1994 and for the years then ended appearing in this
Prospectus and Registration Statement have been audited by Parente, Randolph,
Orlando, Carey & Associates, independent auditors, as set forth in their report
thereon appearing elsewhere herein, and are included in reliance upon such
report given upon the authority of such firm as experts in auditing and
accounting.

90
<PAGE>
GLOSSARY OF SELECTED INSURANCE TERMS

Except as otherwise specified or as the context may otherwise require, the
following terms used herein shall have the meanings assigned to them below. All
terms in the singular shall have the same meanings when used in the plural and
vice versa.

<TABLE>
<S> <C>
Accident year........................ The annual accounting period in which loss events occurred, regardless of
when the losses are actually reported, booked or paid.

Actuary or Actuarial firm............ A person or firm which conducts various statistical studies used to
evaluate risks, the adequacy of premium charged therefor and the adequacy
of provisions made for losses and loss expenses.

Admitted insurer..................... An insurer that has received a license or certificate of authority from a
state regulatory authority to transact an insurance business in that
state.

A.M. Best............................ A.M. Best Company, Inc., a rating agency and publisher for the insurance
industry.

Binding authority.................... The authority given to an agent to bind an insurance company to an
insurance policy within prescribed parameters.

Case reserves........................ Loss reserves established with respect to individual reported claims.

Cede; Ceding company................. When a company reinsures its risk with another, it 'cedes' business and is
referred to as the 'ceding company.'

Claims-made basis.................... A form of insurance that provides coverage for claims made (reported or
filed) during the year the policy is in force for any incidents which
occur during that year or during any previous period in which the
policyholder was insured under the 'claims-made' contract. This form of
coverage is in contrast to the occurrence policy which covers losses from
claims which occurred during the policy period, regardless of when the
claims are asserted.

Combined ratio....................... A combination of the underwriting expense ratio and the loss and LAE
ratio, determined in accordance with either SAP or GAAP. The underwriting
expense ratio measures the ratio of underwriting expenses to net written
premiums, if determined in accordance with SAP, or the ratio of
underwriting expenses (adjusted by deferred policy acquisition costs) to
net earned premiums if determined in accordance with GAAP. The loss and
LAE ratio measures the ratio of incurred losses and LAE to net earned
premiums, determined in accordance with either SAP or GAAP. A combined
ratio on a GAAP or SAP basis below 100.0% generally indicates profitable
underwriting prior to the consideration of investment income. A combined
ratio on a GAAP or SAP basis over 100.0% generally indicates unprofitable
underwriting prior to the consideration of investment income.

Commission........................... The fee paid to an agent or a broker for placing insurance which is
generally a percentage of the premium.

Deferred policy acquisition costs.... The costs that vary with and are primarily related to the acquisition of
new and renewal insurance policies including commissions and certain other
underwriting expenses. These costs are capitalized and charged to expense
in proportion to premium revenue earned.

Dividend ratio....................... The ratio of 'dividends to policyholders' to net earned premiums,
expressed as a percentage.
</TABLE>

91
<PAGE>
<TABLE>
<S> <C>
Excess and surplus lines ('E&S')..... Lines of insurance which are generally unavailable from admitted insurers
and which, consequently, are placed by surplus lines agents or brokers
with insurers that are not admitted in the subject jurisdiction.

Expense ratio........................ Under SAP, the ratio of underwriting expenses to net written premiums. On
a GAAP basis, the ratio of underwriting expenses (excluding interest
expense) to net earned premiums.

Fronting............................. Procedure under which the ceding company cedes the risk it has
underwritten to its reinsurer with the ceding company retaining none or a
very small portion of that risk for its own account.

Generally accepted accounting
principles ('GAAP')................ United States generally accepted accounting principles as promulgated by
the American Institute of Certified Public Accountants and the Financial
Accounting Standards Board.

Gross written premiums............... Direct written premiums plus reinsurance assumed written premiums during a
given period.

Hard market.......................... The portion of the market cycle of the property and casualty insurance
industry characterized by constricted industry capital and underwriting
capacity, increasing premium rates and, typically, enhanced underwriting
performance.

Incurred but not yet reported
('IBNR') reserves.................. Loss reserves for estimated losses which have been incurred but not yet
reported to the insurer.

Incurred losses...................... The total losses sustained by an insurance company under a policy or
policies, whether paid or unpaid. Incurred losses include a provision for
claims that have occurred but have not yet been reported to the insurer.

Inland marine insurance.............. Coverage for property damage or destruction of an insured's property and
liability expense of an insured for damage or destruction of someone
else's property under his/her care, custody or control.

Loss ratio........................... The ratio of the sum of incurred losses and loss adjustment expenses to
net premiums earned based on consolidated financial information prepared
in accordance with GAAP or SAP. Unless otherwise indicated, loss ratio
refers to calendar year loss ratio.

Loss adjustment expenses ('LAE')..... The expenses of settling claims, including legal and other fees, and the
portion of general expenses allocated to claim settlement costs.

Loss and LAE reserves................ Liabilities established by insurers to reflect the estimated cost of
claims payments that the insurer will ultimately be required to pay in
respect of insurance it has written. Reserves are established for losses
and for LAE, and consist of case reserves and IBNR reserves.

Loss development..................... Increases or decreases in losses and LAE greater than or less than
anticipated loss and LAE experience over a given period of time.

National Association of Insurance
Commissioners ('NAIC')............. A voluntary organization of state insurance officials that promulgates
model laws regulating the insurance industry, values securities owned by
insurers, develops and modifies insurer financial reporting statements and
insurer performance criteria and performs other services with respect to
the insurance industry.
</TABLE>

92
<PAGE>
<TABLE>
<S> <C>
Net earned premiums.................. The portion of net written premiums that is recognized for accounting
purposes as income during a period.

Net written premiums................. Gross written premiums for a given period less premiums ceded to
reinsurers during such period.

Occurrence basis..................... Coverage, in liability insurance, for harm suffered by others because of
events occurring while a policy is in force, regardless of when a claim is
actually made.

Policy acquisition costs............. The expense incurred associated with the placing of insurance business and
the issuance of the policy.

Policyholders' (or Statutory)
surplus............................ Total admitted assets less total liabilities, as determined in accordance
with statutory accounting practices.

Premiums earned...................... The amount of net premiums allocable to the expired period of an insurance
policy or policies.

Primary insurer...................... An insurance company that issues insurance policies to the public
generally or to certain non-insurance entities.

Property damage liability insurance.. Coverage in the event that the negligent acts or omissions of an insured
result in damage or destruction to another's property.

Quota share reinsurance.............. A type of reinsurance whereby the reinsurer, in return for a predetermined
portion or share of the insurance premium charged by the primary insurer,
indemnifies the primary insurer against a predetermined portion of the
losses and loss adjustment expenses of the primary insurer under the
covered primary policy or policies.

Reinsurance.......................... The practice whereby one party, called the reinsurer, in consideration of
a premium paid to it agrees to indemnify another party, called the
reinsured, for part or all of the liability assumed by the reinsured under
a policy or policies of insurance which it has issued. The reinsured may
be referred to as the original or primary insurer, the direct writing
company, or the ceding company.

Reinsurers........................... Insurers (known as the reinsurer or assuming company) who agree to
indemnify another insurer (known as the reinsured or ceding company)
against all or part of a loss which the latter may incur under a policy or
policies it has issued.

Retention............................ The amount or portion of risk which an insurer or reinsurer retains or
assumes for its own account. Losses, or a portion thereof, in excess of
the retention level are paid by the reinsurer or a retrocessionaire. In
proportional treaties, the retention may be a percentage of the original
policy's limit. In excess of loss business, the retention is a dollar
amount of loss, a loss ratio or a percentage.

Retrocession; Retrocessionaire....... A transaction whereby a reinsurer cedes to another reinsurer (the
'retrocessionaire') all or part of the reinsurance it has assumed.
Retrocessions do not legally discharge the ceding reinsurer from its
liability with respect to its obligations to the reinsured.

Soft market.......................... The portion of the market cycle of the property and casualty insurance
industry characterized by heightened premium rate competition among
insurers, increased underwriting capacity and, typically, depressed
underwriting performance.
</TABLE>

93
<PAGE>
<TABLE>
<S> <C>
Statutory accounting practices
('SAP')............................ Those accounting principles and practices which provide the framework for
the preparation of insurance company financial statements, and the
recording of transactions, in accordance with the rules and procedures
adopted by regulatory authorities, generally emphasizing solvency
considerations rather than a going-concern concept of accounting. The
principal differences between SAP and GAAP are as follows: (a) under SAP,
certain assets (non-admitted assets) are eliminated from the balance
sheet; (b) under SAP, policy acquisition costs are expensed upon policy
inception, while under GAAP they are deferred and amortized over the terms
of the policies; (c) under SAP, no provision is made for deferred income
taxes; and (d) under SAP, certain reserves are recognized which are not
recognized under GAAP.

Statutory or policyholders'
surplus............................ The excess of admitted assets over total liabilities (including loss
reserves), determined in accordance with SAP.

Underwriting......................... The insurer's process of reviewing applications submitted for the
insurance coverage, deciding whether to accept all or part of the coverage
requested and determining the applicable premiums.

Underwriting expenses................ The aggregate of policy acquisition costs, including commissions, and the
portion of administrative, general and other expenses attributable to
underwriting operations.

Underwriting profits; Underwriting
profitability...................... Refers to the profits or profitability of an insurance company's operation
prior to inclusion of investment income or loss and gains or losses from
sale of invested assets.

Unearned premiums.................... The portion of a premium representing the unexpired portion of the
contract term as of a certain date.

Wholesale general agent.............. Agents (also known as wholesale agents) used by excess and surplus lines
and specialty admitted insurance carriers to write their insurance
products. The general agents' clients are retail insurance brokers who
deal directly with the insureds.
</TABLE>

94
<PAGE>
INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
<S> <C>
FRONT ROYAL, INC. AND SUBSIDIARIES
Report of Independent Auditors............................................................................ F-2
Consolidated Balance Sheets at December 31, 1997 and 1996................................................. F-3
Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995.................... F-4
Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Common Shareholders'
Equity for the years ended December 31, 1997, 1996 and 1995............................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995................ F-6
Notes to Consolidated Financial Statements................................................................ F-7
Condensed Consolidated (Unaudited) Balance Sheets at March 31, 1998 and December 31, 1997................. F-28
Condensed Consolidated (Unaudited) Statements of Income for the three months ended
March 31, 1998 and 1997................................................................................. F-30
Condensed Consolidated (Unaudited) Statements of Changes in Redeemable Convertible Preferred Stock and
Common Shareholders' Equity for the three months ended March 31, 1998 and 1997.......................... F-31
Condensed Consolidated (Unaudited) Statements of Cash Flows for the three months ended
March 31, 1998 and 1997................................................................................. F-32
Notes to Condensed Consolidated (Unaudited) Financial Statements.......................................... F-33

PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
Report of Independent Auditors............................................................................ F-35
Combined Balance Sheet at December 31, 1997............................................................... F-36
Combined Statement of Operations for the year ended December 31, 1997..................................... F-37
Combined Statement of Changes in Stockholders' Equity for the year ended December 31, 1997................ F-38
Combined Statement of Cash Flows for the year ended December 31, 1997..................................... F-39
Notes to Combined Financial Statements.................................................................... F-40
Combined (Unaudited) Balance Sheet at March 31, 1998...................................................... F-49
Combined (Unaudited) Statement of Operations for the three months ended March 31, 1998.................... F-50
Combined (Unaudited) Statement of Changes in Stockholders' Equity for the three months ended
March 31, 1998.......................................................................................... F-51
Combined (Unaudited) Statement of Cash Flows for the three months ended March 31, 1998.................... F-52
Notes to Combined (Unaudited) Financial Statements........................................................ F-53

ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
Report of Independent Auditors............................................................................ F-55
Consolidated Statement of Operations for the year ended December 31, 1996................................. F-56
Consolidated Statement of Cash Flows for the year ended December 31, 1996................................. F-57
Notes to Consolidated Statements of Operations and Cash Flow.............................................. F-58
Report of Independent Auditors............................................................................ F-66
Consolidated Balance Sheets at December 31, 1995 and 1994................................................. F-67
Consolidated Statements of Operations for the years ended December 31, 1995 and 1994...................... F-68
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995 and 1994............ F-69
Consolidated Statements of Cash Flows for the years ended December 31, 1995 and 1994...................... F-70
Notes to Consolidated Financial Statements................................................................ F-71
</TABLE>

F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
Front Royal, Inc.

We have audited the accompanying consolidated balance sheets of Front Royal,
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in redeemable preferred stock and
common shareholders' equity and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Front Royal, Inc.
and Subsidiaries at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.

/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP

Richmond, Virginia
February 20, 1998

F-2
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
AS OF DECEMBER 31
----------------------------
1997 1996
<S> <C> <C>
ASSETS
Investments:
Fixed maturity securities:
Available-for-sale at fair value (amortized cost: 1997, $122,304,263; 1996,
$92,633,656).............................................................. $125,374,861 $ 94,461,765
Held-to-maturity at amortized cost (fair value: 1997, $111,403,288; 1996,
$125,371,347)............................................................. 109,536,621 125,371,347
Equity securities at fair value (cost: 1997, $16,635,621; 1996, $8,665,191).... 18,601,221 8,973,330
Short-term investments......................................................... 24,208,843 15,332,716
------------ ------------
Total investments...................................................... 277,721,546 244,139,158
Cash............................................................................. 2,907,311 9,415,787
Accrued investment income........................................................ 3,304,784 2,792,792
Reinsurance recoverable on unpaid loss and loss adjustment expenses.............. 22,543,301 25,735,843
Reinsurance recoverable on paid loss and loss adjustment expenses................ 1,917,547 1,019,055
Prepaid reinsurance premiums..................................................... 2,777,992 4,606,223
Premiums receivable and agents' balances......................................... 16,657,272 19,893,003
Deferred federal income tax...................................................... 9,173,818 9,099,427
Deferred policy acquisition costs................................................ 8,775,710 9,138,342
Intangible assets, net........................................................... 5,812,352 6,166,542
Other assets..................................................................... 4,723,136 7,980,475
------------ ------------
Total assets........................................................... $356,314,769 $339,986,647
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses................................ $195,330,919 $188,075,278
Unearned premiums.............................................................. 36,007,585 40,328,234
Accrued expenses............................................................... 7,388,830 6,783,442
Accrued policyholders' dividends............................................... 6,054,289 6,341,095
Accrued preferred stock dividend............................................... 1,085,000 --
Other liabilities.............................................................. 13,140,717 11,804,826
------------ ------------
259,007,340 253,332,875
------------ ------------
Senior bank debt............................................................... 36,545,430 38,000,000
------------ ------------
Total liabilities...................................................... 295,552,770 291,332,875
------------ ------------
Commitments and contingent liabilities
Series A Redeemable Convertible Preferred Stock, no par value, 155,000 shares
authorized and 155,000 shares issued and outstanding in 1997 and 1996.......... 15,500,000 15,500,000
Common shareholders' equity:
Common Stock--Class A, no par value, 20,000,000 shares authorized and 5,859,144
and 5,442,030 shares issued and outstanding in 1997 and 1996,
respectively................................................................ 13,739,979 13,402,208
Common Stock--Class B, no par value, 700,000 shares authorized and 268,482 and
272,895 shares issued and outstanding in 1997 and 1996, respectively........ 557,348 575,000
Common Stock--Class C, no par value, liquidation preference value of $4.00 per
share, 3,500,000 and 3,200,000 shares authorized and 3,248,300 and 3,175,000
shares issued and outstanding in 1997 and 1996, respectively................ 12,993,200 12,700,000
------------ ------------
27,290,527 26,677,208
Unrealized gains on available-for-sale securities.............................. 3,323,891 2,136,248
Notes receivable from officers................................................. (166,386) (200,000)
Retained earnings.............................................................. 14,813,967 4,540,316
------------ ------------
Total common shareholders' equity...................................... 45,261,999 33,153,772
------------ ------------
60,761,999 48,653,772
------------ ------------
Total liabilities, redeemable convertible preferred stock and common
shareholders' equity................................................. $356,314,769 $339,986,647
------------ ------------
------------ ------------
</TABLE>

F-3
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Revenues:
Net premiums earned.............................................. $ 90,523,053 $42,115,460 $36,537,388
Net investment income............................................ 17,983,571 5,867,009 5,449,126
Net realized gains/(losses) on investments....................... (479,853) (1,175) 837,619
Other income..................................................... 331,105 630,792 725,778
------------ ----------- -----------
Total revenues........................................... 108,357,876 48,612,086 43,549,911
------------ ----------- -----------
Losses and expenses:
Net losses and loss adjustment expenses.......................... 56,195,994 26,110,279 22,565,776
Policy acquisition costs amortized............................... 25,828,874 12,728,649 11,132,274
Other underwriting expenses...................................... 3,470,821 2,073,558 2,076,439
Dividends to policyholders....................................... 3,602,923 -- --
Interest expense................................................. 3,883,121 2,029,066 1,644,792
Other operating costs and expenses............................... 1,806,048 538,868 1,314,436
------------ ----------- -----------
Total losses and expenses................................ 94,787,781 43,480,420 38,733,717
------------ ----------- -----------
Income before federal income taxes................................. 13,570,095 5,131,666 4,816,194
Federal income tax expense/(benefit):
Current.......................................................... 3,998,141 1,631,279 931,328
Deferred......................................................... (1,786,697) (1,010,535) 332,672
------------ ----------- -----------
Total federal income tax expense/(benefit)............... 2,211,444 620,744 1,264,000
------------ ----------- -----------
Net income......................................................... 11,358,651 4,510,922 3,552,194
Dividends to preferred shareholders................................ 1,085,000 -- --
------------ ----------- -----------
Net income available to common shareholders........................ $ 10,273,651 $ 4,510,922 $ 3,552,194
------------ ----------- -----------
------------ ----------- -----------
Net income per share--basic........................................ $ 1.13 $ .79 $ .62
------------ ----------- -----------
------------ ----------- -----------
Net income per share--diluted...................................... $ .88 $ .70 $ .56
------------ ----------- -----------
------------ ----------- -----------
Weighted average common shares outstanding......................... 9,125,333 5,723,624 5,710,538
Weighted average common and common stock equivalent shares
outstanding...................................................... 12,861,010 6,446,434 6,396,126
</TABLE>

See accompanying notes.
F-4
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND COMMON SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
TOTAL
COMMON
COMMON SHAREHOLDERS' EQUITY SHAREHOLDERS'
----------------------------------------------------------------- EQUITY AND
REDEEMABLE RETAINED REDEEMABLE
CONVERTIBLE COMMON STOCK UNREALIZED EARNINGS/ CONVERTIBLE
PREFERRED ------------------------------------ GAINS/ (ACCUMULATED PREFERRED
STOCK CLASS A CLASS B CLASS C (LOSSES) DEFICIT) STOCK
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1994..................... $ -- $12,673,086 $575,000 $ -- $ (126,862) $(3,522,800 ) $ 9,598,424
Issuance of common
stock--conversion of
debt................... -- 129,122 -- -- -- -- 129,122
Net income............... -- -- -- -- -- 3,552,194 3,552,194
Net unrealized gains..... -- -- -- -- 4,129,388 -- 4,129,388
----------- ----------- -------- ----------- ----------- ------------ -------------
Balances at December 31,
1995..................... -- 12,802,208 575,000 -- 4,002,526 29,394 17,409,128
Issuance of common
stock.................. -- -- -- 12,700,000 -- -- 12,700,000
Issuance of preferred
stock.................. 15,500,000 -- -- -- -- -- 15,500,000
Issuance of discounted
warrants............... -- 600,000 -- -- -- -- 600,000
Notes receivable from
stock sales............ -- -- -- (200,000) -- -- (200,000)
Net income............... -- -- -- -- -- 4,510,922 4,510,922
Net unrealized losses.... -- -- -- -- (1,866,278) -- (1,866,278)
----------- ----------- -------- ----------- ----------- ------------ -------------
Balances at December 31,
1996..................... 15,500,000 13,402,208 575,000 12,500,000 2,136,248 4,540,316 48,653,772
Exercise of warrants..... -- 365,939 -- -- -- -- 365,939
Repurchase of common
stock.................. -- (28,168) (17,652) -- -- -- (45,820)
Payments on notes
receivable from stock
sales.................. -- -- -- 33,614 -- -- 33,614
Issuance of common
stock.................. -- -- -- 293,200 -- -- 293,200
Net income............... -- -- -- -- -- 11,358,651 11,358,651
Net unrealized gains..... -- -- -- -- 1,187,643 -- 1,187,643
Accrual of preferred
dividend............... -- -- -- -- -- (1,085,000 ) (1,085,000)
----------- ----------- -------- ----------- ----------- ------------ -------------
Balances at December 31,
1997..................... $15,500,000 $13,739,979 $557,348 $12,826,814 $ 3,323,891 $14,813,967 $60,761,999
----------- ----------- -------- ----------- ----------- ------------ -------------
----------- ----------- -------- ----------- ----------- ------------ -------------
</TABLE>

See accompanying notes.

F-5
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Operating activities:
Net income.................................................... $ 11,358,651 $ 4,510,922 $ 3,552,194
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of policy acquisition costs................... 25,828,874 12,728,649 11,132,274
Policy acquisition costs deferred.......................... (25,466,241) (13,049,489) (11,491,247)
Net realized (gains)/losses on sale of investments......... 479,853 1,175 (837,619)
Provision for depreciation and amortization................ (908,926) (267,082) (385,661)
Non-cash interest expense.................................. 1,308,689 518,041 231,142
Amortization of goodwill................................... (15,403) (438,637) (445,280)
Deferred income taxes...................................... (1,786,697) (1,010,535) 332,672
Change in operating assets and liabilities:
Unearned premiums........................................ (4,320,649) 1,778,989 1,295,008
Accrued investment income................................ (511,992) 129,315 (177,003)
Reserve for losses and loss adjustment expenses.......... 7,255,641 4,037,638 3,129,355
Reinsurance recoverable and payable...................... 3,512,073 87,720 774,385
Federal income tax payable............................... (147,682) 715,779 101,328
Receivables, payables and accrued expenses............... 6,233,157 (336,315) 750,277
Other.................................................... 2,318,874 (2,014,457) (997,691)
------------- ------------ ------------
Net cash provided by operating activities....................... 25,138,222 7,391,713 6,964,134
------------- ------------ ------------

Investing activities:
Securities available-for-sale:
Purchases--fixed maturities and equities................... (102,292,973) (32,282,424) (67,813,823)
Sales-fixed maturities and equities........................ 64,571,879 16,002,594 58,650,355
Maturities and calls--fixed maturities..................... 500,000 4,425,000 5,320,000
Securities held-to-maturity:
Purchases--fixed maturities................................ (10,489,067) -- --
Maturities and calls--fixed maturities..................... 26,714,776 -- --
Net (purchases)/sales of short-term investments............ (9,810,062) 6,799,509 (4,444,779)
Acquisitions, net of cash acquired......................... -- (29,343,718) --
------------- ------------ ------------
Net cash used in investing activities........................... (30,805,447) (34,399,039) (8,288,247)
------------- ------------ ------------

Financing activities:
Proceeds from bank borrowings and other debt issuances, net of
issuance cost.............................................. -- 37,307,050 74,568
Proceeds from issuance of common stock........................ 613,319 12,700,000 --
Retirement of debt............................................ (1,454,570) (14,067,068) (62,500)
------------- ------------ ------------
Net cash provided by/(used in) financing activities............. (841,251) 35,939,982 12,068
------------- ------------ ------------
Increase/(decrease) in cash..................................... (6,508,476) 8,932,656 (1,312,045)
Cash at beginning of year....................................... 9,415,787 483,131 1,795,176
------------- ------------ ------------
Cash at end of year............................................. $ 2,907,311 $ 9,415,787 $ 483,131
------------- ------------ ------------
------------- ------------ ------------
</TABLE>

See accompanying notes.

F-6
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997

1. ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles and include the
accounts and operations of Front Royal, Inc. and its wholly-owned subsidiaries,
Colony Insurance Company ('Colony'), Rockwood Casualty Insurance Company
('Rockwood Casualty'), Colony Management Services, Inc. and Front Royal
Environmental Insurance Management, Inc. ('FREIM').

Significant intercompany accounts and transactions have been eliminated.
The accounts of the acquired subsidiaries are included in the consolidated
financial statements from the dates of acquisition. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Such estimates and assumptions may
be subject to change in the future as more information becomes known which could
impact the amounts reported and disclosed herein.

Business Operations and Organization

Front Royal, Inc., the parent, was incorporated in September 1990 and
commenced doing business in 1992.

Colony is a Virginia-domiciled insurer that was incorporated in 1962 and
which provides commercial property and casualty insurance on both an admitted
and non-admitted basis throughout most of the United States, focusing primarily
on specialty excess and surplus lines.

Rockwood Casualty is a Pennsylvania-domiciled insurer that was incorporated
in 1990 and which provides commercial property and casualty insurance primarily
in Pennsylvania and Maryland. Rockwood Casualty specializes in underwriting
workers' compensation coverage for both underground and surface coal mining
operations and other commercial risks.

Front Royal Insurance Company ('FRIC'), a wholly-owned subsidiary of
Colony, is an Ohio-domiciled insurer that was incorporated in 1978 and which
provides commercial property and casualty insurance on both an admitted and
non-admitted basis in certain states, supplementing production for Colony.

Colony Management Services, Inc. was incorporated in 1994 and provides
management, accounting, claims, underwriting and data processing services, as
required, to certain Front Royal, Inc. subsidiaries.

FREIM was incorporated in 1991 and provides fee-based insurance services
and risk management services to insurance companies, risk retention groups,
associations and other industry groups.

$12,857,216 (25.4%) and $11,756,612 (23.5%) of Colony's gross written
premiums for the years ended December 31, 1997 and 1996, respectively, were
derived from one agent which sells Colony's products in 28 of its offices.

$7,945,330 (16.0%) and $5,068,717 (10.2%) of Rockwood Casualty's gross
written premiums were derived from two agents for the year ended December 31,
1997.

The loss of any of these agents could have a material adverse effect on the
Company.

Investments

Effective December 31, 1996, upon the acquisition of Rockwood Casualty, the
Company designated certain of Rockwood Casualty's investments as
held-to-maturity. Accordingly, the Company has a portfolio including both
available-for-sale and held-to-maturity investments.

F-7
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
Management determines the appropriate classification of its investments in
fixed maturity securities at the time of purchase. Fixed maturity securities are
classified as held-to-maturity when the Company has the positive intent and
ability to hold these securities to maturity. Fixed maturity securities not
classified as held-to-maturity and all equity securities are classified as
available-for-sale. The Company records the following for its entire portfolio:

The amortized cost of fixed maturity investments is adjusted for
amortization of premiums and accretion of discounts. That amortization or
accretion is included in net investment income.

For the mortgage-backed bond portion of the fixed maturity securities
portfolio, the Company recognizes income using a constant effective yield
based on anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from anticipated
prepayments, the estimated economic life is recalculated and the remaining
unamortized premium or discount is amortized prospectively over the
remaining economic life.

Realized gains and losses on sales of investments, and declines in
value considered to be other-than-temporary, are recognized in operations
on the specific identification basis for debt securities and on the
first-in, first-out basis for equity securities.

For the held-to-maturity portion of its portfolio, the Company records
its securities at amortized cost.

For the available-for-sale portion of its portfolio, the Company
records its securities at fair value. Changes to this fair value are
recorded as unrealized gains or losses directly in shareholders' equity
with no corresponding effect on net income.

Premiums

Premiums are earned on a pro rata basis over the terms of the policies,
generally twelve months. That portion of premiums written applicable to the
unexpired terms of the policies in force is recorded as unearned premiums.

Workers' compensation premiums based on payroll reporting are recorded as
written when payroll reports are received from the insured or are estimated if
reports have not been received.

Workers' compensation premiums on policies with deferred installment
payment plans are recorded as written when individual installments are billed.

Estimated ultimate premiums on retrospectively rated contracts are
recognized as revenue over the period of the contract. Estimated ultimate
premiums are revised quarterly based on current experience; such adjustments
have not been significant.

Participating Policies

Participating business (which is written for the Company only by Rockwood
Casualty) represents approximately 17.1% of net premiums written and 16.6% of
premiums earned for the year ended December 31, 1997. The participating business
consists only of workers' compensation policies and the amount of dividends to
be paid is based on the terms of the individual policies.

Policy Acquisition Costs

Acquisition costs, consisting principally of agents' commissions and
premium taxes, are deferred and amortized over the period in which the related
premiums are earned, generally twelve months. Commissions related to insurance
risks ceded to other insurance companies are recorded as a reduction to deferred
policy

F-8
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)

acquisition costs. Contingent commissions or other equivalent amounts payable to
agents pursuant to contractual agreements of a profit sharing nature are accrued
based on the experience of the underlying business using case and statistical
methods.

Reserve for Losses and Loss Adjustment Expenses

Loss and loss adjustment expense reserves represent the estimated ultimate
net cost of all reported and unreported losses incurred through December 31. The
Company does not discount loss and loss adjustment expense reserves (except for
Rockwood Casualty's workers' compensation coverages, which are discounted at a
4% rate). The reserves for unpaid losses and loss adjustment expenses are
estimated using individual case-basis valuations and statistical analyses. Those
estimates are subject to the effects of trends in loss severity and frequency.
Although considerable variability is inherent in such estimates, management
believes that the reserves for losses and loss adjustment expenses are adequate.
These estimates are continually reviewed and adjusted as necessary as experience
develops or new information becomes known; such adjustments are included in
current operations.

Reinsurance

The Company assumes and cedes reinsurance to allow management to control
exposure to potential losses arising from large risks, to provide additional
capacity for growth and to provide for greater diversification of business. This
reinsurance is effected primarily under excess of loss and quota-share
reinsurance contracts.

Reinsurance premiums, commissions, and expense reimbursements on reinsured
business are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts.
Expense reimbursements received in connection with reinsurance ceded have been
accounted for as a reduction of the related policy acquisition costs. All
reinsurance receivables and prepaid reinsurance premium amounts are reported as
assets.

Goodwill

Excess of purchase price over net assets of business acquired (i.e.,
goodwill) is amortized on a straight-line basis over periods up to 15 years. The
carrying value of goodwill is periodically reviewed by the Company based on the
expected future undiscounted operating cash flows of the related business unit.
The Company believes that no impairment of goodwill exists at December 31, 1997.

Excess of net assets of business acquired over the related purchase price
(i.e., negative goodwill) is amortized on a straight-line basis over a 10 year
period.

Income Taxes

Deferred income tax assets and liabilities are recognized for the expected
future tax effects attributable to temporary differences between the financial
reporting and tax basis of assets and liabilities, based on enacted tax rates
and other provisions of tax laws.

F-9
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
Net Income Per Share

In 1997, the Financial Accounting Standards Board ('FASB') issued Statement
No. 128, Earnings per Share, ('Statement 128') which replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the requirements of
Statement 128.

Reclassifications

Certain amounts in the financial statements for 1996 and 1995 have been
reclassified to conform to the 1997 presentation. Such reclassifications had no
effect on previously reported results of operations or shareholders' equity.

New Accounting Standards

In 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income,
('Statement 130') effective for years beginning after December 15, 1997. The new
rules require companies to display items of other comprehensive income either
below the total for net income on the income statement, on the statement of
changes in shareholders' equity or in a new, separate statement of comprehensive
income. The Company would then disclose the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet.

The adoption of Statement 130 will not affect results of operations or
financial position. Currently the Company has no other comprehensive income, as
defined, other than unrealized gains or losses on available-for-sale securities
which have been disclosed separately in the equity section of the balance sheet.

In June 1997, FASB issued Statement No. 131, Disclosures about Segments of
an Enterprise and Related Information ('Statement 131'), effective for years
beginning after December 15, 1997. Statement 131 requires that a public company
report financial and descriptive information about its reportable operating
segments pursuant to criteria that differ from current accounting practice.
Operating segments, as defined, are components of an enterprise about which
separate financial information is available that is evaluated regularly by
senior management in deciding how to allocate resources and in assessing
performance. The adoption of Statement 131 will not affect results of operations
or financial position, but will affect the disclosure of segment information.

In 1997, the Accounting Standards Executive Board issued Statement of
Position 97-3, Accounting by Insurance and Other Enterprises for Insurance
Related Assessments ('SOP 97-3'), effective for years beginning after December
15, 1998. SOP 97-3 provides guidance on when an insurance or other enterprise
should recognize a liability for assessments related to insurance activities,
including those by state guaranty funds and workers' compensation funds. The
provisions of this statement will have little effect on Colony because it does
not apply to business written on a non admitted basis. Rockwood Casualty
currently provides for guarantee fund assessments on a basis similar to that
prescribed by the statement and therefore, this statement will not have a
significant effect on results of operations or financial position.

F-10
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. INVESTMENTS

The Company's investments, excluding short-term investments, at December 31
of each year, are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------------------
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
<S> <C> <C> <C> <C>
Available-for-sale
Corporate bonds..................................... $ 26,219,425 $ 533,268 $ -- $ 26,752,693
U.S. Government bonds............................... 53,384,736 1,337,277 -- 54,722,013
Non-U.S. Government bonds........................... 2,074,121 29,869 -- 2,103,990
Mortgage-backed bonds............................... 40,625,981 1,170,184 -- 41,796,165
------------ ---------- ---------- ------------
Total fixed maturity securities................ 122,304,263 3,070,598 -- 125,374,861

Equity securities................................... 16,635,621 2,644,657 (679,057) 18,601,221
------------ ---------- ---------- ------------
Total available-for-sale....................... 138,939,884 5,715,255 (679,057) 143,976,082
------------ ---------- ---------- ------------
Held-to-maturity
Corporate bonds..................................... 18,778,616 348,596 -- 19,127,212
U.S. Government bonds............................... 21,123,575 277,665 -- 21,401,240
Mortgage-backed bonds............................... 44,471,462 305,178 (98,733) 44,677,907
State and municipal bonds........................... 25,162,968 1,034,734 (773) 26,196,929
------------ ---------- ---------- ------------
Total held-to-maturity......................... 109,536,621 1,966,173 (99,506) 111,403,288

Short-term investments................................ 24,208,843 -- -- 24,208,843
------------ ---------- ---------- ------------
Total investments.............................. $272,685,348 $7,681,428 $ (778,563) $279,588,213
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------------------
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
<S> <C> <C> <C> <C>
Available-for-sale
Corporate bonds..................................... $ 26,509,425 $ 767,493 $ (420,847) $ 26,856,071
U.S. Government bonds............................... 30,943,289 1,031,845 (286,854) 31,688,280
Mortgage-backed bonds............................... 34,432,866 975,057 (273,405) 35,134,518
State and municipal bonds........................... 748,076 36,165 (1,345) 782,896
------------ ---------- ---------- ------------
Total fixed maturity securities................ 92,633,656 2,810,560 (982,451) 94,461,765

Equity securities................................... 8,665,191 308,139 -- 8,973,330
------------ ---------- ---------- ------------
Total available-for-sale....................... 101,298,847 3,118,699 (982,451) 103,435,095
------------ ---------- ---------- ------------
Held-to-maturity
Corporate bonds..................................... 22,305,685 -- -- 22,305,685
U.S. Government bonds............................... 25,704,836 -- -- 25,704,836
Mortgage-backed bonds............................... 51,872,041 -- -- 51,872,041
State and municipal bonds........................... 25,488,785 -- -- 25,488,785
------------ ---------- ---------- ------------
Total held-to-maturity......................... 125,371,347 -- -- 125,371,347

Short-term investments................................ 15,332,716 -- -- 15,332,716
------------ ---------- ---------- ------------
Total investments.............................. $242,002,910 $3,118,699 $ (982,451) $244,139,158
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
</TABLE>

F-11
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. INVESTMENTS--(CONTINUED)
The fair values for fixed maturity securities are based on quoted market
prices, where available. For fixed maturity securities not actively traded, fair
values are estimated using values obtained from independent pricing services.
The fair values for equity securities are based on quoted market prices.

The amortized cost and estimated fair value of investments in fixed
maturities at December 31, 1997, are summarized by estimated maturity as
follows:

<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE HELD-TO-MATURITY TOTAL
--------------------------- --------------------------- ---------------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
<S> <C> <C> <C> <C> <C> <C>
Maturity:
Due in 1998........ $ 3,771,117 $ 3,858,000 $ 9,195,139 $ 9,337,824 $ 12,966,256 $ 13,195,824
Due in 1999-2002... 50,491,667 51,438,498 19,149,577 19,491,240 69,641,244 70,929,738
Due in 2003-2007... 27,056,724 27,915,698 16,794,263 17,358,252 43,850,987 45,273,950
Due after 2007..... 358,774 366,500 19,926,180 20,538,065 20,284,954 20,904,565
------------ ------------ ------------ ------------ ------------ ------------
81,678,282 83,578,696 65,065,159 66,725,381 146,743,441 150,304,077
Mortgage-backed
securities....... 40,625,981 41,796,165 44,471,462 44,677,907 85,097,443 86,474,072
------------ ------------ ------------ ------------ ------------ ------------
Total.............. $122,304,263 $125,374,861 $109,536,621 $111,403,288 $231,840,884 $236,778,149
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
</TABLE>

The foregoing data is based on the contractual maturities of the
securities. Actual maturities may differ for some securities because borrowers
have the right to call or prepay obligations with or without penalties.

Major categories of the Company's investment income are summarized as
follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Fixed maturity securities............................................. $15,417,389 $5,457,294 $5,036,569
Short-term investments................................................ 1,618,653 661,583 865,823
Equity securities..................................................... 1,384,576 282,403 42,146
Other................................................................. 201,408 -- --
----------- ---------- ----------
Gross investment income............................................. 18,622,026 6,401,280 5,944,538
Investment expenses................................................... (638,455) (534,271) (495,412)
----------- ---------- ----------
Net investment income............................................... $17,983,571 $5,867,009 $5,449,126
----------- ---------- ----------
----------- ---------- ----------
</TABLE>

The Company's realized gains and losses on investments are summarized as
follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Fixed maturity securities:
Gross realized gains................................................ $ 487,218 $ 36,053 $ 861,440
Gross realized losses............................................... (346,854) (46,734) (172,436)
----------- ---------- ----------
Net gains/(losses)............................................... 140,364 (10,681) 689,004
Equity securities:
Gross realized gains................................................ 70,749 9,506 862,451
Gross realized losses............................................... (690,966) -- (713,836)
----------- ---------- ----------
Net gains/(losses)............................................... (620,217) 9,506 148,615
----------- ---------- ----------
Net realized gains/(losses)...................................... $ (479,853) $ (1,175) $ 837,619
----------- ---------- ----------
----------- ---------- ----------
</TABLE>

At December 31, 1997 and 1996, investments with market values of
$12,403,843 and $9,608,840, respectively, were on deposit with state insurance
departments to satisfy regulatory requirements.

F-12
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

3. INTANGIBLE ASSETS

Intangible assets at December 31, are comprised of the following:

<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Non-compete and non-solicitation agreements............................... $ 3,017,314 $ 3,386,907
Goodwill.................................................................. 6,578,732 7,104,806
Negative goodwill......................................................... (3,783,694) (4,325,171)
----------- -----------
Total................................................................ $ 5,812,352 $ 6,166,542
----------- -----------
----------- -----------
</TABLE>

4. OTHER ASSETS

Other assets at December 31, are comprised of the following:

<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Capital lease on real estate................................................ $1,562,876 $1,603,470
Furniture, fixtures and equipment, net...................................... 1,182,075 1,354,936
Receivables pursuant to sale of subsidiaries................................ 1,177,466 --
Deposit with appeals court.................................................. 274,312 274,312
Note receivable............................................................. -- 2,500,000
Receivables pursuant to closing the Rockwood Casualty acquisition........... -- 619,122
Insurance settlement receivable............................................. -- 536,681
Other....................................................................... 526,407 1,091,954
---------- ----------
Total.................................................................. $4,723,136 $7,980,475
---------- ----------
---------- ----------
</TABLE>

5. ACQUISITIONS

On May 21, 1992, the Company completed its first acquisition for a total
cost of $5,766,115. The transaction was accounted for as purchase and resulted
in $1,028,400 of costs in excess of net assets acquired (which is being
amortized on a straight-line basis over ten years).

On December 30, 1994, the Company acquired all of the outstanding stock of
Colony and certain other assets and liabilities (the 'Colony Acquisition') for a
cash purchase price of $15,750,000 which was comprised of a $15,000,000 payment
on December 30, 1994 and a holdback payment of $750,000 due on December 30,
2000. In addition to the cash and deferred purchase price, the Company incurred
other costs in connection with the Colony Acquisition of $1,465,631, bringing
the total cost (when discounting the holdback payment to $498,000 at December
31, 1994) to $16,963,631.

The Colony Acquisition was accounted for using the purchase method and
resulted in a $5,414,768 excess of net assets acquired over the total purchase
price (i.e., negative goodwill) which is being amortized on a straight-line
basis over ten years.

On December 31, 1996, the Company acquired all of the outstanding stock of
Rockwood Casualty and certain other assets and liabilities (the 'Rockwood
Casualty Acquisition') for cash of $41,500,000 and $15,500,000 of Series A
Redeemable Convertible Preferred Stock. The Company also issued discounted
warrants to purchase an aggregate of 400,000 shares of Class A Common Stock at
an exercise price of $2.50 per share for non-compete and non-solicitation
agreements (see Notes 11 and 12 for further discussion). In addition to the cash
paid and the preferred stock issued, the Company incurred costs associated with
the Rockwood Casualty Acquisition of $2,943,649 bringing the total cost to
$60,543,649.

The purchase price of the Rockwood Casualty Acquisition and its related
closing costs were funded with the proceeds of a portion of the $38,000,000
senior bank debt, the issuance of the $15,500,000, Series A Redeemable
Convertible Preferred Stock, the issuance of $12,700,000 of Class of C Common
Stock and an $8,500,000 return of capital from Rockwood Casualty (see Notes 9,
11 and 18 for further discussion).

F-13
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. ACQUISITIONS--(CONTINUED)
The Rockwood Casualty Acquisition was accounted for as a purchase and
resulted in $6,348,503 of costs in excess of net assets acquired which is being
amortized on a straight-line basis over fifteen years.

As part of this acquisition, Rockwood Casualty entered into a fifteen year
lease agreement with an affiliate of the sellers for the property which houses
all of Rockwood Casualty's operations. Under the terms of this lease, Rockwood
Casualty has the option to purchase the property at any time during the lease
for a scheduled price which equals all of the remaining fixed payments
discounted at 8.5%, including a required payment of $2,500,000 at the end of the
lease term. If Rockwood Casualty fails to exercise such option, the lessor may
require Rockwood Casualty to purchase the property for $2,500,000 at the
conclusion of the lease. Total lease payments, over the duration of this lease
exclusive of the $2,500,000 required payment, are $5,288,973. For financial
reporting purposes, the lease has been recorded in other liabilities at its
present value using a discount rate of 8.5% (see Note 14 for further
discussion).

The following table summarizes the effects of Front Royal, Inc.'s
acquisitions:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 30, MAY 21,
1996 1994 1992
TRANSACTION TRANSACTION TRANSACTION TOTAL
<S> <C> <C> <C> <C>
Total purchase price....................... $ 60,543,649 $ 16,963,631 $ 5,766,115 $ 83,273,395
Liabilities assumed at fair market value... 166,242,686 67,399,881 1,119,388 234,761,955
Less: Assets acquired at fair market
value.................................... (220,437,832) (89,778,280) (5,857,103) (316,073,215)
------------- ------------- ----------- -------------
Excess/(shortfall) of purchase price over
net assets acquired...................... $ 6,348,503 $ (5,414,768) $ 1,028,400 $ 1,962,135
------------- ------------- ----------- -------------
------------- ------------- ----------- -------------
</TABLE>

The accompanying consolidated results of operations for 1996 and 1995 do
not include the results of the Rockwood Casualty Acquisition due to the December
31, 1996 closing date.

6. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company does not believe any of the policies currently being written,
or written in recent years, expose the Company to asbestos-related risks. The
Company, however, has identified three insured accounts with policy terms of up
to five years (the latest of which expired in 1987) where an asbestos-related
exposure exists. Reserves for asbestos-related exposures cannot be estimated
with traditional loss reserving techniques. Case reserves (and the costs of
related litigation) have been established based on information that has been
developed on known claimants. In addition, incurred but not reported reserves
have been established to cover additional exposure on both known and unasserted
claims. Those reserves are reviewed and updated continually by management and
outside actuaries. In establishing liabilities for claims for asbestos-related
illnesses, management considers facts currently known, the current state of the
law and litigation arising from coverage issues. Management has performed
extensive reviews of its records to identify insured accounts for which exposure
for asbestos-related illnesses have been established; however, courts and
legislatures have, in the past, attempted to expand coverage and liability.
Accordingly, an indeterminable amount of additional liability could develop.
However, this amount should be limited by the very small number of identified
insured accounts, limited policy terms, already partially exhausted policy
limits, and the existence of significant applicable reinsurance.

Rockwood Casualty discounts its workers' compensation reserves for both
statutory and GAAP financial reporting purposes. The discount rate at December
31, 1997 and 1996 was 4%. Included in the reserve for unpaid losses at December
31, 1997 and 1996 is $87,601,000 and $90,035,000, respectively, related to
workers' compensation coverages (which is net of a discount of $15,061,000 and
$15,509,389, respectively).

F-14
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

6. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES--(CONTINUED)
The following table provides a reconciliation of the beginning and ending
reserve balances for losses and loss adjustment expenses ('LAE'),
net-of-reinsurance, for 1997, 1996 and 1995 to the gross amounts reported in the
balance sheet.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Reserve for losses and LAE, net of related reinsurance recoverables, at
beginning of year........................................................... $162,339 $ 44,160 $ 40,397
Add:
Provision for losses and LAE for claims occurring in the current year, net
of reinsurance........................................................... 63,725 27,058 22,870
Increase (decrease) in incurred losses and LAE for claims occurring in prior
years, net of reinsurance................................................ (7,978) (948) (304)
Provision for discount on claims occurring in the current year.............. (3,014) -- --
Provision for discount on claims occurring in prior years................... 3,463 -- --
-------- -------- --------
Incurred losses and LAE during the current year, net of reinsurance and
discount............................................................... 56,196 26,110 22,566
-------- -------- --------
Deduct:
Losses and LAE payments for claims, net of reinsurance, occurring during:
Current year............................................................. (13,650) (6,325) (5,642)
Prior years.............................................................. (32,097) (15,055) (13,161)
-------- -------- --------
Total paid............................................................... (45,747) (21,380) (18,803)
-------- -------- --------
Add: Reserves related to acquisitions, net of discount........................ -- 113,449 --
-------- -------- --------
Reserve for losses and LAE, net of related reinsurance recoverables, at end of
year........................................................................ 172,788 162,339 44,160
Add: Reinsurance recoverables on unpaid losses and LAE, at end of year
($14,356 in 1996 related to acquisitions)................................... 22,543 25,736 12,073
-------- -------- --------
Reserve for losses and LAE, gross of reinsurance recoverables on unpaid losses
and LAE, at end of year..................................................... $195,331 $188,075 $ 56,233
-------- -------- --------
-------- -------- --------
</TABLE>

The foregoing reconciliation shows that a $7,978,000 redundancy in the 1996
and prior year reserves emerged in 1997. This redundancy is primarily a result
of lower than expected costs of settling workers' compensation claims which were
open at the end of 1996 and lower than expected per claim costs for incurred but
unreported claims at December 31, 1996. The Company attributes these lower costs
primarily to the effects of enacted legislation resulting in the lowering of
medical costs and indemnity costs to workers' compensation carriers.

7. REINSURANCE

The Company's insurance subsidiaries remain liable to their policyholders
if their reinsurers are unable to meet their contractual obligations under
applicable reinsurance agreements. To minimize exposure to significant losses
from reinsurance insolvencies, the Company evaluates the financial condition of
its reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities, or economic characteristics of the reinsurers.
At December 31, 1997, reinsurance recoverables from three reinsurers were
$7,339,000, $2,857,000 and $1,625,000, representing approximately 48% of the
total balance of reinsurance outstanding.

F-15
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

7. REINSURANCE--(CONTINUED)
Net written premiums are summarized as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Direct premiums.......................................... $ 99,665,229 $49,507,334 $42,949,993
Assumed premiums......................................... 580,435 440,806 620,986
Ceded premiums........................................... (12,215,025) (6,544,153) (5,915,747)
------------ ----------- -----------
Net premiums written................................ $ 88,030,639 $43,403,987 $37,655,232
------------ ----------- -----------
------------ ----------- -----------
</TABLE>

Net premiums earned are summarized as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Direct premiums.......................................... $103,702,417 $47,632,943 $41,535,362
Assumed premiums......................................... 862,672 536,211 740,605
Ceded premiums........................................... (14,042,036) (6,053,694) (5,738,579)
------------ ----------- -----------
Net premiums earned................................. $ 90,523,053 $42,115,460 $36,537,388
------------ ----------- -----------
------------ ----------- -----------
</TABLE>

Losses and LAE are summarized as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Direct losses and LAE..................................... $59,090,303 $28,776,472 $26,327,637
Assumed losses and LAE.................................... 324,627 106,973 (303,406)
Ceded losses and LAE...................................... (3,218,936) (2,773,166) (3,458,455)
----------- ----------- -----------
Net losses and LAE................................... $56,195,994 $26,110,279 $22,565,776
----------- ----------- -----------
----------- ----------- -----------
</TABLE>

8. OTHER LIABILITIES

Other liabilities at December 31, are comprised of the following:

<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Amounts payable to reinsurers............................................ $ 3,342,299 $ 2,124,276
Capital lease obligation................................................. 3,168,022 3,006,265
Obligations under non-compete/non-solicitation agreements................ 3,017,314 3,386,907
Federal income tax payable............................................... 930,102 1,077,784
Deferred purchase price payable.......................................... 643,000 593,000
Accounts payable......................................................... 930,896 450,860
Other.................................................................... 1,109,084 1,165,734
----------- -----------
Total............................................................... $13,140,717 $11,804,826
----------- -----------
----------- -----------
</TABLE>

F-16
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

9. DEBT

In connection with the Rockwood Casualty Acquisition and in order to reduce
the interest cost associated with its then existing debt, Front Royal, Inc.
obtained a debt facility with a bank for an original amount of $38,000,000,
payable semi-annually through the maturity date of December 1, 2003 and
requiring the remaining payments as follows:

<TABLE>
<CAPTION>
PRINCIPAL
DATE PAYMENT
<S> <C>
1998....................................................... $ 3,375,000
1999....................................................... 4,625,000
2000....................................................... 5,500,000
2001....................................................... 6,125,000
2002....................................................... 6,625,000
2003....................................................... 10,295,430
-----------
Total................................................. $36,545,430
-----------
-----------
</TABLE>

The debt requires a $6,000,000 escrow (which is recorded in short-term
investments in the accompanying financial statements) be posted by the Company
until maturity.

The facility is subject to mandatory prepayment (which may be waived by the
bank) equal to:

o the net cash proceeds of an initial public offering in an amount equal to
the lesser of 75% of such proceeds or an amount necessary to bring the
ratio of debt to total debt and equity to .20 to 1.0 (no prepayment is
necessary if such ratio is less than .20 to 1.0);

o 50% of the net cash proceeds of any other equity offering exceeding
$250,000 (for which the Company paid $204,570 during 1997);

o 100% of the proceeds of any asset dispositions greater than $2,000,000
(excluding the sale of Hamilton Insurance Company--see Note 13 for
further discussion); and/or

o up to 35% of the Company's excess cash flow (as defined) beginning in
fiscal year 1997 (and payable in 1998).

Interest is payable quarterly or according to an alternative period chosen
by the Company of one, two or three-month periods. The debt can be segregated
into one or more Base Rate Tranches or one or more LIBOR Tranches. A Base Rate
Tranche will bear interest at the higher of either the bank's prime rate or the
Federal Funds Rate plus .5%. In the case of a LIBOR Tranche, the rate will equal
the three month LIBOR rate plus 2.25%, 2.00% or 1.75% if the ratio of debt to
total debt and equity is greater than or equal to .40 to 1.0, less than .40 but
greater than or equal to .35 to 1.0, or less than .35 to 1.0, respectively.

The note is secured by all of the outstanding stock of the primary
subsidiaries of the Company and substantially all of the Company's other assets.
The terms of the debt require Front Royal, Inc. and its subsidiaries to maintain
certain prescribed levels of shareholders' equity, consolidated statutory
surplus and various key operating indices. Additionally, the terms of the debt
prohibit Front Royal, Inc. from paying dividends or issuing additional debt.

On February 2, 1995, the Company entered into a contract with the holder of
the senior bank debt for 50% of its then existing debt (i.e., $5,250,000) which
capped the maximum interest rate payable at 11% (i.e., the three month LIBOR
rate of 8.25% as of February 2, 1995 plus 2.75%). Pursuant to this contract, if
the three month LIBOR interest rate dropped below 8.25%, Front Royal, Inc. was
obligated to pay 59% of the difference between this 8.25% and the lower rate on
the $5,250,000 balance.

F-17
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

9. DEBT--(CONTINUED)
During 1997, 1996 and 1995, the three month LIBOR rate ranged from 5.91% to
5.50%, 5.70% to 5.25% and 6.3% to 5.5%, respectively, and the Company paid
$79,496, $85,125 and $60,946, respectively, under this agreement.

The $5,250,000 outstanding principal on the debt was fully repaid at
December 31, 1996 in connection with the $38,000,000 debt facility noted above.
However, the underlying contract remains in effect until its expiration on March
30, 1998 and has been incorporated as part of the contract detailed below.

On February 18, 1997, the Company entered into another contract with the
holder of the senior bank debt for the balance of the debt in excess of
$5,250,000 (reduced periodically for applicable maturities). This contract caps
the maximum three month LIBOR rate at 6.40%. This contract expires April 1,
2002. The cost of the contract is being amortized into investment expense over
the life of the contract.

Interest paid by the Company was $3,031,264, $1,516,434 and $1,272,390 for
1997, 1996 and 1995, respectively.

10. INCOME TAXES

Front Royal, Inc. files a consolidated federal income tax return with its
subsidiaries. At December 31, 1997, the Company had net operating loss
carryforwards of $3,765,273 for income tax purposes which expire in 2009.
Utilization of these losses for income tax purposes is subject to certain
limitations under Internal Revenue Code Section 382.

Front Royal, Inc.'s effective income tax rate on pre-tax income is lower
than the prevailing corporate federal income tax rate and is summarized as
follows:

<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Income tax expense at federal rates........................... $4,613,832 $1,744,766 $1,637,506
Change in valuation allowance on deferred tax assets.......... (2,318,613) (1,402,249) (320,270)
Other......................................................... (83,775) 278,227 (53,236)
---------- ---------- ----------
Income tax expense....................................... $2,211,444 $ 620,744 $1,264,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>

Federal income taxes paid by the Company was $4,139,812, $1,437,500 and
$830,000 for 1997, 1996 and 1995, respectively.

F-18
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

10. INCOME TAXES--(CONTINUED)
The significant components of the net deferred tax asset at the current
prevailing tax rate are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Deferred tax assets:
Reserve for losses and loss adjustment expenses............. $8,160,949 $8,522,295 $2,950,453
Unearned premiums........................................... 2,259,612 2,429,097 1,329,635
Basis difference on investments resulting from the Colony
and Rockwood Acquisitions................................ 960,666 1,434,901 1,139,276
Net operating losses........................................ 1,280,193 1,427,937 1,575,336
Accrued policyholder dividends.............................. 988,397 1,050,622 --
Other....................................................... 1,500,243 940,417 884,331
---------- ---------- ----------
Deferred tax assets........................................... 15,150,060 15,805,269 7,879,031
Less: valuation allowance..................................... (1,280,193) (2,872,482) (3,640,196)
---------- ---------- ----------
Total deferred tax assets................................ 13,869,867 12,932,787 4,238,835
---------- ---------- ----------

Deferred tax liabilities:
Deferred policy acquisition costs........................... 2,983,742 3,107,036 1,856,396
Unrealized gains on available-for-sale securities........... 1,712,307 726,324 1,360,859
---------- ---------- ----------
Total deferred tax liabilities........................... 4,696,049 3,833,360 3,217,255
---------- ---------- ----------
Net deferred tax asset........................................ $9,173,818 $9,099,427 $1,021,580
---------- ---------- ----------
---------- ---------- ----------
</TABLE>

The components of the changes in the valuation allowance were recorded
through shareholders' equity and operations as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Change recognized in shareholders equity:
Change related to net unrealized (gains)/losses............. $ 726,324 $ 634,535 $(1,360,859)
Change recognized in statement of operations:
Reduction for increased likelihood of realization........... (2,318,613) (1,402,249) (320,270)
----------- ---------- -----------
Total change in valuation allowance........................... $(1,592,289) $ (767,714) $(1,681,129)
----------- ---------- -----------
----------- ---------- -----------
</TABLE>

F-19
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

11. CAPITAL STOCK

Common Stock--Class A Shares

On June 30, 1997, 426,166 warrants for the Company's Class A Common Stock
with exercise prices from $.76 to $2.00 were scheduled to expire. Of this
amount, shareholders exercised 424,156 warrants for total proceeds of $365,939
and the Company issued a corresponding number of shares of Class A Common Stock
(see Note 12 for further discussion).

Common Stock--Class B Shares

The shares of Class B Common Stock generally have the same rights as the
shares of Class A Common Stock except for certain voting rights and restrictions
on the Class B shares. All Class B shares will convert automatically to Class A
shares on the earliest of (a) approval of 2/3 vote of Class A shareholders, (b)
approval by Class A Directors or (c) April 15, 2002.

Common Stock--Class C Shares

In connection with the Rockwood Casualty Acquisition, on December 31, 1996,
the Company issued 31,750 units in a private placement (the 'Private Placement')
at a price of $400 per unit. Each unit included 100 shares of a new Class C
Common Stock, 100 rights (the 'Rights') and one warrant to purchase 7.874 shares
of Class A Common Stock. As a result, the Company raised $12,700,000, issued
3,175,000 shares of Class C Common Stock, a corresponding number of Rights and
issued warrants to purchase 250,000 shares of Class A Common Stock.

These warrants are exercisable at an exercise price of $.01 at any time
after June 1, 2001 or earlier in the event of a sale of all (or substantially
all) of the Company's assets or a change in control of the Company. However, the
Company has the right to reacquire some or all of these warrants at $.01 each at
any time (i) after December 31, 2000, if the book value per share of the Company
is greater than $7.25, subject to adjustment; or (ii) if at the end of each of
the three immediately preceding fiscal quarters the book value per share of the
Company is greater than $7.75, subject to adjustment. The Company shall have the
right to redeem such number of the Class C Warrants as is equal to (i) in the
case of a redemption following December 31, 2000, the number of Class C Warrants
represented by each warrant certificate multiplied by 2.0% times each $0.01 by
which the book value per share of the Company exceeds $7.25; and (ii) in the
case of any redemption prior to December 31, 2000, all of the Class C Warrants.
All of the computations above shall be adjusted to reflect any stock dividends
and any stock splits or combinations or similar transactions taking place after
the original issue date of the Class C Warrants through the end of the above
referenced fiscal quarters or December 31, 2000.

The Class C Warrants may also be redeemed at the option of the Company at a
price equal to $0.01 per Class C Warrant if, at the end of the fiscal quarter
immediately prior to the effective date of any Trigger Event (as defined), the
book value per share of the Company is greater than (i) $7.25 less the book
value per share of the Company at December 31, 1996, divided by (ii) 16 and
multiplied by (iii) the number of fiscal quarters from January 1, 1997 through
such effective date, as adjusted. Management believes such financial goals will
be achieved and intends to reacquire these warrants prior to December 31, 2000.

Each Right entitles the holder to the difference between $4.00 per share of
Class C Common Stock and the fair market value of the Class A Common Stock (if
the fair market value of Class A Common Stock is less than $4.00) on certain
trigger event dates. The Company may fulfill its obligations with respect to the
Rights, if any, by the payment of cash or the issuance of securities, at the
option of the Company. If the Company completes an initial public offering with
a per share price of more than $4.00, these Rights terminate pursuant to their
terms.

The shares of Class C Common Stock have a liquidation preference over the
Class A and Class B shares and are convertible into Class A shares at any time
at the option of the holder. In the event of liquidation, the Class C Common
Stockholders have priority up to $4.00 over the Class A and B shares.

F-20
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

11. CAPITAL STOCK--(CONTINUED)
On August 25, 1997, the Company issued an additional 733 units of Class C
Common Stock for total proceeds of $293,200 on terms and conditions identical to
the December 31, 1996 issuance detailed above. Accordingly, the Company issued
73,300 shares of Class C Common Stock, a corresponding amount of rights and
issued warrants to purchase 5,772 shares of Class A Common Stock.

Redeemable Convertible Preferred Stock--Series A

Also in connection with the Rockwood Casualty Acquisition, on December 31,
1996 the Company issued 155,000 shares of Series A Redeemable Convertible
Preferred Stock. This stock has a 7% per annum dividend which can be accrued or
paid at the option of the Company. The stock is convertible at any time at the
option of the holder into 2,583,333 shares of Class A Common Stock (i.e., $6.00
per share) except in the event of an initial public offering when such
conversion is mandatory.

In the event of conversion, all accrued but unpaid dividends become an 8%
subordinated debt of the Company. This debt would mature on December 31, 2003.

The holder of the Series A Redeemable Convertible Preferred Stock is
entitled to one vote for each share, voting together as a single class to
nominate and elect one member of the Board of Directors. This right ceases to
exist if less than 50,000 shares are outstanding at the record date. The holder
of these shares has no other voting rights except as required by law.

Each holder of these shares has the right, not earlier than 180 days and
not later than 60 days before December 31, 2006, to require the Company to
redeem all or any portion of such holder's shares not previously converted at a
price per share equal to the stated value (i.e., $100.00 per share) plus all
accrued and unpaid dividends at such time. The Company shall have the option to
pay the redemption price in cash, by delivery of 8% promissory notes due on
demand or by a combination of each. The promissory notes would be subordinate in
all respects to the Company's senior debt.

12. WARRANTS AND OPTIONS

Warrants

As of December 31, 1997, Front Royal, Inc. had warrants outstanding for the
purchase of Class A Common Stock comprised of the following:

<TABLE>
<CAPTION>
NUMBER OF SHARES EXERCISE PRICE EXPIRATION DATE
<S> <C> <C>
598,898 $ .01 1999 to 2006
460,750 $ 2.50 1999 to 2001
22,500 $ 2.20 --
- ----------------
1,082,148
- ----------------
- ----------------
</TABLE>

Included in the total of 598,898 warrants with an exercise price of $.01
per share are warrants to purchase 255,772 shares which are contingent and were
issued in connection with the Private Placement (see Note 11 for further
discussion).

In connection with the Rockwood Casualty Acquisition, the Company issued
warrants to purchase an aggregate of 400,000 shares of Class A Common Stock at
an exercise price of $2.50 per share to two individuals in consideration of
their entering into non-compete and non-solicitation agreements that expire on
December 31, 2001. These warrantholders were former owners of Rockwood Casualty
and are currently owners and officers of insurance companies writing business in
lines other than those offered by the Company.

F-21
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

12. WARRANTS AND OPTIONS--(CONTINUED)
A summary of the warrant activity, by year, is as follows:

<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Outstanding at January 1........................................... 1,502,542 852,542 850,038
Warrants granted................................................... 5,772 650,000 2,504
Warrants exercised................................................. (424,156) -- --
Warrants cancelled................................................. (2,010) -- --
--------- --------- -------
Outstanding at December 31......................................... 1,082,148 1,502,542 852,542
--------- --------- -------
--------- --------- -------
Exercisable at December 31......................................... 826,376 1,252,542 852,542
--------- --------- -------
--------- --------- -------
</TABLE>

Options

During 1996, the Company established an incentive Stock Option Plan
pursuant to which stock options may be granted to officers, employees,
consultants, advisors and directors of the Company. The number of shares of
Class A Common Stock reserved for issuance under this plan, as it existed on
December 31, 1996, was 500,000. The Company had previously established a
management incentive Stock Option Plan pursuant to which options to purchase
Class B Common Stock were granted to officers and a director of the Company. The
number of shares of Class B Common Stock reserved for issuance under this plan
was 250,000. All options granted are exercisable over a four year period
commencing from the anniversary date of the grant except for 150,000 options
granted in December 1995 which were fully vested upon their issuance.

As of December 31, 1997, the aggregate shares issuable upon exercise of
Class A and Class B options is as follows:

<TABLE>
<CAPTION>
NUMBER OF SHARES EXERCISE PRICE EXPIRATION DATE
<S> <C> <C>
506,500 $ 5.00 2007
93,500 $ 4.00 2003
90,000 $ 2.00 2002
60,000 $ 2.50 2005
- ----------------
750,000
- ----------------
- ----------------
</TABLE>

A summary of the option activity, by year, is as follows:

<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Outstanding at January 1........................................... 258,500 150,000 --
Options granted.................................................... 506,500 108,500 150,000
Options exercised.................................................. -- -- --
Options cancelled.................................................. (15,000) -- --
--------- --------- -------
Outstanding at December 31......................................... 750,000 258,500 150,000
--------- --------- -------
--------- --------- -------
Exercisable at December 31......................................... 173,375 150,000 150,000
--------- --------- -------
--------- --------- -------
</TABLE>

13. RELATED PARTY TRANSACTIONS

During 1997, 1996 and 1995, the Company issued equity to individuals who
were also directors, officers and/or shareholders. The pricing of all such
issuances was approved by the Board of Directors and was deemed to be the then
fair market value.

As part of the Rockwood Casualty Acquisition, the Company issued warrants
to purchase 400,000 shares of Class A Common Stock to two former owners of
Rockwood. One of these warrantholders is also a director of Front Royal, Inc.
Additionally, these two warrantholders are the owners of a company which:

F-22
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

13. RELATED PARTY TRANSACTIONS--(CONTINUED)

o was an obligor of a $2,500,000, 13% secured note to the Company due on
December 31, 1997. This note was fully repaid during 1997. The note
represented the balance of a $3,500,000 purchase price for a wholly-owned
subsidiary of Rockwood, Premier Auto Insurance Company ('Premier').

o purchased the $15,500,000 Series A Redeemable Convertible Preferred Stock
of the Company issued pursuant to the Rockwood Casualty Acquisition from
one of the sellers of Rockwood Casualty.

The Chairman and a member of the Board of Directors of the Company have
consulting contracts with the Company for $40,000 and $24,000 per year,
respectively, which can be terminated by either party upon 90 days' written
notice.

As part of the December 31, 1996 Private Placement, the Company loaned a
total of $200,000 to three of its officers to purchase units in the transaction.
A total of 50,000 shares of Class C Common Stock were purchased along with 3,937
contingent warrants to purchase Class A Common Stock at an exercise price of
$.01 per share (see Note 11 for further discussion). The notes have an interest
rate of 6.5%, mature on December 31, 2001, are secured by the underlying stock
and require mandatory prepayment of 25% of the net after-tax amount of any cash
bonus paid to these officers (pursuant to which $33,614 was repaid in 1997).

In connection with the Rockwood Casualty Acquisition, the Company entered
into an option agreement to sell a wholly-owned subsidiary of Colony, Hamilton
Insurance Company ('Hamilton'), for an aggregate purchase price of $4,500,000 to
the obligor of the $2,500,000 note described above. This transaction was
completed in December 1997, prior to which Hamilton had transferred its assets
and liabilities in excess of $4,000,000 of statutory surplus to Colony.
Hamilton's business was transferred to Colony via a reinsurance treaty. New
business written by Hamilton on behalf of Colony in states in which Colony is
not yet licensed will also be transferred to Colony via a reinsurance treaty.

14. COMMITMENTS AND CONTINGENCIES

Colony and Rockwood Casualty are named as defendants in legal actions
arising primarily from claims made under insurance policies or in connection
with previous reinsurance agreements. Those actions have been considered in
establishing the Company's reserve liabilities. Management and its legal counsel
are of the opinion that the settlement of these actions will not have a material
adverse effect on Front Royal, Inc.'s financial position or the results of its
operations.

In connection with the Rockwood Casualty Acquisition, Rockwood Casualty
entered into a fifteen-year capital lease agreement. The future minimum rental
payments required under this lease as of December 31, 1997 are as follows:

<TABLE>
<S> <C>
1998........................................................ $ 78,000
1999........................................................ 78,000
2000........................................................ 86,000
2001........................................................ 86,000
2002........................................................ 272,475
Thereafter.................................................. 7,188,498
----------
Total.................................................. $7,788,973
----------
----------
</TABLE>

Additionally as part of the Rockwood Casualty Acquisition, the Company
entered into several agreements with former owners and affiliates of Rockwood
Casualty, including certain non-solicitation and non-compete agreements, for
periods of up to ten years. The agreements require payments as follows: 1998 to
2001--$565,000 per year; 2002 to 2006--$390,000 per year. The net present value
of such agreements is recorded as an intangible asset with a corresponding
liability recorded in other liabilities.

F-23
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

14. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
Also as part of the Rockwood Casualty Acquisition, Premier assumed all of
the private passenger automobile insurance previously written by Rockwood
Casualty via a reinsurance treaty. On December 31, 1996, Premier transferred
$8,700,627 into an escrow account held by Rockwood Casualty to collaterize
outstanding ceded losses and unearned premium. Rockwood Casualty remains
contingently liable to its policyholders if Premier is unable to meet its
contractual obligations under the reinsurance agreement. As of December 31, 1997
the balance of such escrow was $1,389,308, which exceeded the contractually
determined escrow amount at September 30, 1997 of $969,283. This September 30,
1997 balance was based upon Premier's independent consulting actuary's estimate
of such reserve liability for private passenger automobile insurance at that
date.

Rockwood Insurance Company of Indiana ('RIND'), a Company that merged into
Rockwood Casualty on December 31, 1990, issued certain medical malpractice
policies for claims occurring between January 1, 1978 and October 1, 1990. RIND
reinsured these policies pursuant to a loss portfolio transfer agreement with
Covenant Mutual Insurance Company ('Covenant'). Covenant subsequently went into
liquidation and was unable to meet its obligation on the reinsurance agreement.
In May 1993, Rockwood Insurance Company, Rockwood Casualty's former parent,
which went into liquidation proceedings in 1991, established and funded a
Liquidating Trust ('Trust') in accordance with an agreement approved by an order
of the Commonwealth Court of Pennsylvania to service medical malpractice claims
related to Covenant's default.

The Trust was originally funded with $6,500,000, and on June 30, 1994 an
additional $623,000 was deposited in the Trust by Rockwood Casualty's former
parent in accordance with the Trust agreement, as amended. The total assets in
the Trust available to pay claims and expenses at December 31, 1997 and 1996,
were $2,680,000 and $3,282,000, respectively. As part of the Trust agreement, a
certification of reserve liabilities is prepared annually by an independent
consulting actuary acceptable to both the former parent and Rockwood Casualty.
The amount of actuarially determined liabilities related to Covenant's default
as of December 31, 1997 and 1996 was $1,266,230 and $2,256,459, respectively. If
the amount of reserve liabilities on a discounted basis, times 115%, exceeds the
amount in the Trust Fund as of the date of the report, the former parent shall
pay to the Trustee, monies or investment securities in the aggregate amount of
the deficiency. Any amount in excess of the actuarially determined liabilities,
times 115%, may be returned to the former parent.

Rockwood Casualty remains contingently liable for the medical malpractice
claims, in the event that the Trust's assets, which consist primarily of
investments in short term U.S. Treasury obligations and cash equivalents, and
future deficiency funding by the former parent, if necessary, are not sufficient
to fund the ultimate liability. Management believes that there is minimal
exposure relating to this liability.

The Company has developed a plan to modify its information technology to be
ready for the year 2000 and has purchased, where necessary, year 2000 compliant
software and begun converting critical data processing systems. The Company
currently expects the project to be substantially complete by early 1999 and to
cost approximately $1,500,000 (unaudited). This estimate includes internal
costs, but excludes the costs to upgrade and replace systems in the normal
course of business. The Company does not expect this project to have a
significant effect on operations. As of December 31, 1997, $806,818 has been
incurred. The Company's policy is to expense year 2000 remediation costs as
incurred. Hardware and software purchases are capitalized.

F-24
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

15. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Numerator:
Net income available to common shareholders (numerator for
basic earnings per share).............................. $10,273,651 $4,510,922 $3,552,194
Dividends to preferred shareholders....................... 1,085,000 -- --
----------- ---------- ----------
Net income (numerator for diluted earnings per share)..... $11,358,651 $4,510,922 $3,552,194
----------- ---------- ----------
Denominator:
Weighted average common shares outstanding (denominator
for basic earnings per share).......................... 9,125,333 5,723,624 5,710,538
----------- ---------- ----------
Effect of dilutive securities:
Warrants............................................. 1,024,652 674,319 650,220
Employee stock options............................... 127,692 48,491 35,368
Convertible preferred stock.......................... 2,583,333 -- --
----------- ---------- ----------
Dilutive potential common shares.......................... 3,735,677 722,810 685,588
----------- ---------- ----------
Adjusted weighted average common shares outstanding and
assumed conversions (denominator for diluted earnings
per share)............................................. 12,861,010 6,446,434 6,396,126
----------- ---------- ----------
Net income per share--basic................................. $ 1.13 $ .79 $ .62
----------- ---------- ----------
----------- ---------- ----------
Net income per share--diluted............................... $ .88 $ .70 $ .56
----------- ---------- ----------
----------- ---------- ----------
</TABLE>

16. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts reported in the balance sheet for cash and short-term
investments approximate those assets and liabilities' fair values. Fair values
for investment securities are based on quoted market prices and are disclosed in
Note 2. The Company has not determined the fair value of its senior bank debt
obligation or the contracts which cap interest rates related to this debt. The
Company does not believe, however, that the fair value of these financial
instruments would differ materially from their recorded values.

17. STOCK BASED COMPENSATION

The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, ('APB 25') and related
Interpretations in accounting for its employee stock options. Under APB 25, when
the exercise price of the Company's employee stock options equals or exceeds the
market price of the underlying stock on the date of grant, no compensation
expense is recognized (see Note 12 for a summary of the options issued and
outstanding). This methodology was deemed preferable because, as discussed
below, the alternative fair value accounting, as provided for under FASB
Statement No. 123, Accounting for Stock-Based Compensation, ('Statement 123'),
requires use of option valuation models that were not developed for use in
valuing employee stock options.

Pro forma information regarding net income and earnings per share is,
however, required by Statement 123, and has been determined as if the Company
had accounted for its employee stock options under the fair value method
prescribed by that Statement. The fair value for these options (which is
amortized to expense over the

F-25
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

17. STOCK BASED COMPENSATION--(CONTINUED)
vesting period of the options) was estimated at the grant dates using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1997, 1996 and 1995 respectively:

<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Risk-free interest rate..................................... 6.13% 7.25% 6.69%
Expected life of the option................................. 10.63years 7.00years 8.27 ears
Expected stock price volatility............................. .31 .31 .31
</TABLE>

The expected dividend yield used is 0% for all years since the debt
facility prohibits the payment of dividends (see Note 9 for further discussion).

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the employee stock options.

However, the Company's pro forma disclosures, as required under Statement
123, are as follows:

<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Pro forma net income........................................ $11,312,836 $4,510,922 $3,408,794
Pro forma net income per share:
Basic..................................................... $ 1.12 $ .79 $ .60
Diluted................................................... $ .88 $ .70 $ .53
</TABLE>

The effects of applying Statement 123 for providing pro forma disclosures
are not likely to be representative of the effect on pro forma net income for
future years as the expense recognition will vary depending on the vesting
schedule of the options.

No compensation expense has been recorded in operations in 1997, 1996 or
1995 since all options were issued with exercise prices that equaled or exceeded
the then fair market value of the Company's stock.

18. STATUTORY MATTERS

The Company is required to periodically submit financial statements
prepared in accordance with statutory accounting practices to insurance
regulatory authorities. Statutory accounting practices for Colony, Hamilton,
FRIC, and Rockwood Casualty prescribed or permitted by state regulatory
authorities differ from generally accepted accounting principles. The following
net income amounts determined in accordance with statutory accounting practices
was reported to regulatory authorities for the years ended 1997, 1996, and 1995:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Colony...................................................... $3,046,875 $ 3,170,460 $3,156,814
Hamilton.................................................... 740,853 639,451 329,636
FRIC........................................................ 1,220,440 141,889 645,093
Rockwood Casualty........................................... 6,747,430 18,981,074 5,143,737
</TABLE>

As part of the Rockwood Casualty Acquisition, Rockwood Casualty requested
and received permission from the state regulatory authority to transfer
$8,500,000 to Front Royal, Inc. as a return of capital. The proceeds of

F-26
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

18. STATUTORY MATTERS--(CONTINUED)
this return of capital were utilized to finance a portion of the purchase price,
pay certain closing costs and to fund a $6 million senior bank debt escrow (see
Notes 5 and 9 for further discussion).

In 1997, Colony's statutory net income includes $1,242,375 of income
related to the sale of Hamilton (see Note 13 for further discussion).
Additionally, in December 1996, and in 1995, Hamilton and FRIC paid dividends of
$500,000 and $850,000, respectively, to their parent, Colony. The dividends are
included in Colony's statutory net income above. These dividends had been
approved by regulatory authorities.

The net assets of Colony and Rockwood Casualty that are transferable to
Front Royal, Inc. are limited to the amounts by which statutory capital and
surplus exceed minimum statutory requirements. An analysis of such requirement
at December 31, 1997 is as follows:

<TABLE>
<CAPTION>
ROCKWOOD
COLONY CASUALTY
<S> <C> <C>
Statutory Capital and Surplus.................................. $30,535,456 $43,881,750
Minimum Statutory Capital Required............................. 4,000,000 3,000,000
----------- -----------
Excess over Minimum Statutory Capital Requirement.............. $26,535,456 $40,881,750
----------- -----------
----------- -----------
</TABLE>

Despite such excess over statutory minimums, regulatory approval is
required for any distribution in a twelve month period, other than for dividends
or other distributions which, in the aggregate, do not exceed the lesser (in
Virginia, the greater in Ohio and Pennsylvania) of either (i) ten percent of the
insurer's surplus to policyholders as of the immediately preceding December 31
or (ii) net income (excluding realized gains in Virginia) of the prior year.

19. SUBSEQUENT EVENTS

In March 1998, the Company expects to execute a definitive agreement to
purchase the stock of a Florida-domiciled insurance company, certain assets of a
captive wholesale general agency (and an affiliate of the Florida-domiciled
insurance company) and certain other assets and liabilities for a total purchase
price of $35,000,000 in cash, 500,000 shares of Class A Common Stock and
warrants to purchase 1,050,000 shares of Class A Common Stock at an exercise
price of $10.00 per share.

The agreement will be conditional upon state regulatory approval and
governmental clearance under the Hart Scott Rodino Act. The Company expects both
of such approvals to occur in the second quarter of 1998.

The agreement will also be conditional upon the seller delivering the
insurance company with certain levels of invested assets, statutory surplus and
GAAP equity. Front Royal, Inc. will provide a $1,000,000 down payment which
would be refunded should the insurance company not achieve these prescribed
levels of invested assets, statutory surplus or GAAP equity. Additionally, under
certain circumstances, if the transaction is not ultimately completed, Front
Royal, Inc. may be required to forfeit its down payment.

The purchase price will be funded from a combination of internal sources
and debt. The Company is negotiating an increase to its senior bank debt on
terms and conditions similar to its current facility.

F-27
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
<S> <C> <C>
ASSETS
Investments:
Fixed maturity securities:
Available-for-sale at fair value (amortized cost: 1998, $125,098,803;
1997, $122,304,263)....................................................... $128,163,987 $125,374,861
Held-to-maturity at amortized cost (fair value: 1998, $95,012,544;
1997, $111,403,288)....................................................... 93,152,847 109,536,621
Equity securities at fair value (cost: 1998, $16,582,369;
1997, $16,635,621).......................................................... 18,775,263 18,601,221
Short-term investments......................................................... 37,852,749 24,208,843
------------ ------------
Total investments......................................................... 277,944,846 277,721,546

Cash............................................................................. 1,567,869 2,907,311
Accrued investment income........................................................ 2,800,000 3,304,784
Reinsurance recoverable on unpaid loss and loss adjustment expenses.............. 22,952,346 22,543,301
Reinsurance recoverable on paid loss and loss adjustment expenses................ 2,583,137 1,917,547
Prepaid reinsurance premiums..................................................... 2,436,687 2,777,992
Premiums receivable and agents' balances......................................... 17,446,996 16,657,272
Deferred federal income tax...................................................... 9,307,339 9,173,818
Deferred policy acquisition costs................................................ 8,665,767 8,775,710
Intangible assets, net........................................................... 5,787,526 5,812,352
Other assets..................................................................... 5,832,007 4,723,136
------------ ------------
Total assets.............................................................. $357,324,520 $356,314,769
------------ ------------
------------ ------------
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

F-28
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS--(CONTINUED)
(UNAUDITED)

<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses................................ $197,092,824 $195,330,919
Unearned premiums.............................................................. 35,378,270 36,007,585
Accrued expenses............................................................... 5,945,836 7,388,830
Accrued policyholders' dividends............................................... 5,919,403 6,054,289
Accrued preferred stock dividend............................................... 1,356,250 1,085,000
Other liabilities.............................................................. 13,338,237 13,140,717
------------ ------------
259,030,820 259,007,340

Senior bank debt............................................................... 35,295,430 36,545,430
------------ ------------
Total liabilities......................................................... 294,326,250 295,552,770
------------ ------------
Commitments and contingent liabilities
Series A Redeemable Convertible Preferred Stock, no par value,
155,000 shares authorized and 155,000 shares
issued and outstanding in 1998 and 1997........................................ 15,500,000 15,500,000
Common shareholders' equity:
Common Stock--Class A, no par value, 20,000,000
shares authorized and 5,859,144 shares issued and
outstanding in 1998 and 1997, net of issuance costs......................... 13,739,979 13,739,979
Common Stock--Class B, no par value, 700,000 shares authorized
and 268,482 shares issued and outstanding in 1998 and 1997.................. 557,348 557,348
Common Stock--Class C, no par value, liquidation preference value of $4.00 per
share, 3,500,000 shares authorized and 3,248,300 shares
issued and outstanding in 1998 and 1997..................................... 12,993,200 12,993,200
------------ ------------
27,290,527 27,290,527

Notes receivable from officers................................................. (166,386) (166,386)
Retained earnings.............................................................. 16,956,378 14,813,967
Accumulated other comprehensive income......................................... 3,417,751 3,323,891
------------ ------------
Total common shareholders' equity......................................... 47,498,270 45,261,999
------------ ------------
62,998,270 60,761,999
------------ ------------
Total liabilities, redeemable convertible preferred stock, and common
shareholders' equity................................................... $357,324,520 $356,314,769
------------ ------------
------------ ------------
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

F-29
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
<S> <C> <C>
Revenues:
Net premiums earned.............................................................. $20,167,287 $24,308,254
Net investment income............................................................ 4,264,544 4,265,364
Net realized gains on investments................................................ 4,432 42,352
Other income..................................................................... 55,994 27,327
----------- -----------
Total revenues........................................................... 24,492,257 28,643,297
----------- -----------
Losses and expenses:
Net losses and loss adjustment expenses.......................................... 12,186,532 15,790,698
Policy acquisition costs amortized............................................... 5,763,284 6,457,328
Other underwriting expenses...................................................... 1,170,597 956,437
Dividends to policyholders....................................................... 737,284 1,129,691
Interest expense................................................................. 880,631 1,154,571
Other operating costs and expenses............................................... 206,804 40,210
----------- -----------
Total losses and expenses................................................ 20,945,132 25,528,935
----------- -----------
Income before federal income taxes................................................. 3,547,125 3,114,362
Federal income tax expense
Current.......................................................................... 1,127,963 519,307
Deferred......................................................................... 5,501 272,218
----------- -----------
Total federal income tax expense......................................... 1,133,464 791,525
----------- -----------
Net income......................................................................... 2,413,661 2,322,837

Dividends to preferred shareholders................................................ 271,250 271,250
----------- -----------
Net income available to common shareholders........................................ $ 2,142,411 $ 2,051,587
----------- -----------
----------- -----------
Net income per share--basic........................................................ $ 0.23 $ 0.23
----------- -----------
----------- -----------
Net income per share--diluted...................................................... $ 0.18 $ 0.18
----------- -----------
----------- -----------
Weighted average common shares outstanding......................................... 9,375,926 8,889,925
Weighted average common and common stock equivalent shares outstanding............. 13,197,228 12,647,066
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

F-30
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND COMMON SHAREHOLDERS' EQUITY
(UNAUDITED)

<TABLE>
<CAPTION>
COMMON SHAREHOLDERS' EQUITY
------------------------------------------------------------------
REDEEMABLE ACCUMULATED
CONVERTIBLE COMMON STOCK OTHER
PREFERRED ------------------------------------ RETAINED COMPREHENSIVE
STOCK CLASS A CLASS B CLASS C EARNINGS INCOME TOTAL
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1996........ $15,500,000 $13,402,208 $575,000 $12,500,000 $ 4,540,316 $ 2,136,248 $48,653,772
-----------
Net income............... -- -- -- -- 2,322,837 -- 2,322,837
Net unrealized losses.... -- -- -- -- -- (1,122,491) (1,122,491)
-----------
Comprehensive income... -- -- -- -- -- -- 1,200,346
-----------
Accrual of preferred
dividend............... -- -- -- -- (271,250) -- (271,250)
----------- ----------- -------- ----------- ----------- ------------- -----------
Balances at
March 31, 1997........... $15,500,000 $13,402,208 $575,000 $12,500,000 $ 6,591,903 $ 1,013,757 $49,582,868
----------- ----------- -------- ----------- ----------- ------------- -----------
----------- ----------- -------- ----------- ----------- ------------- -----------
Balances at
December 31, 1997........ $15,500,000 $13,739,979 $557,348 $12,826,814 $14,813,967 $ 3,323,891 $60,761,999
-----------
Net income............... -- -- -- -- 2,413,661 -- 2,413,661
Net unrealized gains..... -- -- -- -- -- 93,860 93,860
-----------
Comprehensive income... -- -- -- -- -- -- 2,507,521
-----------
Accrual of preferred
dividend............... -- -- -- -- (271,250) -- (271,250)
----------- ----------- -------- ----------- ----------- ------------- -----------
Balances at
March 31, 1998........... $15,500,000 $13,739,979 $557,348 $12,826,814 $16,956,378 $ 3,417,751 $62,998,270
----------- ----------- -------- ----------- ----------- ------------- -----------
----------- ----------- -------- ----------- ----------- ------------- -----------
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.
F-31
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
<S> <C> <C>
Operating activities:
Net cash provided by/(used in) operating activities............................... $ (248,276) $ 9,276,871
------------ ------------
Investing activities:
Securities available-for-sale:
Purchases--fixed maturities and equities..................................... (9,264,153) (13,620,745)
Sales--fixed maturities and equities......................................... 4,898,148 32,515,561
Maturities and calls--fixed maturities....................................... 1,711,714 --
Securities held-to-maturity:
Purchases--fixed maturities.................................................. -- (9,993,129)
Maturities and calls--fixed maturities....................................... 16,460,031 2,855,800
Net purchases of short-term investments...................................... (13,646,906) (19,103,932)
------------ ------------
Net cash provided by/(used in) investing activities............................... 158,834 (7,346,445)
------------ ------------
Financing activities:
Net cash used in financing activities............................................. (1,250,000) --
------------ ------------
Increase/(decrease) in cash....................................................... (1,339,442) 1,930,426
Cash at beginning of period....................................................... 2,907,311 9,415,787
------------ ------------
Cash at end of period............................................................. $ 1,567,869 $ 11,346,213
------------ ------------
------------ ------------
</TABLE>

See accompanying notes to unaudited condensed consolidated financial statements.

F-32
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1998

1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial information included in this
report has been prepared in conformity with the accounting principles and
practices reflected in the consolidated financial statements for the year ended
December 31, 1997. This report should be read in conjunction with the
aforementioned financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of this information have been made. The results of operations for
the interim periods are not necessarily indicative of results for a full year.

Significant intercompany accounts and transactions have been eliminated.
The accounts of the acquired subsidiaries are included in the condensed
consolidated financial statements from the dates of acquisition. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Such
estimates and assumptions may be subject to change in the future as more
information becomes known which could impact the amounts reported and disclosed
herein.

Net Income Per Share

The Company's net income per share amounts have been calculated in
accordance with Statement of Financial Accounting Standards No. 128, Earnings
per Share ('Statement 128'). The treasury stock method was applied to options
and warrants using the initial public offering price and the estimated average
market price during the period for the period March 31, 1998 and 1997,
respectively.

Comprehensive Income

As of January 1, 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported in
shareholders' equity, to be included in other comprehensive income. Prior
financial statements have been reclassified to conform to the requirements of
Statement 130.

F-33
<PAGE>
FRONT ROYAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

2. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------
1998 1997
<S> <C> <C>
Numerator:
Net income available to common shareholders (numerator
for basic earnings per share)......................... $ 2,142,411 $ 2,051,587
Dividends to preferred shareholders...................... 271,250 271,250
-------------------- --------------------
Net income (numerator for diluted earnings per share).... $ 2,413,661 $ 2,322,837
-------------------- --------------------
Denominator:
Weighted average common shares outstanding (denominator
for basic earnings per share)......................... 9,375,926 8,889,925
-------------------- --------------------
Effect of dilutive securities:
Warrants.............................................. 916,002 1,106,308
Employee stock options................................ 321,967 67,500
Convertible preferred stock........................... 2,583,333 2,583,333
-------------------- --------------------
Dilutive potential common shares......................... 3,821,302 3,757,141
-------------------- --------------------
Adjusted weighted average common shares outstanding and
assumed conversions (denominator for diluted earnings
per share)............................................ 13,197,228 12,647,066
-------------------- --------------------
Net income per share--basic................................ $0.23 $0.23
-------------------- --------------------
-------------------- --------------------
Net income per share--diluted.............................. $0.18 $0.18
-------------------- --------------------
-------------------- --------------------
</TABLE>

F-34
<PAGE>
INDEPENDENT AUDITORS' REPORT

To the Board of Directors of
Preferred National Insurance Company
Wycon Corporation
Americlaim Adjustment Corp.
United American Financial Services Corporation:

We have audited the accompanying combined balance sheet of Preferred National
Insurance Company and Affiliates (the 'Companies') as of December 31, 1997, and
the related combined statements of operations, changes in stockholders' equity,
and cash flows for the year then ended. The combined financial statements
include the accounts of Preferred National Insurance Company and three related
companies, Wycon Corporation, Americlaim Adjustment Corp. and United American
Financial Services Corporation. These companies are under ultimate common
ownership and common management. These financial statements are the
responsibility of the Companies' management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
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 audit provides a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the combined financial position of the Companies as of December 31,
1997, and the combined results of their operations and their combined cash flows
for the year then ended in conformity with generally accepted accounting
standards.

/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP

Miami, Florida
May 22, 1998

F-35
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED BALANCE SHEET
DECEMBER 31, 1997

<TABLE>
<S> <C>
ASSETS
Cash on hand and on deposit........................................................................ $ 4,383,318
Securities available for sale...................................................................... 58,115,468
Accounts and agents balances receivable............................................................ 2,969,632
Reinsurance recoverable............................................................................ 3,118,960
Deferred acquisition costs......................................................................... 4,752,294
Prepaid insurance premiums......................................................................... 2,294,686
Accrued investment income.......................................................................... 314,745
Receivable from affiliates......................................................................... 8,062
Deferred tax asset................................................................................. 487,990
Cash surrender value of life insurance............................................................. 870,033
Other assets, net.................................................................................. 106,736
-----------
Total......................................................................................... $77,421,924
-----------
-----------

LIABILITIES AND STOCKHOLDERS' EQUITY
Losses............................................................................................. $15,676,015
Loss adjustment expenses........................................................................... 4,781,567
Other liabilities.................................................................................. 1,023,910
Income taxes payable............................................................................... 1,183,541
Unearned premiums.................................................................................. 19,905,709
S Corporation distributions payable................................................................ 2,244,062
-----------
Total liabilities............................................................................. 44,814,804
-----------
Commitments and contingencies (Note 9)
Common capital stock............................................................................... 3,501,160
Additional paid-in capital......................................................................... 23,160,351
Retained earnings.................................................................................. 5,878,724
Net unrealized gains on securities available for sale (net of tax provision of $40,131)............ 66,885
-----------
Total stockholders' equity.................................................................... 32,607,120
-----------
Total......................................................................................... $77,421,924
-----------
-----------
</TABLE>

See notes to combined financial statements.

F-36
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997

<TABLE>
<S> <C>
Revenues:
Premiums......................................................................................... $28,578,474
Fees and commissions............................................................................. 3,294,368
Net investment income............................................................................ 2,876,744
Realized capital gains and losses................................................................ 3,359
Other income..................................................................................... 17,655
-----------
Total revenues.............................................................................. 34,770,600
-----------

Expenses:
Losses........................................................................................... 14,027,805
Loss expenses incurred........................................................................... 3,128,593
Underwriting, acquisition and insurance expenses:
Amortization of deferred policy acquisition costs............................................. 4,682,008
Salaries and employee benefits................................................................ 4,357,437
Other......................................................................................... 4,159,938
-----------
Total expenses.............................................................................. 30,355,781
-----------

Earnings before provision for income taxes......................................................... 4,414,819
Provision for income taxes......................................................................... 812,458
-----------
Net income......................................................................................... $ 3,602,361
-----------
-----------
</TABLE>

See notes to combined financial statements.

F-37
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
NET UNREALIZED
GAINS (LOSSES)
COMMON ADDITIONAL ON AVAILABLE
CAPITAL PAID-IN RETAINED FOR SALE
STOCK CAPITAL EARNINGS SECURITIES TOTAL
---------- ----------- ---------- ---------------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996................ $3,501,160 $19,660,351 $4,403,530 $(40,329) $27,524,712
Net income.............................. 3,602,361 3,602,361
Net unrealized gains on securities
available for sale, net of taxes...... 107,214 107,214
S Corporation distributions to
stockholders.......................... (2,127,167) (2,127,167)
Capital contribution.................... 3,500,000 3,500,000

<CAPTION>
---------- ----------- ---------- ---------------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997................ $3,501,160 $23,160,351 $5,878,724 $ 66,885 $32,607,120
<CAPTION>
---------- ----------- ---------- ---------------- -----------
---------- ----------- ---------- ---------------- -----------
</TABLE>

See notes to combined financial statements

F-38
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997

<TABLE>
<S> <C>
Cash flows from operating activities:
Net income............................................................................ $ 3,602,361
------------
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premiums/discounts on bonds.................................... 140,203
Net realized capital gain.......................................................... (3,359)
Deferred income tax benefit........................................................ (307,223)
Increase in accrued interest receivable............................................ (60,175)
Increase in deferred acquisition costs............................................. (3,620,226)
Increase in accounts and agents balances receivable................................ (2,084,612)
Increase in other assets and receivable from affiliates............................ (61,597)
Increase in cash surrender value of life insurance................................. (284,336)
Increase in prepaid insurance premiums............................................. (1,580,520)
Increase in reinsurance recoverable on paid losses................................. (2,452,295)
Increase in losses and loss adjustment expenses.................................... 15,142,404
Increase in unearned premiums...................................................... 13,451,072
Increase in income taxes payable................................................... 501,062
Increase in other liabilities...................................................... 234,774
------------

Total adjustments................................................................ 19,015,172
------------
Net cash provided by operating activities........................................ 22,617,533
------------

Cash flows from investing activities:
Purchases of available for sale securities............................................ (76,501,016)
Proceeds from maturities and sales of available for sale securities................... 52,707,725
------------

Net cash used in investing activities............................................ (23,793,291)
------------

Cash flows from financing activities:
S Corporation distributions to stockholders........................................... (520,281)
Capital contribution.................................................................. 3,500,000
------------

Net cash provided by financing activities........................................ 2,979,719
------------

Net increase in cash.................................................................... 1,803,961

Cash, beginning of year................................................................. 2,579,357
------------

Cash, end of year....................................................................... $ 4,383,318
------------
------------
</TABLE>

See notes to combined financial statements.

F-39
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO FINANCIAL STATEMENTS

YEAR ENDED DECEMBER 31, 1997

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

The accompanying combined financial statements present the financial
position, results of operations and cash flows of Preferred National Insurance
Company (Preferred), Wycon Corporation (Wycon), Americlaim Adjustment Corp.
(Americlaim) and United American Financial Services Corporation (UnaMark) (the
Companies). The Companies are related in their operations and are affiliated
through ultimate common ownership and management since one individual owns a
controlling interest in all of the entities. All significant intercompany
balances and transactions are eliminated in combination.

Preferred, a wholly-owned subsidiary of Preferred National Financial Corp.
(PNFC), is a property and casualty insurance company and files its annual report
with the Insurance Department of the State of Florida. Prior to 1996, the
Company principally underwrote fidelity bonds and surety bonds. In 1996, the
Company began underwriting special multi-peril, professional liability and other
liability insurance. Preferred was incorporated in 1988 and obtained a license
to write specified coverages in the State of Florida on March 10, 1989.
Underwriting activities began in October 1989.

Wycon is the underwriting manager for Preferred and Britamco Underwriters,
Inc. (Britamco). Britamco is a property and casualty insurance company owned by
PNFC. Wycon's duties as underwriting manager include providing all of the
underwriting and administrative services necessary to operate Preferred and
Britamco. Wycon is also a general agent providing underwriting and
administrative services for an independent insurance company. Americlaim
provides claims adjustment services to Preferred and Britamco. UnaMark is a
captive general agency that solicits insurance accounts to be written by
Preferred.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

Cash and Cash Equivalents

Cash and cash equivalents include investments in highly liquid debt
instruments with an original maturity of three months or less.

Premiums and Policy Acquisition Costs

Premiums are earned on a pro rata basis over the periods covered by the
policies. Policy acquisition costs that vary with and are primarily related to
new and renewal business are deferred and amortized over future periods as the
related premiums on policies are earned. The Companies continuously review all
elements of policy acquisition and renewal costs for consideration of proper
inclusion in deferred acquisition costs. Deferred income taxes on deferred
policy acquisition costs are reflected in the financial statements.

Fees and Commissions

Fee income represents policy fees and inspection fees collected from
insureds by the agent. These fees are recognized as the services are performed.
Commission income represents commissions earned in connection with the
underwriting of policies for an independent insurance company. Commissions are
recognized upon the processing of the related policy.

F-40
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Unpaid Losses and Loss Adjustment Expenses

Loss reserves represent the estimated liability on claims reported plus
estimates for losses incurred but not yet reported and the estimated loss
adjustment expenses related to these claims. The liabilities for losses and
related loss adjustment expenses are determined using case basis evaluations and
statistical analyses for incurred but not yet reported claims. They represent
estimates of the ultimate net cost of all losses incurred. These liabilities are
subject to the impact of future changes in claim severity, frequency, and other
factors. While variability is inherent in such estimates, management believes
that the liabilities for losses and related adjustment expenses are adequate.
The estimates are continually reviewed and, as adjustments to these liabilities
become necessary, such adjustments are reflected in current operations.

As discussed above, during 1996, Preferred began underwriting special
multi-peril, professional liability and other liability insurance. Certain
critical assumptions Preferred relied on to estimate reserves for unpaid losses
and loss adjustment expenses for the new business were based on management's
prior experience and external industry sources. Although these data are relevant
to the operations of Preferred, the uncertainty of the reserve projections is
increased by the lack of historical experience.

Securities

Bonds, notes and debentures for which the Companies have the positive
intent and ability to hold to maturity are carried at cost, as adjusted for
premiums and discounts that are recognized in interest income using the interest
method over the period to maturity. Debt and equity securities that have readily
determinable fair values are carried at fair value unless they are classified as
held to maturity. Securities are classified as held to maturity and carried at
amortized cost only if the reporting entity has a positive intent and ability to
hold these securities to maturity. Securities held principally for resale in the
near term are classified as trading account securities and recorded at fair
value. Unrealized gains and losses on trading account securities are included in
income. If not classified as trading or held to maturity, such securities are
classified as available for sale. Unrealized holding gains or losses for
securities available for sale are excluded from earnings and reported as a
separate component of stockholders equity.

Income Taxes

Wycon and UnaMark elected with the consent of their stockholders to be
taxed as S Corporations under Section 1362(a) of the Internal Revenue Code.
Under this section, Wycon and UnaMark do not pay Federal income taxes. Instead,
the stockholders reflect the taxable income or losses in their personal income
tax returns. Consequently, no provisions for Federal income taxes of Wycon and
UnaMark are reflected in the combined financial statements. With respect to
Preferred and Americlaim, certain items of income and expense are reported in
different periods for financial statement purposes and for federal income tax
purposes. The differences relate primarily to different methods of accounting
for deferred acquisition costs, loss reserves, and unearned premiums. Preferred
and Americlaim account for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, which
requires the liability method of computing deferred income taxes. For federal
and state income tax purposes, PNFC and Preferred file consolidated tax returns.
PNFC is liable and makes the payments to the taxing authorities but, pursuant to
an agreement, recovers from Preferred its share of the income taxes. Preferred
records a tax provision as if it were a separate filing entity.

Reinsurance

Premiums written are ceded on a treaty and facultative basis. Property per
risk excess and casualty excess of loss and catastrophe reinsurance contracts
are maintained to protect against losses over specified amounts arising from any
one occurrence or event. Reinsurance premiums, commissions, expense
reimbursements, and reserves

F-41
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
related to reinsured business are accounted for on bases consistent with those
used in accounting for the original policies issued and the terms of the
reinsurance contracts. Premiums ceded to other companies have been reported as a
reduction of premium income. Amounts applicable to reinsurance ceded for
unearned premium reserves and loss and loss adjustment expense reserves have
been reported as prepaid insurance premiums and reinsurance recoverable,
respectively.

Property and Equipment

Property and equipment of $35,354 is included in other assets and is
carried at cost less accumulated depreciation. Depreciation is provided on the
straight-line method over the estimated useful lives of the assets, which range
from five to seven years. Accumulated depreciation on property and equipment was
$77,879 at December 31, 1997. Depreciation expense on property and equipment was
$8,014 for the year ended December 31, 1997.

New Accounting Pronouncement

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires that all components of comprehensive income be reported on
one of the following: (1) the statement of income, (2) the statement of changes
in stockholders' equity, or (3) a separate statement of comprehensive income.
Comprehensive income is comprised of net income and all changes to stockholders
equity, except those due to investments by owners (changes in paid-in capital)
and distributions to owners (dividends). SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997. The adoption of SFAS No. 130 is not
expected to have a material impact on the Companies financial statements
presentation.

In December 1997, the AICPA issued Statement of Position 97-3, Accounting
by Insurance and Other Enterprises for Insurance-Related Assessments ('SOP
97-3'). SOP 97-3 provides guidance on the recognition and measurement of
liabilities for guaranty-fund and other insurance-related assessments. SOP 97-3
is effective for financial statements for fiscal years beginning after December
15, 1998. The effect of the initial adoption of SOP 97-3 is required to be
reported in a manner similar to the reporting of a cummulative effect of a
change in accounting principle. The adoption of SOP 97-3 is not expected to have
a material impact on the Company's financial condition or results of operations.

2. SECURITIES

The amortized cost and estimated fair values of available for sale
securities are as follows:

<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- -------- ---------- -----------
<S> <C> <C> <C> <C>
Bonds:
U.S. Treasury securities and obligations of
U.S. Government agencies.................... $35,833,000 $120,000 $ 22,000 $35,931,000
Obligations of states and political
subdivisions................................ 771,000 1,000 770,000
Corporate securities........................... 21,404,000 10,000 21,414,000
----------- -------- ---------- -----------
Total bonds.................................... $58,008,000 $130,000 $ 23,000 $58,115,000
----------- -------- ---------- -----------
----------- -------- ---------- -----------
</TABLE>

The estimated fair values have been determined by the Companies using
available market information and appropriate valuation methodologies. The fair
values are significantly affected by the assumptions used.

F-42
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

2. SECURITIES--(CONTINUED)
Accordingly, the use of different assumptions may have a material effect on the
fair values. The estimated fair values presented herein are not necessarily
indicative of the amounts that the Companies could realize in a current market
exchange nor of the aggregate underlying value of the Companies themselves.

The amortized cost and estimated fair value of bonds at December 31, 1997,
by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
----------- -----------
<S> <C> <C>
Due in one year or less.................................................. $11,163,000 $11,170,000
Due after one year through five years.................................... 20,247,000 20,347,000
Due after five years through ten years................................... 11,978,000 11,978,000
Due after ten years...................................................... 14,620,000 14,620,000
----------- -----------
$58,008,000 $58,115,000
----------- -----------
----------- -----------
</TABLE>

Net investment income for the year ended December 31, 1997 is comprised of
the following:

<TABLE>
<S> <C>
Securities available for sale............................................................. $2,899,393
Other..................................................................................... 78,923
----------
Investment income, before expense......................................................... 2,978,316
Investment expense........................................................................ 101,572
----------
Net investment income..................................................................... $2,876,744
----------
----------
</TABLE>

Proceeds from sales of securities available for sale during 1997 were
$10,142,000. Gross gains of $45,000 were realized on the sales during 1997.
Gross losses of $41,000 were realized on sales during 1997.

As of December 31, 1997, $2,526,000, $100,000, $210,000 and $157,000 of
securities available for sale were on deposit with the insurance departments of
the States of Florida, Louisiana, Arkansas and South Carolina respectively, as
required by state insurance regulations.

F-43
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

3. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for unpaid losses and loss adjustment expenses
for the year ended December 31, 1997 is summarized as follows:

<TABLE>
<S> <C>
Balance at January 1..................................................................... $ 5,313,000
Less reinsurance recoverable........................................................... 665,000
-----------
Net balance at January 1................................................................. 4,648,000
-----------
Incurred related to:
Current year........................................................................... 17,460,000
Prior years............................................................................ (304,000)
-----------
Total incurred........................................................................... 17,156,000
-----------
Paid related to:
Current year........................................................................... 2,807,000
Prior years............................................................................ 1,353,000
-----------
Total paid............................................................................... 4,160,000
-----------
Net balance at December 31............................................................... 17,644,000
Plus reinsurance recoverable........................................................... 2,813,000
-----------
Balance at December 31................................................................... $20,457,000
-----------
-----------
</TABLE>

As a result of changes in estimates of insured events in prior years,
losses and loss adjustment expenses incurred decreased by $304,000 in 1997
primarily because of favorable development in the fidelity and surety business.

4. INCOME TAXES

The components of the provision for income taxes for the year ended
December 31, 1997 are as follows:

<TABLE>
<S> <C>
Current income taxes:
Federal................................................................................. $1,024,100
State................................................................................... 95,581
----------
Total..................................................................................... 1,119,681
Deferred income tax benefit............................................................... (307,223)
----------
Total..................................................................................... $ 812,458
----------
----------
</TABLE>

Deferred income taxes reflect the net tax effects of: (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for tax purposes; and (b) operating loss
and tax credit carryforwards. The tax effects of significant items comprising
the Companies net deferred tax asset as of December 31, 1997 are as follows:

<TABLE>
<S> <C>
Deferred tax asset:
Difference between accounting and tax basis of unearned premiums........................ $1,325,406
Difference between accounting and tax basis of loss reserves............................ 991,004
----------
Total deferred tax asset.................................................................. 2,316,410
----------
Deferred tax liability:
Deferred policy acquisition costs....................................................... 1,788,289
Write-up of securities available for sale................................................. 40,131
----------
Total deferred tax liability.............................................................. 1,828,420
----------
Net deferred tax asset.................................................................... $ 487,990
----------
----------
</TABLE>

Although realization is not assured, management believes it is more likely
than not that all of the deferred tax asset will be realized based on the
assumption that the historical levels of income will be achieved.

F-44
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
YEAR ENDED DECEMBER 31, 1997

5. REINSURANCE

Surety Bond Surplus Share Reinsurance

In May 1994, Preferred entered into a surety bond surplus reinsurance
agreement with Winterthur Reinsurance Corporation of America under which
Preferred retains all bonds for $99,999 or less. For bonds greater than $100,000
but not more than $3,000,000, Preferred retains the pro rata share as defined
below and cedes the remainder to the reinsurer as follows:

<TABLE>
<CAPTION>
COMPANY REINSURER'S
BOND AMOUNT RETENTION PARTICIPATION
- ------------------------------------------------------------------------------- --------- -------------
<S> <C> <C>
$0-$99,999..................................................................... 100% 0%
$100,000-$199,999.............................................................. 90% 10%
$200,000-$299,999.............................................................. 75% 25%
$300,000-$399,999.............................................................. 65% 35%
$400,000-$499,999.............................................................. 55% 45%
$500,000-$1,000,000............................................................ 40% 60%
$1,000,001-$1,500,000.......................................................... 35% 65%
$1,500,001-$3,000,000.......................................................... 30% 70%
</TABLE>

Preferred receives a 40% flat ceding commission with a contingent
commission of 25% of the net profit, if any, generated during each accounting
period beginning May 1, 1994 through December 31, 1994, and the twelve-month
period beginning each January 1st thereafter. Prior to the agreement described
above, Preferred ceded large contract surety bonds on a facultative basis.

Commercial Liability Excess of Loss

Preferred entered into a commercial liability excess of loss reinsurance
agreement effective January1, 1996 with General Reinsurance Corporation. This
treaty covers commercial multi-peril, medical malpractice, and other liability
business written by Preferred. The policy provides for two levels of coverage as
follows: Limit of $250,000 per occurrence in excess of $250,000 per occurrence
(First Excess); and a limit of $500,000 per occurrence in excess of $500,000 per
occurrence (Second Excess).

Rate as percentages of written premiums are as follows:

<TABLE>
<CAPTION>
FIRST SECOND
LINE OF BUSINESS EXCESS EXCESS
- ------------------------------------------------------------------------- --------------- -------------
<S> <C> <C>
Professional Liability (Non-medical)..................................... 11.63% 8.17%
Dental Professional...................................................... 5.33% 4.69%
Liquor Liability......................................................... 5.16% 1.46%
General Liability........................................................ 4.19% 3.03%
</TABLE>

Preferred receives a contingent commission on the first excess layer of 50%
of the net profit (as defined in the agreement) with a three-year rating period.
The first rating period is from January 1, 1996 to December 31, 1998 with annual
interim adjustments to be made.

Property Per Risk Excess of Loss

Effective May 1, 1996, Preferred entered into a property per risk excess of
loss agreement with General Reinsurance Corporation which provides for two
layers of coverage. The first layer has limits of $500,000 per risk in excess of
$500,000 per risk subject to an occurrence limitation of $1,500,000. The second
layer has limits of $1,000,000 per risk in excess of $1,000,000 per risk subject
to an occurrence limitation of $2,000,000. The first layer requires ceded
premiums of 2.75% of Preferred's subject premium earned. The second layer
requires

F-45
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

5. REINSURANCE--(CONTINUED)
ceded premiums of 1.50% of Preferred's subject premium earned. Effective January
1, 1997, the first layer rate was adjusted to 2.0% of Preferred's subject
premium earned.

Property Catastrophe Excess of Loss

Effective May 1, 1996, Preferred and an insurance company affiliated
through common ownership entered into a property catastrophe excess of loss
agreement with third-party reinsurers. The first layer has limits of 95% of
$5,000,000 ultimate net loss, each loss event in excess of $5,000,000. The
second layer has limits of 95% of $10,000,000 ultimate net loss, each loss event
in excess of $10,000,000. The minimum premium and deposit premiums for the first
layer are $400,720 and $534,300, respectively, adjustable at 5.084% of net
written premium. The minimum and deposit premiums for the second layer are
$445,260 and $593,700, respectively, adjustable at 5.649% of net written
premium. Payment of the deposit premium has been allocated between Preferred and
the affiliated insurance company based upon the pro rata portion of premiums
written by each company. This agreement expired on April 30, 1997.

Effective May 1, 1997, Preferred entered into a property catastrophe excess
of loss agreement with third party reinsurers. The first and second layers have
limits identical to those in the treaty effective May 1, 1996 which expired
April 30, 1997. The minimum and deposit premium for the first layer are $484,500
and $646,000, respectively, adjustable at 4.472% of net written premium. The
minimum and deposit premiums for the second layer are $534,375 and $712,500,
respectively, adjustable at 4.933% of net written premium. The third layer has
limits of 95% of $10,000,000 ultimate net loss, each loss event in excess of
$20,000,000. The minimum and deposit premiums are $320,625 and $427,500,
respectively, adjustable at 2.96% of net written premium.

Facultative Reinsurance--Preferred cedes property and liability business to
various reinsurers on a facultative basis.

The effects of reinsurance on unpaid losses and loss adjustment expenses,
premiums written, premiums earned, and unearned premiums at December 31, 1997
were as follows:

<TABLE>
<CAPTION>
UNPAID LOSSES
AND LOSS
ADJUSTMENT PREMIUMS PREMIUMS UNEARNED
DECEMBER 31, 1997 EXPENSES WRITTEN EARNED PREMIUMS
- ------------------------------------------ ------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Direct.................................... $20,457,000 $46,133,000 $32,682,000 $19,906,000
Ceded..................................... (2,813,000) (5,684,000) (4,104,000) (2,295,000)
------------- ----------- ----------- -----------
Total..................................... $17,644,000 $40,449,000 $28,578,000 $17,611,000
------------- ----------- ----------- -----------
------------- ----------- ----------- -----------
</TABLE>

In the event that all or any of the reinsuring companies might be unable to
meet their obligations under existing reinsurance agreements, Preferred would be
liable for such defaulted amounts. Estimated amounts recoverable from reinsurers
deducted from the reserve for losses and loss adjustment expenses was
approximately $2,813,000 for 1997. Amounts deducted from unearned premiums for
ceded premiums was $2,295,000 as of December 31, 1997. Amounts for ceded
incurred losses and loss adjustment expenses of $2,918,000 were deducted from
incurred losses for 1997.

6. REGULATORY MATTERS

Preferred is subject to comprehensive supervision and regulation by the
Florida Department of Insurance.

Florida insurance regulations require Preferred to maintain not less than
the greater of unimpaired paid-in surplus of $2,100,000 or 10% of total
liabilities as of December 31, 1997. Preferred is restricted by Florida
insurance statutes as to the amount of dividends which can be paid. Dividends
can only be paid out of available

F-46
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)

YEAR ENDED DECEMBER 31, 1997

6. REGULATORY MATTERS--(CONTINUED)
and accumulated surplus funds which are derived from realized net operating
profits and net realized capital gains. Dividend payments are limited to 10% of
such surplus in any one year. In addition, an insurance company may make
dividend payments out of the entire net operating profits and realized net
capital gains derived during the immediate preceding calendar year. During 1997,
no dividends were paid.

During 1995, Preferred underwent an examination for the three-year period
ended December 31, 1994, conducted by the Florida Department of Insurance. A
final report, dated February 2, 1996, has been received by Preferred and did not
indicate any material instances of noncompliance or adjustments to surplus as
regards policyholders.

The following schedule reconciles statutory net income and surplus of
Preferred as reported in the 1997 annual statement filed with the Florida
Department of Insurance, prepared on the basis of statutory accounting
principles (SAP) to Preferreds net income and stockholders' equity under
generally accepted accounting principles (GAAP) at December 31, 1997:

<TABLE>
<CAPTION>
NET INCOME
(LOSS) SURPLUS
----------- -----------
<S> <C> <C>
Balance per statutory accounting practices................................ $(2,464,172) $26,751,558
Write-up of securities available for sale................................. 107,016
Deferred policy acquisition costs......................................... 3,620,226 4,752,294
Deferred income taxes..................................................... 307,223 487,990
Elimination of provision for reinsurance.................................. 8,600
Non-admitted assets....................................................... 426,418
----------- -----------
Balance per generally accepted accounting principles...................... $ 1,463,277 $32,533,876
----------- -----------
----------- -----------
</TABLE>

7. STOCKHOLDERS' EQUITY

The components of combined stockholders' equity as of December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
NET UNREALIZED
COMMON CAPITAL STOCK GAINS ON
------------------------------------- ADDITIONAL SECURITIES
SHARES SHARES PAID-IN RETAINED AVAILABLE FOR
AUTHORIZED ISSUED AMOUNT CAPITAL EARNINGS SALE--NET
---------- --------- ---------- ----------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C>
Preferred National Insurance
Company
$1 par value.............. 5,000,000 3,500,000 $3,500,000 $23,041,334 $5,925,657 $ 66,885
Wycon Corporation
$1 par value.............. 500,000 1,000 1,000
Americlaim Adjustment Corp.
$1 par value.............. 1,000 150 150 50,000 (46,933)
United American Financial
Services Corporation
$.10 par value............ 10,000 100 10 69,017
--------- ---------- ----------- ---------- --------------
3,501,250 $3,501,160 $23,160,351 $5,878,724 $ 66,885
--------- ---------- ----------- ---------- --------------
--------- ---------- ----------- ---------- --------------
</TABLE>

During 1997, PNFC contributed capital in the form of cash in the amount of
$3,500,000 to PNIC.

F-47
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
YEAR ENDED DECEMBER 31, 1997

8. SUBSEQUENT EVENT

PFNC, Wycon, Americlaim and UnaMark executed a Stock and Asset Purchase and
Sale Agreement (the 'Agreement') dated March 6, 1998. The Agreement stipulates
that:

(1) PNFC will sell all of the stock of Preferred National Insurance
Company to Front Royal, Inc. or one or more of its affiliates, and

(2) Wycon, UnaMark and Americlaim will sell certain fixed and
intangible assets, specifically their furniture, fixtures and
equipment and their customer lists, renewal rights and other
intangible assets, to Front Royal, Inc. or one or more of its
affiliates, and

(3) Wycon, Americlaim and UnaMark will assign certain liabilities to
Front Royal, Inc. or one or more of its affiliates.

The Agreement is subject to regulatory approval from the Florida Department
of Insurance.

9. COMMITMENTS

The Companies are lessees under operating leases for office space and
equipment. As of December 31, 1997, the approximate future minimum annual lease
payments with initial or remaining terms of more than one year are as follows:

<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, AMOUNT
- ---------------------------------------------------------------------- ----------
<S> <C>
1998.................................................................. $ 434,136
1999.................................................................. 407,458
2000.................................................................. 322,191
2001.................................................................. 6,130
----------
Total................................................................. $1,169,915
----------
----------
</TABLE>

Total rent expense for the year ended December 31, 1997 was approximately
$410,000.

* * * * * *

F-48
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED BALANCE SHEET
MARCH 31, 1998
(UNAUDITED)

<TABLE>
<S> <C>
ASSETS

Cash on hand and on deposit........................................................................ $ 3,872,822
Securities available for sale...................................................................... 61,094,347
Accounts and agents balances receivable............................................................ 2,285,870
Reinsurance recoverable............................................................................ 3,937,971
Deferred acquisition costs......................................................................... 4,489,067
Prepaid insurance premiums......................................................................... 2,312,145
Accrued investment income.......................................................................... 427,280
Receivable from affiliates......................................................................... 22,124
Deferred tax asset................................................................................. 766,753
Cash surrender value of life insurance............................................................. 870,033
Due from stockholders.............................................................................. 25,000
Other assets, net................................................................................ 93,913
-----------
Total......................................................................................... $80,197,325
-----------
-----------

LIABILITIES AND STOCKHOLDERS' EQUITY

Losses............................................................................................. $19,111,760
Loss adjustment expenses........................................................................... 5,885,725
Other liabilities.................................................................................. 998,650
Income taxes payable............................................................................... 664,573
Unearned premiums.................................................................................. 19,566,288
Note payable to affiliate.......................................................................... 500,000
-----------
Total liabilities............................................................................. 46,726,996
-----------
Common capital stock............................................................................... 3,501,160
Additional paid-in capital......................................................................... 23,160,351
Retained earnings.................................................................................. 6,725,096
Net unrealized gains on securities available for sale (net of tax provision of $50,233)............ 83,722
-----------
Total stockholders' equity.................................................................... 33,470,329
-----------
Total......................................................................................... $80,197,325
-----------
-----------
</TABLE>

See notes to combined unaudited financial statements.

F-49
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF OPERATIONS
THREE-MONTH PERIOD ENDED MARCH 31, 1998
(UNAUDITED)

<TABLE>
<S> <C>
Revenues:
Premiums................................................................................ $8,938,127
Fees and commissions.................................................................... 448,511
Net investment income................................................................... 963,956
Realized capital gains and losses....................................................... 40,220
Other income............................................................................ 4,764
----------
Total revenues....................................................................... 10,395,578
----------
Expenses:
Losses.................................................................................. 4,141,410
Loss expenses incurred.................................................................. 1,233,653
Underwriting, acquisition and insurance expenses:
Amortization of deferred policy acquisition costs.................................... 2,106,070
Salaries and employee benefits....................................................... 961,076
Other................................................................................ 832,962
----------
Total expenses..................................................................... 9,275,171
----------
Earnings before provision for income taxes................................................ 1,120,407
Provision for income taxes................................................................ 274,035
----------
Net income................................................................................ $ 846,372
----------
----------
</TABLE>

See notes to combined unaudited financial statements.

F-50
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
THREE-MONTH PERIOD ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
NET UNREALIZED
GAINS
COMMON ADDITIONAL ON AVAILABLE
CAPITAL PAID-IN RETAINED FOR SALE
STOCK CAPITAL EARNINGS SECURITIES TOTAL
---------- ----------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997............. $3,501,160 $23,160,351 $5,878,724 $ 66,885 $32,607,120
Net income........................... 846,372 846,372
Net unrealized gains on securities
available for sale, net of tax
provision of $10,102.............. 16,837 16,837

<CAPTION>
---------- ----------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C>
Balance, March 31, 1998................ $3,501,160 $23,160,351 $6,725,096 $ 83,722 $33,470,329
<CAPTION>
---------- ----------- ---------- -------------- -----------
---------- ----------- ---------- -------------- -----------
</TABLE>

See notes to combined unaudited financial statements.
F-51
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
COMBINED STATEMENT OF CASH FLOWS
THREE-MONTH PERIOD ENDED MARCH 31, 1998
(UNAUDITED)

<TABLE>
<CAPTION>
Cash flows from operating activities:
<S> <C>
Net income..................................................................................... $ 846,372
-------------
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premiums/discounts on bonds............................................. 48,612
Net realized capital gain................................................................... (40,220)
Deferred income tax benefit................................................................. (288,865)
Increase in accrued interest receivable..................................................... (112,535)
Decrease in deferred acquisition costs...................................................... 263,227
Decrease in accounts and agents balances receivable......................................... 683,762
Increase in other assets and receivable from affiliates..................................... (1,239)
Increase in prepaid insurance premiums...................................................... (17,459)
Increase in reinsurance recoverable on paid losses.......................................... (819,011)
Increase in losses and loss adjustment expenses............................................. 4,539,903
Decrease in unearned premiums............................................................... (339,421)
Decrease in income taxes payable............................................................ (518,968)
Decrease in other liabilities............................................................... (25,260)
-------------
Total adjustments...................................................................... 3,372,526
-------------
Net cash provided by operating activities.............................................. 4,218,898
-------------

Cash flows from investing activities:
Purchases of available for sale securities..................................................... (22,702,374)
Proceeds from maturities and sales of available for sale securities............................ 19,742,042
Advances to stockholders....................................................................... (25,000)
-------------
Net cash used in investing activities.................................................. (2,985,332)
-------------

Cash flows from financing activities:
S Corporation distributions to stockholders.................................................... (2,244,062)
Issuance of note payable to affiliate.......................................................... 500,000
-------------
Net cash used in financing activities.................................................. (1,744,062)
-------------

Net increase in cash............................................................................. (510,496)
Cash, beginning of period........................................................................ 4,383,318
-------------
Cash, end of period.............................................................................. $ 3,872,822
-------------
-------------
</TABLE>

See notes to combined unaudited financial statements.

F-52
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO COMBINED UNAUDITED FINANCIAL STATEMENTS
THREE-MONTH PERIOD ENDED MARCH 31, 1998

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

The accompanying combined financial statements present the financial
position, results of operations and cash flows of Preferred National Insurance
Company ('Preferred'), Wycon Corporation ('Wycon'), Americlaim Adjustment Corp.
('Americlaim') and United American Financial Services Corporation ('UnaMark')
(the 'Companies'). The Companies are related in their operations and are
affiliated through common management and ownership as one individual owns a
controlling interest in all of the entities. All significant intercompany
balances and transactions are eliminated in combination.

Preferred, a wholly-owned subsidiary of Preferred National Financial Corp.
('PNFC'), is a property and casualty insurance company and files its annual
report with the Insurance Department of the State of Florida. Prior to 1996, the
Company principally underwrote fidelity bonds and surety bonds. In 1996, the
Company began underwriting special multi-peril, professional liability and other
liability insurance. Preferred was incorporated in 1988 and obtained a license
to write specified coverages in the State of Florida on March 10, 1989.
Underwriting activities began in October 1989.

Wycon is an underwriting manager for Preferred and Britamco Underwriters,
Inc. ('Britamco'). Britamco is a property and casualty insurance company owned
by PNFC. Wycon's duties as underwriting manager include providing all of the
underwriting and administrative services necessary to operate Preferred and
Britamco. Wycon is also a general agent providing underwriting and
administrative services for an independent insurance company. Americlaim
provides claims adjustment services to Preferred and Britamco. UnaMark is a
captive general agency that solicits insurance accounts to be written by
Preferred.

The combined financial statements included herein have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission (the 'Commission') for interim financial information. As such, the
financial statements do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements and they should be read in conjunction with the financial statements
and related footnotes included in the Companies' combined financial statements
for the year ended December 31, 1997.

The combined financial statements are unaudited but, in the opinion of
management, contain all adjustments (consisting only of normal recurring
adjustments) necessary to present fairly the combined balance sheet of the
Companies as of March 31, 1998, the combined statement of operations of the
Companies for the three-month period ended March 31, 1998, and the combined
statement of cash flows for the three-month period ended March 31, 1998.
Operating results for the three-month period ended March 31, 1998 are not
necessarily indicative of the results for the full fiscal year.

2. NOTE PAYABLE TO AFFILIATE

On January 27, 1998, Wycon executed a note payable to PNFC for $500,000.
The note bears interest at 6% per annum, is unsecured, and due on demand.

3. NEW ACCOUNTING STANDARD

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ('SFAS') No. 130, Reporting Comprehensive Income,
which requires the presentation of total nonowner changes in equity for all
periods displayed. The Companies hold securities which are accounted for under
SFAS No. 115 as available-for-sale. The unrealized gains and losses on these
securities are treated as a component of comprehensive income under SFAS No.
130. The Companies have no other transactions that affect comprehensive income
for the three-month period ended March 31, 1998. The following is a
reconciliation of the Companies' net income and comprehensive income for the
three-month period ended March 31, 1998.

F-53
<PAGE>
PREFERRED NATIONAL INSURANCE COMPANY AND AFFILIATES
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)

THREE-MONTH PERIOD ENDED MARCH 31, 1998

3. NEW ACCOUNTING STANDARD--(CONTINUED)

<TABLE>
<S> <C>
Net income.................................................................................. $846,372
Unrealized gain on securities, net of tax................................................... 16,837
--------
Comprehensive income........................................................................ $863,209
--------
--------
</TABLE>

In December 1997, the AICPA issued statement of position 97-3, Accounting
by Insurance and Other Enterprises for Insurance-Related Assessments ('SOP
97-3'). SOP 97-3 provides guidance on the recognition and measurement of
liabilities for guaranty-fund and other insurance-related assessments. SOP 97-3
is effective for financial statements for fiscal years beginning after December
15, 1998. The effect of the initial adoption of SOP 97-3 is required to be
reported in a manner similar to the reporting of a cumulative effect of a change
in accounting principle. The adoption of SOP 97-3 is not expected to have a
material impact on the Company's financial condition or results of operations.

F-54
<PAGE>
REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
Rockwood Casualty Insurance Company and Subsidiaries

We have audited the accompanying consolidated statements of operations and cash
flows of Rockwood Casualty Insurance Company and Subsidiaries for the year ended
December 31, 1996. These statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the consolidated
statements of operations and cash flows based on our audit.

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

In our opinion, the statements of operations and cash flows referred to above
present fairly, in all material respects, the consolidated results of operations
and cash flows of Rockwood Casualty Insurance Company and Subsidiaries for the
year ended December 31, 1996, in conformity with generally accepted accounting
principles.

/S/ ERNST & YOUNG LLP

ERNST & YOUNG LLP

Richmond, Virginia
September 3, 1997

F-55
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Revenues:
Net premiums earned....................................................................... $ 52,485
Net investment income..................................................................... 10,286
Net realized gains on investments......................................................... 54
Other income.............................................................................. 16
----------
Total revenues.................................................................... 62,841
----------
Losses and expenses:
Net losses and loss adjustment expenses................................................... 15,153
Policy acquisition costs amortized........................................................ 12,149
Other underwriting expenses............................................................... 1,629
Dividends to policyholders................................................................ 6,327
----------
Total losses and expenses......................................................... 35,258
----------
Income before federal income taxes.......................................................... 27,583

Federal income tax expense/(benefit):
Current................................................................................... 9,647
Deferred.................................................................................. (3,690)
----------
Net income.................................................................................. $ 21,626
----------
----------
</TABLE>

See accompanying notes.
F-56
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Operating activities:
Net income................................................................................ $ 21,626
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of policy acquisition costs............................................... 12,149
Policy acquisition costs deferred...................................................... (12,612)
Net realized gains on sale of investments.............................................. (54)
Provision for depreciation and amortization............................................ 115
Deferred income taxes.................................................................. (3,690)
Change in operating assets and liabilities:
Unearned premiums.................................................................... 4,746
Reserve for losses and loss adjustment expenses...................................... (4,449)
Reinsurance recoverable and payable.................................................. (6,636)
Policyholder dividends............................................................... 1,810
Premiums receivable.................................................................. (770)
Other................................................................................ 101
----------
Net cash provided by operating activities................................................... 12,336
----------

Investing activities:
Securities available-for-sale:
Purchases--fixed maturities and equities............................................... (17,997)
Sales--fixed maturities and equities................................................... 23,704
Securities held to maturity:
Purchases--fixed maturities............................................................ (39,086)
Maturities and calls of fixed securities............................................... 32,712
Net sales of short-term investments....................................................... 2,195
Note receivable........................................................................... (2,500)
Other..................................................................................... (120)
----------
Net cash used in investing activities....................................................... (1,092)
----------

Financing activities:
Dividend paid to parent................................................................... (8,500)
----------
Net cash used in financing activities....................................................... (8,500)
----------
Increase in cash............................................................................ 2,744
Cash at beginning of year................................................................... 1,745
----------
Cash at end of year......................................................................... $ 4,489
----------
----------
</TABLE>

See accompanying notes.

F-57
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS
DECEMBER 31, 1996

1. ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated statements of operations and cash flows have
been prepared in conformity with generally accepted accounting principles
('GAAP') which vary in some respects from statutory accounting practices
prescribed or permitted by regulatory authorities.

Consolidation

The accompanying consolidated statements of operations and cash flows
include the accounts and operations of Rockwood Casualty Insurance Company and
its wholly-owned subsidiaries, Mid State Insurance Underwriters, Inc.,
Comprehensive Casualty Services, Inc. and Coal Operators Indemnity Company,
collectively referred to as the 'Company.'

Significant intercompany accounts and transactions have been eliminated.
The preparation of statements of operations and cash flows of insurance
companies requires management to make estimates and assumptions that affect
amounts reported in the statements of operations and cash flows and accompanying
notes. Such estimates and assumptions may be subject to change in the future as
more information becomes known which could impact the amounts reported and
disclosed herein.

Business Operations and Organization

The Company is a wholly-owned subsidiary of Front Royal, Inc. ('FRINC') who
acquired the Company on December 31, 1996. On January 1, 1996, the Company was a
wholly-owned subsidiary of Physicians Insurance Company ('PIC') and Tri-Rock
Limited Partnership ('Tri-Rock'). PIC and Tri-Rock acquired ownership effective
June 30, 1994. Prior to the acquisition by PIC and Tri-Rock, the Company was
owned by Rockwood Insurance Company ('RIC').

Rockwood Casualty Insurance Company is a Pennsylvania-domiciled insurer
which provides commercial property and casualty insurance primarily in
Pennsylvania and Maryland. The Company specializes in underwriting workers'
compensation coverage for both underground and surface coal mining operations
and other commercial risks.

The Company's subsidiaries are primarily in the business of providing
various insurance services to third parties. In aggregate, these subsidiaries
provide less than 1% of consolidated revenues and expenses.

Approximately $14,900,000 of the Company's gross written premiums were
derived from two agents for the year ended December 31, 1996. The loss of either
of these agents could have a material adverse effect on the Company.

Investments

The amortized cost of fixed maturity investments is adjusted for
amortization of premiums and accretion of discounts. That amortization or
accretion is included in investment income.

Income for mortgage-backed bonds is recognized using a constant effective
yield based on anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from anticipated
prepayments, the estimated economic life is recalculated and the remaining
unamortized premium or discount is amortized prospectively over the remaining
economic life.

Realized gains and losses on sales of investments, and declines in value
considered to be other-than-temporary, are recognized in operations on the
specific identification basis for debt securities and on the first-in, first-out
basis for equity securities.

F-58
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
Property and Equipment

Property and equipment is depreciated principally using the straight line
method over the estimated useful lives of the respective assets. Depreciation
expense was $103,000 in 1996.

Premiums

Workers' compensation premiums based on payroll reporting are recorded as
written when payroll reports are received from the insured or are estimated if
reports have not been received.

Workers' compensation premiums on policies with deferred installment
payment plans are recorded as written when individual installments are billed.

Accrued retrospectively rated premiums have been determined based upon
estimated ultimate loss experience on individual policyholder accounts.

Participating Policies

Participating business written by the Company represents approximately 30%
of the total premiums in force and premium income for the year ended December
31, 1996. The participating business is composed of workers' compensation
policies. The amount of dividends to be paid on these policies is determined
based on the terms of the individual policies.

Deferred Policy Acquisition Costs

Acquisition costs, consisting principally of agents' commissions, certain
operating expenses and premium taxes, are deferred and amortized over the period
in which the related premiums are earned, generally twelve months. Commission
related to insurance risks ceded to other insurance companies are recorded as a
reduction to deferred policy acquisition costs.

Reserve for Losses and Loss Adjustment Expenses

Loss and loss adjustment expense reserves represent the estimated ultimate
net cost of all reported and unreported losses incurred through December 31. The
Company discounts loss and loss adjustment expense reserves related to workers'
compensation coverages for both GAAP and statutory reporting purposes at 4%. The
Company does not discount reserves related to other lines of business. The
reserves for unpaid losses and loss adjustment expenses are estimated using
individual case-basis valuations and statistical analyses. Those estimates are
subject to the effects of trends in loss severity and frequency. Although
considerable variability is inherent in such estimates, management believes that
the reserves for losses and loss adjustment expenses are adequate. These
estimates are continually reviewed and adjusted as necessary as experience
develops or new information becomes known; such adjustments are included in
current operations.

Reinsurance

The Company assumes and cedes reinsurance to allow management to control
exposure to potential losses arising form large risks, to provide additional
capacity for growth and to provide for greater diversification of business. This
reinsurance is effected primarily under excess of loss and quota-share
reinsurance contracts.

F-59
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
Reinsurance premiums, commissions, and expense reimbursements on reinsured
business are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts.
Expense reimbursements received in connection with reinsurance ceded have been
accounted for as reductions of the related policy acquisition costs.

Accrued retrospectively rated reinsurance premiums have been determined
based upon estimated ultimate loss experience on business subject to such
experience rating adjustments.

2. INVESTMENTS

Major categories of the Company's investment income are summarized as
follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Fixed maturity securities............................................... $ 9,727
Short-term investments.................................................. 489
Equity securities....................................................... 179
Other................................................................... 25
----------
Gross investment income............................................... 10,420
Investment expenses..................................................... (134)
----------
Net investment income................................................. $10,286
----------
----------
</TABLE>

The Company's realized gains and losses on available-for-sale investments
are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Fixed maturity securities:
Gross realized gains.................................................. $ 76
Gross realized losses................................................. (23)
----------
Net gains.......................................................... 53
Equity securities:
Gross realized gains.................................................. 26
Gross realized losses................................................. (25)
----------
Net gains.......................................................... 1
----------
Net realized gains................................................. $ 54
----------
----------
</TABLE>

F-60
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

3. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The following table provides a reconciliation of the beginning and ending
reserve balances for loss and loss adjustment expenses ('LAE'),
net-of-reinsurance, for 1996.

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Reserve for losses and LAE, net of related reinsurance recoverables, at beginning
of year......................................................................... $120,934
Add:
Provision for losses and LAE for claims occurring in the current year, net of
reinsurance.................................................................. 37,279
Decrease in incurred losses and LAE for claims occurring in prior years, net of
reinsurance.................................................................. (23,755)
-----------
Incurred losses and LAE during the current year, net of reinsurance and gross of
discount..................................................................... 13,524
Provision for discount on current accident year reserves........................ (3,169)
Amortization of discount on prior accident years reserves....................... 4,798
-----------
Incurred losses and LAE during the current year, net of reinsurance and net
of discount................................................................. 15,153
-----------
Deduct:
Losses and LAE payments for claims, net of reinsurance, occurring during:
Current year................................................................. (5,789)
Prior years.................................................................. (16,850)
-----------
Net claim payments during the year........................................... (22,639)
-----------
Reserve for losses and LAE, net of related reinsurance recoverables, at end of
year............................................................................ 113,448
Add:
Reinsurance recoverables on unpaid losses and LAE, at end of year............... 14,356
-----------
Reserve for losses and LAE, gross of reinsurance recoverables on unpaid loses and
LAE, at end of year............................................................. $127,804
-----------
-----------
</TABLE>

The foregoing reconciliation shows that a $23,755,000 redundancy in the
1995 and prior year reserves emerged in 1996. This redundancy is primarily a
result of lower than expected costs of settling claims which were open at the
end of 1995 and lower than expected per claim costs for incurred but unreported
claims at December 31, 1995. The Company attributes the lower costs primarily to
the effects of Pennsylvania Act 44 ('Act 44') which was enacted in September
1993. While the Act was expected to result in the lowering of medical costs to
workers' compensation carriers, the full effect on the Company's medical costs
could not be determined with precision until sufficient experience had emerged
to provide a basis for such determination. The Company revised its estimates of
the ultimate net cost of all reported and unreported losses incurred through
December 31, 1995 by mid 1996, after accumulating ten quarters of loss
experience following the passage of Act 44. The Company's 1996 provision for
loss and loss adjustment expenses occurring in the current year also reflects
the Company's assessment of the effects of Act 44 on the medical cost component
of workers' compensation claims based on actual loss data through December 31,
1996.

F-61
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

4. REINSURANCE

The Company remains liable to its policyholders if its reinsurers are
unable to meet their contractual obligations under applicable reinsurance
agreements. To minimize exposure to significant losses from reinsurance
insolvencies, the Company evaluates the financial condition of its reinsurers
and monitors concentrations of credit risk arising from similar geographic
regions, activities, or economic characteristics of the reinsurers.

Net written premiums are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Direct premiums................................................................ $ 68,212
Assumed premiums............................................................... 1,186
Ceded premiums................................................................. (15,153)
-----------
Net premiums written...................................................... $ 54,245
-----------
-----------
</TABLE>

Net premiums earned are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Direct premiums................................................................ $ 63,609
Assumed premiums............................................................... 1,044
Ceded premiums................................................................. (12,168)
-----------
Net premiums earned....................................................... $ 52,485
-----------
-----------
</TABLE>

Losses and LAE are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Direct losses and LAE.......................................................... $ 20,411
Assumed losses and LAE......................................................... 763
Ceded losses and LAE........................................................... (6,021)
-----------
Net losses and LAE........................................................ $ 15,153
-----------
-----------
</TABLE>

F-62
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

5. INCOME TAXES

The Company files a consolidated federal income tax return with its
subsidiaries. The Company's effective income tax rate on pre-tax income is lower
than the prevailing corporate federal income tax rate and is summarized as
follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Income tax expense at 35%........................... $9,654
Change in valuation allowance on deferred tax
assets............................................ (3,675)
Other............................................... (22)
-------
Income tax expense................................ $5,957
-------
-------
</TABLE>

The Company paid $9,300,000 of federal income taxes in 1996.

6. EMPLOYEE BENEFIT PLANS

The Company sponsored a defined benefit pension plan covering substantially
all full-time employees. Effective August 31, 1997, the defined benefit pension
plan was terminated. Upon receipt of a favorable determination letter from the
Internal Revenue Service, the assets of the plan shall be distributed to
participants.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31, 1996
(DOLLARS IN THOUSANDS)
<S> <C>
Pension Cost:
Service cost--benefit earned during current year.... $117
Interest cost on projected benefit obligation....... 115
Expected return on plan assets...................... (132)
Amortization of transition obligation............... 10
------
Net periodic pension cost........................... $110
------
------
Expected long-term rate of return on assets......... 8.0%
Rates of increase in compensation levels............ 4.5%
</TABLE>

Effective January 1, 1998, the 401(k) Profit Sharing Plan was merged into
the Front Royal, Inc. 401(k) Profit Sharing Plan. The 401(k) Profit Sharing
Trust, established in 1984, was available to substantially all full-time
employees of Rockwood Casualty. The Company did not match employee contributions
and did not make any discretionary contributions in 1996.

7. RELATED PARTIES

Premier Auto Insurance Company ('Premier') is a property and casualty
insurance company formed during 1996 as a wholly-owned subsidiary of the
Company, with an initial capitalization of $3,500,000. As outlined in Note 10,
Premier was sold on December 31, 1996.

During 1996 the Company entered into quota share reinsurance agreements
with PIC and Premier related to private passenger automobile and workers'
compensation insurance. Under the private passenger automobile program, the
Company ceded 100% of the premium and losses written to Premier. Under the
workers'

F-63
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

7. RELATED PARTIES--(CONTINUED)
compensation program, the Company assumed 100% of the premium and losses on
policies written by PIC. The following is a summary of the activity under the
agreements during 1996:

<TABLE>
<CAPTION>
PRIVATE
WORKERS' PASSENGER
COMPENSATION AUTOMOBILE NET
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Written premium assumed/(ceded).............. $1,112 $ (9,543) $(8,431)
Earned premium assumed/(ceded)............... 964 (6,743) (5,779)
Incurred loss and ALAE assumed/(ceded)....... 484 (5,472) (4,988)
Commission assumed/(ceded)................... 128 (1,454) (1,326)
</TABLE>

See Note 10 regarding the disposition of these agreements.

8. COMMITMENTS AND CONTINGENCIES

The Company is named as a defendant in legal actions arising primarily from
claims made under insurance policies. Those actions have been considered in
establishing the Company's reserve liabilities. Management and its legal counsel
are of the opinion that the settlement of these actions will not have a material
adverse effect on the Company.

Rockwood Insurance Company of Indiana ('RIND'), a company that merged into
Rockwood Casualty Insurance Company on December 31, 1990, issued certain medical
malpractice policies for claims occurring between January 1, 1978 and October 1,
1990. RIND reinsured these policies pursuant to a loss portfolio transfer
agreement with Covenant Mutual Insurance Company ('Covenant'). Covenant
subsequently went into liquidation and was unable to meet its obligation on the
reinsurance agreement. In May 1993, the Company's former parent, RIC, which went
into liquidation proceedings in 1991, established and funded a Liquidating Trust
('Trust') in accordance with an agreement approved by an order of the
Commonwealth Court of Pennsylvania, to service the medical malpractice claims
related to Covenant's default. Total assets in the Trust available to pay claims
and expenses at December 31, 1996 was $3,282,000. The Pennsylvania insurance
department currently manages the Trust and administers the claims.

As part of the Trust agreement, a certification of reserve liabilities is
prepared annually by an independent consulting actuary acceptable to both RIC
and the Company. The amount of actuarially determined liabilities related to
Covenant's default as of December 31, 1996 was $2,256,000. If the amount of
reserve liabilities on a discounted basis, times 115%, exceeds the amount in the
Trust Fund as of the date of the report, RIC shall pay to the Trustee, monies or
investment securities in the aggregate amount of the deficiency. Further, any
excess assets shall be returned to RIC.

The Company remains contingently liable for the medical malpractice claims
in the event that the Trust's assets, which consist primarily of investments in
short term U.S. Treasury obligations and cash equivalents, and future deficiency
funding by the former parent, if necessary, are not sufficient to fund the
ultimate liability. Management believes that there is minimal exposure relating
to this liability.

9. STATUTORY MATTERS

The Company is required to periodically submit financial statements
prepared in accordance with statutory accounting practices to insurance
regulatory authorities. Statutory accounting practices differ from generally
accepted accounting principles. Net income determined in accordance with
statutory accounting practices reported to regulatory authorities for the year
ended December 31, 1996 was $18,981,000.

The net assets of the Company that are transferable to Front Royal, Inc.
are limited to the amounts by which statutory capital and surplus exceed minimum
statutory requirements and regulatory approval is required for any distribution
in a twelve month period, other than for dividends or other distributions which,
in the aggregate, do

F-64
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS--(CONTINUED)

9. STATUTORY MATTERS--(CONTINUED)
not exceed the greater of either (i) ten percent of the insurer's surplus to
policyholders as of the immediately preceding December 31 or (ii) net income,
excluding realized gains, of the prior year.

10. CHANGE IN OWNERSHIP

On December 31, 1996 all of the outstanding stock of the Company was sold
by PIC and Tri-Rock to FRINC. The sale of capital stock and related transactions
involving the Company were approved on December 30, 1996 by the Pennsylvania
Insurance Department.

In conjunction with the sale, the following transactions occurred on
December 31, 1996:

The Company received permission from the state regulatory authority
and transferred $8,500,000 to FRINC as a return of capital.

The Company sold all of the outstanding stock of its wholly-owned
subsidiary Premier for $3,500,000 to a company formed by certain former
owners of PIC. The Company received $1,000,000 in cash at closing and a
$2,500,000, 13% note due on December 31, 1997, secured by the stock of
Premier. The note was paid in full by July 1997. There was no gain or loss
on the sale.

Premier assumed all of the private passenger automobile insurance
previously written by the Company in Pennsylvania and West Virginia via an
assumption reinsurance treaty. Premier transferred $8,700,627 into an
escrow account held by the Company to collateralize outstanding ceded
losses and unearned premiums. The Company remains liable to the
policyholders if Premier is unable to meet its contractual obligations
under the reinsurance agreement.

The Company entered into a fifteen year lease agreement with an
affiliate of the Company's former owners for the property which houses all
of the Company's operations.

Following is a schedule of future minimum rental payments required
under the lease as of December 31, 1996.

<TABLE>
<S> <C>
1997........................................................ $ 78,000
1998........................................................ 78,000
1999........................................................ 78,000
2000........................................................ 86,000
2001........................................................ 86,000
Thereafter.................................................. 4,902,688
----------
Total.................................................. $5,308,688
----------
----------
</TABLE>

F-65
<PAGE>
REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
Rockwood Casualty Insurance Company
Rockwood, Pennsylvania

We have audited the accompanying consolidated balance sheets of Rockwood
Casualty Insurance Company and Subsidiaries as of December 31, 1995 and 1994,
and the related consolidated statements of operations, shareholders' equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Rockwood Casualty
Insurance Company and Subsidiaries as of December 31, 1995 and 1994, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with generally accepted accounting principles.

As discussed in Note 13 to the consolidated financial statements, effective
January 1, 1994, the Company changed its method of accounting for investments by
adopting Statement of Financial Accounting Standards No. 115, 'Accounting for
Certain Investments in Debt and Equity Securities.'

/S/ PARENTE, RANDOLPH, ORLANDO, CAREY
& ASSOCIATES
Parente, Randolph, Orlando, Carey &
Associates

Wilkes-Barre, Pennsylvania
September 3, 1997

F-66
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
ASSETS
Investments:
Fixed maturity securities:
Available-for-sale at fair value (amortized cost: 1995, $19,354; 1994, $28,643)...... $ 20,018 $ 26,806
Held-to-maturity at amortized cost (fair value: 1995, $123,481; 1994, $80,940)....... 123,623 89,727
Equity securities at fair value (cost: 1995, $2,857; 1994, $9,622)...................... 3,258 8,628
Short-term investments.................................................................. 8,469 4,474
Other................................................................................... 345 375
-------- --------
Total investments.................................................................. 155,713 130,010
Cash...................................................................................... 1,745 1,585
Accrued investment income................................................................. 1,870 1,779
Reinsurance recoverable on unpaid loss and loss adjustment expenses....................... 11,320 8,988
Prepaid reinsurance premiums.............................................................. 880 1,334
Premiums receivable and agents' balances (less allowance for doubtful accounts of $50 at
December 31, 1995 and 1994, respectively)............................................... 14,149 12,356
Deferred policy acquisition costs......................................................... 2,894 2,491
Deferred federal income tax............................................................... 2,357 964
Other assets.............................................................................. 758 680
-------- --------
Total assets....................................................................... $191,686 $160,187
-------- --------
-------- --------

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses......................................... $132,254 $115,380
Unearned premiums....................................................................... 14,000 13,410
Accrued expenses........................................................................ 562 302
Reinsurance payable..................................................................... 1,308 771
Accrued policyholders' dividends........................................................ 4,530 3,729
Other liabilities....................................................................... 3,685 2,455
-------- --------
Total liabilities.................................................................. 156,339 136,047
-------- --------
Shareholders' equity:
Common Stock--Class A, no par value, 500,000 shares authorized, issued and
outstanding.......................................................................... 1,792 1,792
Common Stock--Class B, no par value, 572,961 shares authorized, issued and
outstanding.......................................................................... 2,053 2,053
-------- --------
3,845 3,845
Additional paid-in capital.............................................................. 1,000 --
Unrealized gains/(losses) on available-for-sale securities.............................. 703 (1,868)
Retained earnings....................................................................... 29,799 22,163
-------- --------
Total shareholders' equity......................................................... 35,347 24,140
-------- --------
Total liabilities and shareholders' equity......................................... $191,686 $160,187
-------- --------
-------- --------
</TABLE>

See accompanying notes.
F-67
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1994
(DOLLARS IN THOUSANDS)

<S> <C> <C>
Revenues:
Net premiums earned................................................................ $ 55,329 $ 52,617
Net investment income.............................................................. 9,324 8,344
Net realized losses on investments................................................. (466) (590)
Gain on termination of tax sharing agreement....................................... -- 2,652
Other income....................................................................... 193 28
---------- ----------
Total revenues................................................................ 64,380 63,051
---------- ----------
Losses and expenses:
Net losses and loss adjustment expenses............................................ 37,708 42,300
Policy acquisition costs amortized................................................. 12,647 11,282
Other underwriting expenses........................................................ 363 219
Dividends to policyholders......................................................... 5,026 3,816
---------- ----------
Total losses and expenses..................................................... 55,744 57,617
---------- ----------
Income before federal income taxes................................................... 8,636 5,434
Federal income tax expense/(benefit):
Current............................................................................ 2,718 1,629
Deferred........................................................................... (2,718) --
---------- ----------
Net income........................................................................... $ 8,636 $ 3,805
---------- ----------
---------- ----------
</TABLE>

See accompanying notes.

F-68
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
ADDITIONAL UNREALIZED TOTAL
PAID-IN GAINS/ RETAINED SHAREHOLDERS'
CLASS A CLASS B CAPITAL (LOSSES) EARNINGS EQUITY
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1993............... $ 2,000 $ -- $ 1,845 $ 457 $ 18,358 $22,660
Recapitalization of common stock.......... (208) 2,053 (1,845) -- -- --
Cumulative effect of a change in
accounting principle................... -- -- -- 1,218 -- 1,218
Net income................................ -- -- -- -- 3,805 3,805
Net unrealized losses..................... -- -- -- (3,543) -- (3,543)
------- ------- ---------- ---------- -------- -------------
Balances at December 31, 1994............... 1,792 2,053 -- (1,868) 22,163 24,140
Transfer to paid-in capital............... -- -- 1,000 -- (1,000) --
Net income................................ -- -- -- -- 8,636 8,636
Net unrealized gains...................... -- -- -- 2,571 -- 2,571
------- ------- ---------- ---------- -------- -------------
Balances at December 31, 1995............... $ 1,792 $ 2,053 $ 1,000 $ 703 $ 29,799 $35,347
------- ------- ---------- ---------- -------- -------------
------- ------- ---------- ---------- -------- -------------
</TABLE>

See accompanying notes.
F-69
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
-----------------------
1995 1994
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Operating activities:
Net income.......................................................................... $ 8,636 $ 3,805
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of policy acquisition costs......................................... 12,647 11,282
Policy acquisition costs deferred................................................ (13,050) (11,482)
Net realized losses on investments............................................... 466 590
Provision for depreciation and amortization...................................... 103 75
Deferred income taxes............................................................ (2,718) --
Change in operating assets and liabilities:
Unearned premiums........................................................... 590 1,219
Accrued investment income................................................... (91) (180)
Reserve for losses and loss adjustment expenses............................. 16,874 20,898
Reinsurance recoverable and payable......................................... (1,341) (812)
Policyholder dividends...................................................... 801 852
Premiums receivable......................................................... (1,792) (1,135)
Other liabilities........................................................... 1,580 (1,164)
------- -------
Net cash provided by operating activities............................................. 22,705 23,948
------- -------
Investing activities:
Securities available-for-sale:
Purchases--fixed maturities and equities......................................... (6,083) (7,159)
Sales--fixed maturities and equities............................................. 22,799 6,540
Securities held-to-maturity:
Purchases-fixed maturities....................................................... (74,637) (40,216)
Maturities and calls of fixed securities......................................... 39,614 20,576
Net purchases of short-term investments............................................. (3,995) (4,174)
Other............................................................................... (243) (155)
------- -------
Net cash used in investing activities................................................. (22,545) (24,588)
------- -------
Increase (decrease) in cash........................................................... 160 (640)
Cash at beginning of year............................................................. 1,585 2,225
------- -------
Cash at end of year................................................................... $ 1,745 $ 1,585
------- -------
------- -------
</TABLE>

See accompanying notes.

F-70
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995

1. ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ('GAAP') which vary in
some respects from statutory accounting practices prescribed or permitted by
regulatory authorities.

Consolidation

The accompanying consolidated financial statements include the accounts and
operations of Rockwood Casualty Insurance Company and its wholly-owned
subsidiaries Mid State Insurance Underwriters, Inc., Comprehensive Casualty
Services, Inc. and Coal Operators Indemnity Company, collectively referred to as
the 'Company.'

Significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements of insurance companies requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Such estimates and assumptions may
be subject to change in the future as more information becomes known which could
impact the amounts reported and disclosed herein.

Business Operations and Organization

Effective June 30, 1994, the Company was acquired by Physicians Insurance
Company ('PIC') and Tri-Rock Limited Partnership ('Tri-Rock'). Prior to June 30,
1994, the Company was a wholly-owned subsidiary of Rockwood Insurance Company
('RIC').

Approximately $14,600,000 and $13,300,000 of Rockwood's gross written
premiums were derived from two agents for the years ended December 31, 1995 and
1994, respectively. The loss of either of these agents could have a material
adverse effect on the Company.

Investments

The Company invests only in high quality investments. Management determines
the appropriate classification of its investments in fixed maturity securities
at the time of purchase. Fixed maturity securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
these securities to maturity. Fixed maturity securities not classified as
held-to-maturity and all equity securities are classified as available-for-sale.
The Company records the following for its portfolio:

The amortized cost of fixed maturity investments is adjusted for
amortization of premiums and accretion of discounts. That amortization or
accretion is included in investment income.

F-71
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
the estimated economic life is recalculated and the remaining unamortized
premium or discount is amortized prospectively over the remaining economic
life.

For the held-to-maturity portion of its portfolio, the Company records
its securities at amortized cost.

For the available-for-sale portion of its portfolio, the Company
records its securities at fair value. Changes to this fair value are
recorded as unrealized gains or losses, directly in shareholders' equity,
net of related deferred income taxes, with no corresponding effect on net
income.

Short-term investments, primarily consisting of money-market mutual funds
are carried at cost, which approximates fair value.

Premiums

Workers' compensation premiums based on payroll reporting are recorded as
written when payroll reports are received from the insured or are estimated if
reports have not been received.

Workers' compensation premiums on policies with deferred installment
payment plans are recorded as written when individual installments are billed.

Accrued retrospectively rated premiums have been determined based upon
estimated ultimate loss experience on individual policyholder accounts.

Participating Policies

Participating business written by the Company represents approximately 28%
and 26% of the total premiums in force at December 31, 1995 and 1994,
respectively. The participating business is composed of workers' compensation
policies. The amount of dividends to be paid on these policies is determined
based on the terms of the individual policies.

Deferred Policy Acquisition Costs

Reserve for Losses and Loss Adjustment Expense

Loss and loss adjustment expense reserves represent the estimated ultimate
net cost of all reported and unreported losses incurred through December 31. The
Company discounts loss and loss adjustment expense reserves related to workers'
compensation coverages for both GAAP and statutory reporting purposes at 4%. The
Company does not discount reserves related to other lines of business. The
reserves for unpaid losses and loss adjustment expenses are estimated using
individual case-base valuations and statistical analyses. Those estimates are
subject to the effects of trends in loss severity and frequency. Although
considerable variability is inherent in such estimates, management believes that
the reserves for losses and loss adjustment expenses are adequate.

F-72
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1. ACCOUNTING POLICIES--(CONTINUED)
These estimates are continually reviewed and adjusted as necessary as experience
develops or new information becomes known; such adjustments are included in
current operations.

REINSURANCE

Accrued retrospectively rated reinsurance premiums have been determined
based upon estimated ultimate loss experience on business subject to such
experience rating adjustments.

INCOME TAXES

F-73
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. INVESTMENTS

The Company's investments, excluding short-term investments, mortgage
loans, and real estate, at December 31 of each year, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------------------------------------
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Available-for-sale:
Corporate bonds...................................... $ 7,986 $ 654 $ (2) $ 8,638
U.S. Government bonds................................ 1,499 170 -- 1,669
Mortgage-backed bonds................................ 9,869 105 (263) 9,711
--------- ---------- ---------- --------
Total fixed maturity securities................... 19,354 929 (265) 20,018
Equity securities.................................... 2,857 496 (95) 3,258
--------- ---------- ---------- --------
Total available-for-sale.......................... 22,211 1,425 (360) 23,276
--------- ---------- ---------- --------
Held-to-maturity:
Corporate bonds...................................... 24,258 284 (122) 24,420
U.S. Government bonds................................ 25,338 193 (7) 25,524
--------- ---------- ---------- --------
Mortgage-backed bonds................................ 48,330 279 (836) 47,773
State and municipal bonds............................ 25,697 183 (116) 25,764
--------- ---------- ---------- --------
Total held-to-maturity............................ 123,623 939 (1,081) 123,481
--------- ---------- ---------- --------
Total investments................................. $ 145,834 $2,364 $ (1,441) $146,757
--------- ---------- ---------- --------
--------- ---------- ---------- --------

DECEMBER 31, 1994
-------------------------------------------------
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Available-for-sale:
Corporate bonds...................................... $ 13,214 $ 169 $ (258) $ 13,125
U.S. Government bonds................................ 5,500 69 (98) 5,471
Mortgage-backed bonds................................ 9,432 -- (1,670) 7,762
State and municipal bonds............................ 497 -- (49) 448
--------- ---------- ---------- --------
Total fixed maturity securities................... 28,643 238 (2,075) 26,806
Equity securities.................................... 9,622 306 (1,300) 8,628
--------- ---------- ---------- --------
Total available-for-sale.......................... 38,265 544 (3,375) 35,434
--------- ---------- ---------- --------
Held-to-maturity:
Corporate bonds...................................... 14,027 33 (974) 13,086
U.S. Government bonds................................ 17,193 38 (755) 16,476
Mortgage-backed bonds................................ 33,670 7 (4,447) 29,230
State and municipal bonds............................ 24,837 3 (2,692) 22,148
--------- ---------- ---------- --------
Total held-to-maturity............................ 89,727 81 (8,868) 80,940
--------- ---------- ---------- --------
Total investments................................. $ 127,992 $ 625 $(12,243) $116,374
--------- ---------- ---------- --------
--------- ---------- ---------- --------
</TABLE>

The fair values for fixed maturity securities are based on quoted market
prices, where available. For fixed maturity securities not actively traded, fair
values are estimated using values obtained from independent brokers. The fair
values for equity securities are based on quoted market prices.

F-74
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. INVESTMENTS--(CONTINUED)
The amortized cost and estimated fair value of investments in fixed
maturities at December 31, 1995, are summarized by estimated maturity as
follows:

<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE HELD-TO-MATURITY TOTAL
-------------------- --------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Maturity:
Due in 1996............................. $ -- $ -- $ 7,693 $ 7,772 $ 7,693 $ 7,772
Due in 1997-2000........................ 6,003 6,506 21,826 22,084 27,829 28,590
Due in 2001-2005........................ 3,482 3,801 19,306 19,443 22,788 23,244
Due after 2005.......................... -- -- 26,468 26,409 26,468 26,409
--------- ------- --------- -------- --------- --------
9,485 10,307 75,293 75,708 84,778 86,015
Mortgage-backed securities................ 9,869 9,711 48,330 47,773 58,199 57,484
--------- ------- --------- -------- --------- --------
Total..................................... $19,354 $20,018 $ 123,623 $123,481 $ 142,977 $143,499
--------- ------- --------- -------- --------- --------
--------- ------- --------- -------- --------- --------
</TABLE>

The foregoing data is based on the estimated maturities of the securities.
Actual maturities may differ for some securities because borrowers have the
right to call or prepay obligations with or without penalties.

Major categories of the Company's investment income for the years ended
December 31, are summarized are as follows:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Fixed maturity securities............................................ $8,564 $7,225
Short-term investments............................................... 380 357
Equity securities.................................................... 455 818
Other................................................................ 27 45
------ ------
Gross investment income............................................ 9,426 8,445
Investment expense................................................... (102) (101)
------ ------
Net investment income.............................................. $9,324 $8,344
------ ------
------ ------
</TABLE>

At December 31, 1994 the Company permanently marked down to market a
held-to-maturity fixed income security and recorded a $615,000 realized capital
loss. In March 1995 the security matured, with payment based upon a combination
of foreign currencies, resulting in the Company reporting an additional $177,000
loss on the security.

F-75
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. INVESTMENTS--(CONTINUED)
The Company's realized gains and losses on investments are summarized as
follows:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Fixed maturity securities:
Gross realized gains......................................................... $ 133 $ 17
Gross realized losses........................................................ (27) --
------ ------
Net gains............................................................... 106 17
Equity securities:
Gross realized gains......................................................... 26 18
Gross realized losses........................................................ (421) (10)
------ ------
Net gains/(losses)...................................................... (395) 8
------ ------
Net realized gains/(losses).................................................. (289) 25
Loss on permanent impairment of investment................................... (177) (615)
------ ------
Net realized losses.......................................................... $ (466) $ (590)
------ ------
------ ------
</TABLE>

At December 31, 1995 and 1994, investments with market values of $572,000
and $529,000, respectively, were on deposit with state insurance departments to
satisfy regulatory requirements.

3. OTHER ASSETS

Other assets at December 31, are composed of the following:

<TABLE>
<CAPTION>
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Property and equipment........................................................... $ 607 $ 345
Less accumulated depreciation.................................................. (280) (188)
----- -----
Property and equipment, net...................................................... 327 157
Equity in officers' life insurance............................................... 232 227
Other............................................................................ 199 296
----- -----
Total..................................................................... $ 758 $ 680
----- -----
----- -----
</TABLE>

F-76
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

4. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company discounts reserves related to workers compensation business for
both statutory and GAAP financial reporting purposes. The discount rate at
December 31, 1995 and 1994 is 4%. Included in the reserve for unpaid losses at
December 31, 1995 and 1994 is $100,731,000 and $87,739,000, respectively,
related to workers' compensation coverages which are net of discounts of
$17,139,000 and $14,794,000, respectively.

The following table provides a reconciliation of the beginning and ending
reserve for losses and loss adjustment expenses ('LAE'), net-of-reinsurance, for
1995 and 1994 to the gross amounts reported in the balance sheets.

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Reserves for losses and LAE, net of related reinsurance recoverables, at beginning of
year.................................................................................... $106,392 $ 86,290
Add:
Provision for losses and LAE for claims occurring in the current year, net of
reinsurance.......................................................................... 46,653 45,738
Decrease in incurred losses and LAE for claims occurring in prior years, net of
reinsurance.......................................................................... (6,600) (345)
-------- --------
Incurred losses and LAE during the current year, net of reinsurance and gross of
discount............................................................................ 40,053 45,393
Provision for discount on current accident year reserves................................ (4,165) (4,049)
Amortization of discount on prior accident years reserves............................... 1,820 956
-------- --------
Incurred losses and LAE during the current year, net of reinsurance and net of
discount.......................................................................... 37,708 42,300
-------- --------
Deduct:
Losses and LAE payments for claims, net of reinsurance, occurring during:
Current year......................................................................... (6,003) (6,113)
Prior years.......................................................................... (17,163) (16,085)
-------- --------
Total paid......................................................................... (23,166) (22,198)
-------- --------
Reserve for losses and LAE, net of related reinsurance recoverables, at end of year....... 120,934 106,392
Add:
Reinsurance recoverables on unpaid losses and LAE, at end of year....................... 11,320 8,988
-------- --------
Reserve for losses and LAE, gross of reinsurance recoverables on unpaid loses and LAE, at
end of year............................................................................. $132,254 $115,380
-------- --------
-------- --------
</TABLE>

The foregoing reconciliation shows that a $6,600,000 redundancy in the 1994
and prior year reserves emerged in 1995. This redundancy resulted primarily from
settling case-basis reserves established in prior years for amounts that were
less than expected. The Company believes that Pennsylvania Act 44, enacted in
September 1993, has had a favorable effect on the medical cost component of its
workers' compensation losses and contributed to the favorable development.

5. REINSURANCE

F-77
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. REINSURANCE--(CONTINUED)
At December 31, 1995, reinsurance recoverables from five reinsurers
representing approximately 72% of the total balance of reinsurance were as
follows:

<TABLE>
<CAPTION>
REINSURER DECEMBER 31, 1995
<S> <C>
Reliance Insurance Company................................................. $ 2,526,000
Pennsylvania Surface Coal Mining Insurance Exchange........................ 1,604,000
North Star Reinsurance Company............................................. 1,577,000
American Reinsurance Company............................................... 1,291,000
Cologne Reinsurance Company................................................ 1,283,000
</TABLE>

The remaining reinsurance recoverables of $3,039,000 were primarily
associated with ten other reinsurers.

Net written premiums are summarized as follows:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Direct premiums................................................................. $ 64,584 $ 59,169
Assumed premiums................................................................ 148 512
Ceded premiums.................................................................. (5,863) (5,801)
-------- --------
Net premiums written....................................................... $ 58,869 $ 53,880
-------- --------
-------- --------
</TABLE>

Net premiums earned are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Direct premiums................................................................. $ 61,479 $ 57,917
Assumed premiums................................................................ 166 545
Ceded premiums.................................................................. (6,316) (5,845)
-------- --------
Net premiums earned........................................................ $ 55,329 $ 52,617
-------- --------
-------- --------
</TABLE>

F-78
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. REINSURANCE--(CONTINUED)
Losses and LAE incurred are summarized as follows:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Direct losses and LAE........................................................... $ 40,280 $ 42,988
Assumed losses and LAE.......................................................... 336 340
Ceded losses and LAE............................................................ (2,908) (1,028)
-------- --------
Net losses and LAE incurred................................................... $ 37,708 $ 42,300
-------- --------
-------- --------
</TABLE>

6. OTHER LIABILITIES

Other liabilities at December 31, are composed of the following:

<TABLE>
<CAPTION>
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Premium taxes, licenses and fees................................................. $ 1,403 $ 1,103
Contingent commission............................................................ 725 560
Amounts withheld or on deposit for the accounts of others........................ 1,337 641
Other............................................................................ 220 151
------- -------
Total.......................................................................... $ 3,685 $ 2,455
------- -------
------- -------
</TABLE>

F-79
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

7. INCOME TAXES

The Company files a consolidated federal income tax return with its
subsidiaries. Prior to July 1, 1994, the Company filed a consolidated federal
income tax return with RIC's parent, Rockwood Holding Company. The Company's
effective income tax rate on pre-tax income for 1995 and 1994 differs from the
prevailing corporate federal income tax rate as follows:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Income tax expense at 34%......................................................... $2,936 $1,847
Change in valuation allowance on deferred tax assets.............................. (2,089) 885
Tax exempt income, net............................................................ (847) (1,103)
------ ------
Income tax expense................................................................ $ -- $1,629
------ ------
------ ------
</TABLE>

The significant components of the net deferred tax asset at the current
prevailing tax rate of 34% are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Reserve for losses and loss adjustment expenses................................. $5,756 $5,321
Unearned premiums............................................................... 892 651
Accrued policyholder dividends.................................................. 603 530
Other........................................................................... 127 109
Unrealized loss on available-for-sale securities................................ -- 964
------ ------
Total deferred tax assets before valuation allowance.............................. 7,378 7,575
Less: valuation allowance......................................................... (3,675) (5,764)
------ ------
Total deferred tax assets, net of valuation allowance............................. 3,703 1,811
------ ------
Deferred tax liabilities:
Deferred policy acquisition costs............................................... 984 847
Unrealized gains on available-for-sale securities............................... 362 --
------ ------
Total deferred tax liabilities.................................................... 1,346 847
------ ------
Net deferred tax asset............................................................ $2,357 $ 964
------ ------
------ ------
</TABLE>

The Company is required to establish a 'valuation allowance' for any
portion of the deferred tax asset that management believes may not be realized.
The change in the valuation allowance is attributable to the origination and
reversal of temporary differences and, in 1995 and 1994 an income tax payment of
$2,718,000 and $95,000, respectively.

8. CAPITAL STOCK

The capital stock of the Company was sold effective June 30, 1994 by RIC to
a group of private investors consisting of PIC and Tri-Rock. Effective July 1,
1994, the capital stock was restructured into two classes of common stock,
consisting of (1) 500,000 shares of Class A Voting Stock ('Class A'), owned 50%
by PIC and 50% by Tri-Rock and; (2) 572,961 shares of Class B Non-Voting Stock
('Class B'), owned 100% by PIC. All shares have no par value. The stated values
for Class A and Class B stock are $1,792,000 and $2,053,000, respectively. The
creation of two new classes of common stock resulted in $1,845,000 of paid-in
surplus being reallocated to common stock in 1994. All outstanding shares of
commons stock as of June 30, 1994 were exchanged for Class A and B shares.

F-80
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

8. CAPITAL STOCK--(CONTINUED)
During 1995, the Board of Directors authorized the reclassification of
$1,000,000 from retained earnings to gross paid-in and contributed surplus, to
comply with Pennsylvania Insurance Department capitalization requirements.

9. RELATED PARTIES

The Company paid Rockwood Asset Management, Inc. ('RAM') $636,000 and
$319,000 during 1995 and 1994, respectively, under agreements for office
facilities, computer equipment and software license, and an installment purchase
of office equipment. The minimum future payments to RAM required under the
agreements is $3,593,000 as follows: 1996--$819,000; 1997--$607,000;
1998--$607,000; 1999--$607,000; 2000-- $607,000 and 2001--$346,000.

The Company terminated all contractual agreements and relationships with
RIC, which went into liquidation proceedings in 1991, effective June 30, 1994,
resulting in RIC accepting as full and final payment all funds received as of
that date for the Company's obligations under a Tax Sharing and Expense Sharing
Agreement. The Company recognized a gain in 1994 of $2,652,000 resulting from
the termination of the Tax Sharing Agreement.

10. EMPLOYEE BENEFIT PLANS

The Company sponsors a defined benefit pension plan covering substantially
all full-time employees. Benefits under the plan are based on years of service
and average compensation during the participant's highest three consecutive
calendar years. The funding policy is to make contributions to the plan annually
in amounts at least equal to the minimum funding requirements of the Employee
Retirement Income Security Act of 1974 and deductible for federal income tax
purposes. Contributions are intended to provide not only for benefits attributed
to service to date but also for those expected to be earned in the future.

F-81
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

10. EMPLOYEE BENEFIT PLANS--(CONTINUED)
The plan's total obligations and assets, which are primarily invested in
mutual funds and fixed income securities, along with the components of net
periodic pension costs are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Pension Obligations:
Actuarial present value of accumulated benefit obligation, including vested
benefits of $935 and $945, respectively......................................... $ 938 $ 947
------ ------
------ ------
Actuarial present value of projected benefit obligation for service rendered to
date............................................................................ $1,559 $1,673
Plan assets at fair value......................................................... 1,330 1,220
------ ------
Projected benefit obligations in excess of plan assets............................ 229 453
Unrecognized transition obligation................................................ (144) (154)
Unrecognized experience and effects of changes in assumptions..................... 154 (127)
------ ------
Net pension obligation............................................................ $ 239 $ 172
------ ------
------ ------
</TABLE>

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1995 1994
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Pension Cost:
Service cost--benefit earned during current year.................................. $ 111 $ 121
Interest cost on projected benefit obligation..................................... 99 116
Return on plan assets............................................................. (86) (111)
Amortization of transition obligation............................................. 10 10
------ ------
Net periodic pension cost......................................................... $ 134 $ 136
------ ------
------ ------
Weighted average discount rate.................................................... 7.0% 7.5%
Rates of increase in compensation levels.......................................... 4.5% 4.5%
Expected long term rate of return on assets....................................... 8.0% 8.0%
</TABLE>

The Company intends to terminate its defined benefit pension plan during
1997.

The 401(k) Profit Sharing Trust, established in 1984, is available to
substantially all full-time employees of Rockwood Casualty. No discretionary
Company contributions were made in 1995 and 1994.

11. COMMITMENTS AND CONTINGENCIES

Rockwood Insurance Company of Indiana ('RIND'), a company that merged into
Rockwood Casualty Insurance Company on December 31, 1990, issued certain medical
malpractice policies for claims occurring between January 1, 1978 and October 1,
1990. RIND reinsured these policies pursuant to a loss portfolio transfer
agreement with Covenant Mutual Insurance Company ('Covenant'). Covenant
subsequently went into liquidation and was unable to meet its obligation on the
reinsurance agreement. In May 1993, the Company's former parent, RIC,
established and funded a Liquidating Trust ('Trust') in accordance with an
agreement approved by an order of the Commonwealth Court of Pennsylvania to
service the medical malpractice claims related to Covenant's default. The
Pennsylvania Insurance Department currently manages the Trust and administers
the claims.

F-82
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

11. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
The Trust was originally funded with $6,500,000, and on June 30, 1994 an
additional $623,000 was deposited in the Trust by RIC in accordance with the
Trust agreement, as amended. Total assets in the Trust at December 31, 1995 and
1994 available to pay claims and expenses were $3,677,000 and $4,863,000,
respectively. As part of the Trust agreement, a certification of reserve
liabilities is prepared annually by an independent consulting actuary acceptable
to both RIC and the Company. The amount of actuarially determined liabilities
related to Covenant's default as of December 31, 1995 and 1994 were $3,220,000
and $4,567,000, respectively. If the amount of reserve liabilities on a
discounted basis, times 115%, exceeds the amount in the Trust Fund as of the
date of the report, RIC shall pay to the Trustee, monies or investment
securities in the aggregate amount of the deficiency. Further, any excess assets
shall be returned to RIC.

The Trust disbursed $1,324,000 and $1,360,000 in loss and loss adjustment
expenses in 1995 and 1994, respectively, to fund the Company's medical
malpractice claims related to this business and paid $100,000 and $151,000 to
the Pennsylvania Insurance Department, respectively, for administrative
expenses.

12. FAIR VALUE OF FINANCIAL INSTRUMENTS

13. CHANGES IN ACCOUNTING PRINCIPLES--ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT
AND EQUITY SECURITIES

FASB Statement 115, Accounting for Certain Investments in Debt and Equity
Securities, was adopted by the Company as of January 1, 1994. In accordance with
Statement 115, the prior-year financial statements were not restated to reflect
the change in accounting principle.

With the classification of the then existing portfolio as
available-for-sale and held-to-maturity securities, the January 1, 1994 balance
of shareholders' equity was increased by $1,218,000 (i.e., the amount which
would have been recorded if those securities had been sold at their fair value
on January 1, 1994, net of related deferred income taxes) to reflect the net
unrealized gains on fixed maturity securities classified as available-for-sale.
These securities had previously been carried at amortized cost.

14. STATUTORY MATTERS

The Company is required to periodically submit financial statements
prepared in accordance with statutory accounting practices to insurance
regulatory authorities. Statutory accounting practices differ from generally
accepted accounting principles. Net income determined in accordance with
statutory accounting practices reported to regulatory authorities for the years
ended December 31, 1995 and 1994 was $5,144,000 and $3,656,000, respectively.

The net assets of the Company that are transferable to its owners are
limited to the amounts by which statutory capital and surplus exceed minimum
statutory requirements. An analysis of such requirement at December 31, 1995 is
as follows:

<TABLE>
<S> <C>
Statutory Capital and Surplus.............................. $30,974,000
Minimum Statutory Capital Required......................... 3,000,000
-----------
Excess over Minimum Statutory Capital Requirement.......... $27,974,000
-----------
-----------
</TABLE>

F-83
<PAGE>
ROCKWOOD CASUALTY INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

14. STATUTORY MATTERS--(CONTINUED)
greater of either (i) ten percent of the insurer's surplus to policyholders as
of the immediately preceding December 31 or (ii) net income, excluding realized
gains, as of the immediately preceding year.

In addition, no Pennsylvania stock casualty insurance company shall make
any dividend on its capital, except from profits arising from its business.
Therefore, the maximum shareholders' dividend that may be paid during 1996
without prior written approval of the Insurance Commissioner is $5,144,000, or
1995's statutory net income.

15. SUBSEQUENT EVENTS

The capital stock of the Company was acquired by Front Royal, Inc.
('FRINC'), effective December 31, 1996, from PIC and Tri-Rock. The acquisition
of the Company by FRINC and related transactions were approved on December 30,
1996 by the Pennsylvania Insurance Department.

In conjunction with the acquisition, the following transactions occurred on
December 31, 1996:

The Company sold all of the outstanding stock of its wholly-owned
subsidiary Premier Auto Insurance Company ('Premier'), formed in 1996, to
Fort Washington Holdings, Inc. ('Fort Washington') for a total purchase
price of $3,500,000. The Company received $1,000,000 in cash at closing and
a $2,500,000, 13% note due on December 31, 1997, secured by the stock of
Premier. The note was repaid in full by July 1997. There was no gain or
loss on the sale.

Premier assumed all of the private passenger automobile insurance
previously written by the Company in Pennsylvania and West Virginia via an
assumption reinsurance treaty. On December 31, 1996, Premier transferred
$8,701,000 into an escrow account held by the Company to collaterize
outstanding ceded losses and unearned premiums. The Company remains liable
to the policyholders if Premier is unable to meet its contractual
obligations under the reinsurance agreement.

The Company entered into a fifteen year lease agreement with an
affiliate of the Company's former owners for the property which houses all
of the Company's operations.

Following is a schedule of future minimum rental payments required under
the lease as of December 31, 1996.

<TABLE>
<S> <C>
1997.................................................................. $ 78,000
1998.................................................................. 78,000
1999.................................................................. 78,000
2000.................................................................. 86,000
2001.................................................................. 86,000
Thereafter............................................................ 4,902,688
----------
Total............................................................... $5,308,688
----------
----------
</TABLE>

Also on December 31, 1996, the Company received permission from the state
regulatory authority to transfer $8,500,000 to FRINC as a return of capital.

F-84
<PAGE>

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

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS, AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO BUY, THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN
THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary......................... 3
Risk Factors............................... 11
Use of Proceeds............................ 19
Dividend Policy............................ 19
The Recapitalization....................... 20
Capitalization............................. 21
Dilution................................... 22
Pro Forma Condensed Combined Financial
Statements............................... 23
Selected Historical Consolidated Financial
Data..................................... 28
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 30
Business................................... 40
Management................................. 65
Principal and Selling Shareholders......... 73
Certain Transactions....................... 79
Description of Capital Stock............... 80
Shares Eligible for Future Sale............ 84
Certain U.S. Tax Consequences to Non-U.S.
Holders.................................. 86
Underwriting............................... 88
Legal Matters.............................. 90
Experts.................................... 90
Glossary of Selected Insurance Terms....... 91
Index to Financial Statements.............. F-1
</TABLE>

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

UNTIL , 1998, ALL DEALERS EFFECTING TRANSACTIONS IN THE
COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE
REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF
DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO
THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

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

5,000,000 SHARES

Front Royal, Inc.

COMMON STOCK

------------------------
PROSPECTUS
------------------------

DONALDSON, LUFKIN & JENRETTE

BT ALEX. BROWN

WHEAT FIRST UNION

, 1998

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
(ALTERNATE PAGE FOR SELLING SHAREHOLDERS' PROSPECTUS)

SUBJECT TO COMPLETION, DATED , 1998

PROSPECTUS

Front Royal, Inc.
300,000 SHARES

This Prospectus relates to 300,000 shares (the 'Shares') of common stock,
no par value (the 'Common Stock'), of Front Royal, Inc. (the 'Company') which
are being offered for sale by Wycon Corporation ('Wycon') and United American
Financial Services Corporation ('UnaMark' and together with Wycon, the
'Alternate Selling Shareholders'). The Shares may not be sold by the Selling
Shareholders until 180 days from the date of this Prospectus, or earlier with
the sole consent of Donaldson, Lufkin & Jenrette Securities Corporation, the
representative (the 'Representative') of the underwriters of the Company's
concurrent initial public offering (the 'Offering'). The Shares were acquired by
the Alternate Selling Shareholders in the Preferred National Acquisition (as
defined herein). See 'Prospectus Summary--The Company--Preferred National
Acquisition.'

The Company will not receive any of the proceeds from the sale of the
Shares by the Alternate Selling Shareholders. The Shares offered hereby may be
sold from time to time by the Alternate Selling Shareholders, or by transferees,
commencing 180 days from the date of this Prospectus, or earlier with the sole
consent of the Representative. No underwriting arrangements have been entered
into by the Alternate Selling Shareholders. The distribution of the Shares by
the Alternate Selling Shareholders may be effected from time to time in
transactions (which may include block transactions) on The Nasdaq Stock Market,
in negotiated transactions, through the writing of options on the Shares or a
combination of such methods of sale, at fixed prices that may be changed, at
market prices prevailing at the time of sale, or at negotiated prices. The
Alternate Selling Shareholders may effect such transactions by selling the
Shares directly to purchasers or through broker-dealers that may act as agents
or principals. Such broker-dealers may receive compensation in the form of
discounts, concessions or commissions from the Alternate Selling Shareholders
and/or the purchasers of Shares for whom such broker-dealers may act as agents
or to whom they sell as principals, or both (which compensation as to a
particular broker-dealer might be in excess of customary commissions). See 'Plan
of Distribution.'

The Alternate Selling Shareholders may be deemed to be 'Underwriters' as
defined in the Securities Act of 1933 (the 'Securities Act'). If any
broker-dealers are used by the Alternate Selling Shareholders, any commissions
paid to broker-dealers and, if broker-dealers purchase any Shares as principals,
any profits received by such broker-dealers on the resales of the Shares may be
deemed to be underwriting discounts or commissions under the Securities Act. In
addition, any profits realized by the Alternate Selling Shareholders may be
deemed to be underwriting commissions. All costs, expenses and fees in
connection with the registration of the Shares offered by the Alternate Selling
Shareholders will be borne by the Company. Brokerage commissions, if any,
attributable to the sale of the Shares will be borne by the Alternate Selling
Shareholders.

Prior to the commencement of this offering (the 'Alternate Selling
Shareholders' Offering'), the Company is offering, by separate Prospectus in the
Offering, shares of Common Stock at a price of $ per share. See 'Concurrent
Sales.' All references in this Prospectus to the over-allotment option refer to
the over-allotment option granted to the underwriters in the Offering. All
references in this Prospectus to (i) the over-allotment option refer to the
over-allotment option granted to the Underwriter in the Offering, (ii) the
'Selling Shareholders' refer to the Selling Shareholders in the Offering, and
(iii) all references to the Underwriting section shall be disregarded since this
section is not included in this Prospectus.

Application has been made to list the Common Stock on the Nasdaq National
Market under the symbol 'FRYL.' There can be no assurance that such listing
application will be approved.

SEE 'RISK FACTORS' BEGINNING ON PAGE FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

THE DATE OF THIS PROSPECTUS IS , 1998

ALT-1
<PAGE>

(ALTERNATE PAGE FOR SELLING SHAREHOLDERS' PROSPECTUS)

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

AVAILABLE INFORMATION

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

ALT-2
<PAGE>
(ALTERNATE PAGE FOR SELLING SHAREHOLDERS' PROSPECTUS)

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

THE ALTERNATE SELLING SHAREHOLDERS' OFFERING

<TABLE>
<S> <C>
Securities Offered............................................. 300,000 shares of Common Stock

Common Stock Outstanding Prior to the Alternate Selling
Shareholders' Offering....................................... shares(1)

Use of Proceeds................................................ The Company will not receive any of the proceeds
from the sales of Shares by the Alternate
Selling Shareholders.

Proposed Nasdaq National Market Symbol......................... FRYL.
</TABLE>

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

(1) Assumes no exercise of outstanding stock options and warrants. As of the
date of this Prospectus, there are outstanding options and warrants to
purchase 945,826 shares of Common Stock at a weighted average price of $4.70
per share, excluding certain price adjustment warrants which the Company
does not expect will be exercised. Does not include an aggregate of
1,500,000 shares of Common Stock reserved for future issuance under the
Company's employee stock plans. See 'Capitalization,' 'Description of
Capital Stock,' 'Management--Stock Option Plans' and Note 12 of Notes to the
Front Royal, Inc. and Subsidiaries Consolidated Financial Statements.

ALT-3
<PAGE>

(ALTERNATE PAGE FOR SELLING SHAREHOLDERS' PROSPECTUS)

USE OF PROCEEDS

The Company will not receive any proceeds from the sale of the Common Stock
offered pursuant to this Prospectus by the Alternate Selling Shareholders.

PRINCIPAL SHAREHOLDERS

[From Offering Prospectus less Selling Shareholders]

CONCURRENT SALES

On the date of this Prospectus, a registration statement under the
Securities Act with respect to an underwritten public offering of 5,000,000
shares of Common Stock by the Company and the Selling Shareholders named therein
was declared effective by the Commission and the Underwriters commenced the
offering of the Common Stock offered thereby. Sales of Common Stock under this
Prospectus by the Alternate Selling Shareholders or even the potential of such
sales could have an adverse effect on the market price of the Common Stock.

ALTERNATE SELLING SHAREHOLDERS AND PLAN OF DISTRIBUTION

The following table sets forth certain information with respect to each
Alternate Selling Shareholder for whom the Company is registering securities for
resale to the public. The Company will not receive any of the proceeds from the
sale of such securities. Other than with respect to the transactions consummated
in connection with the Preferred National Acquitisition, there are no material
relationships between the Alternate Selling Shareholders and the Company, nor
have any such material relationships existed within the past three years. The
Shares were acquired by the Alternate Selling Shareholders in the Preferred
National Acquisition. See 'Prospectus Summary--The Company--Preferred National
Acquisition.'

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP PRIOR TO OFFERING(1)
-----------------------------------------
ALTERNATE SELLING SHAREHOLDERS AMOUNT
- ----------------------------------------------- -----------------------------------------
<S> <C>
Wycon Corporation.............................. 675,000(2)
United American Financial Services
Corporation.................................. 225,000
----------
Total................................... 900,000(2)
----------
----------

BENEFICIAL OWNERSHIP PRIOR TO OFFERING(1) MAXIMUM NUMBER OF
----------------------------------------- SHARES OF COMMON STOCK
ALTERNATE SELLING SHAREHOLDERS PERCENT TO BE SOLD
- ----------------------------------------------- ----------------------------------------- ----------------------
<S> <C> <C>
Wycon Corporation.............................. 8.5% 75,000
United American Financial Services
Corporation.................................. 3.0% 225,000
----- ----------
Total................................... 11.5% 300,000
----- ----------
----- ----------

</TABLE>

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

(1) Assumes completion of the Recapitalization.

(2) Includes warrants to purchase 600,000 shares of Common Stock with an
exercise price of $16.67 per share which are currently exercisable.

The Alternate Selling Shareholders have agreed that they will not sell any
of the Shares for a period of 180 days from the date of this Prospectus unless
the Representative consents (in its sole discretion) to an earlier sale. Subject
to this restriction, the Alternate Selling Shareholders have advised the Company
that sales of the Shares may be effected from time to time in transactions
(which may include block transactions) on The Nasdaq Stock Market, in negotiated
transactions, through the writing of options on the Shares or a combination of
such methods of sale, at fixed prices that may be changed, at market prices
prevailing at the time of sale, or at negotiated prices. The Alternate Selling
Shareholders may effect such transactions by selling the Shares directly to
purchasers or through broker-dealers that may act as agents or principals. Such
broker-dealers may receive compensation in the form of discounts, concessions or
commissions from the Alternate Selling Shareholders and/or the purchasers of
Shares for whom such broker-dealers may act as agents or to whom they sell as
principals, or both (which compensation as to a particular broker-dealer might
be in excess of customary commissions).

The Alternative Selling Shareholders and any broker-dealers that act in
connection with the sale of the Shares as principals may be deemed to be
'underwriters' within the meaning of Section 2(11) of the Securities Act and any
commission received by them and any profit on the resale of the Shares as
principals might be deemed to be underwriting discounts and commissions under
the Securities Act. The Alternate Selling Shareholders may agree to indemnify
any agent, dealer or broker-dealer that participates in transactions involving
sales of the Shares against certain liabilities, including liabilities arising
under the Securities Act. All costs, expenses and fees in connection with the
registration of the Shares offered by the Alternate Selling Shareholders will be
borne by the Company. Brokerage commissions, if any, attributable to the sale of
the Shares will be borne by the Alternate Selling Shareholders. The Company will
not receive any proceeds from the sales of the Shares by the Alternate Selling
Shareholders. Sales of the Shares by the Alternate Selling Shareholders, or even
the potential of such sales, could have an adverse effect on the market price of
the Common Stock.

ALT-4
<PAGE>

(ALTERNATE PAGE FOR SELLING SHAREHOLDERS' PROSPECTUS)

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

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE
UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH
OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.

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

SUMMARY TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................
Risk Factors..................................
Use of Proceeds...............................
Dividend Policy...............................
The Recapitalization..........................
Capitalization................................
Dilution......................................
Pro Forma Condensed Combined Financial
Statements..................................
Selected Historical Consolidated Financial
Data........................................
Management's Discussion and Analysis of
Financial Condition and Results of
Operations..................................
Business......................................
Management....................................
Principal Shareholders........................
Certain Transactions..........................
Description of Capital Stock..................
Concurrent Sales..............................
Alternate Selling Shareholders and Plan of
Distribution................................
Shares Eligible for Future Sale...............
Legal Matters.................................
Experts.......................................
Glossary of Selected Insurance Terms..........
Index to Financial Statements................. F-1
</TABLE>

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

300,000 SHARES

FRONT ROYAL, INC.

COMMON STOCK

------------------------
PROSPECTUS
------------------------

, 1998

------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

Set forth below is an estimate of the approximate amount of the fees and
expenses (other than underwriting discounts and commissions) payable by the
Registrant in connection with the issuance and distribution of the Common Stock.

<TABLE>
<S> <C>
SEC Registration Fee.......................................... $ 37,752
Blue Sky Fees and Expenses.................................... 10,000*
Nasdaq Listing Fee............................................ 50,000
NASD Filing Fee............................................... 3,000*
Printing and Mailing Fees..................................... 100,000
Counsel Fees and Expenses..................................... 200,000
Accountant's Fees and Expenses................................ 300,000
Transfer Agent and Registrar Fees............................. 3,500*
Miscellaneous................................................. 95,748
--------
Total.................................................... $800,000
--------
--------
</TABLE>

- ------------------
* Estimate

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

The Registrant's Amended Articles of Incorporation and Amended Bylaws
include provisions to (i) eliminate the personal liability of its directors for
monetary damages resulting from breaches of their fiduciary duty to the fullest
extent permitted by Section 55-8-30(e) of the North Carolina Business
Corporation Act (the 'Business Corporation Act'), and (ii) require the
Registrant to indemnify its directors and officers to the fullest extent
permitted by Sections 55-8-50 through 55-8-58 of the Business Corporation Act,
including circumstances in which indemnification is otherwise discretionary.
Pursuant to Sections 55-8-51 and 55-8-57 of the Business Corporation Act, a
corporation generally has the power to indemnify its present and former
directors, officers, employees and agents against expenses incurred by them in
connection with any suit to which they are, or are threatened to be made, a
party by reason of their serving in such positions so long as they acted in good
faith and in a manner they reasonably believed to be in, or not opposed to, the
best interests of the corporation, and with respect to any criminal action, they
had no reasonable cause to believe their conduct was unlawful. The Registrant
believes that these provisions are necessary to attract and retain qualified
persons as directors and officers. These provisions do not eliminate the
directors' duty of care, and, in appropriate circumstances, equitable remedies
such as injunctive or other forms of non-monetary relief will remain available
under the Business Corporation Act. In addition, each director will continue to
be subject to liability for breach of the director's duty of loyalty to the
Registrant, for acts or omissions that the director believes to be contrary to
the best interests of the Registrant or its shareholders, for any transaction
from which the director derived an improper personal benefit, for acts or
omissions involving a reckless disregard for the director's duty to the
Registrant or its shareholders when the director was aware or should have been
aware of a risk of serious injury to the Registrant or its shareholders, for
acts or omissions that constitute an unexcused pattern of inattention that
amounts to an abdication of the director's duty to the Registrant or its
shareholders, for improper transactions between the director and the Registrant
and for improper distributions to shareholders and loans to directors and
officers. These provisions do not affect a director's responsibilities under any
other laws, such as the federal securities laws or state or federal
environmental laws.

The Registrant's Amended Bylaws require the Registrant to indemnify its
directors and officers against expenses, judgments, fines, settlements and other
amounts actually and reasonably incurred (including expenses of a derivative
action) in connection with any proceeding, whether actual or threatened, to
which any such person may be made a party by reason of the fact that such person
is or was a director or officer of the Registrant or any of its affiliated
enterprises, provided such person acted in good faith and in a manner such
person reasonably believed to be in or not opposed to the best interest of the
Registrant and, with respect to any proceeding, had no

II-1
<PAGE>
reasonable cause to believe his or her conduct was unlawful. The Registrant's
Bylaws also set forth certain procedures that will apply in the event of a claim
for indemnification thereunder.

At present, there is no pending litigation or proceeding involving a
director or officer of the Registrant as to which indemnification is being
sought nor is the Registrant aware of any threatened litigation that may result
in claims for indemnification by any officer or director.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

In connection with the Preferred National Acquisition, the Company will
issue 500,000 shares of Class A Common Stock (300,000 shares of Common Stock
giving effect to the Recapitalization) and the Preferred National Warrants to
entities affiliated with Preferred National. No Underwriters, brokers or other
agents were involved in the transaction. These securities were issued pursuant
to an exemption from registration provided by Section 4(2) of the Securities Act
and the rules and regulations thereunder.

On June 30, 1997 the Company issued 424,156 shares of Class A Common Stock
upon the exercise of expiring warrants at exercise prices ranging from $0.76 to
$2.00.

In connection with the Rockwood Acquisition, on December 31, 1996, the
Company issued 31,750 Units (defined below) to 27 individuals and entities and
on August 25, 1997 the Company issued an additional 733 Units to 11 individuals
and entities in private placements. All such purchasers were 'accredited
investors' as defined in Regulation D. The purchase price for each Unit was
$400, for an aggregate purchase price of $13.0 million. Each 'Unit' consisted of
100 shares of Class C Common Stock, 100 purchase price adjustment rights and one
Warrant to purchase 7.874 shares of Class A Common Stock. Also in connection
with the Rockwood Acquisition, on December 31, 1996, the Company issued $15.5
million of Series A Redeemable Convertible Preferred Stock to Fort Washington in
a private placement. No underwriters, brokers or other agents were involved in
these transactions. These securities were issued pursuant to an exemption from
registration provided by Section 4(2) of the Securities Act and Rule 506 of
Regulation D promulgated thereunder.

In early 1995, the Company issued 51,648 shares of Class A Common Stock at
$2.50 per share in connection with the conversion of $129,122 of principal and
accrued interest on outstanding subordinated debt to certain shareholders. No
underwriters, brokers or other agents were involved in the transaction. These
securities were issued pursuant to an exemption from registration provided by
Section 3(a)(9) of the Securities Act and the rules and regulations thereunder.

As of September 26, 1997, the Company had granted options under its 1992
Stock Option Plan exercisable into 250,000 shares of Common Stock, to three
individuals. These options were granted from December 31, 1995 through May 13,
1997; the exercise prices of such options range from $2.00 to $5.00 per share;
and such options are exercisable through 2007 and expire at various times from
2002 to 2007. As of September 26, 1997, the Company had granted options under
the 1996 Incentive Plan exercisable into 500,000 shares of Common Stock to 47
individuals. These options were granted from December 19, 1996 through May 13,
1997; the exercise prices such options range from $4.00 to $5.00 per share; and
such options are exercisable through 2007 and expire at various times from 2003
to 2007. No underwriters, brokers or other agents were involved in these
transactions. These securities were issued pursuant to the exemption from
registration provided by Rule 701 under the Securities Act.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(1) Exhibits.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
1.1 -- Form of Underwriting Agreement.**
3.1 -- Second Amended and Restated Articles of Incorporation of the Registrant.
3.2 -- Fourth Amended and Restated Bylaws of the Registrant.
3.3 -- Plan of Recapitalization.
4.1 -- Form of Common Stock Certificate.**
</TABLE>

II-2
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
5.1 -- Opinion of Robinson Silverman Pearce Aronsohn & Berman LLP.**
5.2 -- Opinion of Brooks Pierce McLendon Humphry & Leonard.**
10.1 -- Form of Warrant, dated September 23, 1994.*
10.2 -- Form of Stock and Asset Purchase Agreement, dated October 21, 1994, among Figgie International,
Inc., Waite Hill Holdings, Inc., Waite Hill Services, Inc. and the Registrant.*
10.3 -- Employment Agreement, dated December 31, 1997, between the Registrant and J. Adam Abram.*
10.4 -- Employment Agreement, dated December 31, 1997, between Colony Management Services, Inc. and John
K. Latham.
10.5 -- Form of Stock Purchase Agreement, dated December 6, 1996, among PIC Insurance Group, Inc.,
Tri-rock Limited Partnership and the Registrant.*
10.6 -- Credit Agreement, dated December 18, 1996, among the Registrant and First Union National Bank, as
amended.*
10.7 -- Employment Agreement, dated December 31, 1997, between the Registrant and Gregg T. Davis, as
amended.*
10.8 -- Form of Subscription Agreement, dated December 27, 1996, between the Registrant and the
signatories thereto.*
10.9 -- Agreement of Reinsurance and Assumption, dated December 30, 1996, between Rockwood Casualty
Insurance Company and Premier Auto Insurance Company.*
10.10 -- Form of Amended and Restated Registration Rights Agreement, dated December 31, 1996, between the
Registrant and signatories thereto.*
10.11 -- Form of Warrant, dated December 31, 1996.*
10.12 -- Lease, made December 31, 1996, between Rockwood Asset Management, Inc. and Rockwood Casualty
Insurance Company.*
10.13 -- Shareholder and Registration Rights Agreement, dated December 31, 1996, between the Registrant,
Fort Washington Holdings, Inc., PIC Insurance Group, Charles Lederman and Timothy McCartney.*
10.14 -- Non-Compete and Non-Solicitation Agreements, dated December 31, 1996, between the Registrant and
(i) Frank Lucchino, (ii) John R. McGinley, Jr., (iii) Pittsburgh Mutual Insurance Company, (iv)
PIC Insurance Group, Inc., (v) Charles M. Lederman, (vi) Timothy I. McCarthy, Sr., (vii) Peter C.
Dozzi, (viii) Premier Auto Insurance Company and (ix) Terrence Jacobs.*
10.15 -- Amended and Restated License Agreement, dated December 31, 1996, between Rockwood Casualty
Insurance Company and Rockwood Asset Management, Inc.*
10.16 -- Form of Class A Common Stock Purchase Warrant, dated December 31, 1996.*
10.17 -- Stock Purchase Agreement, dated December 31, 1996, between Rockwood Casualty Insurance Company and
Fort Washington Holdings, Inc.*
10.18 -- Pledge Agreement, dated December 31, 1996, between Rockwood Casualty Insurance Company and Fort
Washington Holdings, Inc.*
10.19 -- Non-Compete and Non-Solicitation Agreement, dated December 31, 1996, between Front Royal Insurance
Company, Colony Insurance Company, Rockwood Casualty Insurance Company and Hamilton Insurance
Company.*
10.20 -- Option Agreement, dated December 31, 1996, between Colony Insurance Company and Fort Washington
Holdings, Inc.*
10.21 -- Non-Compete and Non-Solicitation Agreement, dated December 31, 1996, between Front Royal Insurance
Company, Colony Insurance Company and Rockwood Casualty Insurance Company.*
</TABLE>

II-3
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.22 -- Non-Solicitation Agreement, dated December 31, 1996, between the Registrant and Bruce Eckert.*
10.23 -- Employment Agreement, dated December 31, 1996, between the Registrant and John Yediny.*
10.24 -- Tax allocation Agreement, dated December 31, 1996, between the Registrant and Rockwood Casualty
Insurance Company.*
10.25 -- Front Royal, Inc. 1996 Incentive Plan, as amended.*
10.26 -- Front Royal, Inc. 1992 Stock Option Plan.*
10.27 -- Form of Subscription Agreement, executed in connection with the August 25, 1997 Private Placement,
between the Registrant and signatories thereto.*
10.28 -- Form of First Amendment to the Amended and Restated Registration Rights Agreement, executed in
connection with the August 25, 1997 Private Placement, between the Registrant and signatories
thereto.*
10.29 -- Form of Warrant, dated August 25, 1997.*
10.30 -- Stock and Asset Purchase and Sale Agreement, dated as of March 6, 1998, among Front Royal, Inc.
and PNIC Holdings, Inc., as Buyer and Preferred National Financial Corp., Wycon Corporation,
United American Financial Services Corporation and Ameridian Adjustment Corp., as Seller, and
Stephen Weicholz (for certain limited purposes).*
10.31 -- Form of Second Amendment to Amended and Restated Registration Rights Agreement between the
Registrant and the signatories thereto.
10.32 -- Form of Class C Preference Agreement among the Registrant and certain holders of the Class C
Common Stock.
21.1 -- List of Subsidiaries of Registrant.
23.1 -- Consent of Robinson Silverman Pearce Aronsohn & Berman LLP (included in Exhibit 5.1).**
23.2 -- Consent of Ernst & Young LLP.
23.3 -- Consent of Parente, Randolph, Orlando, Carey & Associates.
23.4 -- Consent of Deloitte & Touche LLP.
23.5 -- Consent of Brooks Pierce McLendon Humphry & Leonard (included in Exhibit 5.2).**
24.1 -- Powers of Attorney (included on Signature Page).*
27.1 -- Financial Data Schedule.
</TABLE>

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

* Previously filed.

** To be filed by Amendment.

(2) Financial Statement Schedules.

<TABLE>
<CAPTION>
Report of Independent Auditors on Schedules
<S> <C> <C>
Schedule I -- Summary of Investments
Schedule II -- Condensed Financial Information of Registrant (Parent Company)
-- Balance sheets
-- Statements of Income
-- Statements of Cash Flows
-- Notes to Condensed Financial Statements
Schedule IV -- Reinsurance
Schedule V -- Valuation and Qualifying Accounts
Schedule VI -- Supplemental Information Concerning Property/Casualty Insurance Operations
</TABLE>

II-4
<PAGE>
All other schedules have been omitted because they are not required or not
material or because the required information is included in the financial
statements included elsewhere herein.

ITEM 17. UNDERTAKINGS

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

The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.

The undersigned registrant hereby undertakes that:

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

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

II-5
<PAGE>
SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN THE CITY OF MORRISVILLE, STATE OF
NORTH CAROLINA, ON THE 29TH DAY OF JULY, 1998.

FRONT ROYAL, INC.

By /s/ J. ADAM ABRAM
---------------------------------
J. Adam Abram
President and Chief Executive
Officer

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
* Chairman of the Board of Directors July 29, 1998
- ------------------------------------------
Richard W. Wright

/s/ J. Adam Abram President, Chief Executive Officer and July 29, 1998
- ------------------------------------------ Director (Principal Executive Officer)
J. Adam Abram

/s/ Gregg T. Davis Chief Financial Officer and Chief Operating July 29, 1998
- ------------------------------------------ Officer (Principal Financial Officer)
Gregg T. Davis

* Director July 29, 1998
- ------------------------------------------
Matthew Bronfman

* Director July 29, 1998
- ------------------------------------------
Alan N. Colner

* Director July 29, 1998
- ------------------------------------------
Joel L. Fleishman

* Director July 29, 1998
- ------------------------------------------
Robert V. Hatcher, Jr.

* Director July 29, 1998
- ------------------------------------------
Ira M. Lubert

* Director July 29, 1998
- ------------------------------------------
Lewis P. Wilkinson

* Director July 29, 1998
- ------------------------------------------
Wilson Wilde

* Director July 29, 1998
- ------------------------------------------
James L. Zech
</TABLE>

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

* By J. Adam Abram pursuant to
the Power of Attorney granted
to him on June 17, 1998.

/s/ J. Adam Abram

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

II-6
<PAGE>
REPORT OF INDEPENDENT AUDITORS

Front Royal, Inc. and Subsidiaries

We have audited the consolidated financial statements of Front Royal, Inc. and
Subsidiaries as of December 31, 1997 and 1996, and for each of the three years
in the period ended December 31, 1997, and have issued our report thereon dated
February 20, 1998 (included elsewhere in this Registration Statement). Our
audits also included the financial statement schedules listed in Item 16(b) of
this Registration Statement. These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits.

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

/s/ ERNST & YOUNG LLP
-----------------------
ERNST & YOUNG LLP

Richmond, Virginia
February 20, 1998

S-1
<PAGE>
SCHEDULE I

FRONT ROYAL, INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
DECEMBER 31, 1997

<TABLE>
<CAPTION>
AMOUNT AT WHICH
SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- ------------------------------------------------------------- ------------ ------------ -----------------
<S> <C> <C> <C>
Fixed maturities:
Available-for-Sale:
United States Government and government
agencies and authorities.............................. $ 91,282,474 $ 93,695,393 $ 93,695,393
Foreign governments..................................... 2,074,121 2,103,990 2,103,990
Public utilities........................................ 2,270,804 2,278,890 2,278,890
All other corporate..................................... 26,676,864 27,296,588 27,296,588
------------ ------------ -----------------
Total available-for-sale.............................. 122,304,263 125,374,861 125,374,861
------------ ------------ -----------------
Held-to-Maturity:
United States Government and government
agencies and authorities.............................. 62,166,242 62,660,439 62,166,242
States, municipalities and political subdivisions....... 25,162,968 26,196,929 25,162,968
Public utilities........................................ 5,562,524 5,586,910 5,562,524
All other corporate bonds............................... 16,644,887 16,959,010 16,644,887
------------ ------------ -----------------
Total held-to-maturity................................ 109,536,621 111,403,288 109,536,621
------------ ------------ -----------------
Total fixed maturities................................ 231,840,884 236,778,149 234,911,482
------------ ------------ -----------------
Equity securities:
Common stocks:
Banks, trust and insurance companies.................... 3,641,164 4,172,588 4,172,588
Industrial, miscellaneous and all other................. 12,309,220 13,681,133 13,681,133
Nonredeemable preferred stocks............................. 685,237 747,500 747,500
------------ ------------ -----------------
Total equity securities................................. 16,635,621 18,601,221 18,601,221
------------ ------------ -----------------
Short-term investments....................................... 24,208,843 XXXXXXX 24,208,843
------------ ------------ -----------------
Total investments....................................... $272,685,348 XXXXXXX $ 277,721,546
------------ ------------ -----------------
------------ ------------ -----------------
</TABLE>

S-I-1
<PAGE>
SCHEDULE II

FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEETS

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------
1997 1996
<S> <C> <C>
ASSETS
Cash.............................................................................. $ 1,391,165 $ 4,167,040
Short-term investments............................................................ 6,281,264 2,025,112
Investments in subsidiaries, at equity............................................ 92,612,374 80,742,269
Other assets...................................................................... 748,001 530,625
Intercompany receivable........................................................... 167,941 174,655
------------ -----------
Total assets................................................................. $101,200,745 $87,639,701
------------ -----------
------------ -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expenses.................................................................. $ 2,808,316 $ 985,929
Accrued preferred stock dividend.................................................. 1,085,000 --
Senior bank debt.................................................................. 36,545,430 38,000,000
------------ -----------
Total liabilities............................................................ 40,438,746 38,985,929
Commitments and contingent liabilities
Series A Redeemable Convertible Preferred Stock, no par value, 155,000 shares
authorized and 155,000 shares issued and outstanding in 1997 and 1996........ 15,500,000 15,500,000
Common shareholders' equity:
Common Stock--Class A, no par value, 20,000,000 shares authorized and 5,859,144
and 5,442,030 shares issued and outstanding in 1997 and 1996, respectively... 13,739,979 13,402,208
Common Stock--Class B, no par value, 700,000 shares authorized and 268,482 and
272,895 shares issued and outstanding in 1997 and 1996, respectively......... 557,348 575,000
Common Stock--Class C, no par value, 3,500,000 and 3,200,000 shares authorized
and 3,248,300 and 3,175,000 shares issued and outstanding in 1997 and 1996,
respectively................................................................. 12,993,200 12,700,000
------------ -----------
27,290,527 26,677,208
Notes receivable from officers.................................................. (166,386) (200,000)
Retained earnings............................................................... 14,813,967 4,540,316
Unrealized gains on available-for-sale securities............................... 3,323,891 2,136,248
Total common shareholders' equity............................................ 45,261,999 33,153,772
------------ -----------
60,761,999 48,653,772
------------ -----------
Total liabilities, redeemable preferred stock and common shareholders'
equity...................................................................... $101,200,745 $87,639,701
------------ -----------
------------ -----------
</TABLE>

See Notes to Condensed Financial Statements.
S-II-1
<PAGE>
SCHEDULE II

FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF INCOME

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Dividends received from consolidated subsidiaries................... $ 4,850,000 $11,100,000 $ --
Net investment income............................................... 405,503 108,147 130,954
----------- ----------- -----------
Total revenues.................................................... 5,255,503 11,208,147 130,954
----------- ----------- -----------
Interest expense.................................................... 3,389,849 1,981,238 1,590,679
Other operating costs and expenses.................................. 1,156,846 251,073 358,703
----------- ----------- -----------
Total expenses.................................................... 4,546,695 2,232,311 1,949,382
----------- ----------- -----------
Income/(loss) before federal income tax benefit and equity in
undistributed income/(loss) of consolidated subsidiaries.......... 708,808 8,975,836 (1,818,428)
Federal income tax benefit.......................................... (1,537,143) (768,340) (671,039)
----------- ----------- -----------
Income/(loss) before equity in undistributed income/(loss) of
consolidated subsidiaries......................................... 2,245,951 9,744,176 (1,147,389)
Equity in undistributed income/(loss) of consolidated subsidiaries
................................................................. 9,112,700 (5,233,254) 4,699,583
----------- ----------- -----------
Net income.......................................................... $11,358,651 $ 4,510,922 $ 3,552,194
----------- ----------- -----------
----------- ----------- -----------
</TABLE>

See Notes to Condensed Financial Statements.

S-II-2
<PAGE>
SCHEDULE II

FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Operating activities:
Net income....................................................... $ 11,358,651 $ 4,510,922 $ 3,552,194
Adjustments to reconcile net income to net cash provided by/(used
in) operating activities:
Equity in undistributed net income/(loss) of subsidiaries..... (9,112,700) 5,233,254 (4,699,583)
Amortization.................................................. -- -- 170,876
Change in operating assets and liabilities:
Federal income tax payable.................................. 190,206 58,196 (82,039)
Accrued preferred stock dividend............................ 1,085,000 -- --
Receivables, payables, accrued expenses and other........... (1,199,629) 539,147 (270,344)
------------ ------------ -----------
Net cash provided by/(used in) operating activities................ 2,321,528 10,341,519 (1,328,896)
------------ ------------ -----------
Investing activities:
Acquisitions..................................................... -- (42,332,442) --
Net purchases of short-term investments.......................... (4,256,152) (22,433) (2,132)
------------ ------------ -----------
Net cash used in investing activities.............................. (4,256,152) (42,354,875) (2,132)
------------ ------------ -----------
Financing activities:
Proceeds from bank borrowings and other debt issuances,
net of issuance costs......................................... -- 37,307,050 74,568
Retirement of debt............................................... (1,454,570) (14,067,068) --
Proceeds from issuance of common stock,
net of repurchases............................................ 613,319 12,700,000 (62,500)
------------ ------------ -----------
Net cash provided by/(used in) financing activities................ (841,251) 35,939,982 12,068
------------ ------------ -----------
Increase/(decrease) in cash........................................ (2,775,875) 3,926,626 (1,318,960)
Cash at beginning of year.......................................... 4,167,040 240,414 1,559,374
------------ ------------ -----------
Cash at end of year................................................ $ 1,391,165 $ 4,167,040 $ 240,414
------------ ------------ -----------
------------ ------------ -----------
</TABLE>

See Notes to Condensed Financial Statements.

S-II-3
<PAGE>
SCHEDULE II

FRONT ROYAL, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

In the parent company-only financial statements, the Company's investment
in subsidiaries is stated at cost plus equity in undistributed earnings of
subsidiaries since the date of acquisition. The Company's share of net income of
its unconsolidated subsidiaries is included in consolidated income using the
equity method. The parent company-only financial statements should be read in
conjunction with the Company's consolidated financial statements.

Other operating costs and expenses are recorded net of reimbursements from
subsidiaries of $1,705,000, $1,204,000 and $1,148,000 in 1997, 1996 and 1995,
respectively.

S-II-4
<PAGE>
SCHEDULE IV
FRONT ROYAL, INC. AND SUBSIDIARIES
REINSURANCE

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED TO
AMOUNT COMPANIES COMPANIES AMOUNT NET
------------ ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
1997
Premiums earned:
Property/casualty insurance............. $103,702,417 $14,042,036 $862,672 $90,523,053 1.0%
------------ ----------- ---------- ----------- ---
------------ ----------- ---------- ----------- ---

1996
Premiums earned:
Property/casualty insurance............. $ 47,632,943 $ 6,053,694 $536,211 $42,115,460 1.3%
------------ ----------- ---------- ----------- ---
------------ ----------- ---------- ----------- ---

1995
Premiums earned:
Property/casualty insurance............. $ 41,535,362 $ 5,738,579 $740,605 $36,537,388 2.0%
------------ ----------- ---------- ----------- ---
------------ ----------- ---------- ----------- ---
</TABLE>

S-IV-1
<PAGE>
SCHEDULE V

FRONT ROYAL, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1997

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
DESCRIPTION PERIOD EXPENSES DEDUCTIONS PERIOD
- --------------------------------------------------------------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for premiums receivable and
agents' balances.......................................... $410,070 $375,000 $ 8,400 $ 776,670
Year ended December 31, 1996:
Allowance for premiums receivable and
agents' balances(1)....................................... $277,166 $225,000 $ 92,096 410,070
Year ended December 31, 1995:
Allowance for premiums receivable and
agents' balances.......................................... $202,234 $ 74,932 $ -- $ 277,166
</TABLE>

- ------------------
(1) Rockwood Casualty Insurance Company was acquired December 31, 1996. The
$225,000 charged to expense represents Rockwood's allowance at this date.

S-V-1
<PAGE>
SCHEDULE VI

FRONT ROYAL, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY/CASUALTY INSURANCE OPERATIONS

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Deferred policy acquisition costs............................... $ 8,775,710 $ 9,138,342 $ 5,459,988
Reserves for unpaid losses and loss adjustment expenses......... 195,330,919 188,075,278 56,232,964
Discount deducted from reserves................................. 15,061,000 15,509,389 --
Unearned premiums............................................... 36,007,585 40,328,234 19,803,635

<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Earned premiums................................................. $ 90,523,053 $ 42,115,460 $ 36,537,388
Net investment income........................................... 17,983,571 5,867,009 5,449,126
Losses and loss adjustment expenses incurred related to:
Current Year.................................................. 60,711,000 27,058,000 22,870,000
Prior years................................................... (4,515,000) (948,000) (304,000)
Amortization of deferred policy acquisition costs............... 25,828,874 12,728,649 11,132,274
Paid losses and loss adjustment expenses........................ 45,747,000 21,380,000 18,803,000
Premiums written, net........................................... 88,030,639 43,403,987 37,655,232
</TABLE>

S-VI-1
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
------------------------
FORM S-1

PRE-EFFECTIVE AMENDMENT NO. 1 REGISTRATION STATEMENT

UNDER
THE SECURITIES ACT OF 1933
------------------------

FRONT ROYAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

EXHIBITS

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------
<S> <C> <C>
1.1 -- Form of Underwriting Agreement.**
3.1 -- Second Amended and Restated Articles of Incorporation of the Registrant.
3.2 -- Fourth Amended and Restated Bylaws of the Registrant.
3.3 -- Plan of Recapitalization.
4.1 -- Form of Common Stock Certificate.**
5.1 -- Opinion of Robinson Silverman Pearce Aronsohn & Berman LLP.**
5.2 -- Opinion of Brooks Pierce McLendon Humphry & Leonard.**
10.1 -- Form of Warrant, dated September 23, 1994.*
10.2 -- Form of Stock and Asset Purchase Agreement, dated October 21, 1994, among Figgie
International, Inc., Waite Hill Holdings, Inc., Waite Hill Services, Inc. and the
Registrant.*
10.3 -- Employment Agreement, dated December 31, 1997, between the Registrant and J. Adam
Abram.*
10.4 -- Employment Agreement, dated December 31, 1997, between Colony Management Services,
Inc. and John K. Latham.
10.5 -- Form of Stock Purchase Agreement, dated December 6, 1996, among PIC Insurance Group,
Inc., Tri-rock Limited Partnership and the Registrant.*
10.6 -- Credit Agreement, dated December 18, 1996, among the Registrant and First Union
National Bank, as amended.*
10.7 -- Employment Agreement, dated December 31, 1997, between the Registrant and Gregg T.
Davis, as amended.*
10.8 -- Form of Subscription Agreement, dated December 27, 1996, between the Registrant and
the signatories thereto.*
10.9 -- Agreement of Reinsurance and Assumption, dated December 30, 1996, between Rockwood
Casualty Insurance Company and Premier Auto Insurance Company.*
10.10 -- Form of Amended and Restated Registration Rights Agreement, dated December 31, 1996,
between the Registrant and signatories thereto.*
10.11 -- Form of Warrant, dated December 31, 1996.*
10.12 -- Lease, made December 31, 1996, between Rockwood Asset Management, Inc. and Rockwood
Casualty Insurance Company.*
10.13 -- Shareholder and Registration Rights Agreement, dated December 31, 1996, between the
Registrant, Fort Washington Holdings, Inc., PIC Insurance Group, Charles Lederman and
Timothy McCartney.*
10.14 -- Non-Compete and Non-Solicitation Agreements, dated December 31, 1996, between the
Registrant and (i) Frank Lucchino, (ii) John R. McGinley, Jr., (iii) Pittsburgh Mutual
Insurance Company, (iv) PIC Insurance Group, Inc., (v) Charles M. Lederman, (vi)
Timothy I. McCarthy, Sr., (vii) Peter C. Dozzi, (viii) Premier Auto Insurance Company
and (ix) Terrence Jacobs.*
10.15 -- Amended and Restated License Agreement, dated December 31, 1996, between Rockwood
Casualty Insurance Company and Rockwood Asset Management, Inc.*
10.16 -- Form of Class A Common Stock Purchase Warrant, dated December 31, 1996.*
10.17 -- Stock Purchase Agreement, dated December 31, 1996, between Rockwood Casualty Insurance
Company and Fort Washington Holdings, Inc.*
10.18 -- Pledge Agreement, dated December 31, 1996, between Rockwood Casualty Insurance Company
and Fort Washington Holdings, Inc.*
10.19 -- Non-Compete and Non-Solicitation Agreement, dated December 31, 1996, between Front
Royal Insurance Company, Colony Insurance Company, Rockwood Casualty Insurance Company
and Hamilton Insurance Company.*
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------
<S> <C> <C>
10.20 -- Option Agreement, dated December 31, 1996, between Colony Insurance Company and Fort
Washington Holdings, Inc.*
10.21 -- Non-Compete and Non-Solicitation Agreement, dated December 31, 1996, between Front
Royal Insurance Company, Colony Insurance Company and Rockwood Casualty Insurance
Company.*
10.22 -- Non-Solicitation Agreement, dated December 31, 1996, between the Registrant and Bruce
Eckert.*
10.23 -- Employment Agreement, dated December 31, 1996, between the Registrant and John
Yediny.*
10.24 -- Tax allocation Agreement, dated December 31, 1996, between the Registrant and Rockwood
Casualty Insurance Company.*
10.25 -- Front Royal, Inc. 1996 Incentive Plan, as amended.*
10.26 -- Front Royal, Inc. 1992 Stock Option Plan.*
10.27 -- Form of Subscription Agreement, executed in connection with the August 25, 1997
Private Placement, between the Registrant and signatories thereto.*
10.28 -- Form of First Amendment to the Amended and Restated Registration Rights Agreement,
executed in connection with the August 25, 1997 Private Placement, between the
Registrant and signatories thereto.*
10.29 -- Form of Warrant, dated August 25, 1997.*
10.30 -- Stock and Asset Purchase and Sale Agreement, dated as of March 6, 1998, among Front
Royal, Inc. and PNIC Holdings, Inc., as Buyer and Preferred National Financial Corp.,
Wycon Corporation, United American Financial Services Corporation and Ameridian
Adjustment Corp., as Seller, and Stephen Weicholz (for certain limited purposes).*
10.31 -- Form of Second Amendment to Amended and Restated Registration Rights Agreement between
the Registrant and the signatories thereto.
10.32 -- Form of Class C Preference Agreement among the Registrant and certain holders of the
Class C Common Stock.
21.1 -- List of Subsidiaries of Registrant.
23.1 -- Consent of Robinson Silverman Pearce Aronsohn & Berman LLP (included in Exhibit
5.1).**
23.2 -- Consent of Ernst & Young LLP.
23.3 -- Consent of Parente, Randolph, Orlando, Carey & Associates.
23.4 -- Consent of Deloitte & Touche LLP.
23.5 -- Consent of Brooks Pierce McLendon Humphry & Leonard (included in Exhibit 5.2).**
24.1 -- Powers of Attorney (included on Signature Page).*
27.1 -- Financial Data Schedule.
</TABLE>

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

* Previously filed.

** To be filed by Amendment.

<PAGE>

SECOND AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
FRONT ROYAL, INC.

ARTICLE I

The name of the Corporation is Front Royal, Inc.

ARTICLE II

The period of duration of the Corporation is perpetual.

ARTICLE III

The aggregate number of shares of capital stock which the Corporation
shall have authority to issue is Thirty Five Million (35,000,000) divided into
two classes as follows:

A. The Corporation is hereby authorized to issue Thirty Million
(30,000,000) shares of common stock, no par value per share (the
"Common Stock"); and

B. The Corporation is hereby authorized to issue Five Million
(5,000,000) shares of preferred stock, no par value per share, having
such rights, privileges, restrictions and preferences as the Board of
Directors of the Corporation may authorize from time to time (the
"Preferred Stock"). The Board of Directors of the Corporation shall
have full power and authority to establish one or more series within
the class of Preferred Stock, to define the designations,
preferences, privileges, restrictions and relative rights (including
conversion rights) of shares within such class and to determine all
variations between series.

Subsection B of this Article III shall not be amended, revised, restated,
cancelled or repealed in any fashion unless approved by the affirmative vote
of 66.67% of the voting power of the then outstanding shares of any class or
series of capital stock of the Corporation entitled to vote on such proposed
amendment, revision, repeal or restatement, voting together as a single class.

ARTICLE IV

The street and mailing address of the registered office of the
Corporation is 2200 Gateway Blvd., Suite 205; Morrisville, Wake County, North
Carolina 27560. The registered agent of the Corporation is J. Adam Abram.

<PAGE>

ARTICLE V

The number of directors of the Corporation shall be not less than
seven (7) nor more than eleven (11)., with the exact number to be fixed from
time to time as provided in the Corporation's By-Laws.

The directors shall be divided into three (3) classes, as nearly as
equal as possible in number as may be, to serve in the first instance for
terms of one, two and three years, respectively, from the date such class of
directors takes office or until their earlier death, resignation, retirement,
removal of disqualification or until their successor shall be elected and
shall qualify, and thereafter the successors in each class of directors shall
be elected for terms of three (3) years or until their earlier death,
resignation, retirement, removal or disqualification or until their successor
shall be elected and shall qualify. In the event of any increase or decrease
in the number of directors at a time when the directors are so classified, the
additional or eliminated directors shall be classified or chosen so that all
classes of directors shall remain or become as nearly equal as possible in
number as may be.

This Article V shall not be amended, revised, restated, cancelled or
repealed in any fashion unless approved by the affirmative vote of 66.67% of
the voting power of the then outstanding shares of any class or series of
capital stock of the Corporation entitled to vote on such proposed amendment,
revision, repeal or restatement, voting together as a single class.

ARTICLE VI

The Shareholders of the Corporation shall not be entitled to
cumulative voting. This Article VI shall not be amended, revised, restated,
cancelled or repealed in any fashion unless approved by the affirmative vote
of 66.67% of the voting power of the then outstanding shares of any class or
series of capital stock of the Corporation entitled to vote on such proposed
amendment, revision, repeal or restatement, voting together as a single class.

ARTICLE VII

No director of the Corporation shall have personal liability arising
out of any action whether by or in the right of the Corporation or otherwise
for monetary damages for any breach of duty as a director to the fullest
extent permitted by the North Carolina Business Corporation Act, provided that
this limitation shall not apply to (i) acts or omissions not made in good
faith that the director at the time of such breach knew or believed were in
conflict with the best interests of the Corporation, (ii) any liability under
N.C. Gen. Stat. ss.55-8-33, (iii) any transaction from which such director
derived an improper personal benefit, or (iv) acts or omissions occurring
prior to the date on which this Article VII became effective. As used herein,
the term "improper personal benefit" does not include a director's
compensation or other incidental benefit for or on account of service as a
director, officer, employee, independent contractor, attorney or consultant of
the Corporation. Any and all breaches of duty arising out of the same
transaction or occurrences of inter-related series of transactions or
occurrences shall be deemed to be one breach of duty for the monetary damages,
limitations set forth above. If the North Carolina General Statutes are
amended after approval by

<PAGE>

the Corporation's shareholders of this Article VII to authorize corporate
action further eliminating or limiting the personal liability of directors,
then the liability of a director of the Corporation shall be eliminated or
limited to the fullest extent permitted by the North Carolina General
Statutes, as so amended. No amendment or repeal of the provisions of this
Article VII shall apply to or have any effect on the liability or alleged
liability of any director of the Corporation for or with respect to any act or
failure to act on the part of such director occurring prior to such amendment
or repeal. The provisions of this Article VII shall not be deemed to limit or
preclude indemnification of a director by the Corporation for any liability
which has not been eliminated by the provisions of this Article VII. This
Article VII shall not be amended, revised, restated, cancelled or repealed in
any fashion unless approved by the affirmative vote of 66.67% of the voting
power of the then outstanding shares of any class or series of capital stock
of the Corporation entitled to vote on such proposed amendment, revision,
repeal or restatement, voting together as a single class.

<PAGE>

FOURTH AMENDED AND RESTATED

BY-LAWS

FRONT ROYAL, INC.

<PAGE>

Table of Contents

ARTICLE I

Offices

Section 1.1 Principal Office
Section 1.2 Registered Office
Section 1.3 Other Offices

ARTICLE II

Meetings of Shareholders

Section 2.1 Place of Meetings
Section 2.2 Annual Meetings
Section 2.3 Substitute Annual Meetings
Section 2.4 Special Meetings
Section 2.5 Notice of Meetings
Section 2.6 Voting Lists
Section 2.7 Quorum
Section 2.8 Proxies
Section 2.9 Voting of Shares
Section 2.10 Presiding Officer
Section 2.11 Inspectors of Voting

ARTICLE III

Directors

Section 3.1 General Powers
Section 3.2 Number and Qualifications
Section 3.3 Terms of Directors
Section 3.4 Nomination and Election of Directors
Section 3.5 Removal
Section 3.6 Vacancies
Section 3.7 Chairman and Vice-Chairman of the Board
Section 3.8 Compensation

<PAGE>

ARTICLE IV

Meetings of Directors

Section 4.1 Regular Meetings
Section 4.2 Special Meetings
Section 4.3 Notice of Meetings
Section 4.4 Waiver of Notice
Section 4.5 Quorum
Section 4.6 Manner of Acting
Section 4.7 Presumption of Assent
Section 4.8 Informal Action by Directors
Section 4.9 Participation by Audio Medium

ARTICLE V

Committees

Section 5.1 Executive Committee
Section 5.2 Other Committees
Section 5.3 Vacancy
Section 5.4 Removal
Section 5.5 Committee Membership and Procedures
Section 5.6 Responsibility of Directors

ARTICLE VI

Officers

Section 6.1 Offices
Section 6.2 Appointment and Term
Section 6.3 Removal and Resignation
Section 6.4 Compensation by Contract Rights
Section 6.5 Chairman and Vice-Chairmen of the Board
Section 6.6 Chief Executive Officer
Section 6.7 President
Section 6.8 Secretary
Section 6.9 Duties of Other Officers
Section 6.10 Bonds

<PAGE>

ARTICLE VII

Contracts, Loans, Checks and Deposits

Section 7.1 Contracts
Section 7.2 Loans
Section 7.3 Checks and Drafts
Section 7.4 Deposits

ARTICLE VIII

Shares and Their Transfer

Section 8.1 Certificates for Shares
Section 8.2 Transfer of Shares
Section 8.3 Closing Transfer Books and
Fixing Record Date
Section 8.4 Lost Certificates
Section 8.5 Holder of Record
Section 8.6 Transfer Agent and Registrar
Section 8.7 Control Shares Acquisitions Act

ARTICLE IX

Indemnification of Directors, Officers and Others

Section 9.1 Definitions
Section 9.2 Indemnification
Section 9.3 Determination
Section 9.4 Advances For Expenses
Section 9.5 Reliance and Consideration
Section 9.6 Insurance
Section 9.7 Continuation of Prior Provisions

ARTICLE X

General Provisions

Section 10.1 Distributions
Section 10.2 Seal
Section 10.3 Waiver of Notice
Section 10.4 Amendments
Section 10.5 Fiscal Year
Section 10.6 Succession Order
Section 10.7 Voting of Shares
Section 10.8 Definitions

<PAGE>

ARTICLE I

Offices

Section 1.1. Principal Office. The principal office of the
Corporation shall be located in the City of Morrisville, County of Wake, State
of North Carolina or at such other location as determined by the Board of
Directors.

Section 1.2. Registered Office. The registered office of the
Corporation required by law to be maintained in the State of North Carolina
may be, but need not be, identical with the principal office, and the address
of the registered office may be changed from time to time as provided in the
Act.

Section 1.3. Other Offices. The Corporation may have offices at such
other places, either within or without the State of North Carolina, as the
Board of Directors from time to time may determine or as the affairs of the
Corporation may require.

ARTICLE II

Meetings of Shareholders

Section 2.1. Place of Meetings. All meetings of shareholders shall be
held at the principal office of the Corporation or at such other place, either
within or without the State of North Carolina, as shall be designated by the
Board of Directors or, upon the failure of the Board to make such designation,
by the Chairman of the Board and set forth in the notice of the meeting.

Section 2.2. Annual Meeting. The annual meeting of shareholders shall
be held at the designated location within two hundred and ten (210) days of
the close of each fiscal year and at a date and an hour fixed by the Board of
Directors for the purpose of electing directors of the Corporation and for the
transaction of such other business as may be properly brought before the
meeting. Any matters to be brought forth and considered at the annual meeting,
other than such matters brought forth at the direction of the Board of
Directors, shall be presented in writing in a timely notice to the Secretary
of the Corporation. To be timely, a shareholder's notice must be received at
the principal office of the Corporation not less than fifty (50) nor more than
seventy-five (75) days prior to the annual meeting.

Section 2.3. Substitute Annual Meeting. If the annual meeting shall
not be held during the period established in Section 2.2, a substitute annual
meeting may be called in accordance with the provisions of Section 2.4 or as
provided by the Act. A meeting so called shall be designated and treated for
all purposes as the annual meeting.

Section 2.4. Special Meetings. Special meetings of the shareholders
may be called at any time by a majority of the Board of Directors of the
Corporation, by the Chairman of the Board, or by any shareholder pursuant to
the written request of the holders of not less than ten percent (10%) of all
the votes entitled to be cast on any issue proposed to be considered at such
meeting; provided, however, that the right of shareholders to call a special
meeting shall be suspended and without effect at all times that the
Corporation is a "public corporation," as defined in the Act.

Section 2.5. Notice of Meetings. Written or printed notice stating
the time and place of a meeting of shareholders shall be delivered not less
than ten (10) nor more than sixty (60) days before the date thereof, either
personally or by mail, by or at the direction of the Chairman of the Board,
the Board of Directors, or such other person calling the meeting, to each
shareholder of record entitled to vote at such meeting and each

<PAGE>

other person specifically entitled to receive such notice under the Act. If
mailed, such notice shall be deemed to be delivered when deposited in the
United States mail, addressed to the shareholder's address as it appears on
the record of the shareholders of the Corporation with postage thereon
prepaid. Notices to non-shareholders shall be deemed to be delivered as
provided by the Act.

In the case of an annual meeting, the notice of meeting need not
specifically state the business to be transacted thereat unless such a
statement is expressly required by the provisions of the Act or applicable
federal laws. In the case of a special or substitute annual meeting, the
notice shall describe the purpose or purposes for which the meeting is being
called. Only the business within the purpose or purposes described in the
special or substitute annual meeting notice may be conducted at such meeting.

Unless a meeting is adjourned (a) to a new date, time or place, and
such new date, time or place is not announced at the meeting prior to
adjournment or (b) to a date more than 120 days after the date fixed for the
original meeting, notice of the adjourned meeting need not be given.

Section 2.6. Voting Lists. The Secretary of the Corporation shall
prepare an alphabetical list by "voting group" (and within each "voting group"
by class or series of shares) of the shareholders entitled to vote at each
meeting, or any adjournment thereof, with the address of and number of shares
held by each shareholder, which list shall be kept on file at the principal
office of the Corporation for a period beginning two (2) business days after
notice of such meeting is given and continuing through such meeting. Such list
shall be subject to inspection and copying (at the shareholder's expense),
during the time it is kept on file under the provisions of the preceding
sentence, by any shareholder at the Corporation's principal office at any time
during regular business hours. This list shall also be produced and kept open
at the time and place of the meeting and shall be subject to inspection by any
shareholder at any time during the meeting or any adjournment.

Section 2.7. Quorum. The holders of a majority of the shares of each
"voting group" entitled to vote on a matter, represented in person or by
proxy, shall constitute a quorum for action on such matter by such "voting
group". If there is no quorum at the opening of a meeting of shareholders,
such meeting may be adjourned from time to time by the vote of a majority of
the shares voting on the motion to adjourn; and, at any adjourned meeting at
which a quorum is present, any business may be transacted which might have
been transacted at the original meeting. Once a share is represented for any
purpose at a meeting, it is deemed present for the remainder of the meeting
and any adjournment thereof unless a new record is or, under the Act, must be
set for that adjourned meeting.

Section 2.8. Proxies. Shares may be voted either in person or by one
or more agents authorized by a proxy in a form permissible under the Act and
executed by the shareholder or by the shareholder's duly authorized
attorney-in-fact. An appointment of proxy is effective when received by the
Secretary of the Corporation or other officer or agent of the Corporation
authorized to tabulate votes. An appointment of proxy is not valid after the
expiration of eleven (11) months from the date it is deemed effective unless
the person executing it expressly specifies therein the length of time for
which it is to continue in force or limits its use to a particular meeting. An
appointment of proxy is revocable by the shareholder unless the appointment
form conspicuously states that it is irrevocable and the appointment form is
"coupled with an interest" as provided in the Act.

Section 2.9. Voting of Shares. Subject to the provisions of Section
3.4 hereof, each outstanding share having voting rights shall be entitled to
one vote on each matter submitted to a vote at a meeting of shareholders.

2
<PAGE>

Except in the election of directors as provided in Section 3.4 and
the removal of the directors pursuant to Section 3.5, the vote of a majority
of the shares of a "voting group" voted on any matter at a meeting of
shareholders at which a quorum of that "voting group" was initially present
shall be the act of the shareholders of that "voting group" on that matter,
unless the vote of a greater number is required by the Act, the Articles of
Incorporation, or these By-Laws. Voting on all matters shall be by voice vote
or by a show of hands unless federal law applicable to the Corporation shall
require a secret ballot vote on that particular matter.

Shares of its own stock held by the Corporation, directly or
indirectly, or through a subsidiary corporation, in a fiduciary capacity may
be voted and shall be counted in determining the total number of shares
entitled to vote. Except as provided in the preceding sentence and absent
special circumstances, shares of the Corporation are not entitled to vote if
they are owned directly or indirectly, by another corporation in which the
Corporation owns, directly or indirectly, a majority of the shares entitled to
vote for directors of that second corporation.

The Chairman of the Board and the Secretary of the Corporation are
authorized to establish all reasonable and necessary procedures to permit the
voting by beneficial owners of their shares registered in the names of
nominees. The determination of whether acceptable evidence has been presented
by a person or entity to establish his, her or its beneficial ownership of,
and authority to vote, shares of the Corporation shall be made by the Chairman
of the Board, and his decision shall be final.

Section 2.10. Presiding Officer. The Chairman of the Board shall
preside at the shareholders' meetings. In his absence, the provisions of
Section 10.6 of these By-Laws shall control. The Secretary or, in the absence
of the Secretary, any person designated by the Chairman of the Board shall act
as secretary of such meetings.

Section 2.11. Inspectors of Voting. At each meeting of the
shareholders the proxies shall be received and be taken in charge, and all
questions touching qualifications of voters or the validity of proxies, the
presence of a quorum, the acceptance of votes and the results of shareholder
votes shall be decided, by voting inspectors who shall act in accordance with
Section 55-7-24 of the Act. Such voting inspectors (who may not be nominees
for election to office at such meeting) shall be appointed prior to the
meeting by the Chairman of the Board.

ARTICLE III

Directors

Section 3.1. General Powers. All corporate powers shall be exercised
by and under the authority of, and the business and affairs of the Corporation
shall be managed under the direction of, the Board of Directors.

Section 3.2. Number and Qualifications. The number of directors of
the Corporation shall be not less than seven (7) nor more than eleven (11),
which number may be fixed or changed from time to time, within the minimum and
the maximum, by the Board of Directors; provided, however, that a decrease in
the number of directors shall not shorten the term of any director in office
at the time of such decrease. Directors need not be residents of the State of
North Carolina. Each director of the Corporation shall at all times meet

<PAGE>

all statutory and regulatory qualifications applicable by virtue of the nature
of the business of the Corporation or as a result of the Corporation having a
class of securities registered under the Securities Exchange Act of 1934, as
amended (the "1934 Act").

Section 3.3. Terms of Directors. The directors of the Corporation
shall be divided into three (3) classes, as nearly as equal as possible in
number as may be, to serve in the first instance for terms of one (1), two (2)
and three (3) years, respectively, or until their earlier death, resignation,
retirement, removal or disqualification or until their successors shall be
elected and shall qualify, and thereafter, the successors in each class of
directors shall be elected to serve for terms of three (3) years or until
their earlier death, resignation, retirement, removal or disqualification or
until their successors shall be elected and shall qualify. In the event of an
increase or decrease in the number of directors, the additional or eliminated
directorship shall be so classified that all class of directors remain or
become as nearly equal in number as may be.

Section 3.4. Nomination and Election of Directors. Nominations of
persons for election to the Board of Directors of the Corporation at a meeting
of the shareholders held to elect directors may be made by or at the direction
of the Board of Directors or may be made at such shareholders meeting by any
share holder of the Corporation entitled to vote for the election of directors
at such meeting who complies with the notice procedures set forth in this
Section 3.4. Such nominations, other than those made by or at the direction of
the Board, shall be made pursuant to timely notice in writing to the Secretary
of the Corporation. To be timely, a shareholder's notice must be received at
the principal office of the Corporation not less than fifty (50) days nor more
than seventy-five (75) days prior to the shareholders meeting; provided,
however, that in the event that such applicable shareholders meeting is not an
annual meeting of shareholders, notice by the shareholder to be timely must be
so received no later than the close of business on the tenth (10th) day
following the day on which such notice of the date of the shareholders meeting
was mailed or public disclosure of such meeting was made, whichever first
occurs. Such shareholder's notice to the Secretary shall set forth (a) as to
each person whom the shareholder proposes to nominate for election or
re-election as a director, (i) the name, age, business address and residence
address of the person, (ii) the principal occupation or employment of the
person, (iii) the class and number of shares of capital stock of the
Corporation which are beneficially owned by the person, and (iv) any other
information relating to the person that is required to be disclosed in
solicitations for proxies for election of directors pursuant to applicable
regulations promulgated under the 1934 Act; and (b) as to the shareholder
giving the notice (i) the name and record address of the shareholder and (ii)
the class and number of shares of capital stock of the Corporation which are
beneficially owned by the shareholder. The Corporation may require any
proposed nominee to furnish such other information as may reasonably be
required by the Corporation to determine the eligibility of such proposed
nominee to serve as a director of the Corporation. No person shall be eligible
for election as a director of the Corporation at a shareholders meeting unless
nominated in accordance with the procedures set forth herein. The Chairman of
the Board shall, if the facts warrant, determine and declare to the
shareholders meeting that a nomination was not made in accordance with the
foregoing procedure and, accordingly, shall be disregarded.

Except as provided in Section 3.6, the directors (or, if applicable,
each director in a class) shall be elected at the annual meeting of the
shareholders; and those persons who receive a plurality of the votes cast
by the shares entitled to vote in the election of directors at such meeting
shall be deemed to have been elected. If federal law applicable to the
Corporation so requires, election of directors shall be by secret ballot.

<PAGE>

Section 3.5. Removal and Resignation. A director may be removed by
the stockholders of the Corporation only for cause by an affirmative vote of
the holders of at least 66.67% of the voting power of the then outstanding
shares of any class or series of capital stock of the Corporation entitled to
vote generally in the election of the Board of Directors, voting together as a
single class. If any director is removed, a successor director shall be
elected pursuant to Section 3.6. A director may not be removed at a meeting
(other than an annual meeting at which election of directors normally occurs)
unless the notice of the meeting states that one of the purposes of the
meeting is the removal of the director. A director may resign at any time by
communicating his resignation to the Board of Directors, its Chairman, or the
Corporation. Such resignation is effective when communicated unless it
specifies in writing a later date or subsequent event upon which it will
become effective.

Section 3.6. Vacancies. A vacancy occurring in the Board of Directors
shall be filled by a vote of the majority of the remaining directors, though
less than a quorum, or by the sole remaining director. A director elected to
fill a vacancy shall serve until the expiration of such term for which the
vacancy occurred.

Section 3.7. Chairman and Vice-Chairmen of the Board. There shall be
a Chairman of the Board of Directors and may be one or more Vice-Chairmen of
the Board of Directors, each elected by the directors from their number at any
meeting of the Board. In addition to his duties expressly set forth in these
Bylaws, the Chairman of the Board shall perform such other duties as may be
directed by the Board. In his absence or disability, the provisions of Section
10.6 shall control. The Vice-Chairmen of the Board shall perform such duties
as may be directed by the Board.

Section 3.8. Compensation. The Board of Directors may compensate
directors for their services as such, may compensate the Chairman of the Board
and the Vice-Chairmen of the Board for their services as such, and may provide
for the payment of all expenses incurred by the directors in attending regular
and special meetings of the Board or any committee thereof.

ARTICLE IV

Meetings of Directors

Section 4.1. Regular Meetings. A regular meeting of the Board of
Directors shall be held immediately after, and at the same or some other
designated place as, the annual meeting of shareholders. In addition, the
Board of Directors may provide, by resolution, the time and place, either
within or without the State of North Carolina, for the holding of additional
regular meetings. Unless otherwise provided by the Board of Directors, the
Board shall meet at least as often as once each fiscal quarter, on the dates
and at the time established as customary by the Board of Directors.

Section 4.2. Special Meetings. Special meetings of the Board of
Directors may be called by or at the request of the Chairman of the Board, the
Chief Executive Officer or any three (3) directors. Such meetings may be held
either within or without the State of North Carolina as fixed by the person or
persons calling any such meeting.

Section 4.3. Notice of Meetings. When held on the dates and at the
time established as customary by the Board of Directors, regular meetings of
the Board of Directors may be held without notice. The person or persons
calling a special meeting of the Board of Directors shall, at least
twenty-four (24) hours

<PAGE>

before the date of such meeting, give notice thereof by telephone, telegraph,
teletype or other form of wire or wireless communication, including facsimile
communication, or by written communication delivered by hand, United States
mail, or private carrier. Written notice of a special meeting of the directors
is effective at the earliest of the following: (a) when received; (b) upon
transmission if sent by facsimile and if completed transmission is evidenced
by a sender's confirmation report generated by the sender's facsimile machine;
(c) on the date shown on the confirmation of delivery issued by a private
carrier, if sent by private carrier to the address of the director last known
to the Corporation; or (d) upon its deposit in the United States mail, as
evidenced by the postmark, if mailed by first class mail, with postage thereon
prepaid, and correctly addressed; provided, however, that in order for such
notice to be effective by this Subsection 4.4(d), the special meeting must be
scheduled no earlier than three (3) days from the date such notice is mailed.
Oral notice is effective when actually communicated to the director. Notice of
an adjourned meeting of directors need not be given if the time and place are
fixed at the meeting adjourning and if the period of adjournment does not
exceed ten (10) days in any one adjournment. Such notice need not specify the
purpose for which the meeting is called. Special meetings may be held without
notice upon the unanimous consent of the directors.

Section 4.4. Waiver of Notice. Any director may waive notice of any
meeting by filing a written and signed waiver with the minutes of the meeting
or in the Corporation's corporate records. A director's attendance at or
participation in a meeting shall constitute a waiver of notice of such
meeting, unless the director at the beginning of the meeting (or promptly upon
his arrival) objects to holding the meeting or transacting any business at the
meeting and does not thereafter vote for or assent to any action taken at the
meeting.

Section 4.5. Quorum. The presence of a majority of the number of
directors prescribed by the Board of Directors under Section 3.2 and in office
immediately prior to a meeting shall constitute a quorum for the transaction
of business at that meeting of the Board.

Section 4.6. Manner of Acting. Except as otherwise provided in these
By-Laws, or by the Act, the act of the majority of the directors attending or
participating in a meeting at which a quorum is present shall be the act of
the Board of Directors, unless the act of a greater number is required by the
Corporation's Restated Articles of Incorporation (as hereafter further
amended) or these By-Laws.

Section 4.7. Presumption of Assent. A director of the Corporation who
is present at a meeting of the Board of Directors at which action on any
corporate matter is taken shall be presumed to have assented to the action
taken unless (a) the director objects at the beginning of the meeting (or
promptly upon the director's arrival) to holding such meeting or transacting
business at it, (b) the director shall file a written dissent or abstention to
such action with the presiding officer of the meeting before the adjournment
thereof or with the Corporation immediately after the adjournment of the
meeting, or (c) the director's contrary vote or abstention is entered in the
minutes of the meeting at the request of such dissenting or abstaining
director. Such right to dissent or abstain shall not apply to a director who
voted in favor of such action.

Section 4.8. Informal Action by Directors. Action taken by the
directors without a meeting is never theless Board action, and may be
described as such, if one or more written consents to the action in question,
describing the action taken, are signed by all the directors and filed with
the minutes of the proceedings of the Board of Directors or in the records of
the Corporation, whether done before or after the action so taken. Action
taken pursuant to this Section 4.8 shall be effective when the last director
signs a written consent to such action, unless the consent specifies a
different effective date.

<PAGE>

Section 4.9. Participation by Audio Medium. Upon approval by the
Board of Directors, any one or more directors may participate in any meeting
of the Board or its committees by means of a conference telephone or similar
communications medium allowing all directors participating in the meeting to
hear one another simultaneously throughout the meeting. Participation by such
means shall constitute presence in person at a meeting.

ARTICLE V

Committees

Section 5.1. Executive Committee. The Board of Directors, by proper
resolution and by the vote required under Section 4.6, may appoint an
Executive Committee which shall be composed of at least three (3) directors
who shall serve at the pleasure of the Board of Directors and which shall have
and exercise the powers of the Board of Directors in the direction of the
management of the business affairs of the Corporation, except at such time as
the Board of Directors is in session. The Chairman of the Board and the Chief
Executive Officer (if the Chief Executive Officer is a director) shall each be
a member of the Executive Committee. The members of the Executive Committee
shall select a Chairman of such committee by a majority vote. Meetings of the
Executive Committee may be held at any time on the call of its Chairman or any
two (2) members of the Committee. A majority of the members of the Executive
Committee shall constitute a quorum. Action by the Executive Committee shall
be by majority vote of the members of the Executive Committee. The Executive
Committee shall keep minutes of its meetings and shall report its actions to
the next succeeding meeting of the Board of Directors.

The Board of Directors shall have the power to direct, limit and
control the Executive Committee, and to rescind or modify any action of the
Executive Committee, by resolution at any special or regular meeting or by
general rules adopted for its guidance. In addition, neither the Executive
Committee nor any other committee appointed under these By-Laws shall have any
authority to do any act listed in Section 55-8- 25(e) of the Act, as now or
hereafter existing, or in any successor to such statute.

Section 5.2. Other Committees. The Chairman of the Board, subject to
approval by the Board of Directors by the vote required under Section 4.6, or
the Board of Directors, by proper resolution and by the vote required under
Section 4.6, may appoint such other committees as may be deemed by the
Chairman or the Board, as applicable, to be appropriate. Each such committee
shall have at least two (2) members.

Section 5.3. Vacancy. Any vacancy occurring on a Board committee
shall be filled by the vote of the Board of Directors required under Section
4.6.

Section 5.4. Removal. Members of all committees of the Board shall
serve at the pleasure of the Board. Any member of a Board committee may be
removed at any time with or without cause by the vote of the Board of
Directors required under Section 4.6.

Section 5.5. Committee Membership and Procedures. Except as otherwise
expressly provided in this Article V, the provisions of these By-Laws
governing meetings, action without meetings, notice, waiver of notice, quorum,
and voting requirements of the Board shall apply to each committee of the
Board.

Section 5.6. Responsibility of Directors. In discharging his duties
as a director, a director shall be entitled to rely on information, opinions,
reports and statements prepared or presented by a Board committee

<PAGE>

of which he is not a member unless he has actual knowledge of a matter which
makes such reliance unwarranted. Such permissible reliance shall relieve such
director of any responsibility or liability imposed upon him by law when and
to the extent permitted by the Act.

If any action taken by a Board committee is not thereafter formally
considered by the Board, a director may dissent from such action by filing his
written objection with the Secretary with reasonable promptness after learning
of such action.

ARTICLE VI

Officers

Section 6.1. Officers. The officers of the Corporation shall consist
of a Chairman of the Board of Directors, Chief Executive Officer, President
and a Secretary. Other officers, including, without limitation, a Vice
Chairman of the Board of Directors, one or more Vice Presidents (whose
seniority and titles, including Executive Vice Presidents and Senior Vice
Presidents, may be specified by the Board of Directors), a Chief Operating
Officer, a Chief Financial Officer, a Treasurer, a Controller, Assistant
Secretaries, and Assistant Treasurers, may from time to time be elected by the
Board of Directors. Any two or more offices, except President and Secretary,
Chief Executive Officer and Secretary, and Chief Operating Officer (if
applicable) and Secretary, may be held by the same person. No officer may act
in more than one capacity when the action of two or more officers is required.

Section 6.2. Appointment and Term. The officers of the Corporation
shall be appointed by the Board of Directors. Such appointments may be made at
any regular or special meeting of the Board. Each officer shall hold office
until the officer's death, resignation, retirement, removal, disqualification,
or his successor is appointed and qualified.

Section 6.3. Removal and Resignation. Any officer or agent appointed
by the Board of Directors may be removed by the Board with or without cause
whenever in its judgment the best interests of the Corporation will be served
thereby. Any such removal or disqualification shall be by the vote of the
Board of Directors required under Section 4.6.

An officer may resign at any time by communicating such officer's
resignation to the Corporation. A resignation is effective when it is
communicated unless it specifies in writing a later effective date. If a
resignation is made effective at a later date and the Corporation accepts the
future effective date, the Board of Directors may fill the pending vacancy
before the effective date if the Board of Directors provides that the
successor does not take office until the effective date.

Section 6.4. Compensation and Contract Rights. The compensation of
all officers of the Corpora tion shall be fixed by the Board of Directors.

The appointment of an officer does not itself create contract rights.
An officer's removal does not itself affect the officer's contract rights, if
any, with the Corporation, and an officer's resignation does not itself affect
the Corporation's contract rights, if any, with the officer.

Section 6.5. Chairman and Vice-Chairmen of the Board. The Chairman of
the Board and the Vice-Chairmen of the Board shall be deemed to be officers of
the Corporation and, in addition to their power and

<PAGE>

duties expressly set forth in these By-Laws, shall have such power and duties
as may be prescribed by the Board of Directors from time to time by the vote
required under Section 4.6.

Section 6.6. Chief Executive Officer. Subject to the direction of the
Board of Directors, the Chief Executive Officer shall direct and supervise the
management of the Corporation in accordance with these Bylaws and the
Corporation's Articles of Incorporation.

Section 6.7. President. The President shall be the principal
administrative officer of the Corporation and, subject to the direction of the
Chief Executive Officer and the Board of Directors, shall direct and supervise
the administration of the management of the Corporation in accordance with
these Bylaws and the Corporation's Articles of Incorporation. In the absence
of the Chief Executive Officer, or in the event of his death, disability or
inability or refusal to act, the President, unless otherwise determined by the
Board of Directors, shall also perform the duties of the Chief Executive
Officer, and when so acting, shall have all of the powers and be subject to
all the restrictions upon the Chief Executive Officer.

Section 6.8. Secretary. The Secretary shall: (a) keep the minutes of
the meetings of shareholders, the Board of Directors and each committee of the
Board in one or more books provided for that purpose; (b) see that all notices
are duly given in accordance with the provisions of these By-Laws or as
required by law; (c) be custodian of the corporate records and of the seal of
the Corporation and ascertain that the seal of the Corporation is affixed to
all documents the execution of which on behalf of the Corporation under its
seal is duly authorized; (d) keep a register of the post office address of
each shareholder which shall be furnished to the Secretary by such
shareholder; (e) have general charge of the stock transfer books of the
Corporation; (f) keep or cause to be kept in the State of North Carolina at
the Corporation's registered office or principal office a record of the
Corporation's shareholders, giving the names and addresses of all shareholders
and the number and class of shares held by each, and prepare or cause to be
prepared voting lists prior to each meeting of shareholders as required by law
and these By-Laws; and (g) in general perform all duties incident to the
office of Secretary and such other duties as from time to time may be assigned
to him by the Chief Executive Officer, the President or the Board of
Directors. The Secretary may sign with the Chief Executive Officer or the
President certificates for shares of the Corporation, the issuance of which
shall have been authorized by resolution of the Board of Directors. The
Secretary shall maintain at the Corporation's principal office (a) the
Corporation's Articles of Incorporation, and all amendments thereto, (b) these
ByLaws, and all the amendments hereto, (c) minutes of the meetings, and all
resolutions, of the Board of Directors, (d) the minutes of the meetings, and
the reports, of all committees of the Board of Directors, (e) the minutes of
all meetings of shareholders and the records of all actions by shareholders
without meetings for the preceding three (3) years, (f) all written
communications to shareholders, and all financial statements required to be
made available to shareholders, for the preceding three (3) years, (g) a list
of the names and business addresses of the Corporation's current directors and
officers, and (h) the Corporation's most recent annual report delivered to the
North Carolina Secretary of State under Section 55-16-22 of the Act.

Section 6.9. Duties of Other Officers. The duties of all officers and
employees not defined and enumerated in these By-Laws shall be prescribed and
fixed by the Chief Executive Officer and in carrying out the authority to do
all other acts necessary to be done to carry out the prescribed duties unless
otherwise ordered by the Board of Directors, including, but not limited to,
the power to sign, certify or endorse notes, certificates of indebtedness,
deeds, checks, drafts or other contracts for and on behalf of the Corporation
and/or to affix the seal of the Corporation to such documents as may require
it.

Section 6.10. Bonds. The Board of Directors may by resolution require
any or all officers, agents and employees of the Corporation to give bond to
the Corporation, with sufficient sureties, conditioned on

<PAGE>

the faithful performance of the duties of their respective offices or
positions, and to comply with such other conditions as may from time to time
be required by the Board of Directors.

ARTICLE VII

Contracts, Loans, Checks and Deposits

Section 7.1. Contracts. The Chief Executive Officer and the President
are authorized to enter any contract, lease or other agreement, and to execute
and deliver any instrument, on behalf of the Corporation which is to be
entered or executed and delivered in the ordinary course of the Corporation's
business. In addition, the Board of Directors may authorize any officer or
officers, or agent or agents, to enter into any contract, lease, or other
agreement or to execute and deliver any instrument on behalf of the
Corporation, whether or not such action is within the ordinary course of the
Corporation's business, and such authority may be general or confined to
specific instances. Any resolution of the Board of Directors authorizing the
execution of any contract, lease or other agreement or delivery of any
instrument on behalf of the Corporation by the proper officers of the
Corporation or by officers of the Corporation generally and not specifying
particular officers shall be deemed to authorize execution or delivery, as
applicable, by the Chief Executive Officer, President or any other officer if
such execution or delivery is within the scope of the duties of such other
officer. The Board of Directors may authorize the Corporation to enter into
employment contracts with any of its employees for any length of time and on
any terms and conditions it deems wise.

Section 7.2. Loans. No loans shall be contracted on behalf of the
Corporation and no evidences of indebtedness shall be issued in its name
unless authorized by a resolution of the Board of Directors, or a committee
thereof, and except as permitted by law. Such authority may be general or
specific in nature and scope.

Section 7.3. Checks and Drafts. All checks, drafts or other orders
for the payment of money issued in the name of the Corporation shall be signed
by such officer or officers, agent or agents of the Corporation and in such
manner as from time to time shall be determined by resolution of the Board of
Directors.

Section 7.4. Deposits. All funds of the Corporation not otherwise
employed from time to time shall be deposited to the credit of the Corporation
in such depositaries as the Board of Directors or a committee thereof, shall
direct.

<PAGE>

ARTICLE VIII

Shares and Their Transfer

Section 8.1. Certificates for Shares. Shares of the Corporation may,
but need not, be represented by certificates. When shares are represented by
certificates, the Corporation shall issue such certificates in such form as
the Board of Directors, or a committee thereof, shall determine in accordance
with the Act to every shareholder for the fully paid shares owned by him.
These certificates shall be signed by, or bear the facsimile signature of the
Chief Executive Officer or the President and the Secretary or an Assistant
Secretary, and sealed with the seal of the Corporation or its facsimile. They
shall be consecutively numbered or otherwise identified; and the name and
address of the persons to whom they are issued, with the number of shares and
the date of issue, shall be entered on the stock transfer books of the
Corporation. Such information may be stored or retained on discs, tapes, cards
or any other approved storage device relating to data processing equipment;
provided that such device is capable of reproducing all information contained
therein in legible and understandable form, for inspection by shareholders or
for any other corporate purpose. Such certificates shall indicate thereon a
reference to any and all restrictive conditions imposed on the shares
represented thereby.

When shares are not represented by certificates, then within a
reasonable time after the issuance or transfer or such shares, the Corporation
shall send the shareholder to whom such shares have been issued or transferred
a written statement of the information required by the Act to be on
certificates.

Section 8.2. Transfer of Shares. The Corporation, or its agent, shall
keep a book or set of books to be known as the stock transfer books of the
Corporation, containing the name of each shareholder of record, together with
such shareholder's address and the number and class or series of shares held
by such shareholder. Transfer of shares of the Corporation represented by
certificates shall be made on the stock transfer books of the Corporation only
upon surrender of the certificates for the shares sought to be transferred by
the holder of record thereof or by such holder's duly authorized agent,
transferee or legal representative, who shall furnish proper evidence of
authority to transfer with the Secretary. All certificates surrendered for
transfer shall be canceled before new certificates for the transferred shares
shall be issued.

If shares of the Corporation (1) are in the custody of a clearing
corporation or a custodian bank, or a nominee of either subject to the
instructions of the clearing corporation; (2) are in bearer form or endorsed
in blank by an appropriate person or registered in the name of the clearing
corporation or a custodian bank, or a nominee of either; and (3) are shown on
the account of a transferor or pledgor on the books of a clearing corporation,
then in addition to other methods, a transfer or pledge of the shares or any
interest therein may be effected by the making of appropriate entries on the
books of the clearing corporation reducing the account of the transferor or
pledgor and increasing the account of the transferee or pledgee by the number
of shares transferred or pledged.

The Board of Directors, or a committee thereof, may make such
additional rules and regulations regarding the transfer of shares and share
certificates as they deem reasonable, necessary and desirable. All such
restrictions upon transfer shall be noted conspicuously upon the
certificate(s) representing ownership of the shares so restricted.

Section 8.3. Closing Transfer Books and Fixing Record Date. For the
purpose of determining the shareholders of any "voting group" entitled to
notice of or vote at any meeting of shareholders, or any adjournment thereof,
or entitled to receive any "distribution", or in order to make a determination
of the

<PAGE>

shareholders of any "voting group" for any other proper purpose, the Board of
Directors may provide that the stock transfer books shall be closed for a
stated period not to exceed, in any case, thirty (30) days. If the stock
transfer books shall be closed for the purpose of determining shareholders of
any "voting group" entitled to notice of or to vote at a meeting of
shareholders, such books shall be closed for at least ten (10) days
immediately preceding such meeting.

In lieu of closing the stock transfer books, the Board of Directors
may fix in advance a date as the record date for any such determination of the
shareholders of a "voting group", such record date in any case to be not more
than seventy (70) days and, in the case of a shareholders meeting, not less
than ten (10) days immediately preceding the date on which the particular
action, requiring such determination of shareholders, is to occur.

If the stock transfer books are not closed and no record date is
fixed for the determination of the shareholders of a "voting group" entitled
to notice of or to vote at a meeting of shareholders, or shareholders entitled
to receive a "distribution", the close of business on the day before the date
on which notice of the meeting is first delivered to shareholders or the date
on which the resolution of the Board of Directors authorizing such
distribution is deemed effective under the Act, as the case may be, shall be
the record date for such determination of shareholders.

When a determination of the shareholders of a "voting group" entitled
to vote at any meeting of shareholders has been made as provided in this
Section 8.3, such determination shall apply to any adjournment thereof except
(a) where the meeting has been adjourned for more than 120 days after the date
fixed for the original meeting or (b) where the determination has been made
through the closing of the stock transfer books and the stated period of
closing has expired.

Section 8.4. Lost Certificates. The Board of Directors or an officer
so authorized by the Board may authorize the issuance of a new share
certificate in place of a certificate claimed to have been lost, destroyed or
mutilated, upon receipt of an affidavit of such fact from the person claiming
the loss, destruction or mutilation satisfactory to the Board or such officer.
When authorizing such issuance of a new certificate, the Board of Directors or
such officer may require the claimant to give the Corporation a bond in such
sum as the Board of Directors or such officer may direct to indemnify the
Corporation against loss from any claim with respect to the certificate
claimed to have been lost or destroyed.

Section 8.5. Holder of Record. The Corporation may treat as absolute
owner of shares the person in whose name the shares stand of record on its
books just as if that person had full competency, capacity and authority to
exercise all rights of ownership irrespective of any knowledge or notice to
the contrary or any description indicating a representative, pledge or other
fiduciary relation or any reference to any other instrument or to the rights
of any other person appearing upon its record or upon the share certificate
except that any person furnishing to the Corporation proof of his appointment
as a fiduciary shall be treated as if he were a holder of record of its
shares.

Section 8.6. Transfer Agent and Registrar. The Corporation may, if
and whenever the Board of Directors so determines, maintain in the State of
North Carolina or any other state of the United States, one or more transfer
offices or agencies and also one or more registry offices which officers and
agencies may establish rules and regulations for the issue, transfer and
registration of certificates. No certificates for shares of stock of the
Corporation in respect of which a Transfer Agent and Registrar shall have been
designated shall be valid unless countersigned by such Transfer Agent and
registered by such Registrar.

<PAGE>

Section 8.7. Control Share Acquisitions Act. Pursuant to Section
55-9A-09 of the Act, the provisions of Control Shares Acquisitions Act, as
stated in Article 9A of the Act, shall not be applicable to the Corporation,
and the Corporation expressly "opts out" of the Control Shares Acquisitions
Act.

ARTICLE IX

Indemnification of Directors, Officers and Others

Section 9.1. Definitions. For purposes of this Article IX, the
following definitions shall apply:

(a) "Corporation" means the Corporation and all "predecessors"
thereof, as such term is defined in Section 55-8-50(b)(1) of the
Act.

(b) "Director" means an individual who is or was a director of the
Corporation or an individual who, while a director of the
Corporation, is or was serving at the Corporation's request as a
director, officer, partner, trustee, employee or agent or another
foreign or domestic corporation, partnership, joint venture, trust,
employee benefit plan, or other enterprise. A director is considered
to be serving an employee benefit plan at the Corporation's request
if such director's duties to the Corporation also impose duties on,
or otherwise involve services by, the director to the plan or to
participants in or beneficiaries of the plan. "Director" includes,
unless the context requires otherwise, the estate or personal
representative of a director.

(c) "Expenses" means expenses of every kind incurred in defending a
Proceeding, including, but not limited to, legal, accounting, expert
and investigatory fees and expenses.

(d) "Indemnified Officer" shall mean each officer of the Corporation
who is also a director of the Corporation and each other officer of
the Corporation who is designated by the Board of Directors from
time to time as an Indemnified Officer. An Indemnified Officer shall
be entitled to indemnification hereunder to the same extent as a
Director, including, without limitation, indemnification with
respect to service by the Indemnified Officer at the Corporation's
request as a director, officer, partner, trustee, employee or agent
of another foreign or domestic corporation, partnership, joint
venture, trust, employee benefit plan or other enterprise.

(e) "Liabilities" means any obligation to pay any or all of the
following: a judgment, a settlement, a penalty, a fine (including an
excise tax assessed with respect to an employee benefit plan) and
reasonable expenses, including, but not limited to, attorneys' fees
of opposing parties incurred with respect to a Proceeding.

(f) "Proceeding" means any threatened, pending, or completed action,
suit or proceeding, whether civil, criminal, administrative or
investigative, whether formal or informal, and any appeal therein
(and any inquiry or investigation that could lead to such a
proceeding).

Section 9.2. Indemnification. In addition to, and not in any way in
limitation of, all indemnification rights and obligations otherwise provided
by law, the Corporation shall indemnify and hold harmless its Directors and
Indemnified Officers against all Liabilities and Expenses in any Proceeding
(including, without limitation, a Proceeding brought by or on behalf of the
Corporation itself) arising out of their status as Directors or officers, or
their service at the Corporation's request as a Director, officer, partner,
trustee,

<PAGE>

employee or agent of another foreign or domestic corporation, partnership,
joint venture, trust, employee benefit plan or other enterprise, or their
activities in any such capacity; provided, however, that the Corporation shall
not indemnify a Director or an Indemnified Officer against Liabilities or
Expenses that such person may incur on account of activities of such person
which at the time taken were known or believed by him or her to be clearly in
conflict with the best interests of the Corporation. The Corporation shall
also indemnify each Director and Indemnified Officer for his or her reasonable
costs, expenses and attorneys' fees incurred in connection with the
enforcement of the rights to indemnification granted herein, if it is
determined in accordance with Section 9.3 that the Director or Indemnified
Officer is entitled to indemnification hereunder.

The Board of Directors shall have the authority to adopt such
resolutions pertaining to the implementation of this Section 9.2 as it may
from time to time determine, and such resolutions shall be given full effect,
even though they supplement, amplify or go beyond the provisions of this
Section 9.2, provided and to the extent such resolution does not violate any
provision of the Act or the Corporation's Articles of Incorporation. This
Section 9.2 shall be construed in a manner to fully effect the purpose and
intent of the resolution of the Corporation's Board of Directors approving and
adopting this provision.

Section 9.3. Determination. Any indemnification under Section 9.2
shall be paid by the Corporation in a specific case only after a determination
that the Director or Indemnified Officer has met the standard of conduct set
forth in Section 9.2. Such determination shall be made:

(a) by the Board of Directors by a majority vote of a quorum
consisting of directors not at the time parties to the Proceeding;

(b) if a quorum cannot be obtained under Section 9.3(a), by a
majority vote of a committee duly designated by the Board of
Directors (in which vote directors who are parties to the Proceeding
may participate), consisting solely of two or more directors not at
the time parties to the Proceeding;

(c) by special legal counsel (i) selected by the Board of Directors
or a committee thereof in the manner prescribed in Section 9.3(a) or
(b); or (ii) if a quorum of the Board of Directors cannot be obtained
under Section 9.3(a) and a committee cannot be designated under
Section 9.3(b), selected by a majority vote of the full Board of
Directors (in which selection directors who are parties in the
Proceeding may participate); or

(d) by the shareholders, but shares owned by or voted under the
control of directors who are at the time parties to the Proceeding
may not be voted on the determination.

The Board of Directors shall take all such action as may be necessary
and appropriate to enable the Corporation to pay the indemnification required
by this Article IX.

Section 9.4. Advances for Expenses. The Expenses incurred by a
Director or an Indemnified Officer in defending a Proceeding may be paid by
the Corporation in advance of the final disposition of such Proceeding as
authorized by the Board of Directors in the specific case upon receipt of an
undertaking by or on behalf of the Director or Indemnified Officer to repay
such amount unless it shall ultimately be determined that such person is
entitled to be indemnified by the Corporation against such Expenses. Subject
to receipt of such undertaking, the Corporation shall make reasonable periodic
advances for Expenses pursuant to this Section 9.4, unless the Board of
Directors shall determine, in the manner provided in Section 9.3 and based on
the facts then known, that indemnification under this Article IX is or will be
precluded.

<PAGE>

Section 9.5. Reliance and Consideration. Any Director or Indemnified
Officer who at any time after the adoption of this Article IX serves or has
served in any of the aforesaid capacities for or on behalf of the Corporation
shall be deemed to be doing or to have done so in reliance upon, and as
consideration for, the right of indemnification provided herein. Such right,
however, shall not be exclusive of any other rights to which such person may
be entitled apart from the provisions of this Article IX. No amendment,
modification or repeal of this Article IX shall adversely affect the right of
any Director or Indemnified Officer to indemnification hereunder with respect
to any activities occurring prior to the time of such amendment, modification
or repeal.

Section 9.6. Insurance. The Corporation may purchase and maintain
insurance on behalf of its directors, officers, employees and agents and those
persons who were or are serving at the request of the Corporation in any
capacity with another corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise against any liability asserted against or
incurred by such person in any such capacity, or arising out of his or her
status as such, whether or not the Corporation would have the power to
indemnify such person against such liability under the provisions of this
Article IX or otherwise. Any full or partial payment made by an insurance
company under any insurance policy covering any director, officer, employee,
agent or other person identified above made to or on behalf of a person
entitled to indemnification under this Article IX shall relieve the
Corporation of its liability for indemnification provided for in this Article
IX or otherwise to the extent of such payment, and no insurer shall have a
right of subrogation against the Corporation with respect to such payment.

Section 9.7. Continuation of Prior Provisions. The provisions of
Section 6 of Article IX of the Corporation's Third Amended and Restated Bylaws
(in effect prior to the adoption of these By-Laws) regarding indemnification
shall be deemed to be continued and incorporated herein, but shall not in any
way diminish or limit the other provisions of this Article IX. The
indemnification obligations of the Corporation under such prior Section 6 of
Article IX shall remain in force respecting, but solely respecting, claims
made and liabilities asserted prior to the adoption of these By-Laws to the
full extent provided under law.

ARTICLE X

General Provisions

Section 10.1. Distributions. The Board of Directors from time to time
may declare or authorize, and the Corporation may pay or distribute, dividends
or other distributions on its outstanding shares in the manner and upon the
terms and conditions provided by the Act and by the Articles of Incorporation.

Section 10.2. Seal. The corporate seal of the Corporation shall
consist of two concentric circles between which is the name of the Corporation
and in the center of which is inscribed the word "SEAL"; and such seal, in the
form approved and adopted by the Board of Directors and as impressed on the
margin hereof, shall be the corporate seal of the Corporation.

Section 10.3. Waiver of Notice. Except as otherwise expressly
provided herein, whenever any notice is required to be given to any
shareholder or director under the provisions of the Act or under the
provisions of the Restated Articles of Incorporation or these By-Laws, a
waiver thereof in writing signed by the person or persons entitled to such
notice and delivered to the Secretary of the Corporation, whether before or
after the time stated therein, shall be equivalent to the giving of such
notice.

<PAGE>

Section 10.4. Amendments; Emergency By-Laws. To the extent permitted
by the Act and except as otherwise expressly provided herein, these By-Laws
may be amended or repealed and new By-Laws may be adopted by (i) the
affirmative vote of the Board of Directors required under Section 4.6 or (ii)
the affirmative vote of 66.67% of the voting power of the then outstanding
shares of any class or series of capital stock of the Corporation entitled to
vote. In addition, in the circumstances described in Section 55-2-07(d) of the
Act, the Board of Directors may adopt, as provided in Sections 55-2-07 and
55-3-03 of the Act, such emergency by-laws as may be necessary or appropriate.
Such emergency by-laws shall supersede any inconsistent provisions of these
By-Laws during the existence of such emergency and shall be approved by the
shareholders at the next annual meeting, if necessary.

Except as authorized by the action of the shareholders as provided by
the Act, the Board of Directors shall have no power to adopt a by-law:

(1) requiring more than a majority of the voting shares of a "voting
group" for a quorum at a meeting of shareholders or more than a majority of
the votes cast by the shareholders of a "voting group" to constitute action by
the shareholders of that "voting group", except where higher percentages are
required by law, the Articles of Incorporation or these Bylaws;

(2) providing for the management of the Corporation otherwise than by
the Board of Directors or its Executive Committee;

(3) increasing or decreasing the number of directors above or below
the maximum or minimum, respectively, set forth in Section 3.2 hereof and the
Articles of Incorporation; or

(4) rescinding any classification and staggering of terms by the
shareholders.

Section 10.5. Fiscal Year. The fiscal year of the Corporation shall
be as determined by the Board of Directors.

Section 10.6. Succession Order. The succession order to the Chairman
of the Board for purposes of these By-Laws shall be the Vice-Chairmen of the
Board in the order of seniority of service in such office (in the event of a
dispute as to seniority, a majority vote of the directors then present shall
establish seniority), and the Chief Executive Officer and, if there are no
persons holding such offices or if the Board of Directors shall determine to
alter such succession order, the person selected to preside by a majority of
the directors present or participating in a meeting at which such designation
is necessary.

Section 10.7. Voting of Shares. Authority to vote shares of another
corporation or any subsidiary of the Corporation and to execute proxies,
written waivers and consents with regard to the voting of such shares, in each
instance in accordance with the resolution or action of the Board of Directors
delegating such authority, shall be vested exclusively in the Chairman of the
Board, the Chief Executive Officer or such other officers of the Corporation
as shall be expressly named from time to time by the Board of Directors in
resolutions adopted or actions taken for that purpose.

Section 10.8. Definitions. As used herein, the term "Act" shall refer
to the North Carolina Business Corporation Act, as in effect on the date the
Bylaws are adopted and as amended from time to time. As used herein, the terms
"distribution," "voting group" and "public corporation" shall have the
meanings set forth in Sections 55-1-40(6), 55-1-40(26) and 55-1-40(18a),
respectively, of the Act. As used herein, the term

<PAGE>

"Restated Articles of Incorporation" shall mean the Restated Articles of
Incorporation of the Corporation as they may exist from time to time and as
hereafter amended or restated.

Restated and adopted, this _______ day of ___________________, 1998.

-------------------------
Secretary

<PAGE>

PLAN OF RECAPITALIZATION
OF
FRONT ROYAL, INC.

This PLAN OF RECAPITALIZATION of Front Royal, Inc., a North Carolina
corporation (the "Corporation"), as adopted and approved by the Board of
Directors of the Corporation, is hereby presented to and approved and adopted
by the holders of the issued and outstanding Class A Common Stock of the
Corporation (the "Class A Shareholders"), the holders of the issued and
outstanding Class B Common Stock of the Corporation (the "Class B
Shareholders"), the holders of the issued and outstanding Class C Common Stock
of the Corporation (the "Class C Shareholders"), and the holders of the Series
A Convertible Preferred Stock of the Corporation (the "Preferred
Shareholders," who are sometimes herein referred collectively with the Class A
Shareholders, the Class B Shareholders and the Class C Shareholders as the
"Shareholders").

W I T N E S S E T H:

WHEREAS, the Shareholders collectively own all of the issued and
outstanding capital stock of the Corporation; and

WHEREAS, the Board of Directors of the Corporation believes it is in
the best interests of the Shareholders and the Corporation to recapitalize the
corporate structure of the Corporation to eliminate the various classes of
common and preferred stock and provide for a single class of common stock, no
par value (the "Common Stock"), in contemplation of an initial public offering
of the Common Stock by the Corporation and the Shareholders (the "Offering"),
the consummation of which will materially benefit the Corporation by, among
other things, creating a trading market for the Corporation's capital stock
where no market now exists and providing additional capital to the Corporation
to finance its growth; and

WHEREAS, the Board of Directors of the Corporation approved and
adopted the plan of recapitalization for the Corporation as stated herein (the
"Plan") and voted to recommend the Plan to the Shareholders of the Corporation
for the Shareholders' approval; and

WHEREAS, the Board of Directors of the Corporation has approved and
adopted the form of the Restated Articles of Incorporation of the Corporation,
a copy of which is attached hereto as Attachment A (the "Restated Articles"),
and the form of the Fourth Amended and Restated Bylaws, a copy of which is
attached hereto as Attachment B (the "Restated Bylaws"), both of which are to
be effective immediately prior to the Offering; and

WHEREAS, the Board of Directors of the Corporation has recommended
that the Restated Articles and Restated Bylaws be presented to the
Shareholders for their adoption and approval; and

<PAGE>

WHEREAS, the Board of Directors of the Corporation has approved the
Class C Preference Agreement (as defined herein) and recommended that the
Class C Preference Agreement be presented to the Shareholders for their
adoption and approval; and

WHEREAS, the approval of the Restated Articles, Restated Bylaws and
the Plan by each of the Class A Shareholders, Class B Shareholders, Class C
Shareholders and Preferred Shareholders is a necessary precondition to the
recapitalization of the Corporation and the Offering;

NOW, THEREFORE, in anticipation of the Offering, the Class A
Shareholders, Class B Shareholders, Class C Shareholders and Preferred
Shareholders hereby approve and adopt the Plan as set forth below pursuant to
the Articles of Incorporation and Bylaws of the Corporation and the North
Carolina Business Corporation Act ("NCBA"):

I. PRESENT CAPITALIZATION

The aggregate number of shares which the Corporation is presently
authorized to issue is 25,200,000. The classes into which such shares are
divided, the designation and number of shares of each class, and the par value
of the shares of each class are as follows:

Par Value/
Number of Shares Number of Shares Stated Value
Class Authorized Outstanding Per Share
- ----- ---------- ----------- ---------

Class A Common Stock 20,000,000 5,859,144 No Par

Class B Common Stock 700,000 268,482 No Par

Class C Common Stock 3,500,000 3,248,300 No Par

Preferred Stock (Series A 1,000,000(1) 155,000 $100
Convertible Preferred
Stock outstanding)

Class A Shareholders and Class C Shareholders are entitled to one
vote per share, while Class B Shareholders do not have voting rights except in
limited circumstances provided by the NCBCA and the Articles of Incorporation
of the Corporation. Class C Shareholders also have additional voting rights,
including rights concerning the amendment of the Articles of Incorporation and
Bylaws and the election of certain members of the Board of Directors. The
holders of the Series A

- --------

(1) The Preferred Stock as authorized by the Articles of Incorporation may be
classified and offered in separate series. Currently, the Board of
Directors has authorized 155,000 shares of Series A Convertible Preferred
Stock, all of which is currently issued and outstanding. No additional
series of Preferred Stock have been authorized or issued.

<PAGE>

Convertible Preferred Stock have limited voting rights regarding the election
of a single director and in other limited circumstances provided by the NCBCA.

II. THE PLAN OF RECAPITALIZATION

Pursuant to the Restated Articles attached hereto as Attachment A,
the Corporation will (i) authorize Thirty Million (30,000,000) shares of
Common Stock, no par value (the "Common Stock"), and (ii) Five Million
(5,000,000) shares of no par value Preferred Stock (the "Preferred Stock").
Holders of shares of Common Stock will be entitled to one vote per share.
Shares of the Preferred Stock, when issued, shall have such voting and other
rights as determined by the Board of Directors.

Immediately prior to the consummation of the Offering (the "Effective
Time"), the Restated Articles and the Restated Bylaws shall become effective
and the Corporation will convert each issued and outstanding share of its
existing Class A Common Stock, Class B Common Stock and Class C Common Stock
(collectively, the "Existing Common Stock"), with no additional action
required by the holders thereof, into shares of the Common Stock on the basis
of one share of the Existing Common Stock for one share of the Common Stock
(such exchange is hereinafter referred to as the "Common Stock Conversion").

All issued and outstanding options and warrants to purchase Class A
Common Stock, Class B Common Stock, and Class C Common Stock shall, upon
consummation of the Common Stock Conversion, be deemed to have been amended to
be exercisable for shares of Common Stock at the exercise price provided in
such original options and warrants and subject to the terms and conditions of
such original options and warrants. Upon consummation of the Common Stock
Conversion and the effectiveness of the Amended Articles, the Corporation
shall reserve for issuance such number of Common Shares as required to comply
with the currently issued and outstanding options and warrants, as amended by
this Plan. Such converted options and warrants shall be adjusted to
incorporate and reflect the Reverse Stock Split (as such term is defined
below).

At the Effective Time, the Corporation will convert each issued and
outstanding share of its Series A Convertible Preferred Stock into shares of
the Common Stock, with no additional action required by the holders thereof,
at the applicable "Conversion Ratio" (as such term is defined in the "Articles
of Amendment of Front Royal, Inc. Authorizing Series A Convertible Preferred
Stock" filed with the North Carolina Secretary of State on December 27, 1996)
at the Effective Time (such exchange is hereinafter referred to as the
"Preferred Stock Conversion").

Simultaneous with the consummation of the Common Stock Conversion and
the Preferred Stock Conversion, the Corporation will effect a three (3) for
five (5) reverse stock split of the issued and outstanding shares of the
Common Stock (the "Reverse Stock Split"). No fractional shares will be issued
as a result of the Reverse Stock Split. If any Shareholder is entitled to a
fractional share as a result of the Reverse Stock Split, such Shareholder
shall receive payment from the Corporation for such fractional share equal to
$__________ (per share) multiplied by such fraction.

<PAGE>

It is hereby recognized and acknowledged that, prior to the adoption
of this Plan and the effectiveness of the Amended and Restated Articles of
Incorporation, the Class C Shareholders are entitled to certain liquidation
preferences as such preferences are outlined in the Corporation's Articles of
Incorporation. In order for the Class C Shareholders to retain similar
liquidation preferences, the Corporation shall execute and enter into an
agreement, a copy of which is attached hereto as Attachment C (the "Class C
Preference Agreement"), with the Class C Shareholders granting them similar
liquidation rights in connection with the shares of Common Stock issued to
them in the Common Stock Conversion. The Class C Preference Agreement shall
provide that upon the liquidation of the Corporation, the Class C Shareholders
will be entitled to receive from the proceeds of such liquidation available
for distribution to the holders of Common Stock a preferential payment prior
to payment to any other holders of the Common Stock equal to the greater of
(i) the Liquidation Preference Amount (as defined herein) or (ii) the pro rata
payment such shareholder would be entitled as a holder of Common Stock. The
Liquidation Preference Amount shall equal $4.00 per share of Common Stock
received by each Class C Shareholder pursuant to the Common Stock Conversion,
which shall be adjusted to $6.67 per share subsequent to the Reverse Stock
Split, and further adjusted upward or downward, as appropriate, to reflect any
stock dividends, stock splits, combinations of shares or similar transactions
affecting the number of Shares of Common Stock received by the Class C
Shareholders pursuant to the Common Stock Conversion. No other shares of
Common Stock, other than those shares received by the Class C Stockholders in
exchange for their Class C Common Stock pursuant to the Common Stock
Conversion, shall be entitled to the liquidation preferences provided in, or
be subject to, the Class C Preference Agreement. Any liquidation rights
pursuant to the Class C Preference Agreement shall be nontransferable from the
Class C Shareholders, and any transfer of the applicable Common Shares by the
Class C Shareholders shall terminate such liquidation rights attached to such
shares of Common Stock. All Class C Shareholders shall be entitled to enter
into the Class C Preference Agreement; however, any Class C Shareholder who
does not enter into the Class C Preference Agreement shall not be entitled to
the benefits stated therein.

Any and all special voting rights, liquidation preferences and other
rights and preferences of the Class A Shareholders, the Class B Shareholders,
the Class C Shareholders and/or the Preferred Shareholders currently in
effect, as stated in the Articles of Incorporation and the Bylaws of the
Corporation, except to the extent specifically preserved in the Class C
Preference Agreement, this Plan, the Amended Charter and the Amended Bylaws,
shall be terminated at the Effective Time. In addition, at the Effective Time,
each of (i) the Stockholders Voting Agreement dated May 19, 1993, and restated
as of June 30, 1994, as amended, by and among the Corporation and certain
Class A Shareholders and Class B Shareholders, (ii) the Shareholder Agreement
dated as of April 30, 1992, as amended, by and among the Corporation (formally
known as F.R. Acquisition Corp.), certain Class A Shareholders, certain Class
B Shareholders and Front Royal Group, Inc., (iii) the Shareholders' Agreement
dated December 31, 1996, as amended, by and among the Corporation and Moore
Global Investments, Ltd., Remington Investment Strategies, L.P., High Ridge
Capital Partners Limited Partnership and other Class A Shareholders, Class B
Shareholders and Class C Shareholders, and (iv) the Rights Agreement dated
December 31, 1996, by and among the Corporation and certain Class C
Shareholders, shall be terminated by the parties thereto and in the manner(s)
described therein. The Amended and Restated Registration Rights Agreement by
and

<PAGE>

among the Company and various shareholders dated December 31, 1996, as
amended, shall survive and remain in full force and effect after the Common
Stock Conversion, the Preferred Stock Conversion, the Reverse Stock Split and
the Offering.

In the unanimous opinion of the Board of Directors after consultation
with the Corporation's legal counsel and investment bankers, the Plan, as
stated herein, will prepare the Corporation's capital structure for the
Offering, which will be to the advantage of the Corporation, the Shareholders,
and the future shareholders of the Corporation. The Plan, together with the
contemplated Offering, provides the Shareholders a market for their shares
while retaining their substantial investment in the Corporation.

It is hereby recognized by the Corporation, its Board of Directors
and the Shareholders that there is no assurance that the Offering will occur,
although it is expected to be consummated. Such parties hereto nevertheless
agree to implement the Plan, and approve the proposed Restated Articles, the
Restated Bylaws, the Class C Preference Agreement, the Reverse Stock Split and
all other increases, changes, and reclassifications in the presently
authorized and issued shares of Class A Common Stock, Class B Common Stock,
Class C Common Stock, and Preferred Stock as contemplated by this Plan.

The expenses incurred in carrying out the Plan will be paid by the
Corporation. The Shareholders will become holders of Common Stock when the
Restated Articles become effective without the necessity of making any
exchange of certificates; however, it is expected that new certificates for
shares of Common Stock will be substituted for the present certificates as set
forth herein.

If the Offering has not been completed and the Restated Articles have
not been filed by the Board of Directors on or prior to December 31, 1998,
this Plan shall be terminated and abandoned; the Common Stock Conversion, the
Preferred Stock Conversion, the Reverse stock Split shall not take place; and
the Class C Preference Agreement shall not be executed.

III. METHOD OF CARRYING OUT THE PLAN

Following the effectiveness of the Restated Articles and the Restated
Bylaws, the Corporation agrees to provide new certificates for shares of the
Common Stock against delivery and surrender of certificates representing
shares of the Class A Common Stock, Class B Common Stock, Class C Common Stock
and Series A Convertible Preferred Stock. The number of shares represented in
such new certificates shall reflect the Reverse Stock Split. Until so
surrendered, each outstanding certificate that, prior to the Effective Time,
represented shares of the Corporation's Capital Stock will be deemed to
evidence for all purposes the number of whole shares of Common Stock into
which such shares were converted as provided herein after giving effect to the
Reverse Stock Split.

<PAGE>

Under the Plan, when shares of Common Stock are issued to the
Shareholders, the surrendered shares of Class A Common Stock, Class B Common
Stock, Class C Common Stock, or Series A Convertible Preferred Stock, as
applicable, will be canceled.

THIS PLAN OF RECAPITALIZATION was adopted by the Shareholders, as
required pursuant to the Articles of Incorporation of the Corporation, the
Bylaws and the NCBA on the ___ day of _______________, 1998.

---------------------------------
J. Adam Abram
President
Front Royal, Inc.

ATTEST:

- ---------------------
Judy Young, Secretary

[CORPORATE SEAL]

<PAGE>

EMPLOYMENT AGREEMENT
--------------------

EMPLOYMENT AGREEMENT dated as of the 31st day of December, 1997,
between Colony Management Services, Inc., a Virginia corporation with offices
at 9201 Forest Hill Avenue, Suite 200, Richmond, Virginia 23235 (the
"Company"), and John K. Latham ("Employee").

W I T N E S S E T H:

1. Employment and Term.

The Company hereby employs Employee as President of the Company, and
Employee hereby accepts such employment, on the terms and conditions set forth
herein, for a term of three (3) years, commencing on the date hereof, unless
sooner terminated or extended as herein provided. The term of this Agreement
and Employee's employment hereunder shall be automatically renewed for
additional periods of three (3) years unless written notice to the contrary
shall be given by either party to the other, not less than ninety (90) days
before the end of the initial or any renewal term (the initial term plus any
renewals thereof shall be referred to herein as the "Term"), in which case
this Agreement shall terminate at the end of such term, and neither party
hereto shall thereafter have any further rights or obligations hereunder
except the obligations of Employee under Section 3(b), (c) and (d) hereof and
any obligations of the Company under Sections 5, 6 and 7 hereof. The date upon
which this Agreement and Employee's employment hereunder shall terminate,
whether pursuant to the terms of this Section 1, or pursuant to any other
provision of this Agreement, shall hereinafter be referred to as the
"Termination Date." For so long as Employee is President of Colony Management
Services, Inc., Front Royal, Inc., the sole shareholder of Colony Insurance
Company, shall appoint Employee as the President and Chief Executive Officer
of Colony Insurance Company, and as such, Employee shall perform all duties
and services incident to his position as President and Chief Executive Officer
of Colony Insurance Company and such other reasonable duties and services of
the nature typically performed by the President and CEO of an insurance
company.

2. Compensation.

(a) For the performance by Employee of his duties in
accordance with this Agreement after the date hereof, including services as an
officer, director and/or member of committees of the Company or any
subsidiaries or affiliates of the Company ("Affiliates"), the Company shall
pay Employee a salary at the rate of Two Hundred Eight Thousand Dollars
($208,000.00) per annum ("Base Salary"), payable in periodic installments in
accordance with the Company's regular payroll practices, as in effect from
time to time. Within one hundred eighty (180) days after the end of each
fiscal year of the Company, Employee's salary shall be

<PAGE>

reviewed and may be increased at the discretion of the Board of Directors of
the Company ("Board of Directors"). Employee's Base Salary or such other
salary as may be payable to Employee by action of the Board of Directors, is
hereinafter called "Salary".

(b) Within one hundred eighty (180) days after the end of
each fiscal year of the Company, Employee may, in the absolute discretion of
the Board of Directors, receive from the Company a bonus based on the
performance of the Company during the preceding fiscal year.

3. Duties and Restrictions.

(a) During the term of this Agreement, Employee shall
perform all duties and services incident to his position as President of the
Company and such other reasonable duties and services as may from time to time
be assigned to him by the Board of Directors and all of the duties and
services to be performed by Employee are at all times to be subject to the
authority of the Board of Directors. Employee shall devote his full business
time during normal business hours to the business of the Company and will use
his knowledge, skills and best efforts to perform faithfully, fully, and
efficiently the responsibilities assigned to him. It is understood that the
Employee may engage in other civic and business activities that do not
interfere with the performance of the Employee's services to the Company.

(b) Employee will not at any time during the term of this
Agreement or thereafter:

(i) reveal, divulge or make known to any person, firm or
corporation or use for his personal benefit, directly or indirectly,
any confidential or proprietary information received by him during
the course of his employment or prior to the commencement thereof.
For purposes of this paragraph 3(b)(i) confidential and proprietary
information shall be defined to mean (i) all historical and pro forma
projections of loss ratios incurred by the Company and any of the
Affiliates, (ii) all historical and pro forma actuarial data relating
to the Company and any of the Affiliates, (iii) historical and pro
forma financial results and projections for the Company and its
Affiliates, (iv) all information relating to the Company's or the
Affiliates' systems and software (other than the portion thereof
provided by the vendor to all purchasers of such systems and
software) and (v) all other information relating to the financial,
business or other affairs of the Company and its Affiliates,
including their customers, that is not available to the general
public or generally known or available within the industry; or

(ii) reveal, divulge or make known to any person, firm or
corporation, or use for his personal benefit, directly or indirectly,
the name or names of any of the customers of the Company or of any of
its Affiliates, nor will he reveal, divulge or make known, to any
person, firm or corporation, or use for his personal

-2-
<PAGE>

benefit, directly or indirectly, any trade secrets or any knowledge
or information, or any fact concerning any business methods or
operational procedures engaged in by the Company or its Affiliates
(collectively, "Privileged Information"); provided, however, the
restrictions set forth in this paragraph 3(b)(ii) shall not apply to
Employee following the termination of his employment with the
Company or its Affiliates with respect to any Privileged Information
known or made generally available to the general public or within
the industry.

(c) Employee will not at any time during the term of this
Agreement, and for a period of one (1) year thereafter in the event Employee's
employment is terminated pursuant to Section 4, 5, 6 or 7(a) hereof or upon
the expiration of the term of this Agreement in accordance with Section 1
hereof, engage in or have any interest in, directly or indirectly, any
Competitive Business, whether as principal, director, officer, employee,
consultant, partner, stockholder, director, trustee or manager of any
competing corporation, association, firm or business or otherwise, or directly
or indirectly solicit, interfere with, or endeavor to entice away from the
Company or any of its Affiliates any of their customers or employees. The
restrictions contained in this subsection 3(c) shall not prevent the purchase
or ownership by Employee of not more than three percent (3%) of the securities
of any class of any corporation, whether or not such corporation is engaged in
any Competitive Business, which are publicly traded on any securities exchange
or any "over the counter" market. Employee will not, for a period of one (1)
year following the Termination Date, solicit for hire any person who was an
employee of the Company or any Affiliate at any time during the term of
Employee's employment hereunder. For purposes of this Agreement, the term
"Competitive Business" shall mean the underwriting of property and casualty
insurance products sold through wholesale agents.

(d) Employee acknowledges that the restrictions contained in
paragraphs (b) and (c) of this Section 3 are reasonable and necessary in order
to protect the legitimate interests of the Company, in view of the nature of
the business in which the Company and its Affiliates are engaged and the
substantial equity interest of Employee in the Company. If any provision
contained in paragraph (b) or (c) of this Section 3 is adjudged unreasonable
in any proceeding, then such provision shall be deemed modified by reducing
the period of time during which such provision is applicable and/or, if
applicable, the geographic area to which such provision applies, to the extent
necessary for such provision to be adjudged reasonable and enforceable.

4. Termination For Cause. This Agreement may be terminated by the
Company "for cause" at any time, by written notice to Employee, for any of the
following reasons:

(a) If Employee shall willfully violate the
provisions of Section 3 of this Agreement, or shall willfully fail to
comply with any other term or condition of this Agreement or shall
grossly neglect his duties hereunder;

-3-
<PAGE>

(b) If Employee shall (i) be convicted of a felony
or a crime involving moral turpitude (meaning a crime that includes
the commission of an act of gross depravity, dishonesty or bad
morals), or (ii) willfully commit an act of dishonesty, fraud or
embezzlement against the Company;

(c) If Employee willfully fails to comply for any
reason with a written reasonable directive of the Board of Directors
determined to be in the best interest of the Company and its
shareholders.

In the event of termination pursuant to paragraph (a), (b)
or (d) of this Section 4, then Employee's Salary and right to receive any
fringe benefits pursuant to Section 8 hereof shall terminate on the
Termination Date fixed in a written notice from the Company, which shall be no
earlier than the date of such notice.

In the event of termination pursuant to paragraph (c) of
this Section 4, then Employee shall be entitled to receive:

(i) an amount equal to Employee's Base Salary
for a period of twelve (12) months after the Termination Date,
payable in accordance with the terms of Section 2 hereof;

(ii) the continuation at the Company's
expense of coverage under all plans, insurance policies and other
fringe benefits described in Section 8 hereof, for a period of
twelve (12) months after the Termination Date; and

(iii) any amounts payable to Employee through
the Termination Date pursuant to Sections 9 and 10 hereof.

Thereafter, notwithstanding anything to the contrary contained in this
Agreement, the Company shall have no further obligations to Employee, except
as provided in any stock option or other bonus or incentive plan to which
Employer is entitled, and Employee shall have no further rights hereunder.

5. Termination by Employee.

Employee may terminate his employment hereunder upon giving
the Board of Directors ninety (90) days advanced written notice. In the event
Employee gives ninety (90) days written notice of his resignation or Employee
elects to have the term of this Agreement expire, upon the Termination Date,
the Company shall have no further obligations to Employee, Employee shall have
no further rights hereunder, and Employee shall have no further obligations
under this Agreement except those set forth in section 3(b) and 3(c).

-4-
<PAGE>

6. Expiration or Termination Without Cause. The Company may terminate
this Agreement at any time without cause or may elect to have the term of this
Agreement expire. In the event that the Company terminates this Agreement
without cause or elects to have the term of this Agreement expire, Employee
shall be entitled to receive:

(i) an amount equal to Employee's Base Salary
for a period of eighteen (18) months after the Termination Date,
payable in accordance with the terms of Section 2 hereof; provided,
however, that if the Employee continues to comply with the covenants
contained in Section 3(c) hereof beyond the one year period set
forth therein, then the Employee shall be entitled to continue to
receive Employee's Base Salary for so long as Employee continues to
comply with such covenants, up to an additional eighteen (18) month
period (it being understood that the maximum time period during
which Base Salary will continue to be paid under this Section 6(i)
shall be three (3) years);

(iii) any amounts payable to Employee through
the Termination Date pursuant to Sections 9 and 10 hereof.

7. Termination by Reason of Disability or Death.

(a) If, on account of physical or mental
disability, Employee shall fail or be unable to perform his assigned
duties in any material respect for a period of (i) one hundred (120)
consecutive days, or (ii) an aggregate of ninety (90) workdays during
any twelve (12) month period, the Company may, at its option,
thereafter terminate this Agreement and Employee's employment
hereunder upon giving at least thirty (30) days written notice to
Employee.

(b) If Employee dies during the term hereof, this
Agreement shall automatically terminate on the date of his death.

(c) In the event that this Agreement and Employee's
employment are terminated in accordance with this Section 7, then
after the Termination Date the Company shall have no further
obligations hereunder, except that, in the event of a termination
pursuant to paragraph (a) above, Employee shall be entitled to the
benefits described in Section 6 hereof (without regard to the proviso
of Section 6(i)), net of any payments or benefits to Employee under
disability insurance or similar plans maintained by the Company.

8. Fringe Benefits.

-5-
<PAGE>

The Company shall provide at the Company's expense to Employee during
the term of the Agreement:

(a) a medical insurance plan covering Employee, his
spouse and his minor children and a disability income insurance
policy, which insurance plans and policies shall be at least
comparable to such plans and policies provided to the Company's
other senior executive personnel.

(b) full participation in all other fringe benefits
provided to the Company's senior executive personnel, which fringe
benefits may include, in the sole discretion of the Board of
Directors, a pension plan, a profit sharing plan, a stock option plan
and/or a stock participation plan.

-6-

<PAGE>

9. Vacation.

Employee shall be entitled, for each year during the term hereof, to
vacation time to be taken at such time or times as shall be mutually
convenient to the Company and Employee.

10. Other Expenses.

During the term of this Agreement, Employee shall be entitled to be
reimbursed for all reasonable business expenses incurred by him in connection
with the performance of his duties hereunder upon the timely submission and
approval of appropriate vouchers therefor, to the Chief Financial Officer of
the Company.

11. Representation by Employee.

Employee represents and warrants that he is not under any obligation,
contractual or otherwise, to any person, firm or corporation that is
inconsistent with this Agreement and his employment hereunder and that he is
free to enter into and perform the terms of this Agreement.

12. Uniqueness of Services.

Employee acknowledges that the services to be rendered under the
provisions of this Agreement are of a special, unique and extraordinary
character and that it would be difficult or impossible to replace such
services and that, by reason thereof, Employee agrees and consents that if he
violates any of the provisions of this Agreement, the Company, in addition to
any other rights and remedies available under this Agreement or otherwise,
shall be entitled to an injunction to be issued by a tribunal of competent
jurisdiction restricting Employee from committing or continuing any violation
of this Agreement.

13. Notices.

Any notices provided for or permitted by this Agreement shall be in
writing and shall be deemed to have been duly given when delivered in person
or three (3) days after it is deposited in a United States Postal Depositary,
postage prepaid, registered or certified mail, return receipt requested,
addressed to the party for whom intended at such party's address set forth
below or to such other address as such party may designate by notice in
writing given in the manner provided by this Section 13, or when actually
received by the party for whom such notice was intended if sent by any other
means:

To Employee: John K. Latham
9201 Forest Hill Avenue
Suite 200
Richmond, VA 23235

-7-

<PAGE>

To The Company: Colony Management Services, Inc.
9201 Forest Hill Avenue, Suite 200
Richmond, VA 23235
Attention: Chairman

Copy To: Front Royal, Inc.
2200 Gateway Boulevard
Morrisville, NC 27523
Attn: Chief Executive Officer

14. Entire Agreement; Amendments.

This Agreement constitutes the entire agreement and understanding
between Employee and the Company with respect to the subject matter hereof and
shall supersede any and all other prior agreements and understandings, whether
oral or written, relating thereto or to the employment of Employee by the
Company. This Agreement may not be rescinded, modified or amended except by an
instrument in writing signed by the parties hereto and any provision hereof
may not be waived except by an instrument in writing signed by the party
hereto against whom any such waiver is sought to be enforced. The waiver by
the Company of a breach by Employee of any provision of this Agreement shall
not operate or be construed as a waiver of any subsequent breach by Employee.

15. Partial Invalidity.

The invalidity or unenforceability, by statute, court decision or
otherwise, of any term or condition of this Agreement shall not affect the
validity or enforceability of any other term or condition hereof.

16. Governing Law.

This Agreement shall be governed by, and construed and enforced in
accordance with, the laws of the Commonwealth of Virginia.

17. Assignability.

This Agreement may not be assigned by Employee, and all of its terms
and conditions shall be binding upon and inure to the benefit of Employee and
his heirs and legal representatives and the Company and its successors.
Successors of the Company shall include, without limitation, any corporation
or corporations acquiring, directly or indirectly, all or substantially all of
the assets of the Company whether by merger, consolidation, purchase or
otherwise and such successor shall thereafter be deemed the "Company" for
purposes hereof.

-8-

<PAGE>

18. Captions.

The caption headings in this Agreement are for convenience of
reference only and are not intended and shall not be construed as having any
substantive effect.

19. Survival.

The obligations imposed upon Employee and the rights granted to the
Company in subsections 3(b), (c) and (d) hereof and the rights granted to
Employee in Sections 5, 6 and 7 hereof shall survive the termination or
expiration of this Agreement for any reason whatsoever.

20. Guarantee of Certain Payments.

To the extent that the Company does not pay any of the amounts
payable to Employee under Sections 4, 6 and 7, following the termination of
Employee's employment with the Company, in accordance with the terms of this
Agreement, then Front Royal, Inc. hereby agrees to pay such amounts to
Employee in accordance with the terms of this Agreement.

IN WITNESS WHEREOF, the parties hereto have caused this Employment
Agreement to be duly executed as of the day and year first above written.

COLONY MANAGEMENT SERVICES, INC.

By: /s/ J. Adam Abram
----------------------------
J. Adam Abram
Chairman

/s/ John K.Latham
----------------------------
John K. Latham

FRONT ROYAL, INC. (solely with respect to
Sections 1 and 20 of this Agreement and as the
sole shareholder of Colony Insurance Company)

By: /s/ J. Adam Abram
--------------------------
J. Adam Abram
Chief Executive Officer

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<PAGE>

Exhibit 10.31

FORM OF SECOND AMENDMENT TO
AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT

SECOND AMENDMENT (this "Amendment") TO AMENDED AND RESTATED
REGISTRATION RIGHTS AGREEMENT, dated as of December 31, 1996 (the "Original
Agreement"), between FRONT ROYAL, INC., a North Carolina corporation (the
"Company"), and the parties thereto (the "Original Parties"), as amended by
the First Amendment to Registration Rights Agreement, dated as of July ___,
1997 (the "First Amendment" and collectively with the Original Agreement, the
"Registration Rights Agreement") between the Company and the other parties
thereto (the "First Amendment Parties" and together with the Original Parties,
the "Current Parties") between the Company, the Current Parties and Wycon
Corporation, United American Financial Services Corporation and Americlaim
Adjustment Corp. (each a "New Party" and collectively, the "New Parties").
Capitalized terms used but not otherwise defined herein shall have the
meanings ascribed to them in the Registration Rights Agreement.

W I T N E S S E T H:

WHEREAS, pursuant to Section 3.03 of the Registration Rights
Agreement, such agreement may be amended upon the written consent of the
holders of more than two-thirds of the Registrable Securities; and

WHEREAS, the Current Parties consenting to this Amendment
are holders of more than two-thirds of the Registrable Securities and hereby
wish to amend the Registration Rights Agreement so that (i) each of the New
Parties will be included in the definition of "Parties" in the Registration
Rights Agreement, (ii) each of the shares of the Class A Common Stock issued
to the New Parties pursuant to the Stock and Asset Purchase and Sale Agreement
dated as of March 6, 1998 (the "Purchase Agreement") among the Company, PNIC
Holdings, Inc., Preferred National Financial Corp. and the New Parties will be
included in the definition of "Registrable Securities" in the Registration
Rights Agreement and each of the shares of the Class A Common Stock issuable
on exercise of the warrants issued to the New Parties (the "New Parties
Warrants") pursuant to the Purchase Agreement will be included in the
definition of "Registerable Securities" in the Registration Rights Agreement
and (iii) each of the New Parties' Warrants will be included in the definition
of "Warrants" in the Registration Rights Agreement.

NOW, THEREFORE, the Company, the holders of at least
two-thirds of the Registrable Securities and the New Parties hereby agree that
the Registration Rights Agreement is amended as follows:

<PAGE>

1. Amendment to Registration Rights Agreement. The Registration
Rights Agreement is hereby amended as follows:

(a) The definition of "Parties" is hereby deleted in its
entirety and the following shall be inserted in lieu thereof:

"(l) "Parties" means, collectively, the First Parties, the
Second Parties, the Third Parties, the Fourth Parties, the
Preferred Holders, the Rockwood Warrant Holders and Wycon
Corporation, United American Financial Services Corporation and
Americlaim Adjustment Corp."

(b) The definition of "Registrable Securities" is hereby deleted
in its entirety and the following shall be inserted in lieu thereof:

"(o) "Registrable Securities" means:

(i) Registrable Shares, as defined in the Original
Registration Agreement; and

(ii) Shares of Class A Common Stock issued or issuable on
exercise of the Second Warrants, the Third Warrants, the Fourth
Warrants and the Fifth Warrants, the Rights and any shares of
Common Stock issued on account of such Common Stock; and

(iii) Shares of Class A Common Stock issued or issuable on
conversion of the Class C Common Stock, and any shares of
Common Stock issued on account of such Class A Common Stock;
and

(iv) Shares of Class A Common Stock that are issued on
exercise of the Rights, and any shares of Common Stock issued
on account of such Class A Common Stock; and

(v) Shares of Class A Common Stock issued or issuable on
conversion of the Series A Preferred, and any shares of Common
Stock issued on account of such Class A Common Stock; and

(vi) Shares of Class A Common Stock issued to Wycon
Corporation, United American Financial Services Corporation and
Americlaim Adjustment Corp. pursuant to the Stock and Asset
Purchase and Sale Agreement (the "PNIC Agreement") dated as of
March 6, 1998 among the Company, PNIC Holdings, Inc., Preferred
National Financial Corp., Wycon Corporation, United American
Financial Services

-2-

<PAGE>

Corporation, Americlaim Adjustment Corp. and, for certain
limited purposes specified therein, Stephen Weicholz; and

(vii) Shares of Class A Common Stock issued or issuable on
exercise of the warrants issued to Wycon Corporation, United
American Financial Services Corporation and Americlaim
Adjustment Corporation pursuant to the PNIC Agreement and
Common Stock issued on account of such Common Stock;

provided, however, that shares of Common Stock that are
Registrable Securities shall cease to be Registrable Securities
(x) upon the consummation of any sale of such shares pursuant
to an effective registration statement under the Securities Act
or Rule 144 under the Securities Act or (y) at such time as
such Registrable Securities become eligible for sale under Rule
144(k) under the Securities Act.

(s) "Warrants" shall mean the Series I Warrants, the First
Warrants, the Second Warrants, the Third Warrants, the
Fourth Warrants, the Fifth Warrants and the warrants
issued to Wycon Corporation, United American Financial
Services Corporation and Americlaim Adjustment Corporation
pursuant to the PNIC Agreement.

2. New Parties. Each of the New Parties identified on the signature
page hereto are hereby added as Parties to the Registration Rights Agreement
and by executing this Amendment, hereby agree to be bound by the terms and
obligations hereof and by the terms and obligations of the Registration Rights
Agreement and shall be entitled to the benefits thereof.

3. Required Demand Percentage. The parties confirm that the number of
shares of Common Stock constituting the Required Demand Percentage is
1,947,645.

4. Registration Rights Agreement. Except as expressly amended by this
Amendment, the Registration Rights Agreement is not hereby amended,
supplemented or otherwise modified and shall remain in full force and effect.

-3-

<PAGE>

5. Counterparts. This Amendment may be executed in one or more
counterparts, each of which, taken together, shall constitute one and the same
instrument.

IN WITNESS WHEREOF, the parties hereto have executed this Amendment
as of the ____ day of __________, 1998.

COMPANY:

FRONT ROYAL INC.

By:_________________________
Name:
Title:

NEW PARTIES:

WYCON CORPORATION

By:_________________________
Name:
Title:

UNITED AMERICAN FINANCIAL
SERVICES CORPORATION

By:_________________________
Name:
Title:

AMERICLAIM ADJUSTMENT CORP.

By:_________________________
Name:
Title:

(Signatures of Current Parties on following page)

-4-

<PAGE>

FWH, INC.

By:_________________________
Name:
Title:

FORT WASHINGTON HOLDINGS, INC.

By:_________________________
Name:
Title:

PREMIER AUTO INSURANCE COMPANY

By:_________________________
Name:
Title:

TECHNOLOGY LEADERS L.P.

By: Technology Leaders Management, Inc.
(General Partner)

By:_________________________
Name:
Title:

TECHNOLOGY LEADERS F.R. CORP.

By:_________________________
Name:
Title:

TECHNOLOGY LEADERS OFFSHORE CV

By:_________________________
Name:
Title:

----------------------------
Ira Lubert

-5-

<PAGE>

R.F. MAGUIRE TRUST

By:_________________________
Name:
Title:

----------------------------
J. Adam Abram

JANE M. ABRAM FAMILY PARTNERSHIP, L.P.

By:

By:_________________________
Name:
Title:

MBA VENTURES, L.P.

By:

By:_________________________
Name:
Title:

HIGH RIDGE CAPITAL PARTNERS LIMITED
PARTNERSHIP

By:

By:_________________________
Name:
Title:

----------------------------
James Zech

-6-

<PAGE>

MOORE GLOBAL INVESTMENTS, LTD.

By:

By:_________________________
Name:
Title:

MATTHEW BRONFMAN POUR OFF TRUST

By:_________________________
Name: Matthew Bronfman
Title: Trustee

----------------------------
Matthew Bronfman

MATTHEW BRONFMAN LONG-TERM INVESTMENT
TRUST

By:_________________________
Name: Matthew Bronfman
Title: Trustee

ATLANTIC VENTURE PARTNERS, II, L.P.

By:_________________________
(General Partner)

By:_________________________
Name:
Title:

VIRGINIA CAPITAL, L.P.

By: Virginia Capital Management, Inc.
(General Partner)

By:_________________________
Name:
Title:

-7-

<PAGE>

Exhibit 10.32

FORM OF CLASS C PREFERENCE AGREEMENT

CLASS C PREFERENCE AGREEMENT, dated as of ________, 1998 among Front
Royal, Inc, a North Carolina Corporation (the "Company") and the holders (the
"Class C Shareholders") of the Company's Class C Common Stock, no par value
(the "Class C Common Stock") as of the date hereof who are signatories hereto.

WHEREAS, the Class C Shareholders currently are entitled, among other
things, to elect two members of the Company's Board of Directors (the
"Board"), to approve, as a class, certain corporate transactions and, in the
event of a liquidation of the Company or similar transaction, to receive from
the proceeds available to holders of all common stock an amount equal to the
greater of $4.00 per share of Class C Common Stock or the pro rata amount
distributable to all common shareholders assuming all three classes of the
Company's common stock were a single class;

WHEREAS, in connection with the Company's proposed initial public
offering (the "Offering") the Company has adopted and the Company's
shareholders have approved a Plan of Recapitalization (the "Plan of
Recapitalization"; capitalized terms used herein without definition have the
meanings assigned to them in the Plan of Recapitalization), pursuant to which,
among other things, each of the Company's three classes of common stock will
be converted (the "Common Stock Conversion") into one class of common stock,
no par value (the "Common Stock");

WHEREAS, as a result of the Common Stock Conversion the Class C
Shareholders will lose (i) their ability to elect two directors of the Board,
(ii) their ability to vote as a class on any matters and (iii) their
liquidation preference; and

WHEREAS, pursuant to the Plan of Recapitalization the Company has
agreed to enter into this Agreement to provide the Class C Shareholders with a
contractual liquidation preference that is substantially equivalent to the one
that they are losing as result of the Offering.

NOW THEREFORE, for good and valid consideration, the receipt and
sufficiency of which is hereby confirmed, the Company and the Series C
Shareholders who are signatories hereto hereby agree as follows:

1. Preference. (a) In the event of any liquidation, dissolution or
winding up of the Corporation, whether voluntary or involuntary, the Class C
Shareholders shall be entitled to receive from the Company, out of the
proceeds available for distribution to holders of the Common Stock after
payment of or the setting aside of all funds necessary to pay all creditors of
the Company and all amounts payable to the holders of any senior securities,
without regard to any Class C Shareholder preference, for each share of Common
Stock ("C Common Stock") received by them in exchange for their Class C Common
Stock and owned by them as of such liquidation, dissolution or winding up of
the Company, out of the proceeds from such

<PAGE>

liquidation, dissolution or winding up, an amount equal to the greater of (i)
the Liquidation Preference Amount or (ii) the amount which would be
distributable on account of each share of Common Stock as a result of such
liquidation, dissolution or winding up of the Corporation. If the Class C
Shareholders are to receive the Liquidation Preference Amount pursuant to (i)
above, it shall be paid in full immediately prior to any distribution made
with respect to the shares of Common Stock, other than the C Common Stock, and
once such amount has been paid the C Common Stock shall automatically be
cancelled and the Class C Shareholders shall not be entitled to any additional
payments from the Company on account of the C Common Stock.. If the Class C
Shareholders are to receive the payment pursuant to (ii) above, then they
shall be treated identically to all other holders of the Common Stock upon
such liquidation, dissolution or winding up of the Company.

(b) For purposes of this Agreement, "Liquidation Preference
Amount" shall mean $4.00 per share of C Common Stock, which amount shall be
adjusted to $6.67 per share of C Common Stock subsequent to the Reverse Stock
Split, and further adjusted upward or downward, as appropriate, to reflect any
stock dividends, stock splits, combinations of shares or similar transactions
thereafter affecting the number of shares of C Common Stock outstanding.

(c) If the Class C Shareholders are to receive the Liquidation
Preference Amount, and the amount actually available is insufficient to pay in
full the Liquidation Preference Amount, then the entire assets to be
distributed on account of such liquidation, dissolution or winding up shall be
distributed among the Class C Shareholders ratably based on the number of
shares of C Common Stock owned by each such Class C Shareholder.

2. Assignment. The preference granted by this Agreement is solely for
the benefit and shall only apply to the Class C Shareholders who are
signatories hereto, and such preference is not assignable or transferrable in
any manner, by operation of law or otherwise and such preference shall
terminate with respect to each share of C Common Stock upon any sale, transfer
or disposition of C Common Stock.

3. Effective Date. This Agreement shall become effective
simultaneously with the effectiveness of the Plan of Recapitalization.

4. Entire Agreement. This Agreement constitutes the entire agreement
between the parties with respect to the subject matter hereof and there are no
other oral or written agreements or understandings in regard to the subject
matter hereof. This Agreement may be altered or amended only by written
instrument executed by the parties hereto.

5. Counterpart; Facsimile Signature. This Agreement may be executed
in two or more counterparts, all of which when taken together shall be
considered one and the same agreement and shall become effective when
counterparts have been signed by each party and delivered to the other party,
it being understood that all parties need not sign the same counterpart. In
the event that any signature is delivered by facsimile transmission, such

-2-
<PAGE>

signature shall create a valid and binding obligation of the party executing
(or on whose behalf such signature is executed) the same with the same force
and effect as if such facsimile signature page were an original thereof.

-3-

<PAGE>

IN WITNESS WHEREOF, the parties hereto have executed this Amendment
as of the date first written above.

COMPANY:

FRONT ROYAL INC.

By:_________________________
Name:
Title:

HOLDERS OF CLASS C STOCK

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

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<PAGE>

Exhibit 21.1

Subsidiaries of Front Royal, Inc.

Jurisdiction of Incorporation
Subsidiaries or Organization
- ------------ ---------------
Colony Insurance Company* Virginia

Front Royal Environmental Insurance
Management, Inc.* Virginia

Rockwood Casualty Insurance Company* Pennsylvania

Colony Management Services, Inc.* Virginia

The Redwoods Group* North Carolina

Colony Holdings, Inc.* North Carolina

Front Royal Insurance Company** Virginia

PNIC Holdings, Inc.*** North Carolina

Somerset Casualty Insurance Company**** Pennsylvania

Mid-State Insurance Underwriters, Inc.**** Pennsylvania

Comprehensive Casualty Services, Inc.**** Pennsylvania

Coal Operators Indemnity Company **** Pennsylvania

* Wholly owned subsidiary of Front Royal, Inc.
** Wholly owned subsidiary of Colony Insurance Company
*** Wholly owned subsidiary of Colony Holdings, Inc.
**** Wholly owned subsidiary of Rockwood Casualty Insurance Company

<PAGE>
EXHIBIT 23.2

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the caption 'Experts' and to
the use of our reports dated February 20, 1998 with respect to the consolidated
financial statements and schedules of Front Royal, Inc. and Subsidiaries, and
dated September 3, 1997 with respect to the consolidated statements of
operations and cash flows of Rockwood Casualty Insurance Company and
subsidiaries for the year ended December 31, 1996, in the Registration Statement
on Form S-1 and related Prospectus of Front Royal, Inc. for the registration of
shares of its common stock.

/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP

Richmond, Virginia
July 24, 1998

<PAGE>
EXHIBIT 23.3

INDEPENDENT AUDITORS' CONSENT

We consent to the use in this Registration Statement of Front Royal, Inc.
on Form S-1 of our report dated September 3, 1997, with respect to the
consolidated financial statements of Rockwood Casualty Insurance Company and
subsidiaries as of and for the years ended December 31, 1995 and 1994, appearing
in the Prospectus, which is part of this Registration Statement.

We also consent to the reference to us under the heading 'Experts' in such
Prospectus.

/s/ PARENTE, RANDOLPH, ORLANDO, CAREY & ASSOCIATES
--------------------------------------------------
Parente, Randolph, Orlando, Carey & Associates

Wilkes-Barre, Pennsylvania
July 24, 1998

<PAGE>
EXHIBIT 23.4

INDEPENDENT AUDITORS' CONSENT

We consent to the use in this Registration Statement of Front Royal, Inc.
on Form S-1 of our report dated May 22, 1998, on the combined financial
statements of Preferred National Insurance Company and Affiliates as of December
31, 1997 and for the year then ended, appearing in the Prospectus, which is part
of such Registration Statement, and to the references to us under the heading
'Experts' in such Prospectus.

/s/ DELOITTE & TOUCHE LLP
--------------------------
DELOITTE & TOUCHE LLP

Miami, Florida
July 24, 1998

<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
December 31, 1997 and March 31, 1998 financial statements and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C> <C>
<PERIOD-TYPE> 12-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-END> DEC-31-1997 MAR-31-1998
<DEBT-HELD-FOR-SALE> 125,375 128,164
<DEBT-CARRYING-VALUE> 109,537 93,153
<DEBT-MARKET-VALUE> 111,403 95,013
<EQUITIES> 18,601 18,775
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 277,722 277,945
<CASH> 2,907 1,568
<RECOVER-REINSURE> 1,918 2,583
<DEFERRED-ACQUISITION> 8,776 8,666
<TOTAL-ASSETS> 356,315 357,325
<POLICY-LOSSES> 195,331 197,093
<UNEARNED-PREMIUMS> 36,008 35,378
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 6,054 5,919
<NOTES-PAYABLE> 36,545 35,295
15,500 15,500
0 0
<COMMON> 27,291 27,291
<OTHER-SE> 17,971 20,208
<TOTAL-LIABILITY-AND-EQUITY> 356,315 357,325
90,523 20,167
<INVESTMENT-INCOME> 17,984 4,265
<INVESTMENT-GAINS> (480) 4
<OTHER-INCOME> 331 56
<BENEFITS> 56,196 12,187
<UNDERWRITING-AMORTIZATION> 25,829 5,763
<UNDERWRITING-OTHER> 3,471 1,171
<INCOME-PRETAX> 13,570 3,547
<INCOME-TAX> 2,211 1,133
<INCOME-CONTINUING> 11,359 2,414
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 11,359 2,414
<EPS-PRIMARY> 1.13 .23
<EPS-DILUTED> .88 .18
<RESERVE-OPEN> 188,075 195,331
<PROVISION-CURRENT> 60,711 12,369
<PROVISION-PRIOR> (4,515) (182)
<PAYMENTS-CURRENT> 13,650 911
<PAYMENTS-PRIOR> 32,097 9,922
<RESERVE-CLOSE> 195,331 197,093
<CUMULATIVE-DEFICIENCY> 0 0

</TABLE>