PENN AMERICA GROUP INC, 424B1, 1997-07-18

PENN AMERICA GROUP INC
424B1, 1997-07-18
SURETY INSURANCE

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<PAGE> 1
Filed Pursuant to Rule 424 B1
Registration No. 333-28989

PROSPECTUS
JULY 16, 1997
3,500,000 SHARES

[PENN-AMERICA GROUP LOGO]

Penn-America Group, Inc.

COMMON STOCK

Of the 3,500,000 shares of common stock, par value $0.01 per share (the
"Common Stock"), of Penn-America Group, Inc. (the "Company") offered hereby (the
"Offering"), 2,500,000 shares are being sold by the Company and 1,000,000 shares
are being sold by Penn Independent Corporation ("Penn Independent" or the
"Selling Stockholder"). See "Principal and Selling Stockholders." The Company
will not receive any proceeds from the sale of the Common Stock by the Selling
Stockholder.

The Common Stock is listed on the Nasdaq National Market under the symbol
"PAGI". The last reported sale price of the Common Stock on the Nasdaq National
Market on July 16, 1997 was $17.00 per share. See "Price Range of Common Stock
and Dividends."

SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE COMMON STOCK.

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) STOCKHOLDER(3)
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share.............. $15.750 $0.985 $14.765 $14.765
Total(4)............... $55,125,000 $3,447,500 $36,912,500 $14,765,000
- -------------------------------------------------------------------------------------------------------
</TABLE>

(1) The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."

(2) Before deducting the Company's share of expenses, estimated at $209,000.

(3) Before deducting the Selling Stockholder's share of expenses, estimated at
$83,000.

(4) The Company has granted the Underwriters an option, exercisable within 30
days after the date of this Prospectus, to purchase up to an additional
525,000 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 Stockholder will be $63,393,750, $3,964,625, $44,664,125 and
$14,765,000, respectively. See "Underwriting."

The shares of Common Stock offered hereby are being offered by the several
Underwriters, subject to prior sale, 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 the
shares of Common Stock offered hereby will be made in New York, New York on or
about July 22, 1997.

DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION

CONNING & COMPANY

PENNSYLVANIA MERCHANT GROUP LTD
<PAGE> 2

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."
------------------------

IN CONNECTION WITH THE OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON
THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE
"UNDERWRITING."
------------------------

THE INSURANCE LAWS OF PENNSYLVANIA PROVIDE THAT NO PERSON MAY ACQUIRE
"CONTROL" OF A DOMESTIC INSURANCE COMPANY WITHOUT THE APPROVAL OF THE INSURANCE
COMMISSIONER OF SUCH STATE. A PERSON PURCHASING 10% OR MORE OF THE OUTSTANDING
SHARES OF COMMON STOCK OF THE COMPANY WILL BE PRESUMED TO HAVE ACQUIRED SUCH
CONTROL. THE INSURANCE LAWS OF PENNSYLVANIA ALSO PROVIDE THAT NO SUBSIDIARY OR
AFFILIATE OF ANY LENDING INSTITUTION, PUBLIC UTILITY, BANK HOLDING COMPANY, OR
SAVINGS AND LOAN HOLDING COMPANY MAY, DIRECTLY OR INDIRECTLY, BE LICENSED OR
ADMITTED AS AN INSURER IN PENNSYLVANIA. THE PENNSYLVANIA INSURANCE LAWS HAVE
DEFINED "AFFILIATE" AS A COMPANY OVER WHICH ANOTHER ENTITY HAS "DIRECT OR
INDIRECT OWNERSHIP OR CONTROL OF FIVE PER CENTUM OR MORE OF THE VOTING STOCK".
CONSEQUENTLY, WITHOUT THE APPROVAL OF THE INSURANCE COMMISSIONER OF
PENNSYLVANIA, NO LENDING INSTITUTION, PUBLIC UTILITY, BANK HOLDING COMPANY, OR
SAVINGS AND LOAN HOLDING COMPANY MAY, DIRECTLY OR INDIRECTLY, OWN MORE THAN FIVE
PERCENT (5%) OF THE VOTING STOCK OF THE COMPANY.
------------------------

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company with the Commission can be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, DC
20549, and at the following regional offices of the Commission: 7 World Trade
Center, Suite 1300, New York, NY 10048; and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, IL 60661-2511. Copies of such materials can be
obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., Judiciary Plaza, Washington, DC 20549, at prescribed rates. In
addition, such materials can also be obtained from the Commission's web site at
http://www.sec.gov. Copies of the above reports, proxy statements and other
information may also be inspected at the offices of the Nasdaq National Market,
9513 Key West Avenue, Rockville, MD 20850.

The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the securities 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 the securities offered hereby, reference is hereby
made to the Registration Statement and the exhibits and schedules filed
therewith, which may be obtained from the principal office of the Commission in
Washington, DC, upon payment of the fees prescribed by the Commission.

2
<PAGE> 3

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and consolidated financial
statements (including the notes thereto) appearing elsewhere in this Prospectus.
Except where otherwise indicated, the "Company" refers to Penn-America Group,
Inc. ("PAGI") and its wholly-owned subsidiary, Penn-America Insurance Company
("Penn-America"), as well as Penn-America's wholly-owned subsidiary, Penn-Star
Insurance Company ("Penn-Star"). Penn-Star received its Certificate of Authority
from the Insurance Department of Pennsylvania on February 21, 1997 and commenced
operations on April 1, 1997. Terms defined in the "Glossary of Selected
Insurance Terms" are printed in boldface type the first time they appear in the
text of this Prospectus. All financial information contained in this Prospectus
is presented in accordance with GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
("GAAP"), unless specified as being in accordance with STATUTORY ACCOUNTING
PRACTICES ("SAP"). Except where otherwise indicated, all information contained
in this Prospectus assumes no exercise of the Underwriters' over-allotment
option.

All per share information in this Prospectus has been adjusted to reflect a
three-for-two split of the Company's Common Stock effected on March 7, 1997.

THE COMPANY

Penn-America Group, Inc. is a specialty property and casualty insurance
holding company which, through its subsidiaries, markets and underwrites
commercial property, general liability and multi-peril insurance for small
businesses located primarily in small towns and suburban and rural areas, and
NONSTANDARD personal automobile insurance. The Company provides commercial
property and casualty insurance on both an EXCESS AND SURPLUS LINES basis and an
admitted basis, and personal automobile insurance on an admitted basis. The
Company markets its products through 52 high quality GENERAL AGENTS, who in turn
produce business through over 25,000 RETAIL INSURANCE BROKERS located throughout
the United States. The Company focuses on serving the insurance needs of small
or nonstandard markets which are generally characterized by small average policy
premiums and serviced by retail insurance brokers with limited access to larger,
standard lines insurers. The Company believes that these markets are generally
underserved by larger, standard lines insurers who often limit their
UNDERWRITING to policies above a certain minimum premium size or to certain risk
classes and who operate in large-scale markets in which they can achieve
economies of scale. The Company believes that its distribution network enables
it to effectively access these numerous small markets at a relatively low fixed
cost through the marketing, underwriting and administrative support of its
general agents, as well as the localized market knowledge and expertise of its
general agents and their retail insurance brokers.

The success of the Company's strategy is demonstrated by its strong and
consistent growth and profitability. From 1992 to 1996, GROSS WRITTEN PREMIUMS
grew at a 30.8% compound annual rate from $27.5 million to $80.5 million, and
net operating earnings (excluding realized investment gains) grew at a 41.3%
compound annual rate from $1.6 million to $6.4 million. The Company has operated
at a SAP COMBINED RATIO under 100.0% in every year since 1992. The Company's
average SAP combined ratio from 1992 to 1996 was 95.9%, and the Company's
average return on average stockholders' equity during the same period was 15.0%.

3
<PAGE> 4

environmental and aviation liability). The Company generally reviews new and
renewal commercial policies on a continuous basis and nonstandard personal
automobile policies on a quarterly basis to ensure that its underwriting
guidelines are being followed. In addition to standard commissions, the Company
provides strong incentives to its general agents to produce profitable business
through a contingent commission structure which is substantially tied to
underwriting profitability and through the issuance of shares of Common Stock in
lieu of cash for a portion of the contingent commissions.

Historically, the Company has underwritten the majority of its commercial
lines business on an excess and surplus lines basis. In recent years, the
Company has underwritten a greater proportion of its commercial lines business
on an admitted basis as it has identified profitable admitted markets which
remain underserved by larger standard insurers. Currently, the Company
underwrites all of its nonstandard personal automobile business on an admitted
basis. The Company expects to continue to expand its commercial lines business
by offering additional products and packages which enhance its current property
and liability coverages, by identifying profitable programs and books of
business and by selectively adding high quality general agents. Examples of such
additional products and programs include a commercial automobile product and
specialty programs, which may include miscellaneous professional liability
coverage. The Company currently writes nonstandard personal automobile policies
in five states. The Company has filed applications to write personal automobile
policies in two additional states and is considering expanding into several
other states.

The Company's commercial insureds consist primarily of small, "main street"
businesses, including restaurants, taverns, retailers and artisan contractors,
located principally in small towns and suburban and rural areas. In addition,
the Company has developed customized products and coverages for other small
commercial insureds such as day care facilities, fitness centers and special
events. The Company believes it has benefited from a general migration of small
businesses out of urban centers and into suburban and rural areas. Industry
consolidation, corporate downsizing and the increased use of communications
technology and personal computers, among other factors, have contributed to the
high growth in the number of small businesses in these areas. The Company's
nonstandard automobile insurance products are designed for insureds who do not
qualify for preferred or standard automobile insurance because of their payment
history, driving record, age, vehicle type or other underwriting criteria or
market conditions. Underwriting standards in the preferred and standard markets
have become more restrictive, thereby requiring more insureds to seek
nonstandard coverage and contributing to an increase in the size of the
nonstandard automobile market.

Penn-America was formed in 1975 by Irvin Saltzman, who began working in the
insurance industry in 1947 when he founded a general agency. Jon S. Saltzman,
Irvin Saltzman's son, is President and Chief Executive Officer of the Company
and has been employed by the Company since 1986. The Company completed an
initial public offering ("IPO") on October 28, 1993, at a price to the public of
$6.00 per share. Currently, the Saltzman family, substantially through their
ownership of Penn Independent, owns approximately 61.6% of the Company's Common
Stock. After the Offering, the Saltzman family will own approximately 34.3% of
the outstanding Common Stock of the Company (approximately 32.4% if the
Underwriters' over-allotment option is exercised).

4
<PAGE> 5

The following table sets forth the Company's gross written premiums by
specific product lines during the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995 1994
----------------- ------------------ ------------------
GROSS PERCENT GROSS PERCENT GROSS PERCENT
WRITTEN OF WRITTEN OF WRITTEN OF
PREMIUMS TOTAL PREMIUMS TOTAL PREMIUMS TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Commercial multi-peril.................. $31,551 39.2% $26,653 39.8% $20,556 38.1%
Commercial general liability............ 21,526 26.8 21,643 32.3 18,033 33.4
Commercial property..................... 5,555 6.9 5,288 7.9 4,449 8.3
Commercial automobile................... 98 0.1 38 0.1 -- --
------- ----- ------- ----- ------- -----
Total commercial lines........... 58,730 73.0 53,622 80.1 43,038 79.8
------- ----- ------- ----- ------- -----
Personal automobile liability........... 17,496 21.7 11,179 16.7 6,347 11.8
Personal automobile physical damage..... 4,270 5.3 2,152 3.2 4,541 8.4
------- ----- ------- ----- ------- -----
Total personal automobile
lines......................... 21,766 27.0 13,331 19.9 10,888 20.2
------- ----- ------- ----- ------- -----
Total gross written premiums..... $80,496 100.0% $66,953 100.0% $53,926 100.0%
======= ===== ======= ===== ======= =====
</TABLE>

The following table sets forth the SAP UNDERWRITING RATIOS for Penn-America
and for the property and casualty insurance industry as a whole during the
periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
PENN-AMERICA SAP UNDERWRITING RATIOS:
Loss ratio............................................ 62.7% 62.6% 62.2% 63.2% 63.9%
Expense ratio......................................... 31.6 30.4 32.3 34.8 35.6
----- ----- ----- ----- -----
Combined ratio........................................ 94.3% 93.0% 94.5% 98.0% 99.5%
===== ===== ===== ===== =====
INSURANCE INDUSTRY SAP UNDERWRITING RATIOS:(1)
Loss ratio............................................ 78.6% 78.9% 81.0% 79.5% 88.1%
Expense ratio......................................... 26.2 26.1 26.0 26.1 26.3
Dividend ratio........................................ 1.1 1.4 1.3 1.2 1.2
----- ----- ----- ----- -----
Combined ratio........................................ 105.9% 106.4% 108.3% 106.8% 115.6%
===== ===== ===== ===== =====
</TABLE>

- ------------------------------
(1) Source: For 1996, BestWeek P/C Supplement, March 24, 1997 edition; for 1992
through 1995, Best's Aggregates & Averages--Property--Casualty.

Approximately 89.5% of the Company's investment portfolio as of June 30,
1997 consisted of investment-grade fixed income securities and short-term
investments. Approximately 99.0% of the Company's fixed income securities as of
June 30, 1997 were rated "A-" or better by Standard & Poor's Corporation
("Standard & Poor's") or the equivalent rating by Moody's Investment Service
("Moody's"). As of June 30, 1997, the Company's fixed maturity investments had
an average duration of 2.9 years. Publicly traded equity securities, the
majority of which consisted of preferred stocks, represented 10.4% of the
Company's investment portfolio as of June 30, 1997.

Since 1993 Penn-America has maintained an "A (Excellent)" rating from A.M.
Best Company, Inc. ("A.M. Best"), which rating was reaffirmed by A.M. Best on
May 27, 1997. A.M. Best's ratings are based upon factors of concern to
policyholders, including financial condition and solvency, and are not directed
to the protection of investors.

The Company employs approximately 97 people, all of whom are located at the
Company's headquarters at 420 South York Road, Hatboro, Pennsylvania 19040
(telephone: (215) 443-3600).

5
<PAGE> 6

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company..... 2,500,000 shares
Common Stock offered by the Selling
Stockholder........................... 1,000,000 shares

Common Stock to be outstanding after the
Offering.............................. 9,301,384 shares(1)(2)

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 $36.7 million. The
Company expects to use the net proceeds from the
Offering (i) to repay $9.0 million of bank debt,
(ii) to increase the POLICYHOLDERS' SURPLUS of
Penn-America and Penn-Star in order to support
future growth and (iii) for general corporate
purposes. The Company will not receive any proceeds
from the sale of shares of Common Stock by the
Selling Stockholder.

Dividend policy......................... The Company intends to continue to pay quarterly
cash dividends of $0.04 per share of Common Stock
($0.16 annually), subject to declaration by the
Board of Directors and certain regulatory and other
constraints.

Nasdaq National Market symbol........... PAGI
</TABLE>

- ------------------------------
(1) Based on 6,801,384 shares outstanding on June 30, 1997. Excludes: (i)
334,500 shares issuable upon the exercise of outstanding options under the
Company's 1993 Stock Incentive Plan, of which options for 226,500 shares
were exercisable; (ii) 93,000 shares available for issuance upon grant and
exercise of options under the Company's 1993 Stock Incentive Plan; (iii)
60,236 shares available for issuance under the Executive Incentive
Compensation Plan; and (iv) 30,851 shares available for issuance under the
Agents' Profit Sharing and Performance Awards Plan. See "Management--Company
Stock Incentive Plan", "Management--Executive Incentive Compensation Plan"
and Note 12 of Notes to Consolidated Financial Statements.

(2) Excludes up to 525,000 shares which may be sold by the Company upon exercise
of the Underwriters' over-allotment option. See "Underwriting."

6
<PAGE> 7

SUMMARY CONSOLIDATED HISTORICAL FINANCIAL DATA

The summary consolidated financial data as of June 30, 1997 and 1996 and
for each of the six-month periods ended June 30, 1997 and 1996 have been derived
from unaudited consolidated financial statements and include all adjustments
(consisting only of normal recurring accruals) that the Company considers
necessary for a fair presentation of such financial information for those
periods. The results of operations for the six months ended June 30, 1997 are
not necessarily indicative of the results that may be expected for any other
interim period or for the full year. The summary consolidated financial data as
of December 31, 1996, 1995, 1994, 1993 and 1992 and for each of the years in the
five-year period ended December 31, 1996 have been derived from the audited
consolidated financial statements of the Company. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements of the Company and related notes included elsewhere herein.

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
----------------- --------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues:
Premiums earned............. $43,933 $32,108 $ 69,081 $ 57,228 $ 39,985 $25,961 $21,708
Net investment income....... 3,925 3,248 6,705 5,067 3,635 2,886 2,533
Net realized investment
gains (losses)........... 109 102 906 1,279 (713) 753 1,012
------- ------- ------- ------- ------- ------- -------
Total revenues........... 47,967 35,458 76,692 63,574 42,907 29,600 25,253
Losses and expenses:
Losses and LAE.............. 27,607 20,105 43,292 35,835 24,855 16,411 13,865
Amortization of DAC......... 11,971 8,211 17,785 14,237 9,381 6,146 4,845
Other underwriting
expenses................. 2,615 2,250 4,349 4,356 3,600 3,363 3,241
Interest expense............ 385 438 884 239 81 57 60
------- ------- ------- ------- ------- ------- -------
Total losses and
expenses............... 42,578 31,004 66,310 54,667 37,917 25,977 22,011
Earnings before income tax.... 5,389 4,454 10,382 8,907 4,990 3,623 3,242
Income tax.................... 1,620 1,453 3,389 2,881 1,579 1,115 970
------- ------- ------- ------- ------- ------- -------
Net earnings............. $ 3,769 $ 3,001 $ 6,993 $ 6,026 $ 3,411 $ 2,508 $ 2,272
======= ======= ======= ======= ======= ======= =======
PER SHARE DATA:(1)
Net earnings(2)............... $ 0.56 $ 0.45 $ 1.05 $ 0.91 $ 0.51 $ 0.50 $ 0.49
Net operating earnings(3)..... 0.55 0.44 0.96 0.78 0.59 -- --
Cash dividends(4)............. 0.08 0.05 0.11 0.06 -- 1.13 0.07
Weighted average shares....... 6,719 6,656 6,663 6,645 6,645 4,997 4,652

OTHER OPERATING DATA:
Gross written premiums........ $51,502 $37,201 $ 80,496 $ 66,953 $ 53,926 $35,521 $27,539
Net written premiums.......... 47,598 33,843 73,469 61,286 48,343 28,494 22,616
Net operating earnings(3)..... 3,697 2,934 6,395 5,182 3,882 2,011 1,604
Return on average
stockholders' equity(5)..... 16.9% 16.2% 17.8% 18.7% 12.2% 11.4% 14.7%
GAAP data:
Loss ratio.................. 62.8% 62.6% 62.7% 62.6% 62.2% 63.2% 63.9%
Expense ratio............... 33.2 32.6 32.0 32.5 32.4 36.6 37.2
------- ------- ------- ------- ------- ------- -------
Combined ratio.............. 96.0% 95.2% 94.7% 95.1% 94.6% 99.8% 101.1%
======= ======= ======= ======= ======= ======= =======

STATUTORY DATA:
Policyholders' surplus........ $43,887 $40,557 $ 41,665 $ 39,118 $ 25,677 $25,337 $14,045
Loss ratio.................... 62.8% 62.6% 62.7% 62.6% 62.2% 63.2% 63.9%
Expense ratio................. 32.2 31.5 31.6 30.4 32.3 34.8 35.6
------- ------- ------- ------- ------- ------- -------
Combined ratio................ 95.0% 94.1% 94.3% 93.0% 94.5% 98.0% 99.5%
======= ======= ======= ======= ======= ======= =======
Property and casualty industry
combined ratio(6)........... -- -- 105.9% 106.4% 108.3% 106.8% 115.6%
</TABLE>

7
<PAGE> 8

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
------------------- --------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (AT END
OF PERIOD):
Cash and investments........ $126,629 $103,016 $115,550 $100,428 $ 72,896 $61,764 $47,360
Total assets................ 173,415 143,499 158,605 137,763 100,112 78,507 61,098
Notes payable............... 9,000 10,050 9,000 10,150 1,350 350 --
Total stockholders'
equity.................... 46,738 37,934 42,337 36,250 28,366 27,380 16,543
Total stockholders' equity
per share(1).............. $ 6.87 $ 5.69 $ 6.34 $ 5.46 $ 4.27 $ 4.12 $ 3.94
</TABLE>

- ------------------------------
(1) Adjusted to reflect a three-for-two split of the Company's Common Stock
effected on March 7, 1997.

(2) Net earnings per share for 1993 and 1992 are pro forma to reflect the
economic impact of the dollar amount of a dividend in excess of 1993 and
1992 net earnings, assuming the dividend had been paid at January 1, 1992
with funds obtained from the sale of shares. Pro forma net earnings per
share for 1993 are based upon 4,997,156 shares, which include 4,581,822
weighted average shares outstanding and 415,334 shares assumed to be
outstanding since January 1, 1992 at $6.00 per share.

(3) Excludes realized investment gains (losses), assuming a 34% marginal tax
rate.

(4) Cash dividends for 1993 reflect an extraordinary dividend of $5,000,000 paid
to Penn Independent prior to the Company's IPO in October 1993.

(5) For each six-month period, the return on average stockholders' equity is
calculated on an annualized basis. The annualized return on average
stockholders' equity for the six months ended June 30, 1997 is not
necessarily indicative of the results that may be expected for any other
interim period or for the full year.

(6) Source: For 1996, BestWeek P/C Supplement, March 24, 1997 edition; for 1992
through 1995, Best's Aggregates & Averages--Property--Casualty.

8
<PAGE> 9

RISK FACTORS

Except for the historical information contained in this Prospectus, matters
discussed herein may constitute "forward-looking statements" (within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act). Such
forward-looking information reflects the Company's current best estimates
regarding its future operations. The Company's actual results could differ
materially from those estimated in the forward-looking statements as a result of
several factors, including those discussed below and elsewhere in this
Prospectus.

A variety of factors may materially impact estimates of future operations.
Many of such factors are outside the Company's control and cannot be accurately
predicted. Important factors include, but are not limited to, general economic
conditions, interest rate levels, financial market performance, legislative
initiatives, the adequacy of LOSS RESERVES, price competition impacting premium
levels, relationships with and capacity of the Company's general agents and
changes in state insurance regulations.

In addition to the other information in this Prospectus, the following
factors and risks should be considered carefully by potential purchasers in
evaluating the Company, its business and the shares of Common Stock offered
hereby:

CERTAIN BUSINESS CONSIDERATIONS

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, catastrophe losses and
general economic conditions, including interest rate changes, as well as
legislative initiatives, the frequency of litigation, the size of judgments and
severe weather conditions. The nonstandard automobile insurance market is
influenced by many factors, including state insurance laws, market conditions
for standard automobile insurance and state assigned risk and residual market
plans. Additionally, an economic downturn in the states in which the Company
underwrites its personal automobile business could result in fewer new car sales
and less demand for automobile insurance. 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 is dependent on 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 affect 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."

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, (i) to increase its business from its existing general
agents, (ii) to expand its personal automobile business further in states where
it presently does business and into additional states and (iii) to expand its
commercial lines of 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 hire and train additional personnel,
regulatory requirements and rating agency considerations. 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 "Business."

In recent years, the Company's nonstandard personal automobile business has
accounted for an increasing portion of its total business, and this trend may
continue in the future. In addition, the Company is considering expanding into
specialty programs and other commercial coverages. As the Company's mix of

9
<PAGE> 10

business changes, there can be no assurance that the Company will be able to
maintain its profit margins or other operating results.

ADEQUACY OF LOSS RESERVES

The Company is directly liable for loss and LOSS ADJUSTMENT EXPENSES
("LAE") under the terms of the insurance policies it underwrites. The Company
establishes loss reserves for the ultimate payment of all loss and loss
adjustment expenses incurred. These reserves are based on historical data and
estimates of future events and are imprecise. Although management believes that
the Company's established reserves for loss and loss adjustment expenses are
adequate and the Company annually obtains an opinion with respect to loss
reserves from an independent consulting actuary, ultimate loss and loss
adjustment expenses may vary from established reserves. Furthermore, factors
such as future inflation, claims settlement patterns, legislative activity and
litigation trends, all of which are difficult to predict, may have a substantial
impact on the Company's future loss experience. Accordingly, there can be no
assurance that the Company's reserves will be adequate to cover ultimate loss
development. If the Company's reserves should prove to be inadequate, the
Company will be required to increase reserves with a corresponding reduction in
the Company's net income in the period in which the deficiency is identified.
Future loss experience substantially in excess of established reserves could
have a material adverse effect on the Company's business, results of operations
or financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business--Reserves."

REGULATION

The Company is subject to regulation, primarily by Pennsylvania, its
domiciliary state, and to a lesser degree, the 22 other states in which it is an
ADMITTED INSURER. The regulations are generally designed to protect the
interests of insurance policyholders, as opposed to the interests of
stockholders. Such regulations relate to authorized lines of business, capital
and surplus requirements, rates and forms, investment parameters, underwriting
limitations, transactions with affiliates, dividend limitations, changes in
control and a variety of other financial and non-financial components of the
Company's business. The failure of the Company to comply with certain provisions
of applicable insurance laws and regulations could have a material adverse
effect on the Company's business, results of operations or financial condition.
See "Business--Regulation."

The NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (THE "NAIC") has
adopted a system of assessing the financial condition and stability of insurance
companies, known as "IRIS ratios," and a system to test the adequacy of
statutory capital, known as "risk-based capital," each of which applies to
Penn-America and Penn-Star. IRIS ratios consist of 11 ratios that are compiled
annually from each insurance company's statutory financial reports and then
compared against the NAIC-established "usual range" for each ratio. The
risk-based capital rules establish statutory capital requirements based on
levels of risk retained by an insurance company. Penn-America's adjusted capital
at December 31, 1996 was in excess of the applicable risk-based standards as
established by the NAIC. There is no assurance that Penn-America or Penn-Star
will be able to maintain the required capital levels or IRIS ratios. Failure to
maintain risk-based capital at the required levels, or IRIS ratios within the
NAIC's usual range, could adversely affect Penn-America's or Penn-Star's ability
to secure regulatory approvals as necessary or appropriate.

BINDING AUTHORITY

The Company underwrites the substantial majority of its commercial policies
on a binding authority basis (approximately 85% in 1996, which generated
approximately 80% of the Company's commercial lines gross written premiums). The
Company's personal automobile policies are written solely on a binding authority
basis. The Company generally has 60 days from the effective date to cancel a
policy if the risk insured does not comply with the Company's underwriting
guidelines. In the event that a general agent exceeds its authority by binding
the Company on a risk which does not comply with the Company's underwriting
guidelines, the Company is at risk for that policy until it receives the policy
and effects a cancellation. The Company generally requires general agents to
deliver all policies to the Company within 35 days of the date written. There
can be no assurance that the general agents will bind the Company within the
limits of the Company's underwriting guidelines or deliver policies to the
Company in a timely manner. As a result, the Company may

10
<PAGE> 11

be bound by a policy which does not comply with its underwriting guidelines and,
until it can effect a cancellation, may incur loss and loss adjustment expenses
related to that policy.

RELIANCE ON CERTAIN GENERAL AGENTS

A significant portion of the Company's personal automobile gross written
premiums in 1996 was written by two agents who service the states of Washington,
California and Nevada. These agents accounted for $20.4 million (93.7%) of the
personal automobile gross written premiums in 1996. During 1996, another agent
in California accounted for $6.3 million (10.7%) of commercial gross written
premiums. The loss of any of these three general agencies, or the loss of the
ability to underwrite automobile insurance in California or Washington for any
reason, could have a material adverse effect on the Company's business, results
of operations or financial condition. No other agency accounted for more than
10% of the Company's commercial or personal automobile gross written premiums in
1996. See "Business--Marketing and Distribution" and "Business--Regulation."

COMPETITION; FINANCIAL RATINGS

The Company competes in the property and general liability 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 greater experience in the insurance
industry and offer a broader line of insurance products than the Company, and
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 (such as A.M. Best). Ultimately, this competition, coupled
with the effects of the current prolonged soft market, could affect the
Company's ability to attract business at premium rates which are likely to
generate underwriting profits, and could have a material adverse effect on the
Company's business, results of operations or financial condition. See
"Business--Competition." Penn-America currently has an "A (Excellent)" rating
from A.M. Best. A downgrade of Penn-America's A.M. Best rating could have a
material adverse effect on the Company's business, results of operations or
financial condition. There can be no assurance that the Company will be able to
maintain Penn-America's A.M. Best rating.

HOLDING COMPANY STRUCTURE; DIVIDEND RESTRICTIONS

PAGI is an insurance holding company. Dividends and other payments from
Penn-America are PAGI's primary source of funds to pay expenses, service debt
and pay dividends, if any. The payment of dividends by Penn-America to PAGI and
the payment of dividends by Penn-Star to Penn-America are subject to
restrictions set forth in the Pennsylvania insurance laws. In general, these
restrictions limit the aggregate amount of dividends or other distributions that
Penn-America or Penn-Star may declare or pay within any 12-month period without
the permission of the applicable regulatory authority (generally the greater of
statutory net income for the preceding calendar year or 10% of the statutory
surplus), and require that Penn-America's or Penn-Star's statutory surplus
following any such dividend or distribution be reasonable in relation to its
outstanding liabilities and adequate for its financial needs. The maximum amount
of dividends payable by Penn-America in 1997, without prior approval of the
Pennsylvania insurance regulators, is approximately $6.3 million. Penn-America
paid a dividend of approximately $3.3 million to PAGI in 1996. In addition, the
Company's term loan with PNC Bank (the "Term Loan") includes certain negative
covenants which could have the effect of restricting the Company's ability to
pay dividends. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations--Liquidity and Capital Resources."

The continued payment of dividends by the Company will be determined
regularly by the Board of Directors and will be based on general business
conditions, legal and regulatory restrictions regarding the payment of dividends
and other factors the Board of Directors considers relevant. The Company
currently intends to continue to pay a $0.16 annual dividend per share.

11
<PAGE> 12

CERTAIN RELATIONSHIPS WITH CONTROLLING STOCKHOLDER

Currently, Mr. Irvin Saltzman and his family and affiliates (the "Saltzman
family"), substantially through their ownership of Penn Independent, the
Company's controlling stockholder and the Selling Stockholder, beneficially own
approximately 61.6% of the Company's outstanding Common Stock. Upon completion
of the Offering, the Saltzman family will beneficially own approximately 34.3%
of the Company's outstanding Common Stock (approximately 32.4% if the
Underwriters' over-allotment option is exercised) and will continue to control
the Company. See "Principal and Selling Stockholders."

Mr. Irvin Saltzman, Chairman of Penn Independent, provides consulting
advice for Penn-America's investment portfolio, for which he was paid $64,000
for 1996. In addition, the Company receives services from other executives
(including Messrs. Heerin and Lear and Ms. Saltzman-Levy), staff and
administrative personnel of Penn Independent, including services in connection
with human resource administration and related services. Also, the Company is
charged a portion of the amounts paid by Penn Independent for services such as
insurance, telecommunications, professional fees, postage and office supplies.
In 1996, the Company reimbursed Penn Independent $261,000 for such services.

The Company's headquarters in Hatboro, Pennsylvania are occupied pursuant
to a lease effective June 30, 1995, between Irvin Saltzman, as landlord, and the
Company. The lease is for an initial term of five years and the Company has one
five-year renewal option thereafter. The current rent is $260,000 per year and
the Company is required to pay its pro rata share of all taxes, fees,
assessments and expenses on the entire office facility to the extent that they
exceed $224,000 annually in the aggregate. In the event the Company renews the
lease, the rent will be increased by 50% of the cumulative change in the
Philadelphia area consumer price index during the initial lease term. Management
believes that the amount paid by the Company under the lease represents fair
market value for rent.

The Delaware Valley Underwriting Agencies (the "DVUA Agencies"), which are
wholly-owned insurance agency subsidiaries of Penn Independent, produce business
for the Company. The DVUA Agencies generated approximately 4.8% of the Company's
gross written premiums in 1996. In addition, 4.8% of the DVUA Agencies' business
volume was produced for the Company. Gross written premiums and commissions paid
resulting from transactions with the DVUA Agencies were $3,880,000 and $888,000,
respectively, in 1996. Amounts receivable from the DVUA Agencies were $334,000
as of December 31, 1996.

The Company believes that the terms of the transactions described above are
at least as favorable to the Company as those obtainable from unaffiliated third
parties. See "Certain Relationships and Related Party Transactions" and Note 3
of Notes to Consolidated Financial Statements.

DEPENDENCE ON KEY PERSONNEL

The efforts and abilities of the Company's present management, particularly
that of Jon S. Saltzman, the Company's President and Chief Executive Officer,
are very important to the success of the Company. If the Company were to lose
the services of Jon S. Saltzman or John M. DiBiasi (Penn-America's Executive
Vice President--Underwriting and Marketing), or any of the other key management
personnel, there could be a material adverse effect on the Company's business,
results of operations or financial condition. The Company does not have
employment agreements with any employee, but it does maintain key personnel life
insurance policies on Jon S. Saltzman, John M. DiBiasi, Thomas J. Reed
(Penn-America's Senior Vice President-- Claims) and Rosemary R. Ferrero (Vice
President--Finance, Chief Financial Officer, Treasurer and Secretary). See
"Management."

REINSURANCE

The Company currently purchases reinsurance, which allows it to write more
direct insurance and at greater limits than it otherwise could. The Company's
current treaty reinsurance is with General Reinsurance Corporation ("General
Re"). For catastrophe losses, the Company is covered by a consortium of insurers
led by General Re and Lloyds of London. There can be no assurance that
reinsurance will continue to be available to the Company to the same extent, and
at the same cost, as it has in the past. See "Business--Reinsurance."

12
<PAGE> 13

The maintenance of reinsurance does not legally discharge the Company from
its primary liability for the full amount of the risks it insures, although it
does make the REINSURER liable to the Company. Therefore, the Company is subject
to credit risk with respect to its reinsurers. The Company's reinsurance
recoverable is primarily with General Re. Although the Company's management
believes that its reinsurance is maintained with financially stable reinsurers
and that its reinsurance support is adequate to protect its interests, the
insolvency of General Re or any other reinsurer or their inability to make
payments under the terms of a reinsurance treaty could have a material adverse
effect on the Company's business, results of operations or financial condition.
The Company may choose in the future to re-evaluate the use of reinsurance to
increase, decrease or eliminate the amount of risk it CEDES to reinsurers. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Reinsurance."

SHARES ELIGIBLE FOR FUTURE SALE

Sales of a substantial number of shares of the Common Stock in the public
market following this Offering, or the perception that such sales could occur,
could adversely affect the market price for the Common Stock. Based on the
number of shares outstanding on June 30, 1997, upon completion of this Offering,
the Company will have 9,301,384 shares of Common Stock outstanding, of which
6,023,151 shares will be freely tradeable without restriction or further
registration under the Securities Act, except those shares acquired by
affiliates of the Company. The remaining shares will be "restricted securities"
within the meaning of Rule 144 under the Securities Act. As of June 30, 1997,
334,500 shares of Common Stock were issuable upon the exercise of outstanding
stock options (226,500 of which were exercisable), which shares have been
registered by the Company under the Securities Act and are freely tradeable
without restriction upon issuance. The Company and certain of its current
stockholders, including the Selling Stockholder, holding an aggregate of
3,278,233 shares of Common Stock upon completion of this Offering, have agreed
not to offer, sell, contract to sell or otherwise dispose of, directly or
indirectly, any Common Stock, or any securities convertible into or exchangeable
or exercisable for Common Stock, until 180 days after the date of this
Prospectus, without the prior consent of Donaldson, Lufkin & Jenrette Securities
Corporation, on behalf of the Underwriters. Following the 180 day period,
3,258,469 of the restricted securities will become immediately eligible for
sale, subject to the manner of sale, volume, notice and information requirements
of Rule 144. In addition, the Selling Stockholder, through its control of the
Company, could cause the Company to register its stock, in which case the Rule
144 volume and manner of sale restrictions would not apply. See "Description of
Capital Stock--Shares Eligible for Future Sale."

ANTI-TAKEOVER AND ISSUANCE OF ADDITIONAL SHARES

The Company's Articles of Incorporation and Bylaws contain a number of
provisions relating to corporate governance and the rights of stockholders.
Certain of these provisions may be deemed to have a potential "anti-takeover"
effect in that such provisions may delay, defer or prevent a change of control
of the Company. These provisions include (i) the authority of the Board of
Directors to issue series of its preferred stock, $0.01 par value per share (the
"Preferred Stock"), with such voting rights and other powers as the Board of
Directors may determine and (ii) notice requirements in the Bylaws relating to
nominations to the Board of Directors and to the raising of business matters at
stockholders' meetings. For nominations or other business to be properly brought
before an annual meeting of stockholders by a stockholder, the Company's Bylaws
require such stockholder to deliver a notice to the Secretary, absent specified
circumstances, not less than 60 days nor more than 90 days prior to the first
anniversary of the preceding year's annual meeting. This could have the effect
of discouraging a prospective acquirer from making a tender offer or otherwise
attempting to obtain control of the Company.

Under applicable state insurance laws and regulations, no person may
acquire control of Penn-America or any corporation controlling Penn-America
unless such person has filed a statement containing specified information with
appropriate regulatory authorities and has obtained approval for such an
acquisition. Under applicable laws and regulations, any person acquiring,
directly or indirectly, or holding proxies with respect to, 10% 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% or more
of the outstanding Common Stock,

13
<PAGE> 14

in the Offering or otherwise, would require prior approval by applicable
regulatory authorities. Such prior approval requirement would also apply to an
acquisition of proxies to vote 10% or more of the outstanding Common Stock and,
therefore, could delay or prevent a stockholder from acquiring such proxies in a
proxy contest. No assurance can be given as to whether the Company would seek to
invoke these laws and regulations in the event of a contested solicitation of
proxies. See "Description of Capital Stock--Certain Corporate Anti-Takeover
Provisions."

USE OF PROCEEDS

The net proceeds from the sale of the 2,500,000 shares of Common Stock
offered hereby by the Company (after deduction of underwriting discounts and
commissions and estimated offering expenses) are estimated to be approximately
$36.7 million. Approximately $9.0 million of the net proceeds are expected to be
used to repay in full the indebtedness of the Company under the Term Loan. The
remainder of the net proceeds is expected to be used to increase the
policyholders' surplus of Penn-America and Penn-Star in order to support future
growth and for general corporate purposes. The Company will not receive any
proceeds from the sale of shares of Common Stock by the Selling Stockholder.

Unless prepaid, the Term Loan is scheduled to mature as follows: $1.0
million on December 20, 1997, $2.0 million on December 20, 1998, $3.0 million on
December 20, 1999 and $3.0 million on December 20, 2000. The Term Loan is not
subject to a prepayment penalty and incurs interest at LIBOR plus a factor which
can vary between 100 and 225 basis points. See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations--Liquidity and
Capital Resources" and Note 9 of Notes to Consolidated Financial Statements.

14
<PAGE> 15

PRICE RANGE OF COMMON STOCK AND DIVIDENDS

The Company completed an IPO on October 28, 1993, at a price to the public
of $6.00 per share. The following table sets forth the high and low closing
prices of the Common Stock on the Nasdaq National Market and the cash dividends
paid per share since the IPO for the periods indicated. The prices and dividends
paid have been adjusted to reflect the three-for-two split of the Company's
Common Stock effected on March 7, 1997.

<TABLE>
<CAPTION>
MARKET PRICE
-------------------
PERIOD HIGH LOW DIVIDEND
<S> <C> <C> <C>
1993:
Fourth Quarter (from October 28).......................... $ 6 21/24 $ 4 53/64 $ --
1994:
First Quarter............................................. $ 5 43/64 $ 4 21/64 $ --
Second Quarter............................................ 4 3/4 4 21/64 --
Third Quarter............................................. 5 21/64 4 27/64 --
Fourth Quarter............................................ 5 11/64 4 21/64 --
1995:
First Quarter............................................. $ 5 11/64 $ 4 21/64 $ --
Second Quarter............................................ 6 1/2 4 43/64 0.0200
Third Quarter............................................. 7 43/64 6 21/64 0.0200
Fourth Quarter............................................ 9 43/64 7 0.0200
1996:
First Quarter............................................. $10 21/64 $ 7 43/64 $0.0267
Second Quarter............................................ 11 11/64 8 1/2 0.0267
Third Quarter............................................. 11 11/64 9 1/2 0.0267
Fourth Quarter............................................ 11 5/64 10 27/64 0.0267
1997:
First Quarter............................................. $14 1/2 $10 21/64 $0.0400
Second Quarter............................................ 15 1/2 11 1/4 0.0400
Third Quarter (through July 16)........................... 17 15 1/2 --
</TABLE>

The Company intends to continue to pay quarterly cash dividends of $0.04
per share of Common Stock (a rate of $0.16 annually). The payment of dividends
is subject to the discretion of the Board of Directors and will depend upon
general business conditions, legal and contractual restrictions on payment of
dividends and other factors that the Board of Directors deems relevant.

As an insurance holding company, PAGI depends primarily on dividends and
other payments from Penn-America for the payment of cash dividends to
stockholders. The payment of dividends from Penn-America to PAGI and from
Penn-Star to Penn-America are restricted by insurance laws, and insurance
regulators have authority in certain circumstances to prohibit payments of
dividends and other amounts that would otherwise be permitted without regulatory
approval. In addition, certain covenants contained in the Company's Term Loan
could have the effect of restricting the payment of dividends. See "Risk
Factors--Holding Company Structure; Dividend Restrictions" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

15
<PAGE> 16

CAPITALIZATION

The following table sets forth the consolidated capitalization of the
Company as of June 30, 1997 and as adjusted to give effect to the sale of
2,500,000 shares of Common Stock offered by the Company (after deduction of
underwriting discounts and commissions and estimated offering expenses) and the
application of the net proceeds as described in "Use of Proceeds." The
capitalization of the Company will not be affected by the sale of Common Stock
offered by the Selling Stockholder.

<TABLE>
<CAPTION>
JUNE 30, 1997
--------------------------
ACTUAL AS ADJUSTED
(IN THOUSANDS)
<S> <C> <C>
Note payable to bank................................................ $ 9,000 $ --
Stockholders' equity:
Preferred stock, $0.01 par value; authorized 2,000,000 shares;
none issued.................................................... -- --
Common stock, $0.01 par value; authorized 20,000,000 shares;
6,801,384 shares issued and outstanding (9,301,384 shares
issued and outstanding, as adjusted)(1)(2)..................... 68 93
Additional paid-in capital........................................ 22,833 59,512
Unrealized investment gains, net.................................. 1,147 1,147
Retained earnings................................................. 22,763 22,763
------- -------
46,811 83,515
Unearned compensation from restricted stock awards................ (73) (73)
------- -------
Total stockholders' equity..................................... 46,738 83,442
------- -------
Total capitalization...................................... $55,738 $ 83,442
======= =======
</TABLE>

(2) Excludes up to 525,000 shares of Common Stock which may be sold by the
Company upon exercise of the Underwriters' over-allotment option. See
"Underwriting."

16
<PAGE> 17

SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

The selected consolidated financial data as of June 30, 1997 and 1996 and
for each of the six-month periods ended June 30, 1997 and 1996 have been derived
from unaudited consolidated financial statements and include all adjustments
(consisting only of normal recurring accruals) that the Company considers
necessary for a fair presentation of such financial information for those
periods. The results of operations for the six months ended June 30, 1997 are
not necessarily indicative of the results that may be expected for any other
interim period or for the full year. The selected consolidated financial data as
of December 31, 1996, 1995, 1994, 1993 and 1992 and for each of the years in the
five-year period ended December 31, 1996 have been derived from the audited
consolidated financial statements of the Company. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements of the Company and related notes included elsewhere herein.

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
----------------- -----------------------------------------------
1997 1996 1996 1995 1994 1993 1992
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues:
Premiums earned................ $43,933 $32,108 $69,081 $57,228 $39,985 $25,961 $21,708
Net investment income.......... 3,925 3,248 6,705 5,067 3,635 2,886 2,533
Net realized investment
gains (losses).............. 109 102 906 1,279 (713) 753 1,012
------- ------- ------- ------- ------- ------- -------
Total revenues.............. 47,967 35,458 76,692 63,574 42,907 29,600 25,253
Losses and expenses:
Losses and LAE................. 27,607 20,105 43,292 35,835 24,855 16,411 13,865
Amortization of DAC............ 11,971 8,211 17,785 14,237 9,381 6,146 4,845
Other underwriting expenses.... 2,615 2,250 4,349 4,356 3,600 3,363 3,241
Interest expense............... 385 438 884 239 81 57 60
------- ------- ------- ------- ------- ------- -------
Total losses and expenses... 42,578 31,004 66,310 54,667 37,917 25,977 22,011
Earnings before income tax....... 5,389 4,454 10,382 8,907 4,990 3,623 3,242
Income tax....................... 1,620 1,453 3,389 2,881 1,579 1,115 970
------- ------- ------- ------- ------- ------- -------
Net earnings................ $ 3,769 $ 3,001 $ 6,993 $ 6,026 $ 3,411 $ 2,508 $ 2,272
======= ======= ======= ======= ======= ======= =======
PER SHARE DATA:(1)
Net earnings(2).................. $ 0.56 $ 0.45 $ 1.05 $ 0.91 $ 0.51 $ 0.50 $ 0.49
Net operating earnings(3)........ 0.55 0.44 0.96 0.78 0.59 -- --
Cash dividends(4)................ 0.08 0.05 0.11 0.06 -- 1.13 0.07
Weighted average shares.......... 6,719 6,656 6,663 6,645 6,645 4,997 4,652

OTHER OPERATING DATA:
Gross written premiums........... $51,502 $37,201 $80,496 $66,953 $53,926 $35,521 $27,539
Net written premiums............. 47,598 33,843 73,469 61,286 48,343 28,494 22,616
Net operating earnings(3)........ 3,697 2,934 6,395 5,182 3,882 2,011 1,604
Return on average stockholders'
equity(5)...................... 16.9% 16.2% 17.8% 18.7% 12.2% 11.4% 14.7%
GAAP data:
Loss ratio..................... 62.8% 62.6% 62.7% 62.6% 62.2% 63.2% 63.9%
Expense ratio.................. 33.2 32.6 32.0 32.5 32.4 36.6 37.2
------- ------- ------- ------- ------- ------- -------
Combined ratio................. 96.0% 95.2% 94.7% 95.1% 94.6% 99.8% 101.1%
======= ======= ======= ======= ======= ======= =======

STATUTORY DATA:
Policyholders' surplus........... $43,887 $40,557 $41,665 $39,118 $25,677 $25,337 $14,045
Loss ratio....................... 62.8% 62.6% 62.7% 62.6% 62.2% 63.2% 63.9%
Expense ratio.................... 32.2 31.5 31.6 30.4 32.3 34.8 35.6
------- ------- ------- ------- ------- ------- -------
Combined ratio................... 95.0% 94.1% 94.3% 93.0% 94.5% 98.0% 99.5%
======= ======= ======= ======= ======= ======= =======
Property and casualty industry
combined ratio(6).............. -- -- 105.9% 106.4% 108.3% 106.8% 115.6%
</TABLE>

17
<PAGE> 18

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

(1) Adjusted to reflect a three-for-two split of the Company's Common Stock
effected on March 7, 1997.

(3) Excludes realized investment gains (losses), assuming a 34% marginal tax
rate.

(4) Cash dividends for 1993 reflect an extraordinary dividend of $5,000,000 paid
to Penn Independent prior to the Company's IPO in October 1993.

(5) For each six-month period, the return on average stockholders' equity is
calculated on an annualized basis. The annualized return on stockholders'
average equity for the six months ended June 30, 1997 is not necessarily
indicative of the results that may be expected for any other interim period
or for the full year.

(6) Source: For 1996, BestWeek P/C Supplement, March 24, 1997 edition; for 1992
through 1995, Best's Aggregates & Averages--Property--Casualty.

18
<PAGE> 19

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

The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and related notes included
herein. All per share information, share amounts and stock options in this
Prospectus have been adjusted to reflect a three-for-two split of the Company's
Common Stock effected on March 7, 1997.

GENERAL

On February 21, 1997, the Insurance Department of Pennsylvania issued a
Certificate of Authority to Penn-Star, Penn-America's newly formed wholly-owned
insurance subsidiary. Penn-Star was granted authority to begin to transact
business as of April 1, 1997. Penn-Star will principally write the nonstandard
personal automobile business presently written directly by its parent,
Penn-America. The formation of a separate subsidiary for the personal automobile
line allows the Company to pursue personal lines business, which must be written
on an admitted basis, without restricting its ability to write commercial
coverages on a non-admitted basis. It also allows for focused management and
monitoring of the nonstandard personal automobile business, which represented
approximately 27.0% of the Company's gross written premiums in 1996.

The Company's financial position and results of operations are subject to
fluctuations due to a variety of factors. Abnormally high severity or frequency
of claims in any period could have a material adverse effect on the Company's
business, results of operations or financial condition. Also, re-evaluations of
the Company's loss reserves could result in an increase or decrease in reserves
and a corresponding adjustment to earnings. Additionally, the insurance industry
is highly competitive. The Company competes with domestic and international
insurers, some of which have greater financial, marketing, management resources
and experience than the Company, and it may compete with new market entrants in
the future. Competition is based on many factors, including the perceived market
strength of the insurer, pricing and other terms and conditions, services
provided, the speed of claims payment, the reputation and experience of the
insurer, and ratings assigned by independent rating organizations (such as A.M.
Best). Penn-America's current rating from A.M. Best is "A (Excellent)". This
rating is based upon factors of concern to policyholders, including financial
condition and solvency, and is not directed to the protection of investors.
Penn-Star began operations on April 1, 1997 and has applied for, but has not yet
received, a rating from A.M. Best.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1997 AND 1996

Gross written premiums increased 38.4% to $51.5 million for the six months
ended June 30, 1997 from $37.2 million for the six months ended June 30, 1996.
The increase resulted from 89.9% growth in personal automobile lines gross
written premiums to $18.7 million and 19.9% growth in commercial lines gross
written premiums to $32.8 million. These increases in gross written premiums
were primarily attributable to increased volume.

NET WRITTEN PREMIUMS increased 40.6% to $47.6 million for the six months
ended June 30, 1997 from $33.8 million for the six months ended June 30, 1996.
During the same periods, net PREMIUMS EARNED increased 36.8% to $43.9 million
from $32.1 million. Net premiums earned increased due to the increase in gross
written premiums, partially offset by an increase in premiums ceded to
reinsurers.

Net investment income increased 20.8% to $3.9 million for the six months
ended June 30, 1997 from $3.2 million for the six months ended June 30, 1996.
This increase resulted principally from growth in invested assets funded
primarily by cash flows from operating activities. The average investment yield
of the fixed maturity portfolio for the six months ended June 30, 1997 was
6.82%, compared to 6.85% for the six months ended June 30, 1996. Net realized
investment gains were $109,000 for the six months ended June 30, 1997, as
compared to $102,000 for the six months ended June 30, 1996.

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Losses and loss adjustment expenses increased 37.3% to $27.6 million for
the six months ended June 30, 1997 from $20.1 million for the six months ended
June 30, 1996, primarily due to an increase in net premiums earned.

Amortization of DEFERRED POLICY ACQUISITION COSTS ("DAC") increased 45.8%
to $12.0 million for the six months ended June 30, 1997 from $8.2 million for
the six months ended June 30, 1996. The increase was attributable to an increase
in net premiums earned and to the higher percentage of net premiums earned in
personal automobile lines relative to commercial lines for the six months ended
June 30, 1997 as compared to the same period ended June 30, 1996. Commission
rates for personal automobile lines are generally higher than commission rates
for commercial lines.

Other underwriting expenses increased 16.2% to $2.6 million for the six
months ended June 30, 1997 from $2.3 million for the six months ended June 30,
1996, primarily due to the increase in gross written premiums.

The LOSS RATIO increased slightly to 62.8% for the six months ended June
30, 1997 from 62.6% for the six months ended June 30, 1996. The statutory
expense ratio increased to 32.2% for the six months ended June 30, 1997 from
31.5% for the six months ended June 30, 1996. The increase in the statutory
expense ratio was primarily due to the increase in the percentage of net
premiums written in personal automobile lines relative to commercial lines. The
statutory combined ratio increased to 95.0% for the six months ended June 30,
1997 from 94.1% for the six months ended June 30, 1996.

As a result of the factors described above, the Company's net income for
the six months ended June 30, 1997 increased 25.6% to $3.8 million or $0.56 per
share, from $3.0 million or $0.45 per share for the six months ended June 30,
1996.

YEARS ENDED DECEMBER 31, 1996 AND 1995

Gross written premiums increased 20.2% to $80.5 million in 1996, as
compared to $67.0 million in 1995. The 20.2% growth in gross written premiums in
1996 was primarily attributable to increased premium volume. The increase in
volume is attributable to an 18.4% increase in commercial multi-peril to $31.6
million and a 63.3% increase in personal automobile to $21.8 million. 72% of the
Company's existing agents' offices had increased gross written premium volume in
1996 over the previous year.

Net written premiums increased 19.9% to $73.5 million in 1996, as compared
to $61.3 million in 1995. The increase in net written premiums is due primarily
to the volume increase in both commercial multi-peril and personal automobile.
During 1996, property and casualty reinsurance retention limits remained
unchanged at $200,000 and $500,000, respectively.

Net premiums earned increased 20.7% to $69.1 million in 1996, as compared
to $57.2 million in 1995. This increase is attributable to the overall growth in
net written premiums.

Investments and cash increased 15.1% to $115.6 million. This growth in the
investment portfolio was fueled by approximately $17 million from net cash flows
from operations. Net investment income increased 32.3% to $6.7 million, as
compared to $5.1 million in 1995. This increase resulted from the investment of
proceeds from a $10 million loan from PNC Bank in December of 1995 and a 13.6%
increase in cash flows from operations.

Net realized investment gains after taxes for the year ended December 31,
1996 were $598,000 or $0.09 per share, compared to $844,000 or $0.13 per share
for the year ended December 31, 1995. Gross realized gains after-tax were
$985,000 and consisted primarily of equity securities. Gross realized losses
after-tax were $387,000 and consisted primarily of fixed maturities available
for sale.

Loss and loss adjustment expenses increased 20.8% to $43.3 million in 1996,
as compared to $35.8 million in 1995. This increase was consistent with the
20.7% increase in premiums earned. The loss ratio increased slightly to 62.7%
from 62.6% in 1995.

Amortization of deferred acquisition costs increased 24.9% to $17.8 million
in 1996, as compared to $14.2 million in 1995. The increase can be attributed
to: (i) premium growth; (ii) an increase in commercial lines

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contingent commission accrual; and (iii) increased volume in personal automobile
lines, which have higher commission rates than commercial lines.

Other underwriting expenses were unchanged at $4.4 million despite a 20.2%
increase in gross written premiums. This is primarily attributed to more
significant growth in the personal auto lines than the commercial lines. The
majority of underwriting expenses related to personal auto lines is commission
expense which is reflected in the amortization of deferred acquisition costs.
Additionally, several cost savings were realized during 1996, including a
capital stock tax refund and a reduction in bad debt expense.

Net earnings increased 16.0% to $7.0 million, or $1.05 per share in 1996,
as compared to $6.0 million or $0.91 per share in 1995.

YEARS ENDED DECEMBER 31, 1995 AND 1994

Gross written premiums increased 24.2% in 1995 to $67.0 million, as
compared to $53.9 million in 1994. The 24.2% growth in gross written premiums in
1995 primarily was attributable to increased volume since rate increases were
negligible. The increase in volume was attributable to a 29.7% increase in
commercial multi-peril to $26.7 million as compared to 1994, a 20.0% increase in
other liability to $21.6 million and a 22.4% increase in personal automobile to
$13.4 million. 85% of the Company's existing agents' offices had increased gross
written premium volume in 1995 over the previous year.

Net written premiums increased 26.8% to $61.3 million in 1995, as compared
to $48.3 million in 1994. Net written premiums increased more dramatically than
gross written premiums, principally due to an increase in both property and
casualty reinsurance retention limits as of January 1, 1995 from $175,000 to
$200,000, and $300,000 to $500,000, respectively. Net premiums earned increased
43.1% to $57.2 million, as compared to $40.0 million, which was attributable to
the overall growth in net written premiums.

Net investment income increased 39.4% to $5.1 million in 1995, as compared
to $3.6 million in 1994. Investments and cash increased 37.8% to $100.4 million.
This growth in the investment portfolio was fueled by approximately $15 million
from cash flows from operations. The remaining increase in investment income was
attributed to a higher yield of 6.8% in 1995 versus 6.4% in 1994.

At December 31, 1995, the carrying value of Collateralized Mortgage
Obligations ("CMOs") was $7.7 million compared to $8.1 million in 1994. These
obligations were all AAA-rated, government-issued securities. The decrease in
the portfolio during 1995 was attributable to the sale of one such security and
accelerated prepayments during the course of the year on the remaining
securities.

Net realized investment gains after taxes for the year ended December 31,
1995 were $844,000 or $0.13 per share, as compared to $713,000 of losses or
$0.08 per share for the year ended December 31, 1994. These realized gains
principally were due to the sale of equity securities within the portfolio.
Management believed that the values for these securities had been maximized and
believed it to be opportunistic to realize these gains.

Loss and loss adjustment expenses increased 44.2% to $35.8 million in 1995,
as compared to $24.9 million in 1994. This increase was consistent with the
43.1% increase in premiums earned.

Amortization of deferred acquisition costs increased 51.8% to $14.2 million
in 1995, as compared to $9.4 million in 1994. This increase can be attributed to
the 43.1% increase in premiums earned in 1995 and the effect of the decrease in
ceded commissions resulting from increased retention.

Net earnings increased 76.7% to $6.0 million or $0.91 per share in 1995, as
compared to $3.4 million or $0.51 per share in 1994. This increase was
attributable to the increase in earned premiums, the reduction in the statutory
combined ratio of 1.5 points, the $1.3 million in realized investment gains and
the improvement on the yield in the investment portfolio.

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LIQUIDITY AND CAPITAL RESOURCES

PAGI is a holding company, the principal asset of which is the common stock
of Penn-America. PAGI's cash flows depend primarily on dividends and other
payments from Penn-America. PAGI uses these funds to pay (i) interest and
principal under the Term Loan, (ii) operating expenses, (iii) taxes and other
payments and (iv) dividends to PAGI stockholders. Penn-America's sources of
funds consist primarily of premiums, investment income and proceeds from sales
and redemptions of investments. Funds are used by Penn-America principally to
pay claims and operating expenses, to purchase investments and to make dividend
and other payments to PAGI.

Net cash provided by operating activities increased 122.2% to $10.4 million
for the six months ended June 30, 1997 from $4.7 million for the six months
ended June 30, 1996. The increase in net cash provided by operations resulted
principally from the increase in net written premiums during the period.

Net cash used by investing activities increased 28.6% to $9.4 million for
the six months ended June 30, 1997 from $7.3 million for the six months ended
June 30, 1996. This increase was primarily due to the higher amount of net cash
provided by operating activities for the six months ended June 30, 1997.

Net cash provided by financing activities was $396,000 for the six months
ended June 30, 1997 as compared to $289,000 used for financing activities for
the same period in 1996. The cash provided by financing activities in 1997
resulted primarily from $990,000 in contributions to stockholders' equity as the
result of the exercise of stock options, partially offset by $539,000 of cash
dividends paid to stockholders.

The Company believes that it has sufficient liquidity to meet its
anticipated insurance obligations and operating and capital expenditure needs.
The Company's investment strategy emphasizes quality, liquidity and
diversification, as well as total return. With respect to liquidity, the Company
considers liability durations, specifically related to loss reserves, when
determining desired investment maturities. In addition, maturities have been
staggered to produce cash flows for loss payments and reinvestment
opportunities. The average duration of the fixed maturity portfolio as of June
30, 1997 was approximately 2.9 years.

The Company's fixed maturity portfolio represented $105.9 million or 86.6%
of the total investment portfolio as of June 30, 1997. Approximately 99.0% of
these securities were rated "A-" or better by Standard & Poor's or Moody's.
Short-term investments represented $3.6 million or 3.0% of total investments as
of June 30, 1997. Equities, the majority of which consist of preferred stocks,
represented $12.7 million or 10.4% of total investments as of June 30, 1997.

As of June 30, 1997, the investment portfolio contained $8.1 million or
6.7% of CMOs. All of these securities are "AAA"-rated securities issued by
government or government-related agencies, are publicly traded, and have market
values obtained from an independent pricing service. Changes in estimated cash
flows due to changes in prepayment assumptions from the original purchase
assumptions are revised based on current interest rates and the economic
environment. The Company had no other derivative financial instruments, real
estate or mortgages in the investment portfolio as of June 30, 1997.

On December 20, 1995, the Company entered into the Term Loan, under which
it had an outstanding balance of $9.0 million as of June 30, 1997. Unless
prepaid, the Term Loan is scheduled to mature as follows: $1.0 million in 1997,
$2.0 million in 1998, $3.0 million in 1999 and $3.0 million in 2000. The
interest rate on the Term Loan is equal to LIBOR plus a factor which can vary
between 100 and 225 basis points. The Term Loan is secured by the common stock
of Penn-America and contains various covenants, including the maintenance of
certain net worth requirements and leverage and liquidity ratios. In April 1997,
the Company signed a commitment letter to increase the Term Loan to $15.0
million. The structure of the new credit facility will provide that the current
$9.0 million outstanding under the Term Loan be repaid in equal installments
over a five-year period and the new $6.0 million credit line would be repaid
over a three-year period beginning after the second anniversary of the new
facility. The terms of the new agreement, including the interest rate, security
and covenants, are expected to be substantially similar to the terms of the
existing Term Loan. See "Use of Proceeds" and Note 9 of Notes to Consolidated
Financial Statements.

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<PAGE> 23

The principal source of cash to use for the payment of dividends to PAGI's
stockholders is dividends from Penn-America. Penn-America is required by law to
maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of dividends
from statutory surplus may require prior approval of the Pennsylvania regulatory
authorities. The maximum dividend that may be paid in 1997 by Penn-America to
PAGI without prior approval of regulatory authorities is $6,262,000.
Penn-America's statutory surplus increased 5.3% to $43.9 million as of June 30,
1997 from $41.7 million as of December 31, 1996.

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 that 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 are not 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.

NEW ACCOUNTING STANDARDS

At December 31, 1996, the Company had one stock-based compensation plan.
The Company applies APB Opinion No. 25 and related interpretations in accounting
for this plan. Accordingly, no compensation cost has been recognized for its
fixed stock option plan. If compensation cost for the Company were determined
consistently with FASB Statement No. 123, the effect on the Company's net
earnings and net earnings per share would have been immaterial.

In March 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share", which defines the computation, presentation, and
disclosure requirements for earnings per share ("EPS"). It requires dual
presentation of basic EPS and diluted EPS on the face of the income statement.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to reissue common stock were exercised or
converted into common stock. The statement is effective for financial statements
issued for periods ending after December 15, 1997, including interim periods,
and earlier application is not permitted. When adopted, all prior-period EPS
data presented will be restated.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Comprehensive Income", which establishes standards for the reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses). The statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of a statement of financial position. The statement is effective for
fiscal years beginning after December 15, 1997. The Company will adopt the
statement in 1998.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to stockholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The statement is effective for fiscal years beginning after December
15, 1997. The

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Company is in the process of determining the effect of this statement upon its
financial reporting requirements.

OTHER

The NAIC adopted risk-based capital standards which property and casualty
insurers had to meet beginning December 31, 1994. Risk-based capital standards
are designed to measure the acceptable amount of capital an insurer should have
based on its specific risks. The insurance department of an insurer's domicile
may scrutinize or take control of an insurer that fails to meet benchmark
capital levels. Based on the currently adopted standards, Penn-America's capital
and surplus is in excess of the prescribed risk-based capital requirements for
1996.

The Company relies on its existing management information systems in
operating and monitoring all major aspects of the Company's business, including
underwriting, claims and various financial systems. Additionally, the Company
relies, to a lesser extent, on the information systems of its general agents and
indirectly the producing retail insurance brokers. Any disruption in the
operation of the management information systems of the Company, its general
agents or their retail insurance brokers, could have a material adverse effect
on the Company's business, results of operations or financial condition. Like
many computer systems, the Company's systems use two-digit data fields which
recognize dates using the assumption that the first two digits are "19" (i.e.
the number 97 is recognized as the year 1997). Therefore, the Company's date-
critical functions relating to the year 2000 and beyond, such as underwriting,
claims and financial systems, may be adversely affected unless changes are made
to these computer systems. The Company has addressed this issue and a third
party contractor is in the process of reviewing all lines of code in all
applicable programs of the Company in order to implement the required changes.
However, no assurance can be given that these issues will be resolved without
any future disruption or that the Company will not incur significant expense in
resolving these issues.

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BUSINESS

GENERAL

Penn-America Group, Inc. is a specialty property and casualty insurance
holding company which, through its subsidiaries, markets and underwrites
commercial property, general liability and multi-peril insurance for small
businesses located primarily in small towns and suburban and rural areas, and
nonstandard personal automobile insurance. The Company provides commercial
property and casualty insurance on both an excess and surplus lines basis and an
admitted basis, and personal automobile insurance on an admitted basis. The
Company markets its products through 52 high quality general agents, who in turn
produce business through over 25,000 retail insurance brokers located throughout
the United States. The Company focuses on serving the insurance needs of small
or nonstandard markets which are generally characterized by small average policy
premiums and serviced by retail insurance brokers with limited access to larger,
standard lines insurers. The Company believes that these markets are generally
underserved by larger, standard lines insurers who often limit their
underwriting to policies above a certain minimum premium size or to certain risk
classes and who operate in large-scale markets in which they can achieve
economies of scale. The Company believes that its distribution network enables
it to effectively access these numerous small markets at a relatively low fixed
cost through the marketing, underwriting and administrative support of its
general agents, as well as the localized market knowledge and expertise of its
general agents and their retail insurance brokers.

The success of the Company's strategy is demonstrated by its strong and
consistent growth and profitability. From 1992 to 1996, gross written premiums
grew at a 30.8% compound annual rate from $27.5 million to $80.5 million, and
net operating earnings (excluding realized investment gains) grew at a 41.3%
compound annual rate from $1.6 million to $6.4 million. The Company has operated
at a SAP combined ratio under 100.0% in every year since 1992. The Company's
average SAP combined ratio from 1992 to 1996 was 95.9%, and the Company's
average return on average stockholders' equity during the same period was 15.0%.

The Company's distribution strategy is to maintain strong relationships
with fewer and higher quality general agents than its competitors. The Company
carefully selects a limited number of agents in each state based on their
experience and reputation and strives to preserve each agent's franchise value
within its marketing territory. The Company seeks to grow with these general
agents and develop strong, longstanding relationships by providing a high level
of service and support. From 1992 to 1996, the Company achieved 192.3%
cumulative growth in gross written premiums with a 36.8% increase in the number
of general agents from 38 to 52. The Company maintains low fixed costs by
underwriting the substantial majority of its policies on a binding authority
basis. The Company closely monitors the quality of business it underwrites by
maintaining close relationships with a small number of general agents. The
Company provides its general agents with a comprehensive, regularly updated
underwriting manual which clearly outlines the Company's pricing and
underwriting guidelines. The Company does not write high risk policies (e.g.,
medical malpractice, environmental and aviation liability). The Company
generally reviews new and renewal commercial policies on a continuous basis and
nonstandard personal automobile policies on a quarterly basis to ensure that its
underwriting guidelines are being followed. In addition to standard commissions,
the Company provides strong incentives to its general agents to produce
profitable business through a contingent commission structure which is
substantially tied to underwriting profitability and through the issuance of
shares of Common Stock in lieu of cash for a portion of the contingent
commissions.

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nonstandard personal automobile policies in five states. The Company has filed
applications to write personal automobile policies in two additional states and
is considering expanding into several other states.

Penn-America was formed in 1975 by Irvin Saltzman, who began working in the
insurance industry in 1947 when he founded a general agency. Jon S. Saltzman,
Irvin Saltzman's son, is President and Chief Executive Officer of the Company
and has been employed by the Company since 1986. The Company completed an IPO on
October 28, 1993, at a price to the public of $6.00 per share. Currently, the
Saltzman family, substantially through their ownership of Penn Independent, owns
approximately 61.6% of the Company's Common Stock. After the Offering, the
Saltzman family will own approximately 34.3% of the outstanding Common Stock of
the Company (approximately 32.4% if the Underwriters' over-allotment option is
exercised).

INDUSTRY OVERVIEW

The Company operates as an admitted insurer in 23 states and as a
non-admitted insurer in 27 states and the District of Columbia. Insurance
companies generally are admitted (licensed) to transact business in each state
in which they operate and are subject to regulatory scrutiny. These carriers are
often referred to as standard carriers. Most states, however, provide a limited
exemption from licensing for insurers writing coverage generally not available
from standard carriers, thereby providing additional capacity during times of
limited capacity from standard carriers and allowing more competition in
geographical areas not adequately served by standard carriers. This market is
served by companies generally referred to as excess and surplus lines or
nonstandard carriers.

Much of the business insured in the excess and surplus lines market is
comprised of hard-to-place risks that do not fit the current underwriting
guidelines of the standard market due to their unique characteristics and needs.
In the event that a retail insurance broker cannot find coverage for unique or
hard-to-place risk with a company in the standard market, it will turn to the
excess and surplus lines market to place suitable insurance coverage. The retail
insurance broker contacts general agents, who in turn submit the risk to excess
and surplus lines companies for consideration. Because these companies are
non-admitted carriers, they are able to use unregulated policy forms and premium
rates, giving their underwriters more flexibility than the regulated admitted
carriers in writing these hard-to-place risks. In general, the coverage provided
by excess and surplus lines insurers is more restrictive and the premiums are
higher than the standard market's policies and rates. Furthermore, in the event
that an excess and surplus lines carrier becomes insolvent and is unable to pay
its claims in full, the insured cannot rely on a state guaranty fund for
protection, except in New Jersey.

The excess and surplus lines market has continued to grow during the 1990s.
Based on information provided by A.M. Best, from 1990 to 1995, the excess and
surplus lines market grew at a 6.4% compound annual rate from $6.8 billion of
annual DIRECT WRITTEN PREMIUMS to $9.2 billion. The Company believes that this
growth was due to the increased professionalism, underwriting expertise,
innovative products and large capacity that the excess and surplus lines
companies have been able to provide. In recent years, many large national and
regional insurers have streamlined non-core lines of business. Consequently,
many peripheral lines have been abandoned and are now covered in the excess and
surplus lines market.

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Specialty admitted carriers underwrite business on an admitted basis with a
substantial portion of their premiums produced through general agents. The
Company believes that this market segment has gained prominence due to
consumers' general preference for policies underwritten by admitted carriers.
Similar to excess and surplus lines carriers, specialty admitted companies
principally underwrite unique or hard-to-place coverage that is not typically
underwritten in the standard market. One of the underlying differences between
the specialty admitted carriers and those companies underwriting excess and
surplus lines is the need for the business to be placed with an admitted
company, thereby gaining the protection of the state guaranty fund system.

The nonstandard personal automobile insurance market provides coverages to
insureds who do not qualify for preferred or standard insurance because of their
payment history, driving record, age, vehicle type or other factors, including
market conditions for preferred and standard risks. Underwriting standards for
preferred and standard risks have become more restrictive, thereby requiring
more drivers to seek coverage in the nonstandard market. These factors have
contributed to an increase in the size of the nonstandard automobile market.
Based on information provided by A.M. Best, from 1990 to 1995, the nonstandard
personal automobile insurance market grew at an 11.9% compound annual rate from
$9.9 billion of annual direct written premiums to $17.4 billion, and from 12.4%
to 16.7%, respectively, of the total personal automobile insurance market.

The nonstandard automobile insurance market is influenced by many factors,
including state insurance laws, market conditions for preferred and standard
automobile insurance and state assigned risk and residual market plans. Premium
levels for nonstandard risks are generally higher than for preferred or standard
risks because nonstandard risks generally involve a potential for increased risk
exposure and higher claims experience. Loss exposure is limited by the fact that
nonstandard drivers typically purchase low liability limits, often at a state's
statutory minimum. The nonstandard automobile market is also characterized by
the insurer's ability to minimize its exposure to unprofitable business by
effecting timely changes in premium rates and policy terms in response to
changing loss and other experiences.

PRODUCTS

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

Commercial General Liability. Liability insurance generally protects against
legal liability for bodily injury and property damage. The Company's commercial
general liability insurance provides limits generally ranging from $25,000 to $3
million, with the majority of policies currently in force having limits of
between $500,000 and $1 million. The average annual premium on policies
currently in force is approximately $1,200 and the typical standard deductible
is $500. The Company's general liability policies pay defense and related
expenses

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in addition to per occurrence and aggregate policy limits. General liability
insureds include restaurants, taverns, retailers, artisan contractors and
similar classes.

Commercial Property. Property insurance generally protects an owner of real or
personal property against covered causes of loss to that property. The Company's
commercial property lines provide limits usually no higher than $3 million, with
almost all of the policies being written at limits below $1 million. The average
annual premium on policies currently in force is approximately $1,100 and the
typical standard deductible is $500. Properties insured include restaurants,
taverns, retail establishments, vacant buildings and other similar classes.

Commercial Multi-Peril. The Company also underwrites the same commercial
property and general liability risks together as a "package" for its insureds,
generally referred to as "commercial multi-peril." The limits on these policies
are the same as if written on a monoline basis. The average annual premium on
policies currently in force is approximately $2,200 and the typical standard
deductible is $500, which applies separately for the property and general
liability coverage. The growth in the Company's commercial multi-peril policies
has outpaced the growth in separate property and liability policies over the
last several years. The Company expects this trend to continue since a
substantial number of the Company's commercial insureds customarily require both
liability and property insurance coverage.

Personal Automobile. The Company currently writes personal automobile policies
in the states of Washington, California, Nevada, Kentucky and South Dakota on a
nonstandard basis. These risks typically do not qualify for preferred or
standard insurance because of a driver's age, driving record, vehicle type or
other factors. The personal automobile business is typically written at minimum
statutory limits ranging from $15,000 to $25,000 per person and from $30,000 to
$50,000 per occurrence, depending on the state. The average annual premium is
approximately $1,300. The Company writes this coverage on a one-, three-, six-
or twelve-month policy basis in California, but primarily on a six-month basis
in all other states. The Company has filed applications to underwrite personal
automobile policies in two additional states and is considering expanding into
several other states.

MARKETING AND DISTRIBUTION

The Company currently markets its insurance products through a select
number of high quality general agents. The Company believes that it benefits
significantly from a general agency system because it obtains the significant
underwriting and marketing expertise of the general agents who have strong
business experience and relationships in their local territory. In addition, the
general agency system allows the Company to avoid the expense of maintaining
national or regional sales forces. This enables the Company to focus its efforts
on reviewing the underwriting decisions of its agents and evaluating submission
business, rather than devoting greater resources to making routine underwriting
decisions. The Company actively competes for quality general agents to
distribute its products.

The Company selectively appoints general agents and grants authority on a
state-by-state basis so that each general agent only has authority in a state(s)
where they have marketing expertise. Prior to appointing a general agent, the
Company extensively reviews the candidate's financial condition, geographic
diversification of risk, historical loss experience and reputation, as well as
the agent's results and practices with other insurers. An on-site review is made
of the prospective agent's office, including an audit of selected policy files
and confirmation that the agent has sufficient experience to merit authority to
bind the Company only to appropriate risks. The agent is also interviewed at the
Company's office in order to confirm the compatibility between the agent and the
Company's underwriting staff. Such a comprehensive review is necessitated by the
Company's philosophy of establishing an agent relationship only if it has
long-term potential.

Once appointed, the Company provides each general agent with a
comprehensive agency manual which enables the agent to begin writing business
immediately. The manual allows the agent to write coverages effectively and
consistently within the Company's comprehensive underwriting guidelines. The
agents are provided limited binding authority, based primarily on INSURANCE
SERVICES OFFICE ("ISO") rates and forms, to write a variety of property, general
liability, commercial multi-peril and personal automobile business, provided
that the risks and terms involved in a particular coverage are within the
guidelines set forth in the agency manual. The Company has devoted extensive
research to the development of its detailed agency

28
<PAGE> 29

manual to enable its agents to select and price risks consistently. The
Company's agency manual is regularly updated to be responsive to changes in the
marketplace. The Company devotes substantial resources to the continuous
monitoring and support of its general agents.

The general agents are compensated on a commission basis, which is on
average 20.6% of the gross written premium for commercial business and 26.6% for
personal lines automobile business. A portion of this commission is passed on to
the retail insurance broker. In addition, the general agency contracts between
the Company and its general agents contain profit contingency inducements under
the Agents' Profit Sharing and Performance Award Program, which is designed to
reward general agents who meet the Company's loss ratio and premium volume
criteria. The Company also provides performance awards under this program to its
commercial agents for timely policy issuance, timely premium payments and
successful underwriting audits. Such contingent commissions and performance
awards accounted for 7.1% of the total commissions incurred by the Company in
1996. During 1995, the Agents' Profit Sharing and Performance Award Program was
modified to provide that at least one-third of the contingent commission awards
would be given in the form of Common Stock. The Company authorized 75,000 shares
of Common Stock for issuance under this program. Stock awards for 1996, which
were issued in May 1997, amounted to 27,746 shares, accounting for 51.4% of the
total contingent commissions paid for 1996. In May 1997, the Company began a new
program under which the Company will award $1,000 in the form of Common Stock to
each new general agent it appoints.

The following table sets forth the geographic distribution of the Company's
gross written premiums during the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
1996 1995 1994
--------------------------- --------------------------- ---------------------------
GROSS WRITTEN PERCENT GROSS WRITTEN PERCENT GROSS WRITTEN PERCENT
PREMIUMS OF TOTAL PREMIUMS OF TOTAL PREMIUMS OF TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Pacific................ $29,435 36.6% $24,823 37.2% $21,560 40.0%
South.................. 15,677 19.5 12,519 18.7 9,601 17.8
Southwest.............. 11,693 14.5 7,949 11.9 5,601 10.4
Mid-Atlantic........... 10,665 13.2 10,607 15.8 8,976 16.6
New England............ 7,832 9.7 7,849 11.7 6,228 11.6
Midwest................ 4,685 5.8 2,977 4.4 1,911 3.5
Mountain............... 509 0.7 229 0.3 49 0.1
------- ---- ------- ---- ------- ----
Total............. $80,496 100.0% $66,953 100.0% $53,926 100.0%
======= ==== ======= ==== ======= ====
</TABLE>

UNDERWRITING AND PRICING

In the commercial property and casualty market, the rates and terms of
coverage provided by property and casualty insurance carriers are frequently
based on ISO rates and forms. ISO makes available to its members advisory,
rating, statistical and actuarial services, policy language and related
services. ISO and its related organizations currently provide such services,
including rates and forms, to more than 1,500 property and casualty insurance
companies in the U.S. One of the important services that ISO provides is an
actuarial-based estimate of the "ideal" premium rate for risks in each of
approximately 1,250 risk classifications. These rates reflect an analysis of the
loss and loss adjustment expenses on claims reported to ISO. ISO statistics,
however, include only claims and policy information reported to ISO, and
therefore do not reflect all of the loss experience for each class. Also, the
historical results for a particular class may not be sufficient to provide
actuarially meaningful results.

The Company primarily uses ISO statistics as a benchmark for risk selection
and pricing. Other carriers may or may not rely heavily on this information, and
several of the larger standard carriers have developed their own actuarial
databases. As a general rule, most standard carriers set rates lower than ISO
rates. However, the Company, because of its strategy of providing insurance to
underserved markets, typically charges 100% or higher of prescribed ISO rates.

All policies written by the Company are either generated by the general
agents pursuant to their binding authority or on a SUBMIT BASIS from the general
agents if the risk falls outside of that authority. In 1996,

29
<PAGE> 30

approximately 85% of the commercial policies written by the Company were on a
binding authority basis, generating approximately 80% of the Company's
commercial lines gross written premiums. The personal automobile program is
written solely on a binding authority basis. The Company has established strict
underwriting guidelines within the terms of its agency manual which identify the
risks that: (i) are within the binding authority of the general agents; (ii)
must be submitted to the Company and (iii) risks which the Company would not
insure on any basis. The agency manual was prepared after extensive research,
including input from its reinsurers, and is regularly updated by the Company's
underwriting staff. Generally, the Company provides its general agents with
pricing flexibility on a per-policy basis, with the objective that in the
aggregate, the weighted average premium of all new and renewal commercial
policies written by a general agent are at approximately 110% of ISO rates. Most
standard carriers typically price at 60-80% of ISO rates, based on ISO data. The
Company's underwriting staff carefully monitors its general agents and performs
on-site reviews and underwriting audits of its agents on a periodic basis for
quality and compliance with Company guidelines.

With respect to risks written by general agents under binding authority,
the Company generally has 60 days from the effective date to cancel a policy if
the risk insured does not comply with the Company's underwriting guidelines. In
the event an agent exceeds its authority by binding the Company on a risk where
the agent had no authority to do so, the Company is at risk for that policy
until it receives the policy and effects a cancellation. General agents must
deliver all policies to the Company within 35 days of the date written. The
Company monitors this activity closely through its computer system and
underwriting department.

The risks the Company writes on a submit basis are generally similar to the
binding authority classes, but may have larger coverage limits or greater
complexity. In determining whether to accept such risks, the Company's
underwriting staff will review such factors as the type of risk, the agent's
knowledge and control of the risk, potential underwriting profitability and
historical data regarding any similar risk previously underwritten by the
Company. During this process, the Company will quote a proposed premium
reflecting relevant ISO rates, if available, and adjustments that may be
warranted based on the individual characteristics of the particular risk. The
underwriting staff then assembles a complete underwriting file with respect to
the particular submission and specific approval procedures are employed,
depending on the characteristics and magnitude of the particular risk.

The Company generally reviews all commercial policies as they are received
from general agents for completeness, accuracy, and compliance with the
Company's underwriting guidelines. Further, the Company conducts a detailed
audit of each of its general agents at least once a year. The audit involves
thoroughly reviewing between 50 and 100 policies to check for completeness,
accuracy, pricing, use of proper exclusions, verification of information, and
compliance with the Company's regulatory filings, as well as the general agent's
use of the Company's overall product lines.

The Company routinely reviews selected data for nonstandard personal
automobile policies as such data is received from general agents for
completeness, accuracy, and compliance with the Company's underwriting
guidelines. Generally, the Company conducts detailed on-site audits of its
general agents on a quarterly basis. These audits involve thoroughly reviewing
between 50 and 100 policies to verify proper classifications, ratings, accident
and violation surcharges, adherence to manual guidelines, use of proper
exclusions, verification of information relative to inspections and compliance
with the Company's regulatory filings.

The Company provides its general agents with written feedback based on the
results of its audits and monitors their timely responses to any issues
highlighted in such audits.

30
<PAGE> 31

The following table sets forth the SAP underwriting ratios for Penn-America
and for the property and casualty insurance industry as a whole during the
periods indicated:

- ------------------------------
(1) Source: For 1996, BestWeek P/C Supplement, March 24, 1997 edition; for 1992
through 1995, Best's Aggregates & Averages--Property--Casualty.

CLAIMS MANAGEMENT AND ADMINISTRATION

The Company's approach to claims management is designed to investigate
reported incidents at the earliest juncture, to select, manage and supervise all
legal and adjustment aspects thereof and to provide a high level of service and
support to general agents, retail insurance brokers and insureds throughout the
claims process. The Company's general agents have no authority to settle claims
or otherwise exercise control over the claims process. All commercial and
personal lines claims are supervised and processed centrally by the Company's
claims management staff. Senior management reviews all claims over $25,000.

RESERVES

The Company is directly liable for loss and loss adjustment expense
payments under the terms of the insurance policies that it writes. In many
cases, several years may elapse between the occurrence of an insured loss, the
reporting of the loss to the Company and the Company's payment of that loss. The
Company reflects its liability for the ultimate payment of all incurred losses
and loss adjustment expenses by establishing loss and loss adjustment expense
reserves for both reported and unreported claims, which are balance sheet
liabilities representing estimates of future amounts needed to pay claims and
related expenses.

When a claim involving a probable loss is reported, the Company establishes
a CASE RESERVE for the estimated amount of the Company's ultimate loss and loss
adjustment expense payments. The estimate of the amount of the ultimate loss is
based upon such factors as the type of loss, jurisdiction of the occurrence,
knowledge of the circumstances surrounding the claim, severity of injury or
damage, potential for ultimate exposure and policy provisions relating to the
claim. The loss adjustment expenses include the estimated expenses of settling
the claim, including legal and other fees, and general expenses of administering
the claims adjustment process.

All newly reported claims received with respect to personal automobile
policies are set up with an initial average reserve. The average reserves for
these claims are determined every quarter by dividing all of the closed claims
into the total amount paid during the three month period. If a claim is open
more than 90 days, that open case reserve is evaluated and the reserve is
adjusted upward or downward according to the facts and damages of that
particular claim.

In addition, management establishes reserves on an aggregate basis to
provide for INCURRED BUT NOT REPORTED LOSSES ("IBNR"). The Company's independent
actuarial consultant annually reviews the provision for IBNR and the reserves
taken as a whole. The Company does not discount its loss reserves.

31
<PAGE> 32

The estimates of reserves are subject to the effect of trends in claims
severity and frequency and are continually reviewed. As part of this process,
the Company reviews historical data and considers various factors, including
known and anticipated legal developments, changes in social attitudes, inflation
and economic conditions. As experience develops and other data become 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 following table sets forth a reconciliation of beginning and ending
reserves as shown on the Company's financial statements (on a GAAP basis, gross
of reinsurance) for unpaid loss and loss adjustment expenses for the periods
indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Reserves for unpaid losses and loss adjustment expenses,
at beginning of year........................................ $60,139 $44,796 $33,314
------- ------- -------
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year............ 48,076 40,606 30,652
Increase (decrease) in provision for insured events of prior
years.................................................... 3,744 3,377 (518)
------- ------- -------
Total incurred losses and loss adjustment expenses............ 51,820 43,983 30,134
------- ------- -------
Payments:
Losses and loss adjustment expenses attributable to insured
events of the current year............................... 17,931 13,054 9,855
Losses and loss adjustment expenses attributable to insured
events of prior years.................................... 23,300 15,586 8,797
------- ------- -------
Total payments................................................ 41,231 28,640 18,652
------- ------- -------
Reserves for unpaid losses and loss adjustment expenses, at
end of year................................................. $70,728 $60,139 $44,796
======= ======= =======
</TABLE>

The Company has experienced adverse development of gross reserves of $3.7
million and $3.4 million in 1996 and 1995, respectively, and favorable
development of $518,000 in 1994, for prior years' insured events. The net
reserves had favorable development of $804,000, $1.7 million and $2.9 million in
1996, 1995 and 1994, respectively. The unfavorable development on the gross
reserves occurred primarily on the gross reserves held as of December 31, 1993,
which deficiency is ceded to the Company's reinsurers. 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 following table represents the development of unpaid loss and loss
adjustment expense reserves during the ten years ended December 31, 1996. The
top of the table reflects the ten year development of the Company's reserves net
of reinsurance. The bottom of the table reconciles 1996, 1995, 1994, 1993, and
1992 ending reserves to the gross reserves in the Company's consolidated
financial statements. Prior to 1992, the Company developed its reserves on a net
of reinsurance basis and restatement for those prior years is not presented. The
top line of the table shows the estimated reserve for unpaid loss and loss
adjustment expenses at the balance sheet date for each of the indicated years.
These figures represent the estimated amount of unpaid loss and loss adjustment
expenses for claims arising in all prior years that were unpaid at the balance
sheet date, including losses that had been incurred but not yet reported. The
table also shows the re-estimated amount of the previously recorded reserve
based on experience as of the end of each succeeding year. The estimate changes
as more information becomes available about the frequency and severity of
claims.

32
<PAGE> 33

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for
unpaid losses
and LAE, as
stated........ $12,200 $18,618 $21,741 $25,391 $25,352 $25,681 $ 26,110 $ 26,830 $ 35,307 $ 46,512 $55,656
Net cumulative
paid as of(1)
1 year
later....... $ 4,232 $ 4,641 $ 4,911 $ 8,655 $ 6,929 $ 6,605 $ 7,381 $ 6,852 $ 12,384 $ 17,210
2 years
later....... 6,491 6,995 10,743 13,361 11,610 10,988 11,127 13,127 20,617
3 years
later....... 7,884 11,728 14,132 16,952 14,667 13,325 15,546 18,656
4 years
later....... 9,827 14,127 15,823 19,050 16,341 16,417 19,253
5 years
later....... 11,171 15,209 17,074 20,359 18,363 19,283
6 years
later....... 11,623 16,023 17,405 21,866 20,214
7 years
later....... 12,043 16,219 18,303 23,383
8 years
later....... 12,052 16,636 19,248
9 years
later....... 12,399 17,157
10 years
later....... 12,512
Reserves
re-estimated
as of end of
year(2)
1 year
later....... $13,734 $18,483 $21,036 $25,128 $23,468 $23,228 $ 24,478 $ 23,897 $ 33,601 $ 45,708
2 years
later....... 13,777 18,054 21,396 24,329 22,658 22,383 21,945 23,489 34,281
3 years
later....... 13,505 18,370 20,570 23,923 22,252 20,471 22,032 24,558
4 years
later....... 13,555 17,739 20,206 23,615 21,465 20,819 22,767
5 years
later....... 13,440 17,552 19,822 23,639 21,469 21,726
6 years
later....... 12,861 17,342 19,499 24,021 21,990
7 years
later....... 12,983 17,488 19,621 24,683
8 years
later....... 12,878 17,432 20,222
9 years
later....... 12,964 17,932
10 years
later....... 13,091
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net cumulative
redundancy
(de-
ficiency)..... $ (891) $ 686 $ 1,519 $ 708 $ 3,362 $ 3,955 $ 3,343 $ 2,272 $ 1,026 $ 804
======= ======= ======= ======= ======= ======= ======= ======= ======= =======

Gross liability for unpaid losses and LAE, as stated............. $ 31,703 $ 33,314 $ 44,796 $ 60,140 $70,728
Reinsurance recoverable.......................................... 5,593 6,484 9,489 13,628 15,072
Net liability for unpaid losses and LAE, as stated............... 26,110 26,830 35,307 46,512 55,656
------- ------- ------- ------- -------
Gross liability re-estimated--1 year later....................... 30,609 32,796 48,173 63,884
Reinsurance recoverable re-estimated............................. 6,131 8,899 14,572 18,191
Net liability re-estimated--1 year later......................... 24,478 23,897 33,601 45,693
------- ------- -------
Gross liability re-estimated--2 years later...................... 30,390 36,243 53,009
Reinsurance recoverable re-estimated............................. 8,445 12,574 18,728
Net liability re-estimated--2 years later........................ 21,945 23,699 34,281
------- -------
Gross liability re-estimated--3 years later...................... 33,992 41,600
Reinsurance recoverable re-estimated............................. 11,960 17,041
Net liability re-estimated--3 years later........................ 22,032 24,588
-------
Gross liability re-estimated--4 years later...................... 38,165
Reinsurance recoverable re-estimated............................. 15,399
Net liability re-estimated--4 years later........................ 22,767
------- ------- ------- -------
Gross cumulative redundancy (deficiency)......................... $(6,462) $(8,286) $(8,213) $(3,744)
======== ======== ======== ========
</TABLE>

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

(1) "Net cumulative paid as of" reflects the amounts of paid losses and LAE
subsequent to the year in which the original reserves were established.

(2) "Reserves re-estimated as of" reflects the amounts of unpaid losses and loss
adjustment expenses which 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 (1)
above, plus the amounts of unpaid losses and LAE re-evaluated at the end of
each succeeding year-end.

33
<PAGE> 34

REINSURANCE

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 the exposure in return for a portion of the
premium. The ceding of liability to a reinsurer does not legally discharge the
primary insurer from its liability for the full amount of the policies on which
it obtains reinsurance. The primary insurer will be required to pay the entire
loss if the reinsurer fails to meet its obligations under the reinsurance
agreement.

In formulating 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. The Company's policy
is to use only reinsurers that have an A.M. Best rating of "A (Excellent)" or
better and that have at least $250 million in policyholder surplus.

The Company's current treaty reinsurance is with General Re, which is rated
"A++ (Superior)" by A.M. Best. Since January 1995, the Company has maintained
net retention limits of $500,000 (including indemnity and/or loss adjustment
expense) for casualty insurance and $200,000 for property insurance, with a
combined Company retention for any one loss resulting from a common occurrence
involving both the property and casualty coverage on a single risk of $500,000.
The Company also maintains casualty contingent excess coverage with General Re,
which covers exposures such as punitive damages and other extra-contractual
obligations, losses in excess of policy limits (such as bad faith and errors and
omissions) and liability actions brought by two or more of the Company's
insureds against each other resulting from the same occurrence. See "Risk
Factors--Reinsurance."

The Company is currently covered for catastrophe losses by a consortium of
reinsurers led by General Re and Lloyds of London. Under the terms of the
agreement, the Company retains the first $1 million of losses and the consortium
reinsures 95.0% of the next $19 million, with the Company retaining 5.0% of each
of the layers within the $19 million.

The Company may write individual risks with limits greater than the treaty
limits on a per policy basis by using FACULTATIVE REINSURANCE. The facultative
reinsurers must also meet Penn-America's reinsurer guidelines.

The following table reflects the amounts of gross and ceded written
premiums during the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Gross written premiums........................ $80,496 $66,953 $53,926
Ceded written premiums........................ 7,027 5,667 5,583
</TABLE>

INVESTMENTS

The Company's investment policy seeks to maximize investment income
consistent with the overriding objective of maintaining liquidity and minimizing
risk. Approximately 89.5% of the Company's investment portfolio as of June 30,
1997 consisted of investment-grade fixed income securities and short-term
investments. Approximately 99.0% of the Company's fixed income securities as of
June 30, 1997 were rated "A-" or better by Standard & Poor's or an equivalent
rating by Moody's. As of June 30, 1997, the Company's fixed maturity investments
had an average duration of 2.9 years. Publicly traded equity securities, the
majority of which consisted of preferred stocks, represented 10.4% of the
Company's investment portfolio as of June 30, 1997.

As of June 30, 1997, the Company's investment portfolio contained $8.1
million (6.7%) of CMOs. All of these CMOs are "AAA"-rated securities 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

34
<PAGE> 35

to changes in prepayment assumptions from the original purchase assumptions are
revised based on current interest rates and the economic environment. Although
the Company is permitted to invest in other derivative financial instruments,
real estate mortgages and real estate, the Company does not participate in these
markets and does not have any such investments in its investment portfolio.

The Company's investment portfolio is under the direction of the Board of
Directors of Penn-America acting through its Investment Committee (consisting of
Irvin Saltzman, Chairman, Jon Saltzman and Robert Lear). The Investment
Committee establishes and monitors the Company's investment policies, which are
intended to maximize after-tax income while maintaining a high level of quality
and liquidity in its portfolio for insurance operations. All investment
transactions must receive approval from the Chairman of the Investment Committee
prior to their initiation by the Company's outside investment advisors.

In April 1997, the Company retained General Reinsurance, New England Asset
Management ("NEAM"), to manage the fixed income portfolio. The Investment
Committee retains Carl Domino Associates, L.P. ("CDA"), a registered investment
advisor, to recommend purchases and sales for the equity portfolio.

The following table shows the classifications of the Company's investments
at June 30, 1997:

<TABLE>
<CAPTION>
JUNE 30, 1997
------------------------------------------
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.............................. $ 30,434 $ 30,434 24.9%
Corporate securities............................... 19,122 19,122 15.6
Public utilities................................... 3,998 3,998 3.3
------- ------- -----
Total available for sale...................... 53,554 53,554 43.8
------- ------- -----
Held to maturity:
U.S. Treasury securities and obligations of U.S.
government agencies.............................. 27,621 27,719 22.7
Corporate securities............................... 10,231 10,291 8.4
Mortgage-backed securities......................... 7,925 8,146 6.7
Public utilities................................... 6,005 6,056 4.9
Other securities................................... 150 150 0.1
------- ------- -----
Total held to maturity........................ 51,932 52,362 42.8
------- ------- -----
Total fixed maturities........................ 105,486 105,916 86.6
------- ------- -----
Equity investments:
Common stocks......................................... 4,379 4,379 3.6
Preferred stocks...................................... 8,325 8,325 6.8
------- ------- -----
Total equity investments...................... 12,704 12,704 10.4
------- ------- -----
Short-term investments.................................. 3,648 3,648 3.0
------- ------- -----
Total investments............................. $ 121,838 $122,268 100.0%
======= ======= =====
</TABLE>

35
<PAGE> 36

The following table sets forth the composition of the Company's portfolio
of fixed maturity investments by rating as of June 30, 1997.

<TABLE>
<CAPTION>
JUNE 30, 1997
--------------------------
AMORTIZED PERCENTAGE
COST OF TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
RATINGS:(1)
AAA (including U.S. government obligations).......................... $ 68,347 64.4%
AA................................................................... 3,000 2.8
AA-.................................................................. 5,304 5.0
A+................................................................... 8,038 7.6
A.................................................................... 12,329 11.6
A-................................................................... 8,035 7.6
BBB.................................................................. 998 0.9
Not rated............................................................ 150 0.1
-------- -----
Total........................................................... $ 106,201 100.0%
======== =====
</TABLE>

- ------------------------------
(1) Ratings are assigned primarily by Standard & Poor's, with the remaining
ratings assigned by Moody's and converted to the equivalent Standard &
Poor's rating.

The following table sets forth the Company's investment results during the
periods indicated:

<TABLE>
<CAPTION>
SIX
MONTHS
ENDED YEARS ENDED DECEMBER 31,
JUNE 30, ------------------------
1997 1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest on fixed maturities................................. $3,461 $6,108 $4,615 $3,294
Dividends on equity securities............................... 382 691 533 564
Interest on short-term investments........................... 219 380 291 139
Other........................................................ 16 61 42 35
------ ------ ------ ------
Total investment income...................................... 4,078 7,240 5,481 4,032
Investment expense........................................... (153) (535) (414) (397)
------ ------ ------ ------
Net investment income................................... $3,925 $6,705 $5,067 $3,635
====== ====== ====== ======
</TABLE>

COMPETITION

The property and casualty insurance industry is highly competitive and
includes several thousand insurers, ranging from large companies offering a wide
variety of products worldwide to smaller, specialized companies in a single
state or region and offering in some cases only a single product. The Company
competes with a significant number of these insurers in attracting quality
general agents and in selling insurance products. Many of the Company's existing
or potential competitors are larger, have considerably greater financial and
other resources, have greater experience in the insurance industry and offer a
broader line of insurance products than the Company. In commercial lines, the
Company competes with excess and surplus lines and specialty admitted insurers
including Scottsdale Insurance Company (part of Nationwide Mutual Insurance
Company), Essex Insurance Company (Markel Corporation), Nautilus Insurance
Company (W.R. Berkley Corporation), Acceptance Insurance Company and Western
World Insurance Company. The Company competes in nonstandard personal automobile
lines with, among others, Viking Insurance Company (Guaranty National
Corporation), Financial Indemnity Company (Unitrin, Inc.), Essex Insurance
Company and Five Star Insurance Company. The Company also competes with new
forms of insurance organizations (such as risk retention groups) and alternative
self-insurance mechanisms. The Company believes that in order to be successful
in its market, it must be aware of pricing cycles, must be able to minimize the
impact of such cycles through tight expense control and superior customer
service and must continually identify

36
<PAGE> 37

profitable opportunities. Other competitive factors include ratings by A.M.
Best, pricing and admitted versus excess and surplus lines status in a given
state.

REGULATION

General. 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
stockholders, and they relate to such matters as the standards of solvency which
must be met and maintained; 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; 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; 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 Penn-America was completed by the
Pennsylvania Insurance Department in 1995, covering the five-year period ended
December 31, 1994.

Penn-America is licensed as an admitted insurer in 23 states and is an
approved non-admitted (excess and surplus lines) insurer in the other 27 states
and the District of Columbia. 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 will not write a
particular risk prior to placing that risk with the Company.

Insurance Holding Company Laws. Pennsylvania, Penn-America's state of
domicile, has laws governing insurers and insurance holding companies. The
Pennsylvania 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 the Pennsylvania Insurance Department's approval to
acquire, directly or indirectly, 10% or more of the outstanding voting
securities of the PAGI, Penn-America or Penn-Star. 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 insurance subsidiaries of the
holding company group.

Dividend Restrictions. As an insurance holding company, PAGI is primarily
dependent on dividends and other permitted payments from Penn-America to provide
cash for the payment of any cash dividends to its stockholders and repayment of
the Term Loan and related interest expense. The payment of dividends to PAGI by
Penn-America and to Penn-America by Penn-Star are subject to state regulations,
primarily the insurance laws of Pennsylvania. Generally, these laws provide
that, unless prior approval is obtained, dividends of a property and casualty
insurance company in any consecutive 12-month period shall not exceed the
greater of 100% of its statutory net income for the most recent calendar year or
10% of its statutory policyholders' surplus as of the preceding year end. The
maximum annual dividends payable by Penn-America without prior approval in 1997
is approximately $6.3 million. Penn-America paid a dividend of approximately
$3.3 million to PAGI in 1996. 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. Under insolvency or guarantee laws in states in
which Penn-America is licensed as an admitted insurer and in New Jersey,
organizations have been established (often referred to as guaranty funds) with
the authority to assess admitted insurers up to prescribed limits for the claims
of policyholders insured by insolvent, admitted insurance companies. Surplus
lines insurance companies are

37
<PAGE> 38

generally not subject to such assessments, but neither are their policyholders
eligible to file claims against the guaranty funds except in New Jersey.

Additional Legislation or Regulations. 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 midterm cancellations by insurers and require advance notice of renewal
intentions. In addition, Congress is investigating possible avenues for federal
regulation of the insurance industry.

EMPLOYEES

The Company has approximately 97 employees. The Chairman of the Board of
Directors of the Company and certain Directors devote a portion of their time to
the management of Penn Independent, the Company's largest stockholder. The
Company is not a party to any collective bargaining agreements and believes that
its employee relations are good.

PROPERTIES

The Company leases approximately 22,000 square feet in an office building
located in Hatboro, Pennsylvania. The office building also houses Penn
Independent and its subsidiaries. The Company leases the space from Mr. Irvin
Saltzman, Chairman of the Board of Directors of the Company, pursuant to a lease
agreement which expires on June 30, 2000, and provides for an annual rental
payment of approximately $260,000, which amount is considered by the Company to
be at fair market value.

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.

38
<PAGE> 39

MANAGEMENT

Set forth below is certain information concerning PAGI's Directors and
officers and certain other officers of Penn-America and Penn-Star:

<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Irvin Saltzman............................. 74 Chairman, Board of Directors
Jon S. Saltzman............................ 39 President and Chief Executive Officer and
Director
Charles Ellman............................. 68 Director
James E. Heerin, Jr........................ 60 Director
Robert A. Lear............................. 52 Director
M. Moshe Porat............................. 50 Director
Jami Saltzman-Levy......................... 41 Director
Paul Simon................................. 68 Director
Thomas M. Spiro............................ 41 Director
Rosemary R. Ferrero........................ 41 Vice President--Finance, Chief Financial
Officer, Treasurer and Secretary
John M. DiBiasi............................ 42 Director and Executive Vice President--
Underwriting and Marketing of
Penn-America and Penn-Star
Thomas J. Reed............................. 52 Director and Senior Vice President--Claims
of Penn-America and Penn-Star
</TABLE>

Mr. Irvin Saltzman is the founder of Penn-America and of Penn Independent,
and for more than six years was the Chief Executive Officer and Chairman of the
boards of directors of both corporations. Mr. Saltzman has been Chairman of the
Board of Directors of the Company since its formation in July 1993. Mr. Saltzman
has been active in the insurance industry since 1947. See "Principal and Selling
Stockholders" and "Certain Relationships and Related Party Transactions."

Mr. Jon S. Saltzman has been President and Chief Executive Officer of PAGI
since its formation in July 1993. He has been President and Chief Executive
Officer of Penn-America since June 1993. Mr. Saltzman was President and Chief
Operating Officer of Penn-America from June 1989 until June 1993, and was Vice
President, Marketing of Penn-America from January 1986 until June 1988. Mr.
Saltzman is Mr. Irvin Saltzman's son.

Mr. Charles Ellman, who is now retired, has been a Director of PAGI since
1993 and was a Director of Penn-America from May 1976 until May 1995. Prior to
September 1994, Mr. Ellman was also Vice Chairman of the Board of Directors and
a Director of Penn Independent.

Mr. James E. Heerin, Jr. has been a Director of PAGI since 1993 and Vice
President of Penn Independent for more than six years. He was General Counsel
and Secretary of PAGI from its formation in July 1993 until his resignation from
those positions in March 1995. Mr. Heerin served as Vice President, Secretary
and General Counsel of Penn-America from May 1987 to March 1994 and Secretary of
Penn-America from May 1993 to March 1994. Prior to joining Penn Independent, Mr.
Heerin was Vice President and Assistant General Counsel of Pitcairn, Inc.

Mr. Robert A. Lear has been a Director of PAGI since 1993 and President of
Penn Independent since September 1996 and previously served as Executive Vice
President--Finance and Chief Financial Officer of Penn Independent for more than
seven years. Mr. Lear was Vice President--Finance and Chief Financial Officer of
PAGI from its formation in July 1993 until his resignation from those positions
in March 1995. Prior to joining Penn Independent, Mr. Lear had over 15 years of
public accounting experience, specializing in the insurance industry. Mr. Lear
is a certified public accountant.

Dr. M. Moshe Porat has been a Director of PAGI since 1993 and the Dean of
the School of Business and Management at Temple University since August 1996.
Prior to that date, he was the Joseph E. Boettner

39
<PAGE> 40

Professor and Chairman of the Risk Management, Insurance and Actuarial Science
Department at the School of Business and Management at Temple University for
eight years. Prior to joining Temple University, Dr. Porat was the Deputy
General Manager of IHUD Insurance Agencies Ltd., an international insurance
brokerage firm.

Ms. Jami Saltzman-Levy has been a Director of PAGI since 1993 and Vice
President--Human Resources of Penn Independent for more than ten years and
previously worked in various positions within Penn Independent. Ms.
Saltzman-Levy is Mr. Irvin Saltzman's daughter.

Mr. Paul Simon, a Director of PAGI since May 1997, is a Professor and
Director of the Public Policy Institute at Southern Illinois University. Mr.
Simon founded the institute in 1997 shortly after retiring from the United
States Senate after twelve years of service as Illinois's senior Democratic
Senator. His distinguished political career includes 14 years in the Illinois
House and Senate and a term as Lieutenant Governor of the State, the first in
the state's history to be elected with a governor from another party. He built a
chain of 13 newspapers in the southern and central parts of Illinois, which he
sold in 1966 to devote himself full-time to public service and writing. Mr.
Simon is the recipient of 44 honorary degrees and has written 16 books. He is
currently a Director of the Chicago Mercantile Exchange as well as a Director of
a number of foundations.

Mr. Thomas M. Spiro, a Director of PAGI since May 1997, is the Managing
General Partner of TMS Capital Partners, L.P. ("TMS"), a private investment
partnership which he founded in July 1992. He is also a Director and President
of Spiro Capital Management, Inc. ("SCMI"), a private investment corporation
which he founded in June 1992, and which is the successor to Spiro Capital
Management ("SCM"), an investment company which he founded in January 1991. Both
TMS and SCMI employ (and SCM employed) a research-oriented investment strategy
focused primarily on small capitalization public corporations. From January 1987
to December 1990, Mr. Spiro was Senior Vice President of Gollust, Tierney &
Oliver, Inc., a private corporation which managed several investment
partnerships.

Ms. Rosemary R. Ferrero has been Vice President--Finance, Chief Financial
Officer, Treasurer and Secretary of PAGI since May 1995. She has been Vice
President and Chief Financial Officer of Penn-America since May 1994. From 1977
until joining Penn-America in 1994, Ms. Ferrero was a Senior Financial Services
Manager at Coopers & Lybrand, LLP.

Mr. John M. DiBiasi has been Executive Vice President--Underwriting and
Marketing since May 1994 and Vice President--Underwriting and Marketing of
Penn-America since January 1989. From January 1988 until January 1989 he was
Manager--Marketing Research and Product Development of Penn-America. From 1983
until joining Penn-America in 1988, Mr. DiBiasi was Senior Manager, Commercial
Lines of American Reliance Insurance Companies, of Lawrenceville, New Jersey.
Mr. DiBiasi was employed by ISO from 1977 to 1983.

Mr. Thomas J. Reed has been Senior Vice President--Claims of Penn-America
since May 1995 and Vice President of Claims since 1987. Prior to joining
Penn-America, Mr. Reed was the claims manager for the Philadelphia office of the
Hartford Group.

LIMITATION OF LIABILITY OF DIRECTORS AND INDEMNIFICATION OF DIRECTORS AND
OFFICERS

Pursuant to the provisions of the Pennsylvania Business Corporation Law,
the Bylaws of the Company provide that a Director shall not be personally liable
for monetary damages for any action taken, unless the Director breaches or fails
to perform a duty of his office and such breach or failure to perform
constitutes self-dealing, willful misconduct or recklessness. This limitation
does not apply to criminal liability or liability for the payment of taxes. The
Company believes that this provision assists it in securing and retaining the
services of Directors who are not employees of the Company. The Company's Bylaws
also provide for indemnification of the Company's Directors and officers to the
fullest extent permitted by Pennsylvania law.

40
<PAGE> 41

EXECUTIVE COMPENSATION

The following table sets forth certain information regarding compensation
earned during each of the last three years by the Company's Chief Executive
Officer and by the four other most highly compensated executive officers ("named
executive officers") during 1996. All share numbers and stock prices have been
adjusted to reflect a three-for-two split of the Company's Common Stock effected
on March 7, 1997.

<TABLE>
<CAPTION>
ANNUAL
COMPENSATION(1)
-------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(3) COMPENSATION(4)
<S> <C> <C> <C> <C>
Irvin Saltzman(2)................................. 1996 $ 64,000 $ 0 $ 831
Chairman 1995 176,000 0 1,508
1994 164,623 0 1,502

Jon S. Saltzman................................... 1996 230,000 80,500 1,800
President and Chief Executive Officer 1995 208,846 84,125 1,752
1994 173,962 27,500 1,346

John M. DiBiasi................................... 1996 156,000 45,000 2,375
Executive Vice President--Underwriting and 1995 148,308 40,000 2,135
Marketing, Penn-America 1994 122,539 14,300 1,635

Rosemary R. Ferrero............................... 1996 126,000 30,000 1,950
Vice President--Finance, Chief Financial
Officer, 1995 122,539 20,000 900
Treasurer and Secretary 1994.. 75,923 7,150 0

Thomas J. Reed.................................... 1996 116,000 27,500 1,931
Senior Vice President--Claims, Penn-America 1995 112,154 28,800 1,394
1994 102,154 11,000 1,072
</TABLE>

- ------------------------------
(1) Excludes certain perquisites and other amounts which, for any executive
officer, did not exceed in the aggregate the lesser of $50,000 or 10% of the
total annual salary and bonus for such executive officer.

(2) Mr. Irvin Saltzman divides his time between Penn Independent and each of its
subsidiaries, including the Company. Mr. Saltzman's compensation is paid
directly by Penn Independent, with each subsidiary paying for the portion of
his salary and benefits attributable to the time spent for each such
subsidiary. The compensation set forth in this table is the amount paid to
Penn Independent for Mr. Saltzman's services rendered on behalf of the
Company.

(3) Messrs. DiBiasi and Reed and Ms. Ferrero received part of their 1996 bonus
in cash and the balance in 2,093, 1,395 and 1,280 shares, respectively, of
the Company's Common Stock, valued at the average of the bid and ask price
of the Common Stock on December 31, 1996.

(4) Represents employer contributions to the Company's 401(k) Savings Plan.

OPTION/SAR GRANTS

No individual grants of stock options were made during fiscal 1996 to the
Company's Chief Executive Officer or the named executive officers. The Company
does not currently have (and has not previously had) any plan pursuant to which
any stock appreciation rights ("SARs") may be granted.

AGGREGATED OPTION/SAR EXERCISES AND FISCAL YEAR-END OPTIONS/SAR VALUE TABLE

The following table sets forth information relating to options exercised
during 1996 by the Company's Chief Executive Officer and the named executive
officers, and the number and value of options held on December 31, 1996 by such
individuals:

41
<PAGE> 42

AGGREGATED OPTION EXERCISES IN 1996
AND OPTION VALUES AS OF DECEMBER 31, 1996
(ADJUSTED FOR THE THREE-FOR-TWO STOCK SPLIT)

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING
UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED DEC. 31, 1996 DEC. 31, 1996(2)
ON VALUE --------------------------- ---------------------------
NAME EXERCISE(1) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
<S> <C> <C> <C> <C> <C> <C>
Irvin Saltzman............ 0 $0 45,000 30,000 $ 213,750 $ 142,500
Jon S. Saltzman........... 0 0 27,000 18,000 128,250 85,500
John M. DiBiasi........... 0 0 13,500 9,000 64,125 42,750
Rosemary R. Ferrero....... 0 0 0 0 0 0
Thomas J. Reed............ 0 0 9,900 6,600 47,025 31,350
</TABLE>

- ------------------------------
(1) No stock options were exercised during fiscal 1996 by the named executive
officers.

(2) Total value of unexercised options is based upon the difference between the
last sales price of the Company's Common Stock on the Nasdaq National Market
as of December 31, 1996 and the exercise price of the options, multiplied by
the number of option shares.

COMPANY STOCK INCENTIVE PLAN

In August 1993, the Company adopted the 1993 Stock Incentive Plan. The plan
was amended and restated in April 1994. The purpose of the plan is to enable
officers, directors, key employees, consultants and advisors, and service
providers of the Company and its affiliates (as defined in the plan) to
participate in the Company's future and to enable the Company to attract and
retain these persons by offering them proprietary interests in the Company. The
plan is administered by the Compensation Committee of the Board. The plan
authorized the issuance of up to 525,000 shares of Common Stock pursuant to the
exercise of stock options or the award of the restricted stock. As of June 30,
1997, options to purchase 432,000 shares had been awarded.

EXECUTIVE INCENTIVE COMPENSATION PLAN

During 1995, the Board of Directors of the Company adopted an executive
incentive compensation plan which provides up to 75,000 shares, over the life of
this plan, to be granted to key officers, executives and employees of the
Company and its subsidiary. During 1996, 7,229 shares were distributed in
accordance with the plan's provisions for 1995, and during 1997, 7,535 shares
were distributed for 1996. The shares issued under this plan are valued at the
fair market value of the stock at the close of business at the end of each year,
and are issued in the subsequent year, subject to the Board's approval and
attainment of corporate objectives.

BOARD OF DIRECTORS COMPENSATION

Directors of the Company who are employees of the Company or its subsidiary
are not compensated for serving as Directors. Commencing May 14, 1997, the
non-employee Directors of the Company will receive a retainer at the rate of
$15,000 and a committee fee of $5,000 annually. Additionally, non-employee
Directors are granted 3,000 options at the beginning of the yearly term to vest
one year from grant date.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The members of the Compensation Committee during fiscal 1996 were Messrs.
Porat, Ellman, and Lawrence J. Schoenberg, all non-employee Directors of PAGI.
Mr. Schoenberg was replaced on the Compensation Committee by Mr. Simon as of May
14, 1997. No member of the Compensation Committee has a relationship that would
constitute an interlocking relationship with executive officers or directors of
another entity.

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<PAGE> 43

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 30, 1997, and as adjusted to
reflect the sale of the Common Stock offered hereby, by: (i) each person known
by the Company to own beneficially more than 5% of the outstanding shares of
Common Stock; (ii) each Director of the Company; (iii) the Company's Chief
Executive Officer; and (iv) all executive officers and Directors as a group.
Except as noted, all persons listed below have sole voting and investment power
with respect to their shares of Common Stock, subject to community property laws
where applicable.

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO THE AFTER THE
OFFERING(1)(2) OFFERING(1)(2)
----------------------- SHARES BEING ---------------------
NUMBER PERCENT OFFERED NUMBER PERCENT
<S> <C> <C> <C> <C> <C>
Penn Independent Corporation........ 4,087,500 60.1% 1,000,000 3,087,500 33.2%
420 South York Road
Hatboro, PA 19040
Irvin Saltzman...................... 4,132,500(3) 60.8 1,000,000 3,132,500 33.7
420 South York Road
Hatboro, PA 19040
Jon S. Saltzman..................... 4,142,250(4) 60.9 1,000,000 3,142,250 33.8
Jami Saltzman-Levy.................. 4,088,400(5)(6) 60.1 1,000,000 3,088,400 33.2
Eric Anthony Saltzman............... 4,087,500(7) 60.1 1,000,000 3,087,500 33.2
Robert A. Lear...................... 35,400 * 0 35,400 *
Rosemary R. Ferrero................. 2,676 * 0 2,676 *
James E. Heerin, Jr................. 13,650 * 0 13,650 *
John M. DiBiasi..................... 26,264(8) * 0 26,264 *
Thomas J. Reed...................... 16,293(9) * 0 16,293 *
M. Moshe Porat...................... 30,000(10) * 0 30,000 *
Charles Ellman...................... 135,000(11) 2.0 0 135,000 1.5
Thomas M. Spiro..................... 3,000 * 0 3,000 *
Paul Simon.......................... 1,500(12) * 0 1,500 *
--------- ---- ------- --------- ----
All executive officers and
directors......................... 4,451,933 65.5% 1,000,000 3,451,933 37.1%
========= ==== ======= ========= ====
</TABLE>

- ------------------------------
* Less than 1%

(1) Includes shares of restricted stock awarded to certain officers of the
Company under the Company's 1993 Stock Incentive Plan (as amended and
restated) which have not yet vested, over which such persons maintain
voting power, as follows: 7,200 shares for Mr. Jon Saltzman, 4,800 shares
for Mr. Lear, 1,500 shares for Mr. Heerin, 3,000 shares for Mr. DiBiasi and
1,500 shares for Mr. Reed.

(2) Includes shares subject to exercisable options as follows: 45,000 for Mr.
Irvin Saltzman, 27,000 for Mr. Jon Saltzman, 23,400 for Mr. Lear, 9,900 for
Mr. Heerin, 13,500 for Mr. DiBiasi, 9,900 for Mr. Reed, 22,500 for Dr.
Porat and 22,500 for Mr. Ellman.

(3) Of these shares, 4,087,500 are owned of record by Penn Independent. Mr.
Irvin Saltzman, Chairman of the Board of Directors, owns 49.9% of the
outstanding voting securities of Penn Independent.

(4) Of these shares, 4,087,500 are owned of record by Penn Independent. Mr. Jon
S. Saltzman, collectively with Ms. Jami Saltzman-Levy and Mr. Eric Anthony
Saltzman, serves as trustee of five trusts that own a total of 48.2% of the
outstanding voting securities of Penn Independent. Additionally, Mr. Jon
Saltzman serves individually as trustee of two trusts that collectively own
0.3% of the outstanding voting securities of Penn Independent. Mr. Jon
Saltzman also owns 0.1% of the outstanding voting securities of Penn
Independent in his own name.

(5) Of these shares, 4,087,500 are owned of record by Penn Independent. Ms.
Jami Saltzman-Levy, collectively with Mr. Jon S. Saltzman and Mr. Eric
Anthony Saltzman, serves as trustee of five trusts that own a total of
48.2% of the outstanding voting securities of Penn Independent.
Additionally, Ms. Jami Saltzman-Levy serves individually as trustee of six
trusts that collectively own 1.0% of the outstanding voting securities of
Penn Independent. Ms. Jami Saltzman-Levy also owns 0.1% of the outstanding
voting securities of Penn Independent in her own name.

(6) 900 of such shares are owned jointly with her spouse.

43
<PAGE> 44

(7) These shares are owned of record by Penn Independent. Mr. Eric Anthony
Saltzman, collectively with Ms. Jami Saltzman-Levy and Mr. Jon S. Saltzman,
serves as trustee of five trusts that own a total of 48.2% of the
outstanding voting securities of Penn Independent. Mr. Eric Anthony
Saltzman also owns 0.1% of the outstanding voting securities of Penn
Independent in his own name.

(8) 12,706 of such shares are owned jointly with his spouse.

(9) 2,643 of such shares are owned jointly with his spouse.

(10) 7,500 of such shares are owned jointly with his spouse.

(11) Excludes 150 shares held by Mr. Ellman's daughter, to which Mr. Ellman
disclaims beneficial ownership.

(12) All shares are owned jointly with his spouse.

44
<PAGE> 45

DESCRIPTION OF CAPITAL STOCK

As of June 12, 1997, the authorized capital stock of the Company increased
from 10,000,000 to 20,000,000 shares of Common Stock. The Company has authorized
2,000,000 shares of Preferred Stock, as described below. No shares of Preferred
Stock are outstanding.

COMMON STOCK

Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to vote of stockholders and do not have cumulative voting
rights. Accordingly, a holder of a majority of the outstanding shares of Common
Stock entitled to vote in any election of Directors may elect all the Directors
standing for election. Holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared by the Board of Directors out of
funds legally available therefor. Upon the liquidation, dissolution or winding
up of the Company, holders of Common Stock are entitled to receive ratably the
net assets of the Company available for distribution after the payment of all
debts and other liabilities of the Company, subject to prior and superior rights
of the Preferred Stock. Holders of Common Stock have no preemptive,
subscription, redemption or conversion rights. The outstanding shares of Common
Stock are, and the shares offered hereby when issued and paid for will be, fully
paid and nonassessable.

PREFERRED STOCK

No shares of Preferred Stock have been issued and the Company does not
presently contemplate the issuance of such shares. The Board of Directors is
empowered by the Company's Articles of Incorporation to designate and issue from
time to time one or more classes or series of Preferred Stock without any action
of the stockholders. The Board of Directors may fix and determine the relative
rights, preferences and limitations of each class or series so authorized.

The issuance of, or the ability to issue, the Preferred Stock could
adversely affect the voting power and other rights of the holders of the Common
Stock or could have the effect of decreasing the market price of the Common
Stock or of discouraging or making difficult any attempt by a person or group to
obtain control of the Company, including any attempt involving a bid for the
Common Stock at a premium over the then market price.

CERTAIN CORPORATE ANTI-TAKEOVER PROVISIONS

The Company's Articles of Incorporation and Bylaws contain a number of
provisions relating to corporate governance and the rights of stockholders.
Certain of these provisions may be deemed to have a potential "anti-takeover"
effect in that such provisions may delay, defer or prevent a change of control
of the Company. These provisions include (i) the authority of the Board of
Directors to issue series of Preferred Stock with such voting rights and other
powers as the Board of Directors may determine and (ii) notice requirements in
the Bylaws relating to nominations to the Board of Directors and to the raising
of business matters at stockholders' meetings. For nominations or other business
to be properly brought before an annual meeting of stockholders by a
stockholder, the Company's Bylaws require such stockholder to deliver a notice
to the Secretary, absent specified circumstances, not less than 60 days nor more
than 90 days prior to the first anniversary of the preceding year's annual
meeting.

In addition, the Pennsylvania Business Corporation Law of 1988, as amended
(the "BCL"), provides that directors may, in discharging their duties, consider
the interests of a number of different constituencies, including stockholders,
employees, suppliers, customers, creditors and the community in which the
Company is located. Directors are not required to consider the interests of the
stockholders to a greater degree than other constituencies' interests. The BCL
expressly provides that directors do not violate their fiduciary duties solely
by relying on poison pills or the anti-takeover provisions of the BCL.

The BCL also contains several other anti-takeover provisions identified
below that will not be applicable to the Company because the BCL allows
corporations to elect, and the Company has elected, not to be subject to these
anti-takeover provisions. They are (i) the "controlled transactions" provisions,
which permit

45
<PAGE> 46

stockholders in certain change of control transactions to demand payment from a
new 20% stockholder of the fair market value of the demanding stockholders'
shares, (ii) the "business combination" provisions, which prohibit, subject to
certain exceptions, a business combination with a stockholder or group of
stockholders beneficially owning more than 20% of the voting power of a public
corporation, for a 5-year period following the date on which the holder obtains
the 20% ownership, (iii) the "control shares" provision, which limits the voting
power of stockholders acquiring more than 20%, 33% and/or 50% of a corporation's
voting securities, and (iv) the "disgorgement" provision, which permits a
corporation to recover profits resulting from a sale of shares by a stockholder,
under certain circumstances, after the stockholder has acquired or expressed an
intent to acquire at least 20% of the corporation's voting shares. The Company,
by making the above election, has opted not to take advantage of certain
provisions which are intended to limit the possibility of a takeover of the
Company.

SHARES ELIGIBLE FOR FUTURE SALE

Based on the number of shares outstanding on June 30, 1997, upon completion
of this Offering, the Company will have 9,301,384 shares of Common Stock
outstanding (excluding shares of Common Stock reserved for issuance under the
Company's 1993 Stock Incentive Plan). Of these shares, 6,023,151 shares of
Common Stock (plus any additional shares sold upon the Underwriters' exercise of
their over-allotment option) will be freely transferable without restriction or
further registration under the Securities Act, except that any shares purchased
by an existing "affiliate" of the Company, as that term is defined by the
Securities Act, will be subject to certain of the resale limitations of Rule 144
adopted under the Securities Act. The remaining 3,278,233 shares of Common Stock
will be eligible for sale in the public market, subject to Rule 144 and the
lock-up agreement described below. Through its control of the Company, Penn
Independent could cause the Company to register its Common Stock for sale. See
"Risk Factors--Shares Eligible For Future Sale."

In general, under Rule 144 as currently in effect, beginning 90 days after
this Offering, any person (or persons whose shares are aggregated) who has had
beneficially owned shares for at least one year is entitled to sell, within any
three-month period, a number of shares that does not exceed the greater of 1% of
the then outstanding shares of the Common Stock (approximately 93,000 shares
immediately after this Offering) or the average weekly trading volume of the
Company's Common Stock in the over-the-counter market during the four calendar
weeks preceding the date on which notice of the sale if filed with the
Commission. Sales under Rule 144 are also subject to certain manner of sale
provisions, notice requirements and availability of current public information
about the Company. Any person (or persons whose shares are aggregated) who is
not deemed to have been an affiliate of the Company at any time during the three
months preceding a sale, and who has beneficially owned shares, within the
context of Rule 144, for at least two years, is entitled to sell such shares
under Rule 144(k) without regard to the volume limitations, manner of sale
provisions, public information or notice requirements.

The Company, Penn Independent and all of the Company's officers and
Directors have agreed not to offer, sell, contract to sell or grant any option
to purchase or otherwise dispose of any of the shares of Common Stock owned by
them without the prior written consent of the Donaldson, Lufkin & Jenrette
Securities Corporation, on behalf of the Underwriters. This restriction will
apply to all of the shares owned by them for 180 days after the date of this
Prospectus.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Company's Common Stock is First
City Transfer Company.

46
<PAGE> 47

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

The following is a list of transactions between the Company and Penn
Independent, the controlling stockholder and Selling Stockholder, or the
Company's directors, executive officers or affiliates. The Company believes that
the terms of the transactions described in this section are at least as
favorable to the Company as those obtainable from unaffiliated third parties.
See Note 3 of Notes to Consolidated Financial Statements.

HEADQUARTERS LEASE

The Company's headquarters in Hatboro, Pennsylvania are occupied pursuant
to a lease effective June 30, 1995, between Mr. Irvin Saltzman, Chairman of the
Board of Directors, as landlord, and the Company. The lease is for an initial
term of five years and the Company has one five-year renewal option thereafter.
The current rent is approximately $260,000 per year and the Company is required
to pay its pro rata share of all taxes, fees, assessments and expenses on the
entire office facility to the extent that they exceed $224,000 in the aggregate.
In the event of renewal, the rent will be increased by 50% of the cumulative
change in the Philadelphia area consumer price index during the initial lease
term. Management believes that the amount being paid by the Company under the
lease represents a fair market value annual rental charge.

AFFILIATED INSURANCE ENTITIES

The DVUA Agencies, wholly-owned insurance agency subsidiaries of Penn
Independent, write business with the Company. The DVUA Agencies generated
approximately 4.8% of the Company's gross written premiums in 1996. In addition,
4.8% of the DVUA Agencies' business volume was produced for the Company. Gross
written premiums and commissions paid resulting from transactions with the DVUA
Agencies were $3,880,000 and $888,000, respectively, in 1996. Amounts receivable
from the DVUA Agencies were $334,000 as of December 31, 1996. The Company
believes that its arrangements with the DVUA Agencies are on terms no less
favorable to the Company than they would otherwise be if the DVUA Agencies were
unaffiliated third parties.

From time to time, the Company has loaned money to Penn Independent
Financial Services, Inc., a wholly-owned premium financing subsidiary of Penn
Independent. The principal balance of these loans as of December 31, 1996 was
$275,000, and the balance was paid entirely on April 28, 1997.

AGREEMENTS WITH PENN INDEPENDENT CORPORATION

Mr. Saltzman is Chairman of Penn Independent, and provides consulting
advice for Penn-America's investment portfolio, for which he was paid $64,000
for 1996. In addition, the Company receives services from other executives
(including Messrs. Heerin and Lear and Ms. Saltzman-Levy), staff and
administrative personnel of Penn Independent, including services in connection
with human resource administration and related services. Also, the Company is
charged a portion of the amounts paid by Penn Independent for services such as
insurance, telecommunications, professional fees, postage and office supplies.
For 1996, the Company reimbursed Penn Independent approximately $261,000 for
such services.

CARL DOMINO ASSOCIATES, L.P.

Penn-America retains CDA, a registered investment advisor, to recommend
purchases and sales of securities. Penn Independent and Mr. James E. Heerin,
Jr., a Director of the Company, each own a 5% limited partnership interest in
CDA. CDA managed certain fixed maturity and equity security investments of
Penn-America for an annual fee of 0.208%. For 1996, the annual fee paid by
Penn-America to CDA was $207,550. Effective April 1997, CDA only manages the
Company's equity portfolio for an annual fee of 0.45%.

47
<PAGE> 48

UNDERWRITING

Subject to the terms and conditions contained in an Underwriting Agreement
dated July 16, 1997 (the "Underwriting Agreement"), the Underwriters named
below, for whom Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"),
Conning & Company and Pennsylvania Merchant Group Ltd ("PMG") are acting as
representatives (the "Representatives"), have severally agreed to purchase from
the Company and the Selling Stockholder the respective number of shares of
Common Stock set forth opposite their names below.

<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation.................. 1,830,000
Conning & Company.................................................... 610,000
Pennsylvania Merchant Group Ltd ..................................... 610,000
Hoefer & Arnett Inc. ................................................ 50,000
Janney Montgomery Scott Inc. ........................................ 50,000
Brean Murray & Co., Inc. ............................................ 50,000
Advest Inc. ......................................................... 50,000
Dowling & Partners Securities, LLC .................................. 50,000
Ferris, Baker Watts, Inc. ........................................... 50,000
Fox-Pitt, Kelton Inc. ............................................... 50,000
Moors & Cabot, Inc. ................................................. 50,000
Chatsworth Securities LLC ........................................... 50,000
---------
Total...................................................... 3,500,000
=========
</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 take and pay
for all the shares of Common Stock offered hereby (other than those covered by
the over-allotment option described below) if any such shares of Common Stock
are taken.

The Company and Selling Stockholder have been advised by the
Representatives that the Underwriters propose initially to offer the shares of
Common Stock, in part, directly to the public at the price set forth on the
cover page of this Prospectus and, in part, to certain dealers at such price
less a concession not in excess of $0.59 per share. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $0.10 per share to
certain other dealers. After the initial offering of the Common Stock, the
offering price and other selling terms may be changed by the Representatives.

The Company has 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 525,000 additional shares of Common Stock at the public
offering price, less the underwriting discounts and commissions, all as set
forth on the cover page of this Prospectus. The Underwriters may exercise such
option solely for the purpose of covering over-allotments, if any, made in
connection with the Offering. To the extent such option is exercised, each
Underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional shares as the number of
shares of Common Stock to be purchased by such Underwriter shown in the above
table bears to the total number of shares of Common Stock shown in the above
table.

Each of the Company and the Selling Stockholder has agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.

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 over-allot the Offering,
creating a syndicate short position. In addition, 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.

48
<PAGE> 49

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.

The Underwriters and dealers may engage in passive market making
transactions in the Common Stock in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed 30% of its average daily trading volume in the
Common Stock during a specified two month prior period, or 200 shares, whichever
is greater. A passive market maker must identify passive market making bids as
such on the Nasdaq electronic inter-dealer reporting system. Passive market
making may stabilize or maintain the market price of the Common Stock above
independent market levels. Underwriters and dealers are not required to engage
in passive market making and may end passive market making activities at any
time.

Each of the Company, its executive officers and Directors and certain
stockholders of the Company (including the Selling Stockholder) 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. In addition, during such 180 day
period without DLJ's prior written consent, 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 Stockholder) 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.

PMG acted as a managing underwriter in the Company's IPO.

CERTAIN LEGAL MATTERS

Reed Smith Shaw & McClay, Philadelphia, Pennsylvania, will render an
opinion that the shares of Common Stock offered by the Company and the Selling
Stockholder, when sold in accordance with the plan of distribution described
herein, will be legally issued, fully paid and non-assessable. Davis Polk &
Wardwell is acting as counsel for the Underwriters in connection with certain
legal matters relating to the issuance of the Common Stock offered hereby.

EXPERTS

The consolidated financial statements and schedules of the Company as of
December 31, 1996 and 1995, and for each of the years in the three-year period
ended December 31, 1996, included herein and elsewhere in the registration
statement, have been included herein and in the registration statement in
reliance upon the report of KPMG Peat Marwick LLP, independent auditors,
appearing elsewhere herein, and upon the authority of such firm as experts in
accounting and auditing.

49
<PAGE> 50

GLOSSARY OF SELECTED INSURANCE TERMS

The following terms used in this Prospectus have the meanings set forth
below:

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.

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

CASE RESERVE............... The estimated liability of an insurer as to a
particular claim, at a given point in time, with
respect to losses that have been incurred and
reported to the insurer.

CEDE....................... To transfer to an insurer or reinsurer all or a
part of the insurance written by an insurance
entity.

COMBINED RATIO............. A combination of the loss ratio and the expense
ratio, expressed as a percentage, determined in
accordance with either statutory accounting
practices or generally accepted accounting
principles.

DEFERRED POLICY ACQUISITION
COSTS (DAC).............. 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.

DIRECT WRITTEN PREMIUMS.... Gross written premiums less premiums assumed from
other insurers.

DIVIDEND RATIO............. The ratio of "dividends to policyholders" to net
premiums earned, expressed as a percentage.

EXCESS AND SURPLUS LINES... 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 premiums earned.

FACULTATIVE REINSURANCE.... The separately negotiated reinsurance of all or a
portion of the coverage provided by a single
policy, for individual risks not covered by a
reinsurance treaty or amounts in excess of limits
on risks covered by reinsurance treaties.

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.

GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
(GAAP)................... Accounting practices and principles, as defined
principally by the American Institute of
Certified Public Accountants, the Financial
Accounting Standards Board, and the Commission.
GAAP is the method of accounting typically used
by the Company for reporting to persons or
entities other than insurance regulatory
authorities.

50
<PAGE> 51

GROSS WRITTEN PREMIUMS..... The total of premiums received or to be received
for insurance written by an insurer during a
specific period of time without any reduction for
reinsurance ceded.

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 REPORTED
LOSSES (IBNR)............ The estimated liability of an insurer, at a given
point in time, with respect to losses that have
been incurred but not yet reported to the
insurer, and for potential future developments on
reported claims.

INSURANCE SERVICES OFFICE
(ISO)...................... An association of property and casualty insurance
companies providing rating, statistical,
actuarial and policy form services for most
classes of property and casualty business.

LOSS ADJUSTMENT EXPENSES
(LAE).................... The expenses of investigating and settling claims,
including legal fees, outside adjustment expenses
and other general expenses of administering the
claims adjustment process.

LOSS RATIO................. For SAP and GAAP, net losses and loss adjustment
expenses incurred, divided by net premiums
earned, expressed as a percentage.

LOSS RESERVES.............. The estimated liability of an insurer, at a given
point in time, with respect to unpaid incurred
losses, including losses which are incurred but
not yet reported (IBNR) and related loss
adjustment expenses.

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

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.

NET WRITTEN PREMIUMS....... The gross premiums written during a specific period
of time, less the portion of such premiums ceded
to (reinsured by) other insurers.

NONSTANDARD................ Risks that generally have been found unacceptable
by standard lines insurers for various
underwriting reasons.

POLICYHOLDERS' (OR
STATUTORY) SURPLUS......... Total admitted assets less total liabilities, as
determined in accordance with statutory
accounting practices.

PREMIUMS EARNED............ The amount of net written premiums allocable to the
expired period of an insurance policy or
policies.

PREMIUMS TO SURPLUS
RATIO...................... Ratio of the most recent twelve months' statutory
net premiums written divided by the statutory
policyholders' surplus at the end of the period.

51
<PAGE> 52

RETAIL INSURANCE BROKERS... Clients of general agent who deal directly with the
insureds.

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.

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.

STATUTORY ACCOUNTING
PRACTICES (SAP)............ Those accounting principles and practices which
provide the framework for the preparation of
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 generally accepted accounting principles
(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 term 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.

SUBMIT BASIS............... Preliminary application or other request from a
general agent for insurance coverage not meeting
binding authority upon which an insurance company
underwriter can either issue or decline to issue
a premium quote, or upon which a request for
additional information may be made.

UNDERWRITING............... The process whereby an underwriter reviews
applications submitted for insurance coverage and
determines whether it will provide all or part of
the coverage being requested, and the price of
such premiums. Underwriting also includes an
ongoing review of existing policies and their
pricing.

UNDERWRITING RATIOS........ The loss ratio, expense ratio, dividend ratio (if
applicable) and combined ratio.

52
<PAGE> 53

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Consolidated Unaudited Balance Sheets at June 30, 1997 and December 31, 1996.......... F-2
Consolidated Unaudited Statements of Earnings for the six month periods ended June 30,
1997 and 1996....................................................................... F-3
Consolidated Unaudited Statements of Stockholders' Equity for the six month period
ended June 30, 1997................................................................. F-4
Consolidated Unaudited Statements of Cash Flows for the six month periods ended June
30, 1997 and 1996................................................................... F-5
Notes to Consolidated Unaudited Financial Statements.................................. F-6

CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report.......................................................... F-7
Consolidated Balance Sheets at December 31, 1996 and 1995............................. F-8
Consolidated Statements of Earnings for the years ended December 31, 1996, 1995 and
1994................................................................................ F-9
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996,
1995 and 1994....................................................................... F-10
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and
1994................................................................................ F-11
Notes to Consolidated Financial Statements............................................ F-12
</TABLE>

F-1
<PAGE> 54

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE DATA)
<S> <C> <C>
ASSETS
Investments:
Fixed Maturities:
Available for sale, at fair value (amortized cost 1997, $53,839;
1996, $49,244)................................................. $ 53,554 $ 48,954
Held to maturity, at amortized cost (fair value 1997, $51,932;
1996, $44,111)................................................. 52,362 44,227
Equity securities, at fair value (cost 1997, $10,634; 1996,
$10,597)........................................................ 12,704 12,390
Short-term investments, at cost, which approximate fair value...... 3,648 7,000
-------- --------
Total investments.......................................... 122,268 112,571
Cash................................................................. 4,361 2,979
Receivables:
Accrued investment income.......................................... 1,901 1,671
Premiums receivable, net........................................... 11,799 10,494
Reinsurance recoverable............................................ 16,920 15,719
Note receivable, affiliate......................................... -- 275
-------- --------
Total receivables.......................................... 30,620 28,159
Prepaid reinsurance premiums......................................... 2,872 2,668
Deferred policy acquisition costs.................................... 8,310 7,231
Capital leases....................................................... 1,908 1,950
Deferred income tax.................................................. 2,265 2,211
Income tax recoverable............................................... 304 249
Other assets......................................................... 507 587
-------- --------
Total assets............................................... $173,415 $158,605
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses......................... $ 77,976 $ 70,728
Unearned premiums.................................................. 34,733 30,865
Accounts payable and accrued expenses.............................. 1,270 1,773
Capitalized lease obligations...................................... 1,975 2,030
Notes payable, bank................................................ 9,000 9,000
Other liabilities.................................................. 1,723 1,872
-------- --------
Total liabilities.......................................... 126,677 116,268
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares; none
issued.......................................................... -- --
Common stock, $.01 par value; authorized 1997, 20,000,000 shares
and 1996, 10,000,000 shares; issued and outstanding 1997,
6,801,384 shares and 1996, 6,676,131 shares..................... 68 67
Additional paid-in capital......................................... 22,833 21,844
Unrealized investment gains, net of tax............................ 1,147 993
Retained earnings.................................................. 22,763 19,533
-------- --------
46,811 42,437
Unearned compensation from restricted stock awards................. (73) (100)
-------- --------
Total stockholders' equity................................. 46,738 42,337
-------- --------
Total liabilities and stockholders' equity................. $173,415 $158,605
======== ========
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-2
<PAGE> 55

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------
1997 1996
(IN THOUSANDS,
EXCEPT
PER SHARE DATA)
<S> <C> <C>
Revenues:
Premiums earned........................................................ $43,933 $32,108
Net investment income.................................................. 3,925 3,248
Net realized investment gains.......................................... 109 102
------- -------
Total revenues................................................. 47,967 35,458
------- -------
Losses and expenses:
Losses and loss adjustment expenses.................................... 27,607 20,105
Amortization of deferred policy acquisition costs...................... 11,971 8,211
Other underwriting expenses............................................ 2,615 2,250
Interest expense....................................................... 385 438
------- -------
Total losses and expenses...................................... 42,578 31,004
------- -------
Earnings before income tax............................................... 5,389 4,454
Income tax............................................................... 1,620 1,453
------- -------
Net earnings............................................................. $ 3,769 $ 3,001
======= =======
Net earnings per share (note 1).......................................... $ 0.56 $ 0.45
======= =======
Weighted average number of shares outstanding (note 1)................... 6,719 6,656
Cash dividends per share (note 1)........................................ $ 0.08 $ 0.05
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-3
<PAGE> 56

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1997
--------------------------------------------------------------------------------
UNEARNED
COMPENSATION
UNREALIZED FROM
COMMON STOCK ADDITIONAL INVESTMENT RESTRICTED
----------------- PAID-IN GAINS RETAINED STOCK
SHARES AMOUNT CAPITAL (LOSSES), NET EARNINGS AWARDS TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996.......... 6,676,131 $ 67 $ 21,844 $ 993 $ 19,533 $ (100) $42,337
Net earnings.......................... 3,769 3,769
Issuance of common stock.............. 125,253 1 989 990
Amortization of unearned compensation
from restricted stock awards........ 27 27
Unrealized investment gains, net...... 185 185
Unrealized loss on fixed maturities
transferred to held to maturity..... (50) (50)
Accretion of net loss on fixed
maturities transferred to held to
maturity............................ 19 19
Cash dividends paid................... (539) (539)
--------- --- ------- ------ ------- ----- -------
Balance at June 30, 1997.............. 6,801,384 $ 68 $ 22,833 $ 1,147 $ 22,763 $ (73) $46,738
========= === ======= ====== ======= ===== =======
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-4
<PAGE> 57

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1997 1996
(IN THOUSANDS)
<S> <C> <C>
Cash flows from operating activities:
Net earnings......................................................... $ 3,769 $ 3,001
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Amortization and depreciation expense............................. 163 152
Net realized investment gains..................................... (109) (102)
Deferred income tax............................................... (150) (169)
Net decrease in premiums and notes receivable, prepaid reinsurance
premiums and unearned premiums................................... 2,634 1,423
Net increase in unpaid losses and loss adjustment expenses and
reinsurance recoverable.......................................... 6,047 2,670
(Increase) decrease in:
Accrued investment income......................................... (230) (325)
Deferred policy acquisition costs................................. (1,079) (561)
Income tax recoverable............................................ (55) 61
Other assets...................................................... 28 (390)
Increase (decrease) in:
Accounts payable and accrued expenses............................. (503) (1,101)
Other liabilities................................................. (149) 6
------- --------
Net cash provided by operating activities.................... 10,366 4,665
------- --------
Cash flows from investing activities:
Purchases of equity securities....................................... (874) (3,049)
Purchases of fixed maturities available for sale..................... (15,988) (12,049)
Purchases of fixed maturities held to maturity....................... (3,027) (16,071)
Proceeds from sales of equity securities............................. 943 2,684
Proceeds from sales and maturities of fixed maturities available for
sale.............................................................. 3,000 11,181
Proceeds from maturities and calls of fixed maturities held to
maturity.......................................................... 3,214 3,008
Change in short-term investments..................................... 3,352 7,000
------- --------
Net cash used by investing activities........................ (9,380) (7,296)
------- --------
Cash flows from financing activities:
Issuance of common stock............................................. 990 214
Principal payment on note payable, affiliate......................... -- (100)
Dividends paid....................................................... (539) (355)
Principal payments on capital lease obligations...................... (55) (48)
------- --------
Net cash provided (used) by financing activities............. 396 (289)
------- --------
Increase (decrease) in cash............................................ 1,382 (2,920)
Cash, beginning of period.............................................. 2,979 5,204
------- --------
Cash, end of period.................................................... $ 4,361 $ 2,284
======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income tax........................................................ $ 1,825 $ 1,560
Interest.......................................................... 404 412
Supplemental non-cash disclosure:
Cost of securities transferred from available for sale to held to
maturity.......................................................... $ 8,002 --
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-5
<PAGE> 58

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- ORGANIZATION AND BASIS OF PRESENTATION

Penn-America Group, Inc. (the "Company") is an insurance holding company.
Penn Independent Corporation currently owns approximately 60.1% of the
outstanding common stock of the Company.

The accompanying unaudited consolidated financial statements should be read
in conjunction with the financial statements and notes for the year ended
December 31, 1996. In the opinion of management, the financial information
reflects all adjustments (consisting only of normal recurring adjustments) which
are necessary for a fair presentation of the Company's financial position,
results of operations, and cash flows for the interim periods. The Company's
results of operations for interim periods are not necessarily indicative of the
results to be expected for the entire year.

On March 7, 1997, the Company effected a three-for-two split of its common
stock. All share amounts and per share information disclosed herein have been
adjusted to reflect this split.

NOTE 2 -- REINSURANCE

Premiums earned are net of amounts ceded to reinsurers of $3.7 million for
the six months ended June 30, 1997 and $3.3 million for the six months ended
June 30, 1996. Losses and loss adjustment expenses are net of amounts ceded to
reinsurers of $3.7 million for the six months ended June 30, 1997 and $4.7
million for the six months ended June 30, 1996.

F-6
<PAGE> 59

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Penn-America Group, Inc.:

We have audited the accompanying consolidated balance sheets of
Penn-America Group, Inc. and Subsidiary as of December 31, 1996 and 1995, and
the related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1996.
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 also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Penn-America
Group, Inc. and Subsidiary as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.

KPMG Peat Marwick LLP

Philadelphia, Pennsylvania
January 29, 1997

F-7
<PAGE> 60

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE
DATA)
<S> <C> <C>
ASSETS
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 1996, $49,244
and 1995, $42,948)............................................... $ 48,954 $ 43,281
Held to maturity, at amortized cost, (fair value 1996, $44,111 and
1995, $34,812)................................................... 44,227 34,276
Equity securities, at fair value (cost 1996, $10,597 and 1995,
$8,726)........................................................... 12,390 10,667
Short-term investments, at cost, which approximates fair value....... 7,000 7,000
-------- --------
Total investments............................................ 112,571 95,224
Cash................................................................... 2,979 5,204
Receivables:
Accrued investment income............................................ 1,671 1,385
Premiums receivable, net............................................. 10,494 8,981
Reinsurance recoverable.............................................. 15,719 13,952
Note receivable, affiliate........................................... 275 400
-------- --------
Total receivables............................................ 28,159 24,718
Prepaid reinsurance premiums........................................... 2,668 2,438
Deferred policy acquisition costs...................................... 7,231 5,716
Capital leases......................................................... 1,950 1,786
Income tax recoverable................................................. 249 529
Deferred income tax.................................................... 2,211 1,947
Other assets........................................................... 587 201
-------- --------
Total assets................................................. $158,605 $137,763
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses........................... $ 70,728 $ 60,139
Unearned premiums.................................................... 30,865 26,245
Accounts payable and accrued expenses................................ 1,773 1,842
Capitalized lease obligations........................................ 2,030 1,890
Notes payable:
Affiliate......................................................... -- 150
Bank.............................................................. 9,000 10,000
Other liabilities.................................................... 1,872 1,247
-------- --------
Total liabilities............................................ 116,268 101,513
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares; none
issued............................................................ -- --
Common stock, $.01 par value; authorized 10,000,000 shares; issued
and outstanding 1996, 6,676,131 shares and 1995, 4,430,000 (note
2)................................................................ 67 44
Additional paid-in capital........................................... 21,844 21,608
Unrealized investment gains, net..................................... 993 1,501
Retained earnings.................................................... 19,533 13,251
-------- --------
42,437 36,404
Unearned compensation from restricted stock awards................... (100) (154)
-------- --------
Total stockholders' equity................................... 42,337 36,250
-------- --------
Total liabilities and stockholders' equity................... $158,605 $137,763
======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-8
<PAGE> 61

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
<S> <C> <C> <C>

<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Revenues:
Premiums earned........................................... $69,081 $57,228 $39,985
Net investment income..................................... 6,705 5,067 3,635
Net realized investment gains (losses).................... 906 1,279 (713)
------- ------- -------
Total revenues.................................... 76,692 63,574 42,907
------- ------- -------
Losses and expenses:
Losses and loss adjustment expenses....................... 43,292 35,835 24,855
Amortization of deferred policy acquisition costs......... 17,785 14,237 9,381
Other underwriting expenses............................... 4,349 4,356 3,600
Interest expense.......................................... 884 239 81
------- ------- -------
Total losses and expenses......................... 66,310 54,667 37,917
------- ------- -------
Earnings before income tax.................................. 10,382 8,907 4,990
Income tax.................................................. 3,389 2,881 1,579
------- ------- -------
Net earnings................................................ $ 6,993 $ 6,026 $ 3,411
======= ======= =======
Net earnings per share (note 2)............................. $ 1.05 $ 0.91 $ 0.51
======= ======= =======
Weighted average number of shares outstanding (note 2)...... 6,663 6,645 6,645
Cash dividends per share (note 2)........................... $ 0.11 $ 0.06 $ 0.00
</TABLE>

See accompanying notes to consolidated financial statements.

F-9
<PAGE> 62

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
UNREALIZED UNEARNED
INVESTMENT COMPENSATION
COMMON STOCK ADDITIONAL GAINS FROM
------------------ PAID-IN (LOSSES), RETAINED RESTRICTED
SHARES AMOUNT CAPITAL NET EARNINGS STOCK AWARDS TOTAL
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, at December 31,
1993......................... 4,430,000 $ 44 $ 21,637 $ 1,749 $ 4,212 $(262) $27,380
Cumulative effect of the
adoption of SFAS 115......... 27 27
Net earnings................... 3,411 3,411
Unrealized investment (losses),
net.......................... (2,477) (2,477)
Amortization of compensation
expense from restricted
stock........................ 54 54
Additional expenses related to
1993 public stock offering... (29) (29)
--------- --- ------- ---- ------- ----- -------
Balance, at December 31,
1994......................... 4,430,000 44 21,608 (701) 7,623 (208) 28,366
Net earnings................... 6,026 6,026
Cash dividends paid ($0.06 per
share)....................... (398) (398)
Unrealized investment gains,
net.......................... 2,202 2,202
Amortization of compensation
expense from restricted
stock........................ 54 54
--------- --- ------- ---- ------- ----- -------
Balance, at December 31,
1995......................... 4,430,000 44 21,608 1,501 13,251 (154) 36,250
Retroactive effect of 3-for-2
stock split, January 1997
(note 2)..................... 2,225,377 22 (22)
Issuance of common stock....... 20,754 1 258 259
Net earnings................... 6,993 6,993
Cash dividends paid ($0.11 per
share)....................... (711) (711)
Unrealized investment (losses),
net.......................... (508) (508)
Amortization of compensation
expense from restricted
stock........................ 54 54
--------- --- ------- ---- ------- ----- -------
Balance, at December 31,
1996......................... 6,676,131 $ 67 $ 21,844 $ 993 $ 19,533 $(100) $42,337
========= === ======= ==== ======= ===== =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-10
<PAGE> 63

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings............................................. $ 6,993 $ 6,026 $ 3,411
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Amortization expense.................................. 331 352 380
Net realized investment (gains) losses................ (906) (1,279) 713
Deferred income (benefit) tax......................... (2) (497) 23
Net increase in premiums and note receivable, prepaid
reinsurance premiums and unearned premiums.......... 3,001 619 4,798
Net increase in unpaid loss and loss adjustment
expenses and reinsurance recoverable................ 8,822 10,922 8,599
(Increase) decrease in:
Accrued investment income............................. (286) (290) (372)
Deferred policy acquisition costs..................... (1,515) (895) (2,440)
Income tax recoverable................................ 281 (256) (45)
Other assets.......................................... (454) (86) (92)
Increase (decrease) in:
Accounts payable and accrued expenses................. (68) (8) (169)
Other liabilities..................................... 624 199 105
-------- -------- --------
Net cash provided by operating activities................ 16,821 14,807 14,911
-------- -------- --------
Cash flows from investing activities:
Purchases of equity securities........................... (8,636) (4,627) (6,299)
Purchases of fixed maturities available for sale......... (21,611) (17,177) (24,713)
Purchases of fixed maturities held to maturity........... (24,084) (15,343) (21,012)
Proceeds from sales of equity securities................. 8,147 4,863 5,726
Proceeds from sales of fixed maturities available for
sale.................................................. 9,825 1,421 13,640
Proceeds from maturities of fixed maturities available
for sale.............................................. 5,000 11,877 7,641
Proceeds from maturities of fixed maturities held to
maturity.............................................. 14,008 2,222 8,632
Change in short-term investments......................... -- (3,000) 1,746
Other.................................................... 9 19 21
-------- -------- --------
Net cash used by investing activities.................... (17,342) (19,745) (14,618)
-------- -------- --------
Cash flows from financing activities:
Issuance of common stock (additional expenses in 1994)... 259 -- (29)
Principal payments on note payable to bank............... (1,000) (1,000) 1,000
Proceeds from note payable............................... -- 10,000 --
Principal payments on note payable, affiliate............ (150) (200) --
Principal payments on capital lease obligations.......... (102) (73) (30)
Dividends paid........................................... (711) (398) --
-------- -------- --------
Net cash (used) provided by financing activities......... (1,704) 8,329 941
-------- -------- --------
Increase (decrease) in cash................................ (2,225) 3,391 1,234
Cash, beginning of period.................................. 5,204 1,813 579
-------- -------- --------
Cash, end of period........................................ $ 2,979 $ 5,204 $ 1,813
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income tax............................................ $ 3,111 $ 3,634 $ 1,600
Interest.............................................. 857 204 81
</TABLE>

See accompanying notes to consolidated financial statements.

F-11
<PAGE> 64

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

Penn-America Group, Inc. (the "Company") is an insurance holding company.
Penn Independent Corporation ("Penn Independent") currently owns approximately
61.2% of the outstanding common stock of the Company. The accompanying financial
statements include the accounts of the Company and its wholly-owned subsidiary,
Penn-America Insurance Company ("Penn-America"). All significant inter-company
accounts and transactions have been eliminated in consolidation. These financial
statements are prepared in conformity with generally accepted accounting
principles, which differ in some respects from those followed in reports to
insurance regulatory authorities.

The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Penn-America underwrites commercial property, general liability, commercial
multi-peril and personal automobile insurance, generally referred to as
"property and casualty" insurance, on an admitted and non-admitted basis as
regulatory requirements permit. Penn-America is licensed as an admitted insurer
in 22 states and is an approved non-admitted (excess and surplus lines) insurer
in 28 states and the District of Columbia. A significant portion of
Penn-America's gross written automobile premium was written by two agents in
1996, 1995 and 1994 who are located in the states of Washington, California and
Nevada. These agents accounted for 94% in 1996 and 100% in 1995 and 1994 of the
personal automobile gross written premium. During 1996, 1995 and 1994 one agent
in California accounted for 11%, 11% and 17% respectively, of commercial gross
written premium.

INVESTMENTS

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

Investments in fixed maturity securities are adjusted for amortization of
premium and accretion of discounts to maturity date using the interest method.
Income is recognized on the accrual basis. Realized investment gains and losses
are recorded as income when the securities are sold on the specific
identification basis.

Amortized cost for mortgage-backed securities is calculated using the
interest method including anticipated prepayments at the date of purchase.
Significant changes in estimated cash flow from the original purchase
assumptions are accounted for using the composite method.

Equity securities are carried at fair value with the change in unrealized
investment gains or losses credited or charged directly to stockholders' equity,
net of applicable deferred income taxes. Short-term investments are carried at
cost, which approximates fair value.

PREMIUMS AND OTHER RECEIVABLES

Premiums are recognized as revenue ratably over the terms of the respective
policies. Unearned premiums are calculated on the semi-monthly pro rata basis.
Management has established an allowance for

F-12
<PAGE> 65

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

doubtful accounts of $522,000 and $481,000 for 1996 and 1995, respectively, on
premium receivables, which allowance management believes is adequate to cover
uncollectible account balances.

POLICY ACQUISITION COSTS

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

LOSSES AND LOSS ADJUSTMENT EXPENSES

The liability for losses and loss adjustment expenses represents estimates
of the ultimate unpaid net cost of all losses incurred. Estimates of unpaid
reported losses and related allocated loss adjustment expenses are determined on
the basis of claims adjusters' evaluations of individual claims. Estimates of
losses and loss adjustment expenses arising from losses incurred but not yet
reported are based on selected historical and industry data. Such estimates are
not discounted and may be more or less than the amounts ultimately paid when the
claims are settled. These estimates are periodically reviewed and adjusted as
necessary and such adjustments are reflected in current operations.

FAIR VALUES OF FINANCIAL INSTRUMENTS

The Company uses the following methods or assumptions in estimating fair
value disclosures as reported in the balance sheet:

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

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

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

Options: Fair value was estimated on the grant date using the
Black-Scholes option pricing model. The model assumes the following: annual
dividend rate of 1.20% and 1.50% for 1996 and 1995, respectively; and for
both years: risk free interest rates of 6.80%, expected lives of 2.5 years
and volatility of 30%.

REINSURANCE

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

F-13
<PAGE> 66

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

CAPITALIZED LEASE

The capitalized lease is carried at cost less accumulated amortization.
Amortization is calculated on the straight line basis over 20 years, which
represents the term of the mortgage on the office space which the Company rents
from a related party (See Note 3).

INCOME TAX

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

NOTE 2--EARNINGS PER SHARE AND RETROACTIVE ADJUSTMENT FOR STOCK SPLIT

1996, 1995 and 1994 earnings per share are computed by dividing net
earnings by the weighted average number of common shares outstanding during the
year. All per share calculations and stock options disclosure presented have
been adjusted retroactively to reflect a three-for-two stock split declared in
January, 1997. The stock options described in Note 12 have no material dilutive
effect on earnings per common share amounts in any of the periods presented.
Shares outstanding at December 31, 1996 have been restated to reflect the stock
split.

NOTE 3--TRANSACTIONS WITH AFFILIATES

Penn-America leases its home office facility from the controlling
shareholder of Penn Independent. The lease is accounted for as a capitalized
lease. The amount of property capitalized, $2,440,000 and $2,198,000 is
presented net of accumulated amortization of $490,000 and $412,000 as of
December 31, 1996 and 1995, respectively. Amortization expense was $78,000,
$51,000 and $31,000 for 1996, 1995, and 1994, respectively. Penn Independent and
its subsidiaries also lease a portion of the building in which Penn-America's
home office facility is located. Management believes that the lease terms are at
market terms.

Penn Independent provides Penn-America with management and other services
which amounted to $342,000, $455,000, and $552,000, in 1996, 1995 and 1994,
respectively. Such amounts are based on allocations of estimated costs.

All costs incurred by Penn Independent on behalf of Penn-America have been
allocated to Penn-America and are reflected in the financial statements.
Management believes that the methods used to allocate such costs are reasonable,
and that Penn-America's expenses on a stand-alone basis would not be materially
different.

Premiums written resulting from transactions with insurance agency
affiliates of Penn Independent approximated $3,880,000 in 1996, $3,621,000 in
1995, and $3,182,000 in 1994. Commissions paid to such affiliates were $888,000
in 1996, $775,000 in 1995, and $663,000 in 1994. Amounts receivable from
affiliates approximated $334,000 in 1996 and $516,000 in 1995.

The note receivable from affiliate is due from Penn Independent Financial
Services, Inc., a premium finance company and wholly-owned subsidiary of Penn
Independent. The note is due on October 31, 1997, bearing interest at prime plus
one-quarter percent and is secured by a first lien on certain insurance premium
receivables of Penn Independent Financial Services, Inc. The outstanding
balances as of December 31, 1996 and 1995 are $275,000 and $400,000,
respectively.

F-14
<PAGE> 67

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 4--INVESTMENTS

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

<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST(1) GAINS LOSSES VALUE
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of
U.S. government agencies.................... $ 20,767 $ 90 $ (354) $ 20,503
Corporate securities.......................... 16,053 189 (75) 16,167
Mortgage-backed securities.................... 8,376 96 (191) 8,281
Public utilities.............................. 4,048 -- (45) 4,003
-------- ------ ------- --------
Totals...................................... 49,244 375 (665) 48,954
-------- ------ ------- --------
Held to maturity:
U.S. Treasury securities and obligations of
U.S. government agencies.................... 28,727 141 (183) 28,685
Corporate securities.......................... 9,294 54 (82) 9,266
Public utilities.............................. 6,056 10 (56) 6,010
Other securities.............................. 150 -- -- 150
-------- ------ ------- --------
Totals...................................... 44,227 205 (321) 44,111
-------- ------ ------- --------
Total fixed maturity securities............. 93,471 580 (986) 93,065
-------- ------ ------- --------
Equity securities.................................. 10,597 1,857 (64) 12,390
Short-term investments............................. 7,000 -- -- 7,000
-------- ------ ------- --------
Total investments........................ $111,068 $2,437 $(1,050) $112,455
======== ====== ======= ========
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1995
---------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST(1) GAINS LOSSES VALUE
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of
U.S. government agencies................. $ 19,903 $ 262 $ (49) $ 20,116
Corporate securities....................... 13,051 405 (30) 13,426
Mortgage-backed securities................. 7,963 48 (329) 7,682
Public utilities........................... 2,031 26 -- 2,057
-------- ------ ------- --------
Totals................................... 42,948 741 (408) 43,281
-------- ------ ------- --------
</TABLE>

F-15
<PAGE> 68

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, 1995
----------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST(1) GAINS LOSSES VALUE
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Held to maturity:
U.S. Treasury securities and obligations of
U.S. government agencies................. $ 18,755 $ 376 $ (38) $ 19,093
Corporate securities....................... 10,322 212 (32) 10,502
Public utilities........................... 5,049 20 (2) 5,067
Other securities........................... 150 -- -- 150
-------- ------ ------- --------
Totals................................... 34,276 608 (72) 34,812
-------- ------ ------- --------
Total fixed maturity securities.......... 77,224 1,349 (480) 78,093
-------- ------ ------- --------
Equity securities............................... 8,726 1,987 (46) 10,667
Short-term investments.......................... 7,000 -- -- 7,000
-------- ------ ------- --------

Total investments..................... $ 92,950 $3,336 $ (526) $ 95,760
======== ====== ======= ========
</TABLE>

- ------------------------
(1) Adjusted for amortization of fixed maturities.

Fixed maturities at December 31, 1996, 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>
AVAILABLE FOR SALE HELD TO MATURITY
--------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Due in one year or less.................. $ 2,000 $ 2,004 $ 4,264 $ 4,270
Due after one year through five years.... 13,282 13,378 23,626 23,734
Due after five years through ten years... 18,568 18,426 12,322 12,172
Due after ten years...................... 7,018 6,865 4,015 3,935
Mortgage-backed securities............... 8,376 8,281 -- --
------- ------- ------- -------
Total.................................... $49,244 $48,954 $44,227 $44,111
======= ======= ======= =======
</TABLE>

A summary of net investment income is as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Interest on fixed maturities..................... $6,108 $4,615 $3,294
Dividends on equity securities................... 691 533 564
Interest on short-term investments............... 380 291 139
Other............................................ 61 42 35
------ ------ ------
Total investment income.......................... 7,240 5,481 4,032
Less investment expense.......................... (535) (414) (397)
------ ------ ------
Net investment income............................ $6,705 $5,067 $3,635
====== ====== ======
</TABLE>

F-16
<PAGE> 69

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

There are no investments in fixed maturity securities that were
non-income-producing during 1996, 1995 or 1994. Realized pre-tax gains (losses)
on the sale of investments are as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities available for sale:
Gross realized gains............................ $ 32 $ 13 $ 22
Gross realized losses........................... (529) (276) (186)
------ ------ -----
Net (losses).................................... (497) (263) (164)
------ ------ -----
Equity securities:
Gross realized gains............................ 1,460 1,656 18
Gross realized losses........................... (57) (114) (567)
------ ------ -----
Net gains (losses).............................. 1,403 1,542 (549)
------ ------ -----
Total net realized investment gains
(losses).............................. $ 906 $1,279 $(713)
====== ====== =====
</TABLE>

Income taxes (benefits) on net realized investment gains or losses were
$308,000, $435,000 and ($242,000) for 1996, 1995, and 1994, respectively.

The following is a summary of net unrealized appreciation (depreciation) on
investments included within stockholders' equity:

<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Balance, beginning of year................................. $1,501 $ (701)
Change in unrealized appreciation(depreciation):
Fixed maturities......................................... (622) 2,882
Equity securities........................................ (148) 455
------ ------
(770) 3,337
Income tax effect.......................................... (262) 1,135
------ ------
Net change................................................. (508) 2,202
------ ------
Balance, end of year....................................... $ 993 $1,501
====== ======
</TABLE>

The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 1996 and 1995, amounted to $4,409,000 and
$4,415,000, respectively.

NOTE 5--REINSURANCE

In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risks in various areas of exposure with
other insurance enterprises or reinsurers.

Reinsurance contracts do not relieve the Company of its obligations to
policyholders. Failure of reinsurers to honor their obligations could result in
losses to the Company. Allowances have been established for amounts deemed
uncollectible. The Company evaluates the financial condition of its reinsurers
and monitors concentrations of credit risk arising from similar geographic
regions, activities, or economic characteristics of the reinsurers to minimize
its exposure to significant losses from reinsurer insolvencies. At December 31,
1996, reinsurance recoverables and prepaid reinsurance premiums associated with
the two major reinsurers were: General Reinsurance Corporation, $9,053,000 and
National Reinsurance Corporation, $6,007,000.

F-17
<PAGE> 70

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Premiums written and earned consisted of the following:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Premiums written:
Direct...................................... $80,496 $66,953 $53,926
Ceded....................................... 7,027 5,667 5,583
------- ------- -------
Net of reinsurance.................. $73,469 $61,286 $48,343
======= ======= =======
Premiums earned:
Direct...................................... $75,876 $63,005 $45,698
Ceded....................................... 6,795 5,777 5,713
------- ------- -------
Net of reinsurance.................. $69,081 $57,228 $39,985
======= ======= =======
</TABLE>

Recoveries recognized under reinsurance contracts were as follows:

NOTE 6--CAPITALIZED LEASE OBLIGATIONS

Capitalized lease obligations of $2,030,000 and $1,890,000 at December 31,
1996 and 1995, respectively, represented lease obligations arising under the
home office facility lease (see Note 3). Interest is payable at 8.5% on the
outstanding principal balance. Capital lease and capital lease obligations on
the balance sheet increased $242,000 in 1996 and $1,551,000 in 1995 due to the
Company leasing additional office space and entering into a new five-year lease.
This transaction was accounted for as a non-cash transaction. Future minimum
lease payments as of December 31, 1996 are as follows:

<TABLE>
<S> <C>
1997............................................... $ 260
1998............................................... 260
1999............................................... 260
2000............................................... 260
2001............................................... 260
Thereafter......................................... 2,206
-------
Total minimum obligations.......................... 3,506
Less interest...................................... (1,476)
-------
Total.................................... $ 2,030
=======
</TABLE>

F-18
<PAGE> 71

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 7--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

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

<TABLE>
<CAPTION>
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Balance as of January 1....................................... $60,139 $44,796 $33,314
Less reinsurance recoverables............................... 13,627 9,489 6,484
------- ------- -------
Net balance at January 1...................................... 46,512 35,307 26,830
------- ------- -------
Incurred related to:
Current year................................................ 44,096 37,541 27,788
Prior years................................................. (804) (1,706) (2,933)
------- ------- -------
Total incurred........................................... 43,292 35,835 24,855
------- ------- -------
Paid related to:
Current year................................................ 16,940 12,247 9,525
Prior years................................................. 17,208 12,383 6,853
------- ------- -------
Total paid............................................... 34,148 24,630 16,378
------- ------- -------
Net balance at December 31.................................... 55,656 46,512 35,307
Plus reinsurance recoverables................................. 15,072 13,627 9,489
------- ------- -------
Balance as of December 31..................................... $70,728 $60,139 $44,796
======= ======= =======
</TABLE>

As a result of changes in estimates of insured events in prior years, the
provision for losses and loss adjustment expenses decreased $804,000 in 1996,
$1,706,000 in 1995 and $2,933,000 in 1994, primarily due to generally favorable
experience in the automobile and commercial lines in 1996 and the commercial
lines of business in 1995 and 1994.

NOTE 8--INCOME TAX

The components of income tax expense are as follows:

<TABLE>
<CAPTION>
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Current.......................................... $3,391 $3,378 $1,556
Deferred (benefit)............................... (2) (497) 23
------ ------ ------
Total.................................. $3,389 $2,881 $1,579
====== ====== ======
</TABLE>

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

<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Statutory income tax rate........................ 34.0% 34.0% 34.0%
Tax-exempt interest and dividends received
deduction...................................... (1.4) (1.3) (2.1)
Other............................................ -- (0.4) (0.3)
------ ------ ------
Total.................................. 32.6% 32.3% 31.6%
====== ====== ======
</TABLE>

F-19
<PAGE> 72

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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

<TABLE>
<CAPTION>
1996 1995
(IN THOUSANDS)
<S> <C> <C>
Assets:
Effect of discounting unpaid losses and loss adjustment
expenses.............................................. $2,906 $2,600
Excess of tax over financial reporting of earned
premium............................................... 1,917 1,619
Other, net............................................... 383 482
------ ------
Total assets..................................... $5,206 $4,701
====== ======
Liabilities:
Deferred policy acquisition costs, deductible for tax.... 2,459 1,944
Unrealized investment gains.............................. 512 773
Other, net............................................... 24 37
------ ------
Total liabilities................................ 2,995 2,754
------ ------
Net deferred tax asset..................................... $2,211 $1,947
====== ======
</TABLE>

The Company is required to establish a valuation allowance for any portion
of the deferred tax asset that management believes will not be realized. In the
opinion of management, it is more likely than not that the Company will realize
the benefit of the deferred tax asset and, therefore, no such valuation
allowance has been established as of December 31, 1996 and 1995.

NOTE 9--DEBT

During December 1996, the Company repaid $1 million on the outstanding
principal of the $10 million borrowed in 1995. The loan is secured by the common
stock of Penn-America and matures on December 31, 2000. The interest rate is the
LIBOR rate plus a factor which can vary between 100 to 225 basis points and was
6.59% and 7.05% at December 31, 1996 and 1995, respectively. Total interest
expense on the long-term borrowing for 1996 and 1995 was $721,000 and $26,000,
respectively. The terms of the agreement contain various covenants, including
the maintenance by Penn-America of certain net worth requirements and leverage
and liquidity ratios. None of these covenants negatively impact the Company's
liquidity or capital resources at this time. The outstanding balance at December
31, 1996 and 1995 was $9,000,000 and $10,000,000, respectively.

The principal repayment schedule is as follows:

NOTE 10--STOCKHOLDERS' EQUITY

A source of cash to use for the payment of dividends to the Company's
stockholders is dividends from Penn-America. Penn-America is required by law to
maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of a
dividend from statutory surplus may require prior approval of the Pennsylvania
and California regulatory authorities. The

F-20
<PAGE> 73

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

maximum dividend that may be paid by Penn-America to the Company without prior
approval of regulatory authorities in 1997 is $6,262,000.

The National Association of Insurance Commissioners has adopted risk-based
capital (RBC) requirements for property and casualty insurance companies. This
requirement may further impact the payment of dividends to the stockholders. At
December 31, 1996 and 1995, the Company's actual RBC exceeds minimum
requirements; therefore, there are no further restrictions on the payment of
dividends.

The following table reconciles surplus and net earnings of Penn-America as
determined in accordance with accounting practices prescribed or permitted by
the insurance regulatory authorities to stockholders' equity and net earnings of
the Company calculated in accordance with generally accepted accounting
principles (GAAP) as reported herein:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory surplus as regards policyholders.... $41,665 $39,118 $25,677
Deferred policy acquisition costs............. 7,231 5,716 4,821
Deferred income tax........................... 2,214 1,955 2,609
Unrealized investment gains (losses) on fixed
maturities available for sale............... (289) 334 (2,548)
Capital lease, net............................ (80) (104) (127)
Provision for unauthorized reinsurance........ 57 49 48
Non-admitted assets........................... 589 287 209
Other liabilities............................. (95) (295) (395)
Provision for uncollectible accounts.......... (622) (705) (611)
Holding company............................... (8,333) (10,105) (1,317)
------ ------ ------
GAAP stockholders' equity........... $42,337 $36,250 $28,366
====== ====== ======
</TABLE>

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory net income............................. $6,262 $5,364 $ 645
Deferred acquisition costs....................... 1,515 895 2,440
Deferred income tax.............................. (2) 476 (23)
Allowance for uncollectible accounts............. 84 (90) 733
Capital lease.................................... 24 23 --
Other, net....................................... 201 98 --
Holding company.................................. (1,091) (740) (384)
------ ------ ------
GAAP net earnings...................... $6,993 $6,026 $3,411
====== ====== ======
</TABLE>

NOTE 11--PROFIT SHARING PLANS

Penn-America participates in a profit sharing and 401(k) plan with Penn
Independent covering qualified employees. Penn-America's contributions under the
401(k) plan were $51,000, $28,000 and $21,000 for 1996, 1995, and 1994,
respectively. There were no profit sharing distributions in 1996, 1995 and 1994.

F-21
<PAGE> 74

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 12--STOCK INCENTIVE PLANS

(Retroactively adjusted for three-for-two split declared on January 29, 1997)

Stock options: In August, 1993, the Company adopted a Stock Incentive Plan
(the "Plan"). The purpose of the Plan is to enable officers, key employees,
directors, consultants and advisors, and service providers of the Company and
its affiliates (as defined in the Plan), to participate in the Company's future
and to enable the Company to attract and retain these persons by offering them
proprietary interests in the Company. The Plan authorizes the issuance of up to
525,000 shares of Common Stock pursuant to the exercise of stock options or the
award of restricted stock. Options are exercisable according to the various
terms under which they were granted varying from one year after date of grant to
10 years. All options are subject in general to earlier termination if the
optionee leaves the employ of the Company.

The Company applies APB Opinion No. 25 and related interpretations in
accounting for its plan. Accordingly, no compensation cost has been recognized
for its stock option plan. Had compensation cost for the Company's stock option
plan been determined based on the fair value at the grant date consistent with
FASB Statement No. 123, the effect on the Company's net income and earnings per
share would have been immaterial. While the effect on net income for 1996 and
1995 was immaterial for those years, this may not be representative of the
effects on net income for future years. Information regarding the Company's
stock option plan is summarized below:

<TABLE>
<CAPTION>
1996 1995 1994
(SHARES IN THOUSANDS)
<S> <C> <C> <C>
Outstanding at beginning of the year (weighted
average prices of $5.86, $5.89 and $6.00 in 1996,
1995 and 1994, respectively)...................... 383 353 330
Granted (at $8.83, $5.42 and $4.33 per share)....... 30 30 23
Exercised (at $6.00 per share)...................... (8) -- --
Forfeited........................................... -- -- --
----- ----- -----
Outstanding at end of year (weighted average prices
of $6.07, $5.86 and $5.89 per share).............. 405 383 353
===== ===== =====
Options exercisable year-end........................ 279 119 48
===== ===== =====
Weighted average fair value of options granted
during the year................................... $3.07 $1.83 $1.71
===== ===== =====
</TABLE>

The following summarizes stock options outstanding at December 31 1996:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
12/31/96 CONTRACTUAL EXERCISE 12/31/96 EXERCISE
EXERCISE PRICES (IN THOUSANDS) LIFE (YEARS) PRICE (IN THOUSANDS) PRICE
<S> <C> <C> <C> <C> <C>
$4.33................................ 22.5 3.4 $ 4.33 22.5 $ 4.33
5.42................................ 30.0 4.4 5.42 30.0 5.42
6.00................................ 322.5 9.6 6.00 226.5 6.00
8.83................................ 30.0 5.4 8.83 -- 8.83
----- --- ----- ----- ----
$4.33 to $8.83....................... 405.0 8.6 $ 6.07 279.0 $ 5.80
===== === ===== ===== ====
</TABLE>

The Company also awarded at the initial public offering in October 1993, to
certain employees 45,000 shares of restricted stock having an approximate value
of $270,000. Such shares are held by the Company and released to the grantees at
the rate of 20% per year provided that the grantee is still employed by the
Company or its affiliates. The Company charged $54,000 to compensation expense
relating to these awards for each of

F-22
<PAGE> 75

PENN-AMERICA GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

the years 1996, 1995 and 1994. During 1996, 1995 and 1994, 9,000 shares each
year of the restricted stock were released to the applicable employees as
provided by the provisions of the grant.

Executive incentive compensation plan: During 1995, the Board of Directors
of the Company adopted an executive incentive compensation plan which provides
up to 75,000 shares, over the life of this plan, to be granted to key officers,
executives and employees of the Company and its subsidiary. During 1996, 7,229
shares were distributed in accordance with the plan's provisions for fiscal year
1995 and during 1997, 7,535 shares will be distributed for fiscal year-ended
1996. The shares issued under this plan are valued at the fair market value of
the stock at the close of business at the end of each fiscal year, and are
issued in the subsequent year, subject to the Board's approval and attainment of
corporate objectives.

Agents' contingent commission plan: During 1995, the agents' contingent
commission plan was modified to provide that at least one-third (1/3) of the
contingent commission award would be given in stock of the Company. Up to 75,000
shares of the Company's stock were authorized for issuance under this plan.
Agents' stock awards for the 1995 year which were issued in May 1996 amounted to
16,403 shares. The awards for the 1996 year will not be determined until March
1997.

NOTE 13--COMMITMENTS AND CONTINGENCIES

The Company's insurance subsidiary is subject to routine legal proceedings
in connection with its property and casualty insurance business. Neither the
Company nor its subsidiary is involved in any pending or threatened legal or
administrative proceedings which management believes might have a material
adverse effect on the Company's financial condition or results of operations.

The Company leases various computer equipment for use by its insurance
subsidiary. These leases have lease terms primarily expiring in less than a
three-year period. Rental expense for these operating leases were $485,000,
$382,000 and $246,000 for the years ended December 31, 1996, 1995 and 1994.

At December 31, 1996, the future minimum rental payments required under
operating leases that have initial or remaining noncancelable lease terms in
excess of one year were: 1997, $389,000 1998, $327,000, and 1999, $154,000.

NOTE 14--UNAUDITED--QUARTERLY RESULTS OF OPERATIONS FOR 1996 AND 1995
(Adjusted for retroactive effect of three-for-two stock split declared January
29, 1997)

<TABLE>
<CAPTION>
1996
-----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues......................................... $17,244 $18,214 $19,757 $21,477 $76,692
Losses and expenses.............................. 15,118 15,886 17,040 18,266 66,310
Net earnings..................................... 1,429 1,572 1,830 2,162 6,993
Earnings per share............................... 0.21 0.24 0.28 0.32 1.05
</TABLE>

<TABLE>
<CAPTION>
1995
-----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues......................................... $14,821 $15,181 $16,711 $16,861 $63,574
Losses and expenses.............................. 13,108 13,228 13,997 14,334 54,667
Net earnings..................................... 1,156 1,307 1,868 1,695 6,026
Earnings per share............................... 0.17 0.20 0.28 0.26 0.91
</TABLE>

F-23
<PAGE> 76

======================================================

NO DEALER, SALESPERSON OR 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, THE SELLING STOCKHOLDER OR
ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF
AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY 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 AY 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 THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 9
Use of Proceeds....................... 14
Price Range of Common Stock
and Dividends....................... 15
Capitalization........................ 16
Selected Consolidated Historical
Financial Data...................... 17
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 19
Business.............................. 25
Management............................ 39
Principal and Selling Stockholders.... 43
Description of Capital Stock.......... 45
Certain Relationships and Related
Party Transactions.................. 47
Underwriting.......................... 48
Certain Legal Matters................. 49
Experts............................... 49
Glossary of Selected Insurance
Terms............................... 50
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>

======================================================

3,500,000 SHARES

[PENN-AMERICA GROUP LOGO]

Penn-America Group, Inc.

COMMON STOCK

------------------------
PROSPECTUS
------------------------

DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION

CONNING & COMPANY

PENNSYLVANIA MERCHANT GROUP LTD

July 16, 1997

======================================================