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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1943

FOR THE TRANSITION PERIOD FROM TO

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COMMISSION FILE NUMBER 0-25984

SUPERIOR NATIONAL INSURANCE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

California 95-3994873
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.)

26601 Agoura Road, Calabasas, CA 91302
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

Telephone: (818) 880-1600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value Registered - Nasdaq National Market

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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes X No
----- -----

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

The aggregate market value of the Common Stock of the registrant held by
non-affiliates of the registrant on March 5, 1997, based on the closing price of
$13.50 per share of the Common Stock on the Nasdaq National Market on such date
was $46,530,531.

The number of shares of the registrant's Common Stock outstanding as of
March 5, 1997 was 3,446,706.

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SUPERIOR NATIONAL INSURANCE GROUP, INC.
INDEX TO FORM 10-K

PART I Page
----

ITEM 1. Business.............................................................1

ITEM 2. Business Properties.................................................24

ITEM 3. Legal Proceedings...................................................24

ITEM 4. Submission of Matters to a Vote of Security Holders.................24

PART II

ITEM 5. Market for Registrant's Common Equity and Related
Shareholder Matters.................................................25

ITEM 6. Selected Financial Data.............................................27

ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................28

ITEM 8. Financial Statements and Supplementary Data......................F - 1

ITEM 9. Changes in and Disagreements with Accountants on Equity
and Related Accounting and Financial Disclosure....................N/A

PART III

ITEM 10. Directors and Executive Officers of the Registrant..................38

ITEM 11. Executive Compensation..............................................43

ITEM 12. Security Ownership of Certain Beneficial Owners and Management......49

ITEM 13. Certain Relationship and Related Transactions.......................54

PART IV

ITEM 14. Exhibits, Financial Statements Schedules, and
Reports on Form 8-K.................................................55

Signatures..........................................................58

Index to Consolidate Financial Statements..........................59

Financial Statements and Supplementary Data......................F - 1

GLOSSARY OF SELECTED INSURANCE TERMS

Admitted Assets . . . . . . . . . . . . . Assets recognized and accepted by
the state insurance regulatory
authorities for purposes of
determining the statutory financial
condition of an insurance company.

Claim and Claim Adjustment Expense. . . . An estimate of claims that have
occurred, both reported and
unreported (including claim
adjustment expenses), and have been
charged against earnings but remain
unpaid.

Combined Ratio. . . . . . . . . . . . . . The sum of the expense ratio, the
loss ratio and the policyholder
dividend ratio. A combined ratio
under 100% generally indicates an
underwriting profit, and a combined
ratio over 100% generally indicates
an underwriting loss.

Expense Ratio . . . . . . . . . . . . . . The ratio of underwriting expenses
to net premiums earned.

Loss Ratio. . . . . . . . . . . . . . . . The ratio of claims (including
claim adjustment expenses) to net
premiums earned.

Net Premiums Earned . . . . . . . . . . . The portion of net premiums written
applicable to the insurance
provided in any particular
accounting period.

Net Premiums Written. . . . . . . . . . . Premiums retained by an insurer
after deducting premiums on
business reinsured with others.

Participating Policies. . . . . . . . . . Policies which provide for the
discretionary payment of dividends
to policyholders (as a refund of
premiums).

Policy Acquisition Costs. . . . . . . . . Agents' or brokers' commissions,
premium taxes, marketing,
underwriting and other expenses
associated with the production of
business.

Policyholder Dividend Ratio . . . . . . . The ratio of policyholder dividends
accrued to net premiums earned.
Policyholder dividends are amounts
refunded by an insurance company to
the policyholder.

Policyholders' Surplus. . . . . . . . . . The amount remaining after all
liabilities are subtracted from all
assets, applying statutory
accounting principles. This sum is
regarded as financial protection to
policyholders in the event an
insurance company suffers
unexpected or catastrophic losses.

Reinsurance . . . . . . . . . . . . . . . A procedure whereby an insurer
transfers ("cedes") a portion of
the insurance risk to a reinsurer
in exchange for the payment of a
premium. Reinsurance can be
effected by "treaties," where a
reinsurance treaty automatically
covers all risks of a defined
category, amount and type, or by
"facultative reinsurance," which is
negotiated between an original
insurer and the reinsurer on an
individual, contract-by-contract
basis.

Statutory Accounting Principles ("SAP") . Accounting method prescribed or
permitted by state insurance
regulators. The more significant
differences between statutory and
generally accepted accounting
principles ("GAAP") are the
following: (a) premium income is
taken into operations over the
periods covered by the policies,
whereas the related acquisition and
commission costs are expensed when
incurred; (b) deferred income taxes
are not recognized, (c) certain
assets, such as agents' balances
over ninety days due and prepaid
expenses are nonadmitted assets for
statutory reporting purposes; (d)
policyholder dividends are accrued
when declared; (e) the cash flow
statement is not consistent with
classifications and the
presentation under GAAP; (f) bonds
are recorded at amortized cost,
regardless of trading activities;
(g) loss and loss adjustment
expense reserves and unearned
premium reserves are stated net of
reinsurance; and (h) minimum
statutory reserves for losses in
excess of Company's estimates are
required.

Treaty. . . . . . . . . . . . . . . . . . See Reinsurance.

Underwriting. . . . . . . . . . . . . . . The process whereby an insurer
reviews applications submitted for
insurance coverage, determines
whether it will accept all or part
of the coverage requested and
determines the premiums to be
charged.

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

Underwriting Profit (Loss). . . . . . . . The excess (deficiency) resulting
from the difference between net
premiums earned and the sum of
losses (including loss adjustment
expenses), underwriting expenses
and policyholder dividends.

iii

PART I

ITEM 1. BUSINESS

OVERVIEW

Superior National Insurance Group, Inc. ("SNIG") is a holding company that,
through its wholly-owned subsidiary Superior National Insurance Company
("SNIC"), is engaged in writing workers' compensation insurance principally in
the State of California and, until September 30, 1993, was engaged in writing
commercial property and casualty insurance. The "Company" refers to SNIG and
its subsidiaries.

SNIG was incorporated in California on March 29, 1985, under the name
Coastal Holdings, Ltd. to raise the capital necessary to acquire SNIC and
increase SNIC's capital and surplus for the planned expansion of its operations.
SNIG received gross proceeds of approximately $11.1 million from a private
offering of common stock (including $3,274,000 from insurance brokers) and
acquired SNIC for $1.6 million on September 30, 1985. The remainder of the
private offering proceeds after expenses ($9.1 million) was contributed to
SNIC's paid in capital. SNIG issued 2,773,250 shares of common stock associated
with the initial private offering. As of the acquisition date, SNIC was
substantively inactive, with fewer than 200 policies in force and approximately
60 open claims. SNIC did not commence significant operations until early 1986.

During 1987, SNIG issued 218,825 shares of common stock in a secondary
private offering and received net proceeds of approximately $4.3 million,
approximately $4.1 million of which was contributed to SNIC's paid in capital.
On May 25, 1995, a four-into-one reverse stock split of SNIG's common stock
became effective. All shares and per share figures used herein have been
adjusted to reflect that reverse stock split.

SNIC specializes in providing workers' compensation coverage for California
and Arizona businesses. Prior to 1995, SNIC specialized in insuring
medium-sized ($20,000 to $75,000 in annual premium) workers' compensation
accounts in California that it believed would be receptive to limited loss
control consulting and active claim management. With the advent of open rating
SNIC has expanded this concept to Arizona and shifted the focus to insuring
smaller accounts ($3,500 to $20,000 in annual premium) in classifications that
SNIC's management believes to be historically profitable. SNIC's management
believes that by maintaining its focus on certain employment classifications it
can provide claim management and standardized loss control services to such
smaller accounts at a level appropriate to the size and business classification
of the policyholder. As of December 31, 1996, SNIC's average premium per policy
was $8,569. A total of 64% of SNIC's premium in force, and 97% of SNIC's
policy count, as of December 31, 1996, was concentrated in 10,000 policies
having less than $50,000 of estimated annual premium. For the year ended
December 31, 1996, the Company had premiums written of $99.2 million, of which
premiums written in Arizona represented 2%.

SNIC historically competed with other workers' compensation insurers
principally on the basis of loss control expertise, claim management services,
and policyholder dividends. Under the open rating system that became effective
in California on January 1, 1995, SNIC's management has witnessed a significant
shift to pure price competition for SNIC's larger and middle-sized accounts.
Competition for small accounts is dependent on the Company's relationships with
insurance brokers ("producers") and SNIC's ability to provide low-cost servicing
for large groups of small accounts.

From SNIC's inception until September 30, 1993, SNIC underwrote commercial
property and casualty ("P&C") risks. Former SNIC management believed it was
possible to link the production of profitable P&C risks to workers' compensation
risks within SNIC's base of producers, and the combined workers' compensation
and P&C experience of some producers ultimately justified this strategy. In
general, however, former management underwrote P&C business for a large number
of producers bringing little or no profitable workers' compensation business to
SNIC, and significantly under-priced certain groups and classes of P&C business,
in particular, contractors' and developers' general liability business. In
addition, the per-risk excess of loss reinsurance

purchased to cover P&C risks was inappropriate for the exposure assumed by SNIC.
Despite remedial action begun in 1991 to reduce aggregate P&C exposure, renewed
concentration on the strategy of combined workers' compensation and P&C
production within the existing producer plant, and re-underwriting of the book
of business, SNIC continued to incur significant losses in its P&C operations.
Effective October 1, 1993, SNIC withdrew from all P&C lines, the operating
results of which are now recorded as discontinued operations. See DISCONTINUED
OPERATIONS.

For the years ended December 31, 1996 and 1995, all of the Company's
consolidated net premiums earned were attributed to workers' compensation
policies. For the year ended December 31, 1994, 98% of the Company's net
premiums earned were attributed to workers' compensation policies and the
remaining premiums were attributed to its commercial property and casualty lines
of business. As a result of the Company's discontinuation of its property and
casualty operations, none of the Company's premium in force at December 31, 1996
and 1995, was attributed to P&C business.

P&C insurance companies (including workers' compensation insurance
companies) are evaluated by regulators and rating organizations, among others,
with respect to the amount of net premiums they can write based on certain
leverage guidelines established by insurance regulators. The most common
measurement of leverage is the ratio of net premiums written (or premium
retained after cessions to reinsurers) to statutory surplus. SNIC's leverage
for 1996, 1995 and 1994 was 1.7x, 1.5x and 1.4x, respectively. The increase in
the 1996 ratio of premiums written net of reinsurance to statutory surplus was
due to an $11.8 million increase in premiums written net of reinsurance. The
increase in premiums written net of reinsurance is offset in part by a small
increase in statutory surplus resulting from the recording of statutory income.
The increase in net premiums written was primarily due to the Company entering
the Southern California and Arizona marketplaces in late 1995. The Company
increased its premiums written during 1996 over 1995 by $5 million in Southern
California and $2 million in Arizona. Although the 1995 leverage remained
relatively the same as the 1994 leverage, net premiums decreased 18.5% in 1995
but were offset by a 21% decrease in statutory surplus. The decrease in net
premiums was due primarily to lower pricing of policies as a result of open
rating. The decrease in statutory surplus was due to an extraordinary dividend
of 100% of SNIC's shares in Superior (Bermuda) Ltd. to SNIG constituting $15
million of SNIC's statutory capital and surplus. See paragraphs following for
further discussion.

SNIC is currently rated "BBB" by Standard and Poor's, an independent
insurance rating agency. Insurance companies rated "BBB" are considered by
Standard and Poor's to offer adequate financial security, but capacity to meet
policyholder obligations is susceptible to adverse economic and underwriting
conditions. A.M. Best Company, an independent insurance rating agency, has
rated SNIC "B+". Insurance companies rated "B+" by A.M. Best are considered by
A.M. Best to have demonstrated very good overall performance and a good ability
to meet their obligations to policyholders over a long period of time. A.M.
Best's ratings represent an independent opinion of a company's financial
strength and ability to meet its obligations to policyholders. A.M. Best, in
evaluating the proposed acquisition by the Company of Pac Rim Holding
Corporation ("PRIM"), discussed below, has appended a negative implication
notation to the Company's "B+" rating. Standard and Poor's has not made a
corresponding notation.

SNIC is currently licensed to write business in Arizona, Arkansas,
California, Colorado, District of Columbia, Indiana, Iowa, Kentucky, Maryland,
Mississippi, Missouri, Montana, Nevada, New Mexico, Oregon, South Dakota, Utah,
and Wyoming, but virtually all of SNIC's current premium is generated in
California (98%), and Arizona (2%).

The profitability and financial position of the Company are affected by
many factors including competition, the severity and frequency of claims, state
regulation of SNIC's premium rates and policy benefits, and general economic
conditions. The net effect on the Company of these factors cannot be predicted.

The profitability of workers' compensation insurers is affected by many
factors, such as premium rate competition, the severity and frequency of claims,
state regulation, and court decisions that define the extent of coverage and the
amount of compensation due for injuries or losses. One of the features of the
workers' compensation insurance business is that its products must be priced
before the costs are known, as premium rates

generally are set before losses are reported. Accordingly, workers'
compensation insurers have experienced significant year to year fluctuations in
operating results.

SNIG has seven wholly-owned subsidiaries in addition to SNIC: InfoNet
Management Systems, Inc. ("InfoNet"), SN Insurance Services, Inc. ("SNIS"),
Pacific Insurance Brokerage, Inc. ("Pacific"), Superior National Capital Holding
Corporation ("SNCHC"), Superior (Bermuda) Ltd. ("SBL"), SNTL Acquisition Corp.
("Acquisition") and Superior National Insurance Group, Inc. - Delaware ("SNIG -
Delaware"). InfoNet provides data processing purchasing services to SNIG and
its subsidiaries. SNIS and Pacific are inactive. SNCHC's sole function is to
act as a general partner of Superior National Capital, L.P. ("SNCLP"), a Bermuda
limited partnership that issued $20 million face amount of preferred securities
to Centre Reinsurance Services (Bermuda) III Limited effective June 30, 1994.
The proceeds of that transaction were loaned to SNIG and partially contributed
by SNIG to the capital of SNIC. Centre Reinsurance Services (Bermuda) III
Limited is an affiliate of Centre Reinsurance Limited ("Centre Re"). See
TRANSACTIONS WITH CENTRE RE AND ITS AFFILIATES and Note (7) to the Consolidated
Financial Statements, PREFERRED SECURITIES ISSUED BY AFFILIATE. SBL was
established to facilitate the management of the run-off of SNIC's P&C business.
Acquisition was established for the purpose of facilitating SNIG's proposed
acquisition of PRIM. SNIG - Delaware was formed to facilitate the proposed
reincorporation of SNIG in Delaware.

In September 1995, following approval from the California Department of
Insurance (DOI), SNIC formed SBL, a wholly owned subsidiary domiciled in
Bermuda. SBL was capitalized by SNIC with $15 million in long-term reinsurance
receivables. Following the formation of SBL, SNIC ceded approximately $23
million in P&C reserves to SBL and as consideration SBL received from SNIC $23
million of premium on a funds withheld basis. All reinsurance between SNIC and
SBL will be accounted for on a funds withheld basis. After SNIC ceded the P&C
reserves to SBL, SNIC paid to SNIG an extraordinary dividend of 100% of its
shares in SBL constituting $15 million of SNIC's statutory capital and surplus.
In addition, SNIG paid $1.5 million to SBL as a capital contribution making
SBL's total capitalization equal to $16.5 million.

SNIC's only subsidiary is wholly-owned Western Select Service Corp.
("WSSC"), which currently provides vocational rehabilitation, legal, paralegal,
and other services to SNIC.

SNIG relies on dividends from SNIC for its income. Insurance companies are
subject to restrictions affecting the amount of stockholder dividends and
advances that may be paid within any one year without the prior approval of the
DOI. The California Insurance Code provides that amounts may be paid as
dividends on an annual noncumulative basis (generally based on the greater of
(1) net income for the preceding year or (2) 10% of statutory surplus as regards
policyholders as of the preceding December 31) without prior notice to, or
approval by, the DOI. At December 31, 1996, SNIC could have paid approximately
$5.2 million in dividends and advances to SNIG without the DOI's prior approval
based on 10% of reported statutory surplus. No dividends were paid by SNIC to
SNIG in 1996. In 1995, following approval from the DOI, SNIC made an
extraordinary dividend distribution of 100% of its shares in SBL to SNIG,
constituting $15 million of SNIC's statutory capital and surplus. Cash
dividends of $850,000 were paid by SNIC to SNIG in 1994.

On September 17, 1996, SNIG entered into a definitive agreement to acquire
PRIM for an estimated $54 million in cash, which would have resulted in the
payment of $3.00-$3.10 per share to PRIM's common stockholders. In December
1996, shortly before SNIG's shareholders were to vote to approve the financing
for the acquisition, PRIM indicated regulatory approval would be delayed as a
result of the triennial examination by the DOI of the Pacific Rim Assurance
Company, PRIM's wholly-owned subsidiary. In February 1997, PRIM informed the
Company that it would, based on the results of the triennial examination,
strengthen its claims and claims adjustment expense reserve by $12 million as of
December 31, 1996. The magnitude of the reserve strengthening necessitated
renegotiation of the terms of the original definitive agreement. On February 17,
1997, SNIG and PRIM entered into an amended and restated definitive agreement.
Under the terms of the agreement SNIG will acquire PRIM for aggregate
consideration of approximately $42 million in cash. PRIM stockholders will
receive approximately $20 million ($2.11 per share); $20 million will be paid to
PRIM's convertible debenture holders; and the remainder will be paid to PRIM's
warrant and option holders.

SNIG will finance the acquisition with a combination of a common stock
issuance and bank debt. Under an agreement reached September 17, 1996, a group
of investors including Insurance Partners, L.P., TJS Partners, L.P., and SNIG
management have agreed to purchase approximately $18 million of newly issued
SNIG common stock at $7.53 per share, based on the September 1996 market price
of SNIG's common stock. SNIG expects the remaining portion of the purchase
price will be funded by a $44 million term loan provided by a bank syndicate led
by Chase Manhattan Bank ("Chase"). Approximately $6.6 million of the loan
proceeds will be used to repay SNIG's outstanding long-term debt. Additionally,
approximately $10 million of the loan proceeds will be contributed to the
capital of Pacific Rim Assurance Company. The PRIM acquisition and the
financing is subject to regulatory approval and the stock issuance is subject
to shareholder approval. There have been no adjustments made to the financial
results or other information presented to reflect the PRIM transaction.

COMPANY STRATEGY

The Company's objective is to maintain and enhance SNIC's market position
in California and Arizona, specializing in workers' compensation. The Company
believes that it is well-positioned to identify and pursue specialized areas in
the insurance marketplace. The key elements of its strategy are as follows:

RELATIONSHIP WITH PRODUCERS. The Company markets SNIC's insurance products
through approximately 182 producers. The Company's producers are state licensed
independent insurance brokers that are licensed to sell workers' compensation
insurance in the states (jurisdictions) where they represent SNIC. SNIC's
producers are primarily medium-sized firms, most having an ongoing relationship
with the Company's executives. As a regional insurer, the Company believes that
SNIC has the flexibility to respond promptly to the business needs of its
producers and to provide the specialty coverages needed by their customers. The
Company considers the producers as SNIC's marketing target and delivers service
the Company believes exceeds industry standards. The Company believes that SNIC
has a good relationship with its producers and has favorably distinguished
itself from its competitors by providing producers with a commitment to superior
service levels and easy access to SNIC executives.

FOCUS ON MIDDLE-MARKET. The Company focuses its marketing efforts on
smaller businesses with premium per policy of between $3,500 and $20,000,
principally to avoid the extreme price competition associated with larger
insureds and the high administrative costs associated with very small accounts.
The Company also targets certain agriculture and hospitality specialized
industry groups.

EXPENSE CONTROLS. The Company monitors and controls its operating expenses
as an important part of its business. Although the Company's operating expenses
are in line with its competitors, management continues to seek ways to further
reduce operating expenses.

PRICING CONTROLS. The Company utilizes a proprietary software system to
maintain an easily accessible record of its policy pricing. The system
generates daily reports that allow the Company to monitor both SNIC's pricing
activities for specific lines of insurance in particular geographic areas and
the activities of SNIC's producers.

MANAGEMENT INFORMATION SERVICES. The Company believes investments in
up-to-date computer systems will increase personnel productivity, and
underwriting and claims processing effectiveness. Additionally, the Company has
developed a proprietary management system to monitor its operations and provide
quality, detailed and timely information to management for pricing and claims
reporting purposes.

WORKERS' COMPENSATION INSURANCE

OVERVIEW. Workers' compensation is a no-fault statutory system under which
an employer is required to provide its employees with medical care and other
specified benefits for work-related injuries or diseases. There are four types
of benefits payable under workers' compensation policies: disability,
vocational rehabilitation, medical, and death benefits. The amounts of benefits
payable for various types of claims are established by statute and vary with the
nature, severity of the injury or disease, wages, occupation, and age of the
employee. While no dollar limitations are set for medical benefits and limited
dollar amounts are set for vocational rehabilitation benefits, reinsurance
typically covers liability in excess of a specified dollar amount.

Insurers must compensate policyholders' employees injured in the course and
scope of their employment, even though the injuries may have resulted from the
negligence or wrongs of any person (including the employee). However,
subrogation procedures exist which, in certain circumstances, allow an insurer
to recover from third parties all or a portion of the benefits the insurer has
paid. SNIC proceeds against such third parties when it believes the
circumstances so warrant.

PREMIUMS. Effective January 1, 1995 under California's workers'
compensation open rating law, the DOI sets "pure premium" rates (effectively the
estimated pure loss cost) for each employment classification based on its
evaluation of many factors, including the recommendations of the Workers'
Compensation Insurance Rating Bureau ("WCIRB"), and the economic effects of any
recommended rate change. Pure premium rates are generally applied per $100 of
payroll for each employment classification. Changes in pure premium rates are
subject to review and public hearing by the DOI and are changed from time to
time to reflect industry experience. SNIC's "manual rates" are the WCIRB pure
premium rates modified by a pure premium "multiplier," the purpose of which is
to gross-up the pure premium for SNIC's anticipated loss adjustment and
underwriting expenses. SNIC's manual rates may subsequently be modified by a
"loss rating" factor to reward a policyholder for consistently superior
historical loss experience, an "adjustment to expense provision" factor to
modify the manual rate depending on the policy's dividend and commission plan, a
"schedule rating" factor to modify the rate if a policyholder meets certain
financial conditions or safety program requirements, flat charges for
reinsurance or surcharges, adjustments to bring premium to certain minimum rates
established in SNIC's rate filing, and an "experience modification" factor
established by the WCIRB for each policyholder.

The WCIRB determines the experience modification factors for each eligible
employer. The experience rating plan governs all policyholders whose annual
premiums for the preceding three years exceed an amount equal to $16,200
multiplied by SNIC's pure premium multiplier. The modification factors are
based upon the employer's own loss experience as compared to the loss experience
of other employers of similar size and with the same payroll classifications
applicable to its business. The applicable loss experience covers a three-year
period commencing four years and nine months prior to, and terminating one year
and nine months prior to, the date for which the experience modification is
applied.

Prior to 1995, the DOI set minimum premiums for each employment
classification, which were the minimum rates all workers' compensation carriers
were obligated to charge. In July 1993, the California legislature enacted a
series of bills to significantly change the California workers' compensation
system (collectively, the "1993 Reforms") that became effective in full on
January 1, 1995. See REGULATION. The 1993 Reforms addressed various aspects of
the system then in effect, including: limitation of employees' post-termination
claims and claims for psychiatric injuries; managed care alternatives;
restrictions on vocational rehabilitation benefits; additional penalties for
fraud and abuse of the system; scheduled increases in disability benefits
beginning July 1, 1994; implementation of a 7.0% decrease in minimum rates
effective July 16, 1993; and replacement of California's minimum rate law with a
competitive rating law effective January 1, 1995. A further average 12.7%
reduction in minimum rates was ordered by the DOI in late 1993, which became
effective January 1, 1994. Effective October 1, 1994, the DOI ordered an
additional reduction in minimum rates of 16.0%. Beginning January 1, 1995, the
WCIRB began publishing advisory pure premium rates which provide for claim and
claim adjustment expenses as indicated by prior history and an actuarial
projection of future claim and claim expenses. California workers' compensation
underwriters can adopt these rates and apply their own expense factor or file
their own actuarially sound rates. SNIC chose to adopt the WCIRB pure premium
rates

grossed-up by a company expense factor of 1.35. In July 1995, SNIC removed
commissions from the expense factor in order to more accurately negotiate rates
and adjusted the final rate to reflect the actual commission paid while
maintaining the advisory pure premium portion of the filed rates supplied by the
WCIRB. California workers' compensation underwriters are allowed to file plans
that provide credit and/or debit criteria to be applied to their filed rates.
SNIC has filed such a credit and debit plan and applies these factors in a
non-discriminatory manner.

The WCIRB provided 1997 pure premium rates that were in total 6.2% lower
than 1996 and SNIC will adopt these rates effective April 1, 1997.

INSURANCE UNDERWRITING. SNIC historically concentrated on insuring
workers' compensation accounts with annual premiums between $20,000 and $75,000
based on the belief that this type of insured would be receptive to limited loss
control consulting and active claim management while avoiding the intensive
competition that historically existed for larger accounts. In late 1991, SNIC
developed and began marketing a workers' compensation product targeted at
accounts with annual premiums below $10,000 to diversify the size of risks in
its book of business. Under this program, SNIC developed pre-determined
underwriting rules, acceptable risk characteristics, pricing guidelines and
qualifying employment classifications, for the purpose of assisting both SNIC
and its producers with risk selection. Producers submitted a complete
application for coverage to SNIC's underwriting department confirming the
accuracy of the information presented and proper application of underwriting
rules, before SNIC bound coverage and issued a policy. This small risk program
was successfully marketed through a California agents' association from mid-1991
through mid-1994 when the relationship with the association was terminated by
mutual consent. Starting in 1995, the Company reactivated the program on its
own in the general workers' compensation marketplace. See MARKETING.

Because the types of accounts that SNIC insures vary among different
geographic regions in California, SNIC conducts its underwriting activities
through branch offices. SNIC's branch offices are typically allowed to write
accounts with estimated annual premiums of less than $250,000 whereas accounts
with estimated annual premiums above that amount or with certain risk
characteristics must be approved by SNIC's principal underwriting officer. SNIC
provides a market for risks in over 400 of the approximately 450 employment
classifications established by the DOI. The Company generally avoids
underwriting in the remaining classifications because of the historically higher
risk exposure they represent. Classifications generally avoided include, among
others, the manufacturing, handling, and shipping of explosives; oil rig and
derrick work; subway construction; and navigation of marine vessels.
Classifications that require the approval of SNIC's principal underwriting
officer include those which represent potential exclusions from SNIC's
reinsurance treaties, unusual hazards or catastrophic exposures such as taxicab
fleets, carnivals, ski resorts, and detective agencies. Certain risks, such as
the transportation of groups of employees, are generally ceded to reinsurers
under separate reinsurance agreements. SNIC's workers' compensation business is
diverse in terms of employment classifications, with no single classification
accounting for more than eight percent of SNIC's workers' compensation premiums
in force as of December 31, 1996.

In mid-1990, SNIC introduced restricted underwriting standards for
Los Angeles, Orange, San Bernardino, and Riverside counties because SNIC
believed that these counties were adversely affected by the California recession
and were susceptible to the activities of fraudulent and abusive medical
providers. This resulted in a substantial reduction in workers' compensation
premiums on business previously underwritten in those California counties. SNIC
has since re-entered those markets and now is achieving satisfactory results,
but at significantly lower premium volumes.

Prior to insuring an account, SNIC's underwriting department reviews, INTER
ALIA, the employer's prior loss experience and safety record, premium payment
and credit history, operations, geographic location and employment
classifications. SNIC verifies employment classifications principally through
information provided by the WCIRB and, in many instances, through its own
on-site surveys of the employer's place of business.

If the underwriting department determines that an account is one that SNIC
may be willing to insure, a SNIC loss control consultant may review the
employer's prior loss patterns and communicate with the

policyholder on the extent to which such losses may be prevented, and the
commitment of the employer's management to safety in the work place. By helping
reduce an employer's losses, SNIC believes it can reduce the policyholder's
ultimate net cost of insurance as well as help improve its own profit potential
on the risk. See LOSS CONTROL.

SUPPORT SPECIALISTS. To further facilitate its underwriting and claims
management functions, SNIC has a full complement of additional support
specialists. Specifically, SNIC is staffed with a rehabilitation department
that interprets and implements new workers' compensation reform along with
monitoring existing rules and regulations regarding rehabilitation claims, an
audit department that monitors premiums and payroll, and a bill review
department that insures provider invoices are within statutory fee schedules and
that contracted for discounts are applied.

DATA PROCESSING

The Company uses its proprietary, personal computer-based management
information system to satisfy its data processing requirements. The system is
operated on off-the-shelf computer hardware, including a commercial local area
network communications system, and uses the Company's internally-developed,
proprietary computer software. The key advantage of the Company's approach to
data processing is that personal computer technology provides flexibility at
relatively low cost. The Company believes the structure of its system makes it
expandable well beyond the Company's current or projected needs.

MARKETING

The Company's principal marketing strategy is to meet the business needs of
SNIC's producers by providing the insurance coverage and services needed by
their customers. SNIC's insurance policies are sold exclusively through
producers who also represent one or more competing insurance companies. SNIC
views the producers as its marketing target and delivers service which the
Company believes surpasses normal industry levels.

SNIC's producers are primarily medium-sized insurance brokerage firms
located in Central and Northern California. However, SNIC has re-entered the
Southern California market on a limited basis through producers that are
generally new to SNIC. SNIC's percentage of business with each of its
producers, in terms of premium volume, has a significant effect on a producer's
efforts, because management believes that companies that represent a significant
volume of a producer's business typically receive the highest quality business.
SNIC believes that it is recognized by each of its producers as one of its lead
carriers. Additionally, no single policy accounted for more than 4% of net
earned premiums in 1996 and no single producer generated more than 8% of written
premiums.

SNIC closely monitors its producers through its on-line management
information systems, with special attention given to the volume and
profitability of business written through SNIC. Producers who consistently
write unprofitable business, or do not meet the minimum guideline of annual
premium per year, may be canceled. SNIC believes that by continually monitoring
and improving the quality of its producers, long term profitability will be
enhanced.

Marketing staff, along with the branch office managers and the
underwriting, loss control, and regional claim staffs, work closely with
producers and frequently make joint presentations with producers to potential
workers' compensation policyholders. SNIC conducts its marketing by territory
to enable its marketing representatives to better address the specific types of
accounts on which they focus in each region. Producer commissions are generally
determined by negotiation and are dependent on the size and profit potential of
the producer's accounts. Commissions for the size of account SNIC has targeted
over the past three years generally range from 10% to 12% of premiums.

SNIC's average direct commission rate was 11.1% in 1996, 12.0% in 1995, and
11.7% in 1994. SNIC's producers are not permitted to bind SNIC with respect to
any account. All new and renewal policyholder applications must be submitted to
SNIC for approval. SNIC is not committed to accept a fixed portion of any
producer's business.

LOSS CONTROL

In addition to its responsibility for risk evaluation as part of the
underwriting process, SNIC's loss control department may assist SNIC's workers'
compensation policyholders in developing and maintaining safety programs and
procedures to minimize on-the-job injuries and health hazards. After analyzing
the policyholder's loss profile, SNIC's loss control consultants will help
develop a loss control program and establish accident reporting and claim
follow-up activities for the policyholder. SNIC's loss control personnel may
also consult with policyholder management about safety and health issues, as
well as about the effectiveness of the policyholder's loss prevention
procedures. Prior to the end of the policy period, loss control personnel
typically provide a report to the larger premium-size policyholder's senior
management summarizing the programs instituted by the employer over the policy
period and the effect such programs and procedures have had on reducing the
number and severity of employee claims. SNIC's loss control consultants may
also conduct special training seminars for the policyholder's employees on such
subjects as the prevention of back injuries, general first aid and industrial
hygiene.

CLAIM MANAGEMENT

SNIC's policy is to work closely with policyholders to return injured
workers to the job quickly, while avoiding litigation. SNIC maintains four
full-service Claims Servicing Offices ("CSO") in California located in
Calabasas, Fresno, South San Francisco, and Sacramento. Each CSO is managed by
a claims manager and, with the exception of Sacramento, due to its smaller size,
an assistant claims manager. The claims technical staffs in each CSO are
organized into units with, generally, one supervisor supervising four claims
examiners and two claims assistants per unit.

Each CSO also has specialized claims units, the size of which are dependent
upon the size of the CSO. SNIC has responded to fraud by training and
dedicating a claims staff to handle potentially fraudulent claims. The
Calabasas CSO has a Special Investigation Unit staffed with two senior
examiners. The other CSOs each have one senior examiner dedicated to Special
Investigations. Excepting Sacramento, each CSO has a vocational
rehabilitation/disability management unit staffed by vocational rehabilitation
counselors and coordinators and disability management ("DMU") specialists. The
sole purpose of the DMU staff is to provide effective and efficient handling of
vocational rehabilitation plans and to maximize SNIC's early return-to-work
efforts with employers. These efforts provide significant benefits to insureds
and SNIC when considering that each claimant whose return-to-work is
successfully accelerated results in substantial indemnity wage benefit savings.

SNIC's claims department relies extensively on the Company's data
processing systems. The Company's data processing systems were internally
developed by claims staff and data processing personnel, with three main goals
in mind: the capture of timely and meaningful data, the creation of a minimal
processing error environment by means of numerous system prompts and edit
checks, and the automation of many otherwise manual functions. An additional
benefit resulting from the claims system is increased productivity resulting
from the claims examiner's ability to handle a higher case load without
negatively impacting claims processing results.

SNIC's claims handling also includes a specialized subrogation function.
Claims examiners are responsible for the identification of potential recoupments
from third parties responsible for a work-related accident, after which the
examiner notifies a subrogation specialist of this potential. The subrogation
specialist determines whether a subrogation situation exists, and, if so,
assumes responsibility for all aspects of subrogation to finalization. The
subrogation specialists report to an experienced in-house subrogation attorney.

POLICYHOLDER DIVIDENDS

California law permits workers' compensation insurers to issue
participating policies, which allow the insurer to declare and pay dividends to
a policyholder after the expiration of the policy. At the inception of open
rating on January 1, 1995, 65% of SNIC's workers' compensation premiums in force
were participating policies. The percent of participating policies has declined
to less than 1% of premiums at December 31, 1996. The decline in participating
policies is the result of a change in the consumers' preference for the lowest
net price at a policy's inception.

Insurers are prohibited by law from promising policyholders that future
dividends will be paid to them, or stating the amount or rate of dividends to be
paid. However, an insurance carrier is required to disclose its historical
policyholder dividend payment practices and procedures to a prospective
participating policyholder by means of a policyholder dividend disclosure
statement. The disclosure statement must state that there is no guarantee to
the potential policyholder that any of the factors shown in the disclosure
statement will actually be used in determining policyholder dividends for a
specified period. In fact, when an insurance company calculates the dividend a
number of months after the expiration of the policy, conditions may have changed
from the time of the original proposal and the Company may decide not to pay any
or all of the indicated dividend. Any payment of dividends to policyholders is
determined by the board of directors of an insurance company subject to the
legal requirements in California that such dividends may not exceed the earned
surplus on such company's California workers' compensation policies, may not be
unfairly discriminatory, and may not be declared or paid until after the
expiration of the policy period (when there are more facts available for
determining loss experience).

SNIC evaluated the value of dividends on one-year policies in two different
time frames. The initial payout limitation, which was 70% of dividends
liability, was calculated approximately nineteen months after the policy
expiration date, and paid twenty-two months after expiration or later. The
second and final valuation of the remaining 30% of dividends liability was done
approximately one year after the first valuation, and paid approximately three
months after the final calculations. The SNIC Board of Directors considered a
number of factors in connection with the declaration of policyholder dividends,
including loss ratio, class of business, geographical location and premium
payment history of the policyholder, risk and expense factors, competition and
the overall loss ratio and financial condition of SNIC.

Prior to open rating, policyholder dividends served both as an economic
incentive to employers for safe operations and as a means of price
differentiation. As a result of consumers' preference for the lowest net price
at the policy's inception under open rating, however, the dividend payment
feature is no longer a significant factor in the marketing or selling of
workers' compensation insurance in California. Further, as a result of the
continued instability of the California workers' compensation marketplace, the
failure of the legislature to take corrective action as to the impact of
judicial decisions adverse to the insurance industry and AB 1913 (described
below), and the diminished value of the policyholder dividends, SNIC's
management has determined that it is prudent to suspend the further issuance of
policyholder dividends.

CLAIMS AND CLAIM ADJUSTMENT EXPENSE RESERVES

Several years or more may elapse between the occurrence of a workers'
compensation loss, the reporting of the loss, and final payment of the loss.
Claims and claim adjustment expense reserves are estimates of what an insurer
expects to pay claimants. SNIC is required to maintain reserves for payment of
estimated claims and claim adjustment expense for both reported claims and
claims which have been incurred but have not yet been reported ("IBNR"). SNIC's
ultimate liability may be materially more or less than current reserve
estimates.

Reserves for reported claims are established on a case-by-case basis.
Case-by-case reserve amounts are determined by claim examiners, based on the
examiner's judgment and experience, and on SNIC's reserving practices, which
take into account the type of risk, the circumstances surrounding the claim or
policy provisions relating to type of loss, and historical paid claim and claim
adjustment expense data for similar claims. Case-by-

case reserves are not established for claim (loss) adjustment expense ("LAE"),
and the entire reserve for LAE is established based upon the Company's
historical paid data. SNIC's claims department regularly monitors reserve
adequacy for claims which have occurred and been reported to it and adjusts such
reserves as necessary.

Claims and claim adjustment expense reserves for IBNR are estimated based
on many variables including historical and statistical information, inflation,
legal developments, the regulatory environment, benefit levels, economic
conditions, judicial administration of claims, general frequency and severity
trends, medical costs, and other factors affecting the adequacy of loss
reserves. The senior officers of the Company review and adjust IBNR reserves
monthly.

SNIC utilizes the services of an independent actuarial firm to assist in
the evaluation of the sufficiency of loss and loss adjustment reserves for
purposes of meeting state insurance regulatory requirements. SNIC considers the
estimates of the independent actuarial firm as corroborative evidence as to the
reasonableness of its reserves. To the extent SNIC's reserves differ from those
estimated by the independent actuary, management uses its best efforts to
identify reasons for such differences and determine if modifications are
necessary to its initial reserve estimates. No assurance can be given that the
ultimate liability will not vary from such estimates.

Adjustments in aggregate reserves are reflected in the operating results of
the period during which such adjustments are made. Although claims for which
reserves are established may not be paid for several years or more, the reserves
are not discounted, except as required by the Internal Revenue Code of 1986, as
amended (the "Code") to calculate taxable income.

The following table provides a reconciliation of the beginning and ending
claim and claim adjustment expense reserves for each of the years in the
three-year period ended December 31, 1996, computed in accordance with GAAP.

RECONCILIATION OF LIABILITY FOR CLAIMS AND CLAIM ADJUSTMENT EXPENSE

YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
------------ ------------ -----------
(Amounts in thousands)

Beginning reserve, gross of reinsurance. . . . . . . . . . . . . . . $141,495 $171,258 $171,038
Less: Reinsurance recoverable on unpaid losses . . . . . . . . . . . 27,076 31,897 28,971
Beginning reserve, net of reinsurance. . . . . . . . . . . . . . . . 114,419 139,361 142,067
Provision for net claims and claim adjustment expenses
For claims occurring in current year . . . . . . . . . . . . . . 57,614 58,842 72,457
For claims occurring in prior years. . . . . . . . . . . . . . . (1,976) (4,872) 6,304
Total claims and claim adjustment expenses . . . . . . . . . . . 55,638 53,970 78,761
Payments for net claims and claim adjustment expense:
Attributable to insured events incurred in current year. . . . . (19,816) (19,732) (23,061)
Attributable to insured events incurred in prior years . . . . . (59,698) (59,180) (58,406)
Total claims and claim adjustment expense payments . . . . . . . (79,514) (78,912) (81,467)
Ending reserves, net of reinsurance. . . . . . . . . . . . . . . . . 90,543 114,419 139,361
Reinsurance recoverable on unpaid losses . . . . . . . . . . . . . . 24,986 27,076 31,897
Ending reserves, gross of reinsurance. . . . . . . . . . . . . . . . $115,529 $141,495 $171,258

The following table discloses the development of direct workers'
compensation claims and claim adjustment expense reserves of SNIC from December
31, 1987 through December 31, 1996.

ANALYSIS OF DIRECT CLAIMS AND CLAIM ADJUSTMENT EXPENSE DEVELOPMENT

- -----------------------------------------------------------------------------------------------------------------------------------
CALENDAR YEARS ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(In thousands)

Reserve for Direct
Unpaid Claims and
Adjustment Expenses,
Gross of Reinsurance
Recoverables Reserve $21,969 $42,268 $60,615 $88,270 $116,811 $136,102 $171,038 $171,258 $141,495 $115,529

Re-estimated as of:
One Year Later . . . . . 24,241 43,581 68,718 112,160 144,676 162,634 171,960 162,635 137,242
Two Years Later. . . . . 26,120 46,788 79,059 111,151 143,912 148,906 161,262 154,249
Three Years Later. . . . 29,140 50,955 74,619 117,506 138,607 152,420 148,654
Four Years Later . . . . 29,423 47,696 78,112 113,029 137,939 144,898
Five Years Later . . . . 29,541 49,297 75,475 112,840 135,074
Six Years Later. . . . . 29,082 47,554 75,913 109,655
Seven Years Later. . . . 27,759 49,470 74,149
Eight Years Later. . . . 27,846 48,653
Nine Years Later . . . . 27,573
Cumulative Deficiency
(Redundancy). . . . . . . 5,604 6,385 13,534 21,385 18,263 8,796 (22,384) (17,009) (4,235)

Cumulative Amount of
Reserve Paid through
One Year Later . . . . . $9,447 $17,698 $24,478 $36,975 $53,914 $57,348 $60,726 $67,757 $63,587
Two Years Later. . . . . 14,482 19,879 35,195 45,561 56,299 61,648 66,077 61,952
Three Years Later. . . . 15,777 25,830 38,067 52,811 63,354 63,523 64,464
Four Years Later . . . . 18,666 26,165 38,261 56,369 64,703 66,547
Five Years Later . . . . 19,384 26,026 40,794 57,768 68,152
Six Years Later. . . . . 19,660 27,181 42,032 59,622
Seven Years Later. . . . 20,707 27,202 43,146
Eight Years Later. . . . 20,803 27,947
Nine Years Later . . . . 21,123
Gross Reserve - December 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171,038 171,258 141,495 115,529
Reinsurance Recoverables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,971 31,897 27,076 24,986
-------- -------- -------- --------
142,067 139,361 114,419 90,543
Reclassification of amounts recoverable from reinsurers. . . . . . . . . . . . . . . . . (41,889) (34,344) (11,670) -
-------- -------- -------- --------
Net Reserve - December 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,178 105,017 102,749 90,543
-------- -------- -------- --------
-------- -------- -------- --------

Gross Re-estimated Reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148,654 154,249 137,242
Re-estimated Reinsurance Recoverables. . . . . . . . . . . . . . . . . . . . . . . . . . 23,589 25,511 24,799
-------- -------- --------
125,065 128,738 112,443
Reclassification of amounts recoverable from reinsurers. . . . . . . . . . . . . . . . . (41,889) (34,344) (11,670)
-------- -------- --------
Net Re-estimated Reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,176 94,394 100,773
-------- -------- --------
-------- -------- --------

Net Cumulative (Redundancy) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17,002) (10,623) (1,976)
-------- -------- --------
-------- -------- --------

The first line of the preceding table depicts the estimated liability for
unpaid claims and claim adjustment expense recorded at the balance sheet date
for each of the indicated periods. This liability represents the estimated
amount of claims and claim adjustment expense for claims arising in all prior
years that are unpaid as of the balance sheet date, gross of reinsurance
recoverables reserve, including losses that had been incurred but not yet
reported to SNIC. The preceding table also shows the re-estimated amount of the
previously recorded liability based on experience as of the end of each
succeeding year, including cumulative payments made for such claims since the
end of the respective year. The lower portion of the table shows the cumulative
amounts paid as of successive years for such claims. The estimates change as
more information becomes known about the frequency and severity of claims for
each year. A (redundancy) deficiency exists when the initial liability estimate
is (greater) less than the re-estimated liability at each December 31.

The increases in estimated ultimate claims and claim adjustment expense for
the years ended December 31, 1987 and 1988 were due to the lack of Company
history, which prevented management from accurately estimating ultimate loss
costs. For years 1989 to 1992, the increase in estimated ultimate claims and
claim

adjustment expense was driven by continuing litigation in the workers'
compensation market and the economic recession, which encouraged the filing of
both stress claims and fraudulent claims.

Currently, the Company prepares on a monthly basis a comprehensive analysis
of workers' compensation experience and the reserving process is continually
modified to consider additional information regarding trends in pricing,
frequency, and severity.

The Company's 1996 accident year net claim and claim adjustment expense
ratio for accident year 1996 at the end of calendar year 1996 was 65.0%, versus
65.6% for accident years 1995 and 1994, at their respective calendar year ends.
In 1996, the Company experienced approximately $2.0 million in favorable
development on net claims and claim adjustment expense reserves estimated at
December 31, 1995. This $2.0 million favorable development is the result of
$8.4 million in favorable development on direct reserves for accident years 1994
and prior. The favorable development was offset in part by $4.1 million adverse
development on direct reserves for accident year 1995, and $2.3 million adverse
development on ceded reserves for accident years 1995 and prior. Adverse
development on the 1995 accident year began to emerge during 1996. The
Company's 1995 accident year net claim and claim adjustment expense ratio for
accident year 1995 at the end of calendar year 1995, as noted above, was 65.6%,
but had risen to 74.6% at the end of the 1996 calendar year. Similar adverse
development has been experienced throughout the California workers' compensation
industry.

During 1995, the Company experienced approximately $8.6 million of
favorable development on direct claim and claim adjustment expense reserves
estimated at December 31, 1994. Management believes the favorable development
resulted from the Company's improved claims management controls and decreased
claim severity, particularly in the medical component of the workers'
compensation line. Similar favorable development on pre-1995 losses has been
experienced elsewhere in the California workers' compensation industry.
Offsetting the favorable direct development in large part was the re-estimation
during 1995 of reinsurance receivables recorded at December 31, 1994 from
approximately $66.2 million to approximately $59.9 million at December 31, 1995.

In 1993, SNIC experienced significant adverse development on 1992 accident
year claims. In addition to adjusting the 1992 accident year claims estimates
to levels indicated by 1990 and 1991 accident year experience, SNIC also
established initial reserves for the 1993 accident year above the level of
initial reserves established for prior years. During 1995, the Company
recognized approximately $10.7 million of favorable development on direct claim
and claim adjustment expense reserves estimated at December 31, 1994, pertaining
to years prior to 1994. Management believes the favorable development resulted
from the Company's improved claims management controls and decreased claim
severity, in both the medical and vocational rehabilitation components of the
workers' compensation line. Similar favorable development on pre-1994 losses
has been experienced elsewhere in the California workers' compensation industry.

SNIC significantly increased its direct reserves in 1992 based on the
results of an independent actuarial review effective June 30, 1992, of
outstanding claims. The review was commenced primarily because SNIC was
experiencing higher than anticipated costs for claims, including increases in
vocational rehabilitation, medical expenses, and claim adjustment expense, on
the 1990 and 1991 accident years, partially offset by modest improvement in
prior accident years. Management believes the workers' compensation laws in
effect during 1990 and 1991 encouraged claimants to file fraudulent or abusive
claims, causing the increase in claims costs, and SNIC responded by increasing
net of reinsurance reserves for prior accident years' claims by $12.5 million in
1992. Accident year 1992 reserves, however, were recorded at levels consistent
with pre-1990 and 1991 experience. During 1995, the Company's direct claims and
claim adjustment expenses for years 1992 and prior increased from $149 million
in 1994 to $152.5 million in 1995, an increase of $3.5 million.

Conditions and trends that have historically affected SNIC's claims may not
necessarily be indicative of conditions and trends that will affect future
claims. Accordingly, it would not be appropriate to extrapolate future
redundancies or deficiencies based on the results set forth above.

DISCONTINUED OPERATIONS

SNIC's discontinued operations consist of P&C business that was
discontinued effective September 30, 1993. The discontinued operations
liabilities principally pertain to contractors' general liability policies
underwritten during the years 1986 through 1990. There is often a significant
lag between the date of loss of construction-related claims and the date such
claims are reported to SNIC. SNIC believes the existing provision, and the
assets allocated to support the discontinued operations, are sufficient to cover
future claims, but there is significant uncertainty associated with the
reporting and severity of construction claims.

In 1993, the Company recorded a pre-tax charge to income of $3.0 million
for estimated operating losses during the phase-out period. During the second
quarter of 1995, the Company increased by approximately $15 million its reserves
for discontinued operations for accident years 1993 and prior. This increase in
claims and claim adjustment expense reserves from the original estimate at the
measurement date resulted from increased frequency and severity of claims
incurred from those years, relative to previous expectations, which in turn
caused an increase in the estimated ultimate claims and claim adjustment expense
reserves related to 1993 and prior years. No similar adjustment was made in
1996.

SNIC supports discontinued operations with $25.9 million of assets. At
December 31, 1996, discontinued operations assets consisted of $17.3 million of
receivables due from reinsurer associated with the 1991 Centre Re Aggregate
Excess of Loss Contract, and $8.6 million of other reinsurance recoverables on
paid and unpaid losses. To the extent that cash recoveries under the Centre Re
contracts do not match cash requirements of SNIC's discontinued operations,
reinsurance receivables will be substituted with cash from continuing
operations, and the reinsurance receivables will be re-established in continuing
operations. Management estimates that discontinued operations will essentially
have "run off" by the year 2000.

The following table provides a reconciliation of the beginning and ending
loss and loss adjustment expense reserves for discontinued operations for each
of the years in the three-year period ended December 31, 1996, computed in
accordance with GAAP.

RECONCILIATION OF LIABILITY FOR DISCONTINUED OPERATIONS CLAIMS AND CLAIM
ADJUSTMENT EXPENSE

YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
-------- -------- --------
(AMOUNTS IN THOUSANDS)

Beginning reserve, gross of reinsurance. . . . . . . . . . . . . . . . . . . . $40,526 $36,410 $54,898
Less: Reinsurance recoverable on unpaid losses. . . . . . . . . . . . . . . . 9,159 8,777 8,379
------- ------- -------
Beginning reserve, net of reinsurance. . . . . . . . . . . . . . . . . . . . . 31,367 27,633 46,519
Provision for net claims and claim adjustment expenses
For claims occurring in current year . . . . . . . . . . . . . . . . . . . --- --- 4,482
For claims occurring in prior years. . . . . . . . . . . . . . . . . . . . --- 15,006 (2,294)
------- ------- -------
Total claim and claims adjustment expenses . . . . . . . . . . . . . . . . --- 15,006 2,188
------- ------- -------
Payments for net claims and claim adjustment expense
For claims occurring in current year . . . . . . . . . . . . . . . . . . . --- --- (3,019)
For claims occurring in prior years. . . . . . . . . . . . . . . . . . . . (12,877) (11,272) (18,055)
------- ------- -------
Total claim and claims adjustment expense payments . . . . . . . . . . . . (12,877) (11,272) (21,074)
------- ------- -------
Ending reserves, net of reinsurance. . . . . . . . . . . . . . . . . . . . . . 18,490 31,367 27,633
Reinsurance recoverable on unpaid losses . . . . . . . . . . . . . . . . . . . 6,976 9,159 8,777
------- ------- -------
Ending reserves, gross of reinsurance. . . . . . . . . . . . . . . . . . . . . $25,466 $40,526 $36,410
------- ------- -------
------- ------- -------

The following table discloses the development of direct discontinued
operations claims and claim adjustment expense reserves from December 31, 1987
through December 31, 1996.

ANALYSIS OF DISCONTINUED OPERATIONS DIRECT CLAIMS AND CLAIM ADJUSTMENT EXPENSE
DEVELOPMENT

Reserve for Direct
Unpaid Claims and
Claim Adjustment
Expenses, Gross of
Reinsurance Recoverables
Reserve. . . . . . . . . . . $12,678 $25,935 $41,088 $56,735 $65,629 $66,532 $54,898 $36,410 $40,526 $25,466
Re-estimated as of:
One Year Later . . . . . 19,879 32,395 56,093 73,295 83,770 73,298 56,041 54,855 41,293
Two Years Later. . . . . 25,865 43,160 60,679 89,336 91,453 73,067 75,703 55,622
Three Years Later. . . . 30,455 43,585 72,860 98,206 90,717 96,531 76,079
Four Years Later . . . . 30,134 52,261 82,218 102,538 117,215 92,569
Five Years Later . . . . 34,215 61,539 84,304 126,431 113,084
Six Years Later. . . . . 38,051 63,072 103,326 123,722
Seven Years Later. . . . 38,844 77,080 104,428
Eight Years Later. . . . 44,129 78,938
Nine Years Later . . 44,866
Cumulative Deficiency. . . . 32,188 53,003 63,340 66,987 47,455 26,037 21,181 19,212 767

Cumulative Amount of Reserve
Paid Through
One Year Later . . . . . 7,529 13,754 19,839 26,587 29,274 26,473 23,043 14,329 15,827
Two Years Later. . . . . 13,146 15,301 26,399 31,124 29,165 23,483 16,203 16,765
Three Years Later. . . . 15,900 19,844 32,188 39,486 28,136 18,380 19,649
Four Years Later . . . . 18,915 23,007 37,758 42,399 23,255 17,777
Five Years Later . . . . 22,329 28,609 38,798 40,990 22,047
Six Years Later. . . . . 26,129 31,715 37,585 45,029
Seven Years Later. . . . 27,645 31,247 42,260
Eight Years Later. . 27,791 37,394
Nine Years Later . . . . 27,780
Gross Reserve - December 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,898 36,410 40,526 25,466
Reinsurance Recoverables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,379 8,777 9,159 6,976
-------- -------- -------- --------
Net Reserve - December 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,519 27,633 31,367 18,490
-------- -------- -------- --------
-------- -------- -------- --------
Gross Re-estimated Reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76,079 55,622 41,293
Re-estimated Reinsurance Recoverables. . . . . . . . . . . . . . . . . . . . . . . . . . 11,816 12,216 9,926
-------- -------- --------
Net Re-estimated Reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,263 43,406 31,367
Net Cumulative Deficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,744 $15,773 $ 0
-------- -------- --------
-------- -------- --------

The first line of the preceding table depicts the estimated liability for
unpaid claims and claim adjustment expense for discontinued operations recorded
for each of the indicated periods. The table follows the form of the table
depicting workers' compensation reserve development in "Analysis of Direct
Claims and Claim Adjustment Expense Development," above.

From 1987 to 1990, the increase in ultimate claims and claim adjustment
expense for discontinued operations was due to the lack of Company history, as
well as changes in economic and legal environments which prevented management
from reasonably estimating ultimate loss costs. Thereafter, a full actuarial
analysis has been performed semi-annually taking into account the Company's
history of reserve development, industry claim experience, and the effects of
litigation on future loss costs.

A significant percentage of the Company's pre-1991 ultimate loss costs and
reserve development is attributable to construction defect claims associated
with commercial package policies sold to general contractors,

developers, and artisan contractors underwritten from 1986 to 1991. Other
carriers writing these same lines of business have also been negatively affected
by the unfavorable increase in claims frequency and severity that occurred as a
result of changes in the economic and legal environment during this time. At
December 31, 1996, approximately $23 million of the total $25.5 million
(approximately 90%) of direct reserves for discontinued operations, and
approximately 893 of the Company's 992 (approximately 90%)
incurred-but-not-reported claim counts, were attributable to expected future
reports of construction defect claims. Approximately $4.9 million of the total
$17.6 million of paid claim and claim adjustment expense for discontinued
operations was attributable to a single claim paid in the first quarter of 1996.

The Company began to monitor separately the effects of construction defect
claims beginning in 1993. Prior to 1993 the effects of construction defect
claims were combined with all other general liability business for reserve
valuation purposes. The frequency, severity, and time lag between the
occurrence and reporting dates of such claims vary significantly from the
statistics associated with all other lines and sublines of the Company's claims
and claim adjustment expense reserves for discontinued operations. Effective
June 30, 1995, the Company recorded approximately a $15 million pre-tax ($9.8
million net of tax) charge for discontinued property and casualty operations due
principally to an increase in management's estimates of
incurred-but-not-recorded construction defect claims.

The frequency of newly reported construction defect claims increased
significantly in July 1995. Management believes the increase in new
construction defect claims was attributable to the California Supreme Court
decision in MONTROSE CHEMICAL CORPORATION V. ADMIRAL INSURANCE COMPANY
("Montrose") handed down in July 1995. The Montrose decision effectively
broadened the definition of "loss occurrence" to include the entire period
beginning with the construction date and ending with the date of judgment
associated with defective construction. Since July 1995 the Company has
received notices of claims on allegedly defective construction projects where
the manifestation of the loss, the immediate cause of the loss, and the first
report of the loss, all fall outside of the Company's policy terms. Regardless,
under the Supreme Court's ruling, the Company is compelled to defend the
"insured" and contribute to loss settlements. Beginning in July 1996 and
continuing through year-end, management began to see the trend in newly reported
claims decline.

Management believes its current reserves are adequate to cover this
increase in claims activity depending on the length of time the recent reporting
trends continue. Management can not predict the volume of future
Montrose-related claims, the cost of handling the claims, or the ultimate
severity of loss associated with such claims. Further, the approximately $15
million pre-tax charge to discontinued operations recorded effective June 30,
1995, was estimated before the effects of the Montrose decision were reflected
in the Company's loss experience. There can be no assurance, therefore, that
further upward development of ultimate loss costs associated with construction
defect claims will not occur.

The Company has also experienced significant development with respect to
loss costs for components of discontinued operations other than construction
defect claims. While these other claims are generally more predictable than
construction defect claims, there can be no assurance that further upward
development of loss costs associated with such claims will not occur.

REINSURANCE

Reinsurance is generally used to reduce the liability on individual risks
and to protect against individual risk or aggregate catastrophic losses. SNIC
follows the industry practice of reinsuring a portion of its risks. The
availability and cost of reinsurance are subject to prevailing market conditions
and may affect SNIC's profitability. SNIC believes the terms of its contracts
are consistent with industry practice and its reinsurance program is based on
security of the reinsurers, coverage, and price. SNIC monitors its reinsurers'
financial condition carefully and recoverable losses are pursued aggressively.
Occasionally SNIC is involved in disputes with reinsurers, which, if not
settled, may be resolved in arbitration. As of December 31, 1996, SNIC was
involved in a dispute with its property and casualty reinsurers as to the
existence of coverage related to a claim in

the amount of $850,000. Management expects to recover the entire disputed
amount. At December 31, 1996, there were no disputes related to the workers'
compensation operations.

Effective June 30, 1991, SNIC entered into an aggregate excess of loss
reinsurance contract ("1991 Contract") with Centre Re. Under the 1991 Contract,
SNIC purchased for $50 million reinsurance for claims and claim adjustment
expense incurred on or prior to June 30, 1991 to the extent that these amounts
were unpaid at June 30, 1991. The coverage obtained was $87.5 million in excess
of SNIC's retention equal to $55.7 million. Additionally, SNIC ceded
approximately $69.1 million of earned premiums and $78.1 million of claims and
claim adjustment expense to Centre Re through December 31, 1992. Total claims
and claim adjustment expenses occurring prior to December 31, 1992 were ceded to
Centre Re in the amount of $165.6 million under the 1991 Contract. Prospective
cessions of premium and claims were effectively terminated by mutual consent of
SNIC and Centre Re effective December 31, 1992, however, all other terms of the
1991 Contract remain in effect until the treaty terminates on January 1, 1998.

During 1996 and 1995, $33.0 million and $19.8 million of ceded losses were
recovered under the 1991 Contract. Reinsurance recoverable (anticipated future
cash reimbursements from reinsurers) of $145.8 million at December 31, 1995 was
expected under the 1991 Contract. Under related reinsurance agreements with
Centre Re, SNIC carried a funds withheld liability of $105.7 million at December
31, 1995, and irrevocable letters of credit of $27.6 million at December 31,
1995.

Effective January 1, 1993, SNIC entered into an aggregate excess of loss
reinsurance contract ("1993 Contract") with Centre Re. From SNIC's perspective
the 1993 Contract substantively operated as a one year contract with at least
four one year options to renew exercisable solely at SNIC's election during the
first five years of the contract. Subsequent to January 1, 1998, the 1993
Contract could have been terminated by either SNIC or Centre Re upon 30 days'
notice. The 1993 Contract required SNIC to cede not less than $15 million and
not more than $20 million of premiums to Centre Re with respect to any covered
accident year. Claims and allocated claim adjustment expenses occurring during
the accident year are ceded to Centre Re in excess of a variable percentage of
earned premium (60% and 56.5% for the 1995 and 1994 accident years,
respectively) and are subject to a limit of 130% of ceded earned premium, not to
exceed $26.0 million for any accident year. Effective January 1, 1996, the 1993
Contract was canceled at SNIC's election. The Company accrued a $5.3 million
charge related to the cancellation of the 1993 Contract.

SNIC maintains excess of loss reinsurance contracts with various reinsurers
and a quota-share contract with Zurich Reinsurance Centre ("ZRC"). Under its
current excess of loss contracts (with multiple reinsurers), various reinsurers
collectively assume liability on that portion of each loss that exceeds $500,000
on a per occurrence basis, up to a maximum of $150 million per occurrence.

Effective January 1, 1994, SNIC entered into a quota-share reinsurance
contract ("Quota Share Contract") with ZRC. Under the Quota Share Contract, ZRC
provides SNIC with an Assumption of Liability Endorsement ("ALE") facility
(based on a 50% quota-share cession during 1995 and 25% during 1996) and has the
option to modify its percentage participation in subsequent years. The ceding
rate under the contract was 20% for 1994, and ZRC and SNIC mutually agreed to
reduce the quota-share participation to 5% for 1995 and 1996. Further, SNIC
receives ceding commissions ranging between 22.5% and 24.5% for premiums ceded
to ZRC. The purpose of the ceding commission is to cover SNIC's cost of
acquiring new business and may be changed as a result of changes in market
conditions on a quarterly basis.

Effective January 1, 1997, the terms of the Quota Share Contract were
amended. Under the amended terms of the Quota Share Contract, ZRC increased its
participation from 5% of premiums written in 1996 to 6.5% in 1997. In exchange
for the increased participation ZRC will no longer receive a separate fee for
policies written on Assumption of Liability Endorsements. In conjunction with
the amendment to the Quota Share Contract, SNIC entered into a fronting
arrangement that permits it to use a ZRC affiliate's A.M. Best "A" rating for an
additional 2% of premiums written under the terms of the fronting arrangement.

Reinsurance makes the assuming reinsurer liable to the insurer to the
extent of the reinsurance ceded, but it generally does not legally discharge an
insurer of its primary liability for the full amount of the policy liability
(except for ALEs). If a reinsurer fails to meet its obligations under the
reinsurance agreement, the ceding company is required to pay the loss. With
respect to policies with an ALE, however, in the event that SNIC is unable to
meet its claim payment obligations, ZRC assumes all responsibility for the
payment of losses related to the policy. All of the excess of loss reinsurance
is with non-affiliated reinsurers.

SNIC's contracts are generally entered-into on an annual basis. SNIC has
maintained reinsurance treaties with many reinsurers for a number of years. In
general, SNIC's reinsurance contracts are of the treaty variety and cover
underwritten risks specified in the treaties. SNIC also from time to time
purchases facultative reinsurance covering specific liabilities or policies
underwritten. As of December 31, 1996, ZRC, General Reinsurance Corporation and
UNUM Life Insurance Co. accounted for 36.8%, 24.8% and 15.6%, respectively, of
total amounts recoverable by SNIC from all reinsurers on paid and unpaid claims
and claim adjustment expenses, and were the only reinsurers that accounted for
more than 10% of such amounts.

INVESTMENTS

The amount and types of investments that may be made by the Company are
regulated under the California Insurance Code and rules and regulations
promulgated by the DOI. The investments of the Company are primarily managed
internally, although SNIC hires an outside investment management company as
needed on a fee for service basis. The Company's consolidated portfolio
consisted almost entirely of fixed income securities as of December 31, 1996.
The bond portfolio is heavily weighted toward short to intermediate term,
investment grade securities rated "A" or better, with approximately 93% rated
"AA" or better.

Funds withheld assets having carrying and market values of $114.9 and
$117.1 million, respectively, at December 31, 1995, were withheld from Centre Re
as collateral under the 1991 and 1993 Contracts. All investment income and
market value risk associated with such assets is Centre Re's. Interest expense
in the amount of $6.1 million and $8.8 million was paid to Centre Re during 1996
and 1995, respectively. At such time that Centre Re was obligated to pay SNIC
under the 1991 and 1993 contracts, SNIC would have been reimbursed for the
carrying of the funds withheld assets. Funds withheld assets were carried as
held-to-maturity until returned to Centre Re in 1996.

The table below contains information concerning the composition of the
investment portfolio at December 31, 1996:

Type of Investment Carrying Market
Amount Value
(1)
-------- --------
BONDS (2) (In thousands)
U.S. government and agencies. . . . . . . . $35,338 $35,338
AA/Aa rated . . . . . . . . . . . . . . . . 1,417 1,417
A rated . . . . . . . . . . . . . . . . . . 3,617 3,617
BBB/Baa rated . . . . . . . . . . . . . . . 2,954 2,954
B rated . . . . . . . . . . . . . . . . . . 3,004 3,004
-------- --------
Total Bonds. . . . . . . . . . . . . 46,330 46,330
Invested cash and short-term investments. . 101,937 101,937
Common stocks . . . . . . . . . . . . . . . 1,173 1,173
-------- --------
Total. . . . . . . . . . . . . . . . $149,440 $149,440
-------- --------
-------- --------

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

(1) Carrying amount is amortized cost for bonds held to maturity, and market
value for bonds held for sale, common stocks, and short-term investments.

(2) Standard & Poor's Corporation defines "AAA" rated securities as "highest
rating, extremely strong security," "AA" rated securities as "very strong
security," "A" as "strong security," "BBB" as adequate security," and "B" as
"low quality." Moody's Investor Services, Inc. defines "Aaa" rated securities
as "best quality," "Aa" as "high quality," "A" as "strong security," "Baa" as
"adequate security," and "Ba" as "low quality."

The table below reflects investments and interest earned thereon and
average annual yield on investments for each year in the five-year period ended
December 31, 1996.

Year Ended December 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(Dollar amounts in thousands)

Total investments at end of period. . . . . . . . . . . . . . . . . . $149,440 $163,951 $174,345 $144,778 $151,354
Net investment income before taxes. . . . . . . . . . . . . . . . . . $7,769 $9,784 $9,049 $9,550 $10,802
Average annual yield on ending investment portfolio (before taxes). . 5.2 % 5.9 % 5.2 % 6.6 % 7.1 %

The Company in monitoring its asset and liability match attempts to keep
the investment duration at the mid-point of the payout pattern. As of December
31, 1996, the investments under the Company's management (excluding funds
withheld) have a duration of 2.77 years.

The table below sets forth the maturity profile of the Company's bond
portfolio at market value as of December 31, 1996:

Bonds Rated (1)
----------------------------------------------------------------------------------
AAA/Aaa AA/Aa A BBB/Baa B Total
--------- ---------- --------- --------- --------- --------
(Dollar amounts in thousands)

1 year or less. . . . . . . . . . . . . $7,309 $ 7,309
More than 1 year, through 3 years . . . 12,984 $3,617 16,601
More than 3 years, through 5 years. . . - --
More than 5 years, through 10 years . . 4,305 $2,954 $3,004 10,263
More than 10 years, through 15 years. . - --
More than 15 years. . . . . . . . . . . 10,740 1,417 12,157
-------- -------- -------- -------- -------- --------
Total . . . . . . . . . . . . . . . . . $35,338 $1,417 $3,617 $2,954 $3,004 $46,330
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------

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

(1) Standard & Poor's Corporation defines "AAA" rated securities as "highest
rating, extremely strong security," "AA" rated securities as "very strong
security," "A" as "strong security," "BBB" as adequate security," and "B" as
"low quality." Moody's Investor Services, Inc. defines "Aaa" rated securities
as "best quality," "Aa" as "high quality," "A" as "strong security," "Baa" as
"adequate security," and "Ba" as "low quality."

INFORMATION SERVICES

The Company emphasizes the development of personal computer based
information and processing systems for use in all areas of its business.
Management believes that personal computer based processing systems enable the
Company to compete more effectively through enhanced policyholder services,
efficient underwriting, more effective claim support systems, reduced processing
costs, and timely management information. One of the Company's key strategic
initiatives is the maintenance of a creative, flexible, and dynamic data
processing ("DP") capability. The Company invested 4.2%, 3.3%, and 1.8% of
direct written premiums in its DP operations in 1996, 1995, and 1994,
respectively.

SNIC management believes that personnel productivity, and underwriting and
claims processing effectiveness, can be greatly improved through its computer
systems. Beginning in late 1991, the Company began to upgrade its DP operations
to take advantage of the new technologies, and switched to a current generation
database engine, to maintain the claims and underwriting databases. The claims
processing system was placed in service in early 1992, and is continually
modified to reflect new procedural and regulatory requirements. A new Windows
based underwriting and policy issue system was placed in service in mid-1993.

Concurrent with the enhancements of the claims and underwriting systems,
management commenced a project to enhance the quality, quantity, and timeliness
of information available to management to monitor the Company's operations, and
to feed-back corrections to the operations personnel. Management believes most
insurance companies monitor their operations, and feed-back corrections to their
staff, quarterly; a large minority do this annually, and a small minority do it
monthly. SNIC management views quarterly or less frequent monitoring and
feedback as insufficient, and from 1992 to mid-1994 systems were implemented to
permit management to control the Company using batch processed reports, mostly
printed on paper, that were prepared no less frequently than monthly and, to a
major extent in the claims department, weekly.

Beginning with the installation of SNIC's proprietary SWAMI-Registered
Trademark- system in mid-1994, SNIC adjusted the Company's monitor and feedback
cycle to no less frequently than weekly and, in many respects, to a daily basis.
Management believes this to be necessary due to the information intensive nature
of the insurance business; lack of information represents a major aspect of
underwriting risk. The role of SWAMI-Registered Trademark- is to provide
quality,

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

- -Registered Trademark- Windows is a trademark of Microsoft Corporation.

detailed, timely information to management as needed to reduce the risk
represented by lack of information. The SWAMI-Registered Trademark- system has
been constantly enhanced since its implementation.

Management considers information monitoring to be meaningful only if the
result is a thorough understanding of the Company's experience; generally, that
means a need to understand claim frequency and severity by workers' compensation
line components, and paid, reported, and ultimate losses, all available by
producing office, claims servicing office, agent, and underwriter. Management
must also have immediate access to the details behind the numbers, and that
information has to be accessible to, and understandable by, non-actuarial and
non-data processing personnel and executives. SWAMI-Registered Trademark-
provides information of sufficient type and quality such that virtually all of
the routine data processing generated paper reports historically used by the
Company have been rendered obsolete.

SWAMI-Registered Trademark- provides a variety of underwriting information
as well. SNIC management has the ability to monitor producer production and
profitability, selected by branch, whether or not in force, and quickly review
any producer's experience in a variety of ways. Detailed information for each
producer can be instantaneously reviewed on an accident year, policy year, or
calendar year basis. The system provides analytical analysis as to producers,
underwriters, or branch operations, which management uses to take corrective
action with respect to unprofitable producers or ineffective staff. The system
permits management to evaluate commissions, in force business, collections
activity, and product pricing, in detail, utilizing information that is no more
than 24 hours old.

The Company has comprehensive physical and virtual safeguards for its
information and processing systems. Disaster recovery programs and back-up
procedures include nightly back-up storage of all transactions and changes to
the system's database. At the end of each business day, the Company transfers
this information to tapes that are stored off site. The Company maintains
back-up systems in the branch offices to use if the main system fails. Computer
access is restricted by use of codes and passwords.

COMPETITION

California is the largest single-state workers' compensation insurance
market in the United States. For 1995, the latest period for which data is
available, the total direct workers' compensation written premiums in the State
of California were approximately $5.9 billion, of which SNIC wrote approximately
$97 million, or 1.6%. Approximately 300 companies reported to the WCIRB that
they wrote workers' compensation insurance in 1995.

The workers' compensation insurance industry in California is extremely
competitive. Many of SNIC's competitors have been in business longer, have a
larger volume of business, offer more diversified types of insurance coverage,
have greater financial resources, and have greater distribution capabilities
than SNIC. SNIC believes the dominant competitor in the California workers'
compensation industry is the State Compensation Insurance Fund. SNIC
historically concentrated on insuring medium to small workers' compensation
accounts with less than $75,000 in annual premiums, where it competed primarily
on the basis of limited loss control services to insureds who were not generally
offered such services, and claim management services. In late 1991, SNIC
developed and began marketing a small workers' compensation product targeted at
accounts with annual premiums below $10,000 where the underlying payroll is
predominately concentrated in specific employment classifications.

The workers' compensation market is commodity-oriented, highly fragmented,
and reflective of intense price competition. Nevertheless, because each risk is
somewhat unique in terms of insurance exposure, different insurers can develop
widely divergent estimates of prospective losses. Most insurers attempt to
segment classes within markets so that they target the more profitable
sub-classes with lower, although adequate, rates given the estimated
profitability of the segment. In some cases, no statistics are available for
the sub-classes involved, and the insurer implements discounted rate structures
based solely on theoretical judgment. Finally, different insurers have
widely-divergent internal expense positions, due to distribution methods,
economies of scale, and efficiency

of operations. Therefore, although workers' compensation insurance is a
commodity, the price of insurance does not necessarily reflect commodity
pricing.

Beginning in mid-1994 many of SNIC's competitors began offering bonus
commissions to their producers ranging from five to ten percentage points or
more above the standard commissions historically paid. Some of SNIC's
competitors continue to offer bonus commission plans in spite of the significant
decline in rate levels experienced since January 1, 1995. To date, SNIC has not
offered bonus commission programs generally to its producers, but when
appropriate, SNIC will negotiate with individual producers on a case-by-case
basis.

SNIC's ability to attract and retain customers (and therefore, producers)
results from price structures tailored to attract certain sub-segments of the
workers' compensation insurance market. Nevertheless, SNIC's existing and
prospective customer bases are vulnerable to competition, especially from larger
insurers, that at any time are capable of penetrating SNIC's markets with
products priced at levels substantially below SNIC's.

REGULATION

SNIG and its subsidiaries are subject to extensive governmental regulation
and supervision. Regulations relate to such matters as prior approval of rates,
adequacy of reserves, types and quality of investments, minimum capital and
surplus requirements, deposit of securities for the protection of policyholders,
statutory financial reporting requirements, and restrictions on shareholder
dividends. SNIG and its insurance subsidiaries are also subject to periodic
examination by the DOI and must file annual and other reports on their financial
condition and other financial matters. In addition, assessments are made
against SNIC to cover liabilities to policyholders of insolvent insurance
companies and various state regulated involuntary or assigned risk pools have
been created to provide insurance coverage for insureds which are unable to
obtain insurance from private companies. The regulation and supervision of
insurance companies by state agencies is designed principally for the benefit of
their policyholders, not their shareholders. SNIG believes that it and its
subsidiaries are in compliance with state regulatory requirements which are
relevant to their respective businesses.

The DOI triennial audit, begun during the fourth quarter of 1995 of SNIC
covering the three years ended December 31, 1994, was completed in 1996 and
indicated no material issues or actions needed to be taken by SNIC in either its
operations or financial statements.

The California Insurance Code requires the DOI to approve any proposed
change of control of the Company. For such purposes, "control" is presumed to
exist if any person, directly or indirectly, owns, controls, holds with the
power to vote, or holds proxies representing more than 10% of the voting
securities of the Company.

The California Insurance Code also limits the amount of dividends or
distributions an insurance subsidiary may pay in any 12-month period to the
greater of (a) net income for the preceding year or (b) 10% of statutory
policyholders' surplus as of the preceding 31 of December. Payments of greater
amounts require the approval of the DOI.

The California Workers' Compensation Reform Act passed into law in 1989
(the "Reform Act") provided for substantial changes to the California workers'
compensation system beginning January 1, 1990. The changes included an increase
of 50% in maximum temporary disability and permanent total disability benefits
over two years and smaller increases in maximum death benefits and maximum
vocational rehabilitation allowances. In addition, the Reform Act created an
arbitration process that was intended to streamline the resolution of contested
claims and reduce the number of medical opinions allowed in such claims. A bill
clarifying and amending certain provisions of the Reform Act became effective on
January 1, 1991. The legislation was intended to provide technical corrections
for the administrative costs of the Reform Act. The legislation revised the
standards for the use of qualified medical evaluators and allows the injured
worker, the employer, and any attorney involved, to use one expert, thus
reducing the costs of defense and medical and legal costs. The bill also
revised the standard for

psychiatric injuries and vocational rehabilitation services. Further, payments
of temporary disability, partial disability, permanent disability and death
benefits were also increased. The increased benefits and inadequate controls
over medical service providers under the Reform Act significantly increased
SNIC's loss payments during 1990, 1991, and 1992.

In July 1993, the California legislature enacted a series of bills to
significantly change the California workers' compensation system ("1993
Reforms"). The 1993 Reforms were intended to provide substantial cost savings
as a result of: (i) a higher compensability standard for psychiatric injuries
through a requirement that work causation be the predominant cause (more than
50%) in contrast to the previously existing 10% cause standard; (ii) a provision
that psychiatric injuries are not compensable if they arise from lawful
personnel actions; (iii) restrictions on post-termination claims unless, among
other things, notice of an injury prior to termination is given; (iv) possible
extension of the employers' control of medical treatment of up to one year;
(v) imposition of a cap on vocational rehabilitation costs of $16,000, which
previously were not subject to maximum dollar limitations; (vi) restrictions on
the number and timing of medical-legal evaluations; (vii) a prohibition on
referrals by physicians and other providers to facilities in which they have a
financial interest; (viii) a requirement that a schedule of medical-legal fees
be developed; and (ix) a strengthening of provisions which are intended to
combat fraudulent claims and abuse of the system by providing for felony
penalties, restitution and civil liability. In each case, these provisions
contain various qualifications and conditions.

The 1993 Reforms also increased insurers' costs as a result of benefit
increases commencing July 1, 1994, and continuing through July 1, 1996. In
addition, the 1993 Reforms reduced revenue through an immediate reduction in
minimum rates of 7%. The legislation permitted the DOI to approve even lower
rates, and, effective January 1, 1994, the DOI ordered a further 12.7% reduction
in minimum rates. Minimum rates were once again reduced by 16.0% effective
October 1, 1994.

Effective January 1995, California's minimum rate law was replaced by an
open rating system. Under this new rating system, individual insurance
companies file rates and rules not less than 30 days prior to their effective
date, and such rates can only be disapproved by the DOI after a hearing and only
on the basis of solvency, market share, or improper filing. The 1993 Reforms
also permit certain large entities or groups in the construction business to
establish alternative workers' compensation programs. The 1993 Reforms contain
numerous other provisions, including limitations on grounds for cancellation of
policies.

SNIC cannot predict the ultimate effect of open rating on its workers'
compensation business, but during the first two years of open rating intense
price competition has been experienced leading to lower average premiums per
policy. The specified benefit increases are scheduled to occur gradually over a
three-year period. The potential cost savings from the other reforms discussed
above may not be realized for some period of time, and there can be no assurance
that the intended benefits of the cost savings provisions will materialize.
SNIC believes the rates it has filed with the DOI are adequate, but it is unable
to predict the degree to which such rates are competitive in the marketplace.

The California legislature passed, and the DOI has issued its guidelines
with respect to the implementation of, Assembly Bill 1913 (AB 1913). AB 1913,
among other things, causes the experience modification factor of a current
workers' compensation policy and the immediately preceding two policies
(regardless of carrier) to be subject to revision if a claim used in a
modification closes on or after January 1, 1995, for a value of 60% or less than
its highest earlier reported value, if the highest reported incurred value was
$10,000 or more. Such a change in the experience modification factor will
require the current workers' compensation carrier to return a portion of a
policyholders' premium for the current and preceding two policies' periods
regardless if the current carrier was the insured's previous carrier. WCIRB
estimates of the ultimate cost to California workers' compensation underwriters
range from 1% to 2.5% of 1996 premium; however, these estimates are based upon
broad industry estimates and could vary significantly from company to company
based upon the type of claims incurred, size of employer, and employer industry
group. Because of the uncertainty and variability regarding the effects of AB
1913, no reasonable estimate of the cost can be made. The Company paid $505,000
in AB 1913 refunds in the year ending December 31, 1996. The Company's
management is monitoring the situation and will book reserves as necessary.

Proposed federal legislation has been introduced from time to time in
recent years that would provide the federal government with substantial power
to regulate property and casualty insurers including state workers' compensation
systems, primarily through the establishment of uniform solvency standards.
Proposals also have been discussed to modify or repeal the antitrust exemption
for insurance companies provided by the McCarran-Ferguson Act. The adoption of
such proposals could have a material adverse impact upon the operations of the
Company.

A risk-based capital formula was adopted by the National Association of
Insurance Commissioners ("NAIC") in December 1993 for the purpose of helping
regulators identify property and casualty insurers that may be in financial
difficulty. Each insurer is required to report to regulators the quality of its
capital as measured by the company's Authorized Control Level Risk Based Capital
("ACLRBC"), and the relationship of its modified capital base to the level of
risk assumed in specific aspects of its operations. The formula does not
address all of the risks associated with the operations of an insurer, but does
provide a minimum threshold measure of capital adequacy by individual insurance
companies. The formula does not purport to compute a target level of capital.
Companies falling below the threshold will be placed into one of four
categories: Company Action Level (ACLRBC multiplied by a factor of 2.0), where
the insurer must submit a plan of corrective action; Regulatory Action Level
(ACLRBC multiplied by a factor of 1.5), where the insurer must submit such a
plan and the regulator will issue a corrective order; Authorized Control Level
(ACLRBC multiplied by 1.0), which includes the above actions and may include
rehabilitation or liquidation; and Mandatory Control Level (ACLRBC multiplied by
a factor of 0.7), where the regulator must rehabilitate or liquidate the
insurer. The Company has calculated its Risk Based Capital requirements at
December 31, 1996 and has capital available in amounts that exceed the highest
level Risk Based Capital requirement.

The NAIC's Insurance Regulatory Information System ("IRIS") was developed
by a committee of state insurance regulators and is primarily intended to assist
state insurance departments in executing their statutory mandates to oversee the
financial condition of insurance companies operating in their respective states.
IRIS identifies eleven industry ratios and specifies "usual values" for each
ratio. Departure from the usual values on four or more of the ratios generally
leads to inquiries from individual state insurance commissioners. Based on the
1996 statutory financial statements, SNIC was within the usual range of all IRIS
tests.

EMPLOYEES

As of December 31, 1996, the Company had approximately 355 employees, none
of whom was covered by a collective bargaining agreement.

ITEM 2. BUSINESS PROPERTIES

The Company's principal executive offices and the Los Angeles Branch share
approximately 40,000 square feet of space in Calabasas, California pursuant to a
lease expiring in 1999. The Company also leases space for branch offices
located in South San Francisco, Sacramento, and Fresno (all in California).
Such leases expire in 1997, 2001, and 2000, respectively. See Note (12) to
Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS

SNIG and its subsidiaries are parties to various legal proceedings, all of
which are considered routine and incidental to the business of the Company and
are not material to the financial condition and operation of the business.
Neither SNIG nor any of its subsidiaries is a party to any litigation expected
to have a material adverse effect upon the Company's business or financial
position.

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

There were no matters submitted to a vote of security holders, through
solicitation of proxies or otherwise, during the fourth quarter of 1996.

PART II

ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S
COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

SNIG's common stock (the "Common Stock") is listed and traded on The Nasdaq
National Market under the trading symbol "SNTL". "The Nasdaq Stock Market" or
"Nasdaq" is a highly-regulated electronic securities market comprised of
competing Market Makers whose trading is supported by a communications network
linking them to quotation dissemination, trade reporting, and order execution
system. This market also provides specialized automation services for
screen-based negotiations of transactions, on-line comparison of transactions,
and a range of informational services tailored to the needs of the securities
industry, investors and issuers. Nasdaq consists of two distinct market tiers:
The Nasdaq National Market and The Nasdaq SmallCap Market. Nasdaq is operated
by The Nasdaq Stock Market, Inc., a wholly-owned subsidiary of the National
Association of Securities Dealers, Inc. Set forth below are the quarterly high
and low closing sale prices for the Common Stock as reported to SNIG by those
broker-dealers believed by SNIG to be most active in making a market in the
Common Stock. As SNIG's Common Stock was not approved for listing on The Nasdaq
National Market until March 5, 1996, quotations prior to SNIG being listed on
Nasdaq are inter-dealer prices (giving effect to the May 25, 1995, four-into-one
reverse stock split), without retail mark-up, mark-down, or commission and may
not necessarily represent actual transactions.

High Low
------ -----
1996
Fourth quarter . . . . . . . . . . $13.75 $9.88
Third quarter. . . . . . . . . . . $10.75 $7.13
Second quarter . . . . . . . . . . $ 8.00 $4.87
First quarter. . . . . . . . . . . $ 5.63 $4.87
1995
Fourth quarter . . . . . . . . . . $6.00 $4.75
Third quarter. . . . . . . . . . . $5.50 $4.75
Second quarter . . . . . . . . . . $5.00 $4.00
First quarter. . . . . . . . . . . $5.40 $4.60
1994
Fourth quarter . . . . . . . . . . $5.00 $4.60
Third quarter. . . . . . . . . . . $5.00 $4.60
Second quarter . . . . . . . . . . $5.00 $4.00
First quarter. . . . . . . . . . . $4.00 $3.00

As of March 5, 1997, the number of shareholders of record of SNIG's Common
Stock was 295 and 3,446,706 shares of Common Stock were outstanding on that
date.

The Company believes the increase in price in the third and fourth quarter
of 1996 is primarily attributable to the announcement of the PRIM transaction.

The Company's current policy is to retain its earnings for use in its
business; it has paid no cash dividends to its shareholders in its two most
recent fiscal years and has no present intention of paying cash dividends in the
foreseeable future. The payment of dividends in the future is subject to the
discretion of the Board of Directors and will depend on the Company's operating
results, financial condition and capital

requirements, general business conditions, and other relevant factors, including
legal restrictions applicable to the payment of dividends by SNIC. The
California Insurance Code restricts the dividends or distributions an insurance
subsidiary may pay in any 12-month period to the greater of (a) net income for
the preceding year, or (b) 10% of statutory policyholders' surplus as of the
preceding December 31. Payments of greater amounts require the approval of the
DOI. Because the Company conducts no substantial business other than through
SNIC, SNIG would be dependent upon dividends from SNIC in order to pay dividends
to SNIG's shareholders.

During the fiscal year ended December 31, 1996, the Company, through a
series of grants to certain employees pursuant to its 1995 Stock Incentive Plan,
awarded (a) an aggregate of 45,934 shares of restricted Common Stock, which
shares are subject to the Company's right of repurchase, and (b) options to
purchase an aggregate of 146,516 shares of Common Stock, vesting in equal annual
increments of 20% from the date of grant of such option and having exercise
prices ranging from $5.20 to $7.70 per share. In issuing such securities, the
Company relied on the exemption from registration under Section 4(2) of the
Securities Act.

ITEM 6. SELECTED FINANCIAL DATA

SELECTED FINANCIAL DATA - YEARS ENDED 1987 THROUGH 1996
(Amounts in thousands, except share and per share amounts.)

OPERATIONS FOR THE YEAR ENDED DECEMBER 31:

1996 1995 1994 1993 1992
---------------------------------------------------------

REVENUES:
Net premiums written $87,715 $89,139 $105,946 $154,431 $59,827
Net earned premiums 88,648 89,735 110,418 153,585 55,892
Net investment income (excluding capital gains
and losses) 7,738 10,309 9,014 8,481 5,050
Net capital gain (loss) 31 (525) 35 1,069 5,752
---------------------------------------------------------
Total revenues 96,417 99,519 119,467 163,135 66,694
---------------------------------------------------------

COMPONENTS OF NET INCOME (LOSS):
Underwriting profit (loss) (2) 4,799 12,060 5,014 (382) 6,554
Investment income and capital gains 7,769 9,784 9,049 9,550 10,802
Interest (expense) (7,527) (9,619) (8,726) (6,221) (1,258)
Other income (expense), net 186 (536) (340) (743) (243)
Federal income taxes benefit (expense) (739) 5,849 (4) 2,304 ---
Preferred securities (dividends and accretion) -
pre-tax (2,525) (2,255) (1,035) --- ---
(Loss) from discontinued operations - pre-tax (3) --- (14,912) --- (4,532) (15,606)
Extraordinary (loss) - pre-tax --- --- (3,064) (686) ---
Cumulative effect of change in accounting for
income taxes --- --- --- 2,297 ---
---------------------------------------------------------
Net income (loss) $1,963 $371 $894 $1,587 $249
---------------------------------------------------------

PER SHARE:(1)
Income (loss) before items below - after all taxes .88 $5.12 $1.45 $1.31 $4.62
Preferred securities (dividends and accretion) -
pre-tax (.48) (.66) (0.30) --- ---
(Loss) from discontinued operations - pre-tax --- (4.35) --- (1.32) (4.55)
Extraordinary (loss) - pre-tax --- --- (0.89) (0.20) ---
Cumulative effect of change in accounting for
income taxes --- --- --- 0.67 ---
---------------------------------------------------------
Net income (loss) $.40 $.11 $0.26 $0.46 $0.07
---------------------------------------------------------

RATIOS FROM CONTINUING OPERATIONS, NET OF
REINSURANCE:
Claim and claim adjustment expense ratio 62.8% 60.1% 71.3% 74.1% 60.7%
Underwriting expense ratio 38.5% 32.8% 19.6% 18.7% 19.4%
Interest and other expense ratio 8.3% 11.3% 8.2% 4.5% 2.7%
Policyholder dividends ratio -6.7% -6.4% 4.5% 7.4% 8.2%
---------------------------------------------------------
Continuing operations combined ratios,
net of reinsurance 102.9% 97.9% 103.6% 104.7% 91.0%
---------------------------------------------------------

PRE-TAX NET INCOME (LOSS) AS A PERCENT OF NET
EARNED PREMIUMS 3.0% -6.1% 0.8% -0.5% 0.4%
RATE OF RETURN ON BEGINNING EQUITY 4.5% 0.9% 2.2% 4.1% 0.7%

FINANCIAL POSITION AT YEAR-END:
Total cash and investments - carrying value $149,440 $163,951 $176,878 $150,179 $154,953
- market value 149,440 166,103 172,706 156,744 154,294
Total assets 306,569 240,781 286,776 264,098 291,487
Long-term debt 98,961 8,530 9,730 6,743 9,192
Claim and claim adjustment expense reserves 115,529 141,495 171,258 171,038 202,634
Total liabilities 237,807 176,256 227,622 224,044 253,012
Preferred securities issued by affiliate 23,571 21,045 18,790 --- ---
Shareholders' equity 45,191 43,480 40,364 40,055 38,475
Book value per share(1) $13.11 $12.68 $11.77 $11.68 $11.22
Outstanding shares(1) 3,446,492 3,430,373 3,429,873 3,429,873 3,429,873

OPERATIONS FOR THE YEAR ENDED DECEMBER 31:

1991 1990 1989 1988 1987
---------------------------------------------------------

REVENUES:
Net premiums written $93,742 $124,957 $96,656 $75,229 $57,064
Net earned premiums 98,119 124,114 91,127 71,780 53,108
Net investment income (excluding capital gains
and losses) 5,436 5,744 4,398 3,245 2,414
Net capital gain (loss) 331 (223) 788 (550) (167)
---------------------------------------------------------
Total revenues 103,886 129,635 96,313 74,475 55,355
---------------------------------------------------------

COMPONENTS OF NET INCOME (LOSS):
Underwriting profit (loss) (2) (20,912) 3,978 4,994 12,433 4,260
Investment income and capital gains 5,767 5,521 5,186 2,695 2,247
Interest (expense) (158) (478) (603) (570) ---
Other income (expense), net (456) (162) (154) 152 (38)
Federal income taxes benefit (expense) 6,538 (1,741) (1,820) (4,175) (1,592)
Preferred securities (dividends and accretion) -
pre-tax --- --- --- --- ---
(Loss) from discontinued operations - pre-tax (3) --- --- --- --- ---
Extraordinary (loss) - pre-tax --- --- --- --- ---
Cumulative effect of change in accounting for
income taxes --- --- --- --- ---
---------------------------------------------------------
Net income (loss) ($9,221) $7,118 $7,603 $10,535 $4,877
---------------------------------------------------------

PER SHARE:(1)
Income (loss) before items below - after all taxes ($2.69) $2.08 $2.22 $3.14 $1.47
Preferred securities (dividends and accretion) -
pre-tax --- --- --- --- ---
(Loss) from discontinued operations - pre-tax --- --- --- --- ---
Extraordinary (loss) - pre-tax --- --- --- --- ---
Cumulative effect of change in accounting for
income taxes --- --- --- --- ---
---------------------------------------------------------
Net income (loss) ($2.69) $2.08 $2.22 $3.14 $1.47
---------------------------------------------------------

RATIOS FROM CONTINUING OPERATIONS, NET OF
REINSURANCE:
Claim and claim adjustment expense ratio 95.7% 67.9% 63.9% 53.2% 62.7%
Underwriting expense ratio 27.9% 27.9% 27.4% 26.8% 25.9%
Interest and other expense ratio 0.6% 0.5% 0.8% 0.6% 0.1%
Policyholder dividends ratio 11.7% 1.9% 5.0% 4.4% 4.5%
---------------------------------------------------------
Continuing operations combined ratios,
net of reinsurance 135.9% 98.2% 97.1% 85.0% 93.2%
---------------------------------------------------------

PRE-TAX NET INCOME (LOSS) AS A PERCENT OF NET
EARNED PREMIUMS -16.1% 7.1% 10.3% 20.5% 12.2%
RATE OF RETURN ON BEGINNING EQUITY -19.6% 17.6% 23.7% 51.5% 41.4%

FINANCIAL POSITION AT YEAR-END:
Total cash and investments - carrying value $82,285 $86,183 $102,193 $64,844 $48,277
- market value 85,463 86,641 102,447 64,109 47,721
Total assets 124,843 172,726 158,759 103,697 69,299
Long-term debt --- 2,635 4,500 5,000 ---
Claim and claim adjustment expense reserves 44,716 78,009 56,199 41,478 29,394
Total liabilities 86,840 125,760 118,344 71,589 48,824
Preferred securities issued by affiliate --- --- --- --- ---
Shareholders' equity 38,003 46,966 40,415 32,109 20,475
Book value per share(1) $11.08 $13.70 $11.78 $9.58 $6.16
Outstanding shares(1) 3,429,873 3,429,323 3,430,973 3,351,578 3,326,047

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

(1) Adjusted to reflect a four-into-one reverse stock split effective as of May
24, 1995.
(2) In 1991, several liabilities were revised upward including property and
casualty and workers' compensation claims and claim adjustment expense of
$22.6 million, policyholders dividends of $7.1 million, and employee
severance of $1.2 million. In addition, premiums receivables were written
down by $4.0 million.
(3) The Company's losses from discontinued operations resulted principally from
contractors' and developers' liability business underwritten from 1986 to
1991.

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

The following discussion and analysis provides information that management
believes to be relevant to an understanding of the Company's consolidated
results of operations and financial condition. The discussion should be read in
conjunction with the consolidated financial statements and the notes thereto.

OVERVIEW

GENERAL. The Company's net income was $1,963,000 for the year ended
December 31, 1996 as compared to $371,000 for the same period in 1995. Net
income per share for the year ended December 31, 1996 was $0.40 versus $0.11 in
1995. Income before preferred securities accretion, discontinued operations,
and extraordinary loss was $3,630,000 for the year ended December 31, 1996
versus $11,701,000 in 1995. The decrease in the 1996 period is due principally
to a $5.3 million fee for reinsurance, as well as an increase of $1.7 million
from 1995 in claims and claims adjustment expense. Income before preferred
securities accretion, discontinued operations, and extraordinary loss, excluding
the above discussed adjustments, was $10,630,000 for the year ended December 31,
1996 as compared to $11,701,000 for the comparable period in 1995.

The Company's net income was $371,000 for the year ended December 31, 1995,
versus $894,000 in 1994. Net income per share was $0.11 for 1995 versus $0.26 in
1994. Income before preferred securities accretion, discontinued operation, and
extraordinary loss was $11,701,000 for 1995 versus $3,599,000 in 1994, due
principally to favorable adjustments relating to prior year income effects
totaling $13.7 million, consisting of favorable workers' compensation reserve
development, adjustments to policyholder dividend reserves, and tax benefits
resulting from an IRS settlement. Net income for both 1995 and 1994 was
impacted by extraordinary items, including a $9,842,000 net of tax charge to
discontinued operations in the second quarter of 1995, and $2,022,000 net of tax
charge associated with the retirement of the Company's debt incurred in 1992,
effective June 30, 1994.

Net income from 1995 accident and policy year operations was generally
lower versus 1994 due to decreased premium production before and after
reinsurance, increased commission expense caused by reductions in ceded
commissions, increased overhead expenses, and accrued preferred securities
accretion.

The operating results of the workers' compensation insurance industry are
subject to significant fluctuations from quarter to quarter and from year to
year due to the effect of competition on pricing, the frequency and severity of
losses incurred in connection with general economic conditions and changes in
regulatory environment. Fluctuations in interest rates also have a significant
impact on the Company's operating results, as over 50% of the Company's total
assets were interest-bearing investments at December 31, 1996.

SNIC is domiciled in the State of California and prepares its statutory
financial statements in accordance with accounting practices prescribed or
permitted by the DOI. SNIC received written approval from the DOI as to the
accounting for certain aspects of its Centre Re aggregate excess of loss
contracts and the accounting of the assets of SNIC's subsidiary, WSSC. See Note
10 to the Consolidated Financial Statements.

In 1994, after the Company's decision to withdraw from the property and
casualty markets late in 1993, the Company's management focused its effort on
its workers' compensation operations. Also during 1994, several major financing
transactions were completed as discussed in the "Financial Condition" section
below.

In September 1993, in addition to discontinuing its property and casualty
business, the Company also discontinued writing workers' compensation insurance
through its Calabasas Branch due to its poor underwriting results. Management
attributed this situation to the prolonged recession in Southern California as
well as the litigious

nature of the area which, in addition to increasing overall claim costs, had a
greater prevalence of fraudulent claims than other geographical areas in
California. Management does not expect the adverse developments experienced
during 1993 and 1992 on prior years' Southern California business to continue in
the future. As of December 31, 1996, the discontinued Calabasas Branch
continued to "run off" in accordance with management's expectations.

During the first half of 1995, the Company re-entered the Southern
California market with a new marketing and underwriting team targeting different
producers, insureds and industries. The effect of this operation has not been
material, with net premiums written totaling $7.5 million, 8% of the total
premium written, for 1996.

CHASE LOAN. In November 1996, the Company entered into a financing
transaction involving Centre Re and Chase Manhattan Bank (Chase). Chase
extended a $93.1 million term loan (net of transaction costs). The Company used
the proceeds from the financing to purchase from SNIC reinsurance receivables
due from Centre Re.

The principal balance of the loan amortizes based on the payout pattern of
the underlying claims of the reinsurance receivables. Approximately $6.0
million will be payable in 1997; $33.7 million in 1998; $25.6 million in 1999;
$15.2 million in 2000 and immaterial annual amounts thereafter through 2004
totaling approximately $11.2 million. The effective interest rate of the loan
will be approximately 6.87%. See Note 8 to Consolidated Financial Statements.
The reason for the transaction was its positive impact on liquidity and
anticipated positive impact on investment income in future periods. The
realization of investment income is dependent on the performance of the
Company's portfolio, as well as factors beyond the Company's control, such as
interest rates and economic conditions generally.

PRIM ACQUISITION. The Company has agreed to acquire Pac Rim Holding
Corporation for $42 million in cash. (The acquisition is subject to regulatory
and shareholder approval.) PRIM, through its wholly-owned subsidiary, the
Pacific Rim Assurance Company ("PRAC"), is engaged in the underwriting of
workers' compensation insurance principally in California, and also in Arizona,
Texas, Georgia and Alabama. The acquisition of PRIM provides the opportunity
for the Company to realize immediate strategic and financial benefits. The
consolidation of two mid-sized companies whose home offices are located only
eight miles apart should provide significant economies of scale that neither
company could achieve independently. The combined company will be able to
spread fixed costs over a wider premium base. In addition, PRIM's strong
presence in Southern California complements the Company's historical focus on
Northern and Central California. The foregoing statements contain
forward-looking statements regarding efficiencies and economies of scale that
management believes may be achieved through the acquisition of PRIM.
Realization of management's beliefs and projections will depend on a number of
factors, including management's successful execution of its business plan for
integrating the operations of the two companies, the insurance market's
reception to the combined companies, and other factors beyond the Company's
control.

The terms of the transaction with PRIM represent a $12 million purchase
price reduction from the $54 million purchase price announced in September 1996.
An increase in the loss and loss adjustment expense reserves of PRAC by $12
million as of December 31, 1996 necessitated renegotiation of the terms of the
prior agreement. The reserve adjustment resulted in PRAC experiencing an
operating loss of $15.9 million in 1996 for the fiscal year ended December 31,
1996. In order to recognize the full benefits of the transaction, the Company
intends to strengthen PRAC financially by contributing $10 million to PRAC's
capital. Depending on claims experience, additional reserve strengthening for
PRAC (to be renamed Superior Pacific Casualty Company) could be required over
the next five years for accident years 1996 and prior; however, such reserve
adjustments would not be expected to be material to the combined Company's
operating results, and the Company expects to realize strategic and financial
benefits from the acquisition as outlined in the previous paragraph.

Financing for the acquisition of PRIM and the capital contribution will be
obtained by issuing 2,390,438 shares of Common Stock under a Stock Purchase
Agreement entered into September 17, 1996, as amended and restated February 17,
1997, by and among the Company, Insurance Partners, L.P., Insurance Partners
(Offshore) Bermuda, L.P., TJS Partners, L.P. and members of management of the
Company. The shares will be sold at $7.53 per share for a total of $18 million.
In addition, the Company will borrow $44 million from a syndicate of banks led
by Chase, and use part of the proceeds of such loan to refinance existing
long-term debt as well as for

the acquisition and capital contribution. While the Company believes that an
efficient market will have already made appropriate allowances in arriving at
the current price of the Company's shares, the issuance of Common Stock upon
closing of the PRIM transaction at $7.53 per share represents a significant
dilutive event to shareholders based upon the closing price of $13.50 per share
on Nasdaq for the Company's Common Stock on March 5, 1997. In addition, certain
of the purchasers under the Stock Purchase Agreement will be granted
registration rights, and it is likely that all purchasers will be able to sell
shares into the public market under Rule 144 under the Securities Act, beginning
in limited amounts after one year, and, for purchasers who are not then
affiliates, in unlimited amounts after two years.

FINANCIAL CONDITION

Total assets increased $65.8 million to $306.6 million at year-end December
31, 1996. The increase was primarily the result of the proceeds received from
the Chase financing agreement, which were partially offset by a $14.5 million
decrease in investments and a $14.3 million decrease in reinsurance recoverable.

Total liabilities increased $61.6 million to $237.8 million. The increase
in total liabilities is due to the recording of $92 million in long term debt
related to the Chase financing agreement.

Reinsurance recoverable on unpaid losses decreased $13.8 million in 1996
primarily due to the settlement of the 1991 Contract and the return of our funds
withheld assets. Premiums receivable decreased due to improved collection
efforts by the Company.

Policyholder dividends liability decreased $8.1 million due to 1996
dividend payments to policyholders of $1.3 million and adjustment to
policyholders dividend reserves of $6.8 million in response to the market change
in pricing from a statutory basis to an open rating basis. The Company has
discontinued paying policyholder dividends.

RESULTS OF OPERATIONS

Premiums have stabilized in 1996 from the decline in 1995. This
stabilization is due to management's focus on small profitable accounts and the
renewal of those accounts. Premiums had been declining due to competitive
pressures and strategic decisions to focus on smaller accounts. Management is
committed to maintaining operating margins by avoiding exchanging margins for
market share.

Over the past three years, the underwriting results have fluctuated
significantly. The 1996, 1995 and 1994 years returned an underwriting profit of
$4.8 million, $12.1 million and $5.0 million, respectively. The 1996 decrease
in comparison to the 1995 underwriting results was due primarily to a $5.3
million charge recorded in 1996 related to the settlement of the 1993 Centre Re
contract and an increase in net claims and claims adjustment expenses of $1.7
million due to adverse development in the 1995 accident year. The 1995
improvement as compared to 1994 was due to decreases in workers' compensation
reserves of $2.2 million and policyholders dividend reserves of $5.7 million.
These decreases were partially offset by increased underwriting, overhead and
general and administrative expenses.

During the second quarter of 1995, the Company received a $1.7 million tax
refund from the Internal Revenue Service, which confirmed the Company's tax net
operating loss ("NOL") position. Accordingly, the valuation allowance that was
established with the adoption of FAS 109 in 1993 is no longer deemed necessary.
The Company's management has reviewed its deferred tax asset balance and
concluded it is more likely than not the entire deferred tax asset will be
realized. Management's conclusion is based on the utilization of its NOL and
its expectation that sufficient taxable income will be generated in future
periods. The Company is expected to be profitable in the future and has
demonstrated such for the last three years ended December 31, 1996.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

Selected financial data as reported for the twelve months ended December 31,
1996 and 1995 are presented below.

TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------
1996 1995
--------------- --------------
(Dollars in thousands)

Gross premiums written $ 99,282 $ 97,084
Net premiums written 87,715 89,139
Net premiums earned 88,648 89,735

Claims and claim adjustment expenses 55,638 53,970
Underwriting expenses 34,138 29,447
Policyholder dividends (5,927) (5,742)

Underwriting profit (loss) 4,799 12,060

Net investment income 7,769 9,784

UNDERWRITING RATIOS (GAAP BASIS)
Claims and claim adjustment expense ratio 62.8% 60.1%
Underwriting expense ratio 38.5% 32.8%
Policyholder dividends ratio (6.7)% (6.4)%
--------------- --------------
Combined ratio 94.6% 86.5%
--------------- --------------
--------------- --------------

GROSS PREMIUMS WRITTEN increased 2.3% to $99.3 million in 1996 from $97.1
million in 1995. The increase in premiums written is attributable to SNIC's
strategy to underwrite smaller risks. The Company's strategy is to continue to
focus on profitable operating margins first and market share second. The
Company continues to make strenuous efforts to increase production, subject to
the constraints of sound underwriting, and to develop profitable niches. The
result of this strategy was a 24% increase in policy count, which was offset by
a 20% decrease in average written premiums per policy. The Company believes the
acquisition of PRIM will enhance its ability to pursue this strategy.

NET PREMIUMS EARNED decreased 1.2% to $88.6 million in 1996 from $89.7
million in 1995. The decrease in net premiums earned, coupled with an increase
in gross premiums written, reflects an increase in ceded insurance.

CLAIMS AND CLAIM ADJUSTMENT EXPENSE increased 3.1% to $55.6 million in 1996
from $53.9 million in 1995. The increase of $1.7 million is due to adverse
development in the 1995 accident year. The claims and claim adjustment expense
ratio as a percentage of net earned premium increased slightly to 62.8% in 1996
from 60.1% in 1995.

UNDERWRITING EXPENSES, excluding policyholder dividends, increased $4.7
million or 16% in 1996 from 1995. The increase was due primarily to a $5.3
million adjustment recorded in the second quarter of 1996 for accrued costs
related to the settlement of a reinsurance contract. Underwriting expenses for
1996, excluding the $5.3 million in accrued costs, were $28.8 million as
compared to $29.4 million in 1995. The underwriting expense ratio, excluding
the $5.3 million in accrued costs, was 32.5% for 1996 which is comparable to
32.8% in 1995.

POLICYHOLDER DIVIDENDS for 1996 were comparable to 1995, a decrease of $5.9
million in 1996 versus a decrease of $5.7 million in 1995. Prior to open
rating, policyholder dividends served both as an economic incentive to employers
for safe operations and as a means of price differentiation. As a result of
consumers' preference for the

lowest net price at the policy's inception under open rating, dividend paying is
no longer a significant factor in the marketing or selling of workers'
compensation insurance in California.

UNDERWRITING PROFIT from continuing operations decreased $7.2 million to
$4.8 million in 1996 from $12.0 million in 1995. The change in underwriting
results for 1996 is attributable to a $4.7 million increase in underwriting
expense principally due to the cost of canceling the Centre Re contract and a
$2.0 million increase in claims and claim adjustment expense due mainly to prior
accident year adverse development.

NET INVESTMENT INCOME decreased $2 million or 20% in 1996 as compared to
1995. The decrease is attributable to a decrease in the average investable
assets of $11.3 million, and a decline in the average portfolio investment yield
as a result of generally lower market interest rates in 1996 as compared to
1995. See the discussion in LIQUIDITY AND CAPITAL RESOURCES below. The Chase
financing, discussed above, substantially increased the size of the investment
portfolio on which SNIC retains the investment income. However, that
transaction took place too late in 1996 to have a material effect on 1996 net
investment income results.

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

Selected financial data as reported for the twelve months ended December 31,
1995 and 1994 are presented below.

TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------
1995 1994
--------------- --------------
(Dollars in thousands)

Gross premiums written $97,084 $134,769
Net premiums written 89,139 105,946
Net premiums earned 89,735 110,418

Claims and claim adjustment expense 53,970 78,761
Underwriting expenses 29,447 21,660
Policyholder dividends (5,742) 4,983

Underwriting profit 12,060 5,014

Net investment income 9,784 9,049

UNDERWRITING RATIOS (GAAP BASIS)
Claims and claim adjustment expense ratio 60.1% 71.3%
Underwriting expense ratio 32.8% 19.7%
Policyholder dividends ratio (6.4)% 4.5%
--------------- --------------
Combined ratio 86.5% 95.5%
--------------- --------------
--------------- --------------

GROSS PREMIUMS WRITTEN decreased $37.7 million or 28% in 1995 from 1994.
The significant decrease in premium production was due to the competitive
effects of the open rating system in California which replaced California's
minimum rate law effective January 1, 1995. In 1995, production measured in
policy counts was 8% higher than the 1994 period, but the estimated annual
premium associated with those policies was down 26%. The Company's strategy is
to continue to focus on profitable operating margins first and market share
second. The Company is making strenuous efforts to increase production, subject
to the constraints of sound underwriting standards, and to reduce the Company's
fixed and semi-fixed expense ratios commensurate with premium levels. Since
1995, the Company has pursued new markets and distribution channels to increase
market share in profitable niches, such as Phoenix, Arizona, which commenced
operations October 1, 1995.

NET PREMIUMS WRITTEN decreased $16.8 million or 16% in 1995 from 1994. The
decrease in net premiums written is reflective of the decrease in gross premiums
written as discussed above, but was partially offset by a

decrease in ceded premiums of $20.9 million for the twelve months ended December
31, 1995. The decrease in ceded premiums of $20.9 million was related to a
reduction in the ceding rate from 20% in 1994 to 5% in 1995 in the quota-share
contract with ZRC and lower direct premium production in 1995 compared to 1994.

NET PREMIUMS EARNED decreased $20.7 million or 19% in 1995 from 1994. The
decrease in net premiums earned reflects the decrease in net premiums written
described above.

CLAIMS AND CLAIM ADJUSTMENT EXPENSE decreased $24.8 million or 31% in 1995
from 1994. The claims and LAE ratio decreased 11.2 percentage points to 60.1%
in 1995 from 71.3% in 1994. The 1995 claims and LAE include a $2.2 million
decrease in the estimated ultimate claims and LAE on accident years prior to
1995 as a result of continued decreases in the Company's estimates of frequency
and severity of claims incurred for those years. The Company's estimates are
consistent with those of its outside actuaries. This favorable development
provided a 2.5 percentage point improvement in 1995. The remaining decrease of
8.7% in claims and LAE ratio was due to the decline in frequency and severity of
the reporting claims to the Company continued through 1995 accident year.

UNDERWRITING EXPENSES, excluding policyholder dividends, increased $7.8
million or 36% in 1995 from 1994. The increase was primarily due to a $4.5
million decrease in ceding commissions in 1995 from the quota-share contract
with ZRC offset, in part, by a decrease in direct commission expense of $3.0
million due to lower premium production. The remaining increase in underwriting
expenses was due to higher general and administrative expenses in 1995.

POLICYHOLDER DIVIDENDS decreased $10.7 million in 1995 from 1994. The
decrease was primarily due to $5.7 million reduction in the policyholder
dividend accrual in 1995 compared to a policyholder dividend accrual of $5.1
million in 1994.

UNDERWRITING PROFIT from continuing operations increased $7.0 million for
the year ended December 31, 1995. The improvement was primarily due to a $10.5
million increase in underwriting profit attributable to a $4.8 million decrease
in workers' compensation reserves and $5.7 million reduction in policyholder
dividends. In 1995, the Company, based upon internally developed estimates,
decreased workers' compensation reserves by $4.8 million due to continued
favorable loss reserve development on accident years prior to 1995. The
Company's estimates are consistent with reserve estimates of its outside
independent actuaries. Also, in 1995, the Company adjusted its reserves for
policyholder dividends downward by $5.7 million. This was offset by an increase
in underwriting expense of $7.8 million in 1995. The $7.8 million increase in
1995 was primarily due to a $3.0 million decrease in ceding commission as
compared to 1994. Underwriting results for the twelve months ended December 31,
1995, excluding the unusual items discussed earlier, decreased $0.9 million due
primarily to decreased premium production not commensurate with the decrease in
commission and overhead expenses.

NET INVESTMENT INCOME increased $0.7 million or 8.1% for the period ended
December 31, 1995. Of the $0.7 million increase, $0.1 million was attributable
to a 10 basis point increase in the investment yield to 5.70% for the twelve
months of 1995 from 5.60% for the 1994 period. The increase is generally due to
higher investment yields received as a result of general increases in interest
rates during the second half of 1994. The remaining $0.6 million increase
occurred as a result of a 6.3% increase in average investable assets at December
31, 1995 versus December 31, 1994.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is a measure of an entity's ability to secure sufficient cash to
fulfill its contractual obligations and operating needs. The Company's cash
inflows are generated from cash collected from policies sold and investment
income generated from its existing portfolio. The Company's cash outflows are
required primarily to pay policyholders' claims, operating expenses, and,
historically, dividend obligations. Generally, premium is collected months or
years before claims are paid under the policies purchased by the premium. These
funds are used first to pay current claims and expenses. The balance is
invested in high quality securities to augment the investment income generated
by the existing portfolio. Beginning in 1995, there has been a negative impact
on cash flows due to several factors, including a decline in premiums as a
result of the open rating system adopted in California effective January 1, 1995
and the continued payments of property and casualty claims. While the Company
monitors its cash flow carefully, it does not view the trend negatively as it
reflects the run-off of claims written on the higher premium volumes that
existed prior to January 1, 1995, the start of open rating. Further, the
Company's open reserves of P&C claims have declined from $40.5 million in
December 1995 to $25.5 million in 1996. In 1996, somewhat off-setting these
factors are the recovery of reinsurance receivables under the 1991 Centre Re
contract, but such receivables have now been purchased by SNIG and pledged as
collateral to Chase . Additionally, as a result of a pay down of its workers'
compensation claims and claim adjustment expense, the Company expects the DOI to
release approximately $20 million in excess assets currently pledged to secure
future workers' compensation claims. Subsequent to the release of the excess
assets, additional funds will be available for any working capital needs of the
Company. Furthermore, the Chase financing described above has had a positive
impact on liquidity and is anticipated to have a positive impact on investment
income in future periods, although realization of additional income is not
assured.

For its insurance operations, SNIC must have available cash and liquid
assets to meet its obligations to policyholders and claimants in accordance with
contractual obligations in addition to meeting its ordinary operating costs. It
is management's opinion that its present cash resources, with the addition of
$44 million in additional bank debt and $18 million in equity anticipated in
connection with the PRIM acquisition, are sufficient to meet the needs of the
Company, including after the acquisition of PRIM.

After the closing of the PRIM acquisition, should it be completed, the
Company may seek to boost the statutory capital of SNIC in order to pursue new
business opportunities. On February 4, 1997, the Company announced the signing
of a non-binding letter of intent to complete a private placement of Common
Stock with Insurance Partners, L.P. ("IP Delaware") and Insurance Partners
Offshore (Bermuda), L.P. ("IP Bermuda," and with IP Delaware, "IP"), parties
providing the bulk of the equity investment in the PRIM transaction, of up to
$32.5 million, at a price of $11.775 per share, and to issue rights to purchase
Common Stock to shareholders and warrant holders of record as of the close of
business on February 4, 1997 in order to raise a matching amount of capital of
up to $32.5 million, in which rights offering IP would act as standby purchaser.
The letter of intent contemplated that the funds would be used by the Company to
participate in the rehabilitation of Golden Eagle Insurance Company. However,
after the Company determined it would not participate in the rehabilitation, at
least in the near term, it requested that IP keep the letter of intent in place
should the Company desire to raise additional capital following the closing of
the PRIM transaction, so as to provide the Company added financing flexibility.
Additional capital could help the Company better compete in the turbulent market
in California for provision of workers' compensation insurance, better position
the Company with respect to review by insurance rating agencies, and permit
growth in premium volume. The additional capital needs of the Company, if any,
have yet to be determined and any transaction may be delayed to better gauge the
business opportunities generated by the PRIM transaction and the reaction of
rating agencies to the combination of the companies. Before proceeding with any
transaction with IP under the letter of intent, the Board of Directors will
consult with financial advisors as to fairness and, if necessary, based upon the
number of shares to be issued and other factors, will seek shareholder approval
to issue additional stock. To the extent consistent with the fiduciary duties
of the Board of Directors, the Company has indicated to IP that it would offer
IP the first opportunity to provide additional capital under the terms of the
letter of intent, should the need for additional capital arise. The issuance of
rights to purchase Common Stock, if it occurs, would be subject

to registration with the SEC under the Securities Act. Any offering of rights,
if made, would be made only by means of a prospectus.

The effect of inflation on the revenues and net income of SNIG and SNIC
during all three periods discussed below was not significant.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

The Company believes that it has adequate short-term investments and
readily marketable investment grade securities to cover both claim payments and
expenses. As of December 31, 1996, the Company had total cash, cash equivalents
and investments of $149.4 million. This amount includes $1.45 million in
restricted investments. The Company's remaining invested assets were comprised
of $46.3 million in bonds and notes, held at market value; $1.2 million in
equity securities; and $100.5 million in cash and invested cash, including
certificates of deposit with maturities less than one year and money market
deposits. It is management's belief that the liquidity of these investments is
sufficient to meet the Company's obligations and liabilities through December
31, 1997.

The Company used $14.9 million in cash from operating activities for the
year ended December 31, 1996 compared to $23.8 million during the year ended
December 31, 1995. The improved cash flow from operations was primarily the
result of lower claim and claim adjustment expense payments and policyholder
dividends. This positively impacts liquidity and investment income in future
periods. See OVERVIEW.

Early in 1995, SNIC entered into a reverse repurchase facility with a
national securities brokerage firm ("broker") that allows SNIC to engage in up
to $5 million in reverse repurchase transactions secured either by U.S. Treasury
instruments or U.S. Agency debt. This arrangement provides SNIC with additional
short-term liquidity. Under the facility, SNIC contacts the broker and
indicates the size of the reverse repurchase transaction desired, and the nature
of the security SNIC proposes to "sell" to the broker. Based upon the
characteristics of the security, the broker indicates at what price it will
purchase the security and what rate they will sell the security back to SNIC in
30 days. SNIC then transfers the security to the broker in exchange for the
agreed-upon proceeds. SNIC repurchases the security from the broker at a later
date at a previously agreed-upon price. SNIC may roll over any reverse
repurchase transaction, and the transaction is repriced at the time of roll
over. This type of financing allows SNIC a great deal of flexibility to manage
short-term investments, avoiding the unnecessary realization of losses to
satisfy short-term cash needs. Further, this method of financing is relatively
inexpensive as compared to bank debt. Reverse repurchase transactions are
viewed as short-term financing both by the DOI and current accounting
literature. As of December 31, 1996, SNIC had no obligation outstanding under
this facility. Historically, for long-term financing, the Company required
borrowings in order to meet its obligations.

Because SNIG depends primarily on dividends from its insurance subsidiary
for its net cash flow requirements, absent other sources of cash flow, SNIG
cannot pay dividends materially in excess of the amount of dividends that could
be paid by SNIC to SNIG. Insurance companies are also subject to restrictions
affecting the amount of shareholder dividends and advances that may be paid
within any one year without the prior approval of the DOI. The California
Insurance Code provides that amounts may be paid as dividends on an annual
noncumulative basis (generally based on the greater of (1) net income for the
preceding year or (2) 10% of statutory surplus as regards policyholders as of
the preceding December 31) without prior notice to, or approval by, the DOI. No
cash dividends were paid in 1996 and 1995.

SNIC is a party to various leases principally associated with the Company's
home and branch office space. Such leases contain provisions for scheduled
lease charges and escalations in base rent over the lease term. The Company's
minimum commitment with respect to these leases in 1997 is approximately $1.9
million. These leases expire from 1997 to 2001. See Note 12 to the
Consolidated Financial Statements.

Excluding the Company's commitment to acquire PRIM, the Company has no
significant cash commitments beyond its obligations to pay claims, ceded
reinsurance premiums, lease expenses and the Company's commitments to pay
principal and interest on the bank debt.

Effective June 30, 1994, the Company entered into a $10 million term loan
agreement (the "1994 Loan") with Imperial Bank, which was used to retire
subordinated notes issued during 1992. This term loan is to be fully amortized
over seven years with quarterly payments of $300,000 plus interest per quarter
for years one and two, $350,000 plus interest per quarter for years three and
four, and $400,000 plus interest per quarter for years five, six and seven.
Effective July 1, 1995, the borrowing rate was changed from Imperial Bank's
prime rate plus one half percent to a fixed rate of 8% per annum. Additionally,
under the amended terms of the 1994 Loan, the Company could not prepay the Loan
until July 1, 1996. At such time, the Loan may be prepaid based upon an agreed
upon premium which varies by year. The premium for 1997 is 3.5%; 1998 is 2.5%;
1999 is 1%; and 2000 is none.

The Company must adhere to certain requirements and provisions to be in
compliance with the terms of the Imperial Bank notes. The provisions require
SNIC to maintain certain financial ratios and SNIG to maintain Imperial Bank
certificates of deposit in an amount equal to 20% of SNIG's outstanding balance
under the 1994 Loan. At December 31, 1996, the Imperial Bank certificates of
deposit were $1.5 million, all of which was restricted. The Company is in
compliance with all loan covenants as of December 31, 1996.

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

As of December 31, 1995, the Company had total cash, cash equivalents, and
investments of $163.9 million. Included in these amounts is an aggregate of
$114.9 million in funds withheld from Centre Re. As of December 31, 1995, the
Company's investment balances were comprised of $42.1 million in bonds and notes
available-for-sale, $.7 million in common equity securities, $114.9 million in
funds withheld from reinsurers and $6.3 million in cash and invested cash,
including certificates of deposit with maturities of less than one year and
money market deposits.

The Company used $23.8 million in cash from operating activities for the
twelve months ended December 31, 1995 compared to cash generated of $6.2 million
for the comparable period of the prior year. The $30.0 million decline in cash
from operating activities was primarily due to $23.1 million decrease in
premiums received net of reinsurance in 1995.

The Company (used) generated ($1.2) million and $21.6 million in cash from
financing activities in 1995 and 1994, respectively. The use of cash in 1995
was related to the principal paydown of the bank term loan. The cash generated
by financing activities in 1994 was funded principally by the sales of preferred
securities ($18.0 million) and warrants to affiliates of Centre Re ($2.0
million), and the net proceeds of refinancing the Company's 1992 Notes with bank
debt ($2.1 million).

Net cash provided by investing activities was $28.8 million in 1995 which
was used to fund the Company's operations. In 1994 net cash used in investing
activities in 1994 was primarily due to the purchase of short-term investments
with funds obtained from the sale of the preferred securities and warrants
described above.

TAXES

As of December 31, 1996, the Company had available $86.1 million in NOLs to
offset taxable income recognized by the Company in periods after December 31,
1996. For federal income tax purposes, these NOLs will expire in material
amounts beginning in the year 2006. If the issuance of 2,390,438 shares of
Common Stock to IP and the other purchasers is completed, any additional 5%
shift of ownership in the Company may result in a "change of ownership" under
Section 382 of the Code, and severely limit the Company's ability to utilize
NOLs. In order to issue the new stock and complete the PRIM acquisition, the
Company must obtain shareholder approval of a charter amendment that would
prohibit 5% owners of the Company's Common Stock (including holders of options
and warrants) from acquiring additional stock and prohibit any additional person
or entity from becoming a 5% holder of Common Stock. The prohibition against 5%
changes in ownership would expire three years after the closing of the PRIM
acquisition, which is expected to occur in April 1997. The Company would also
reincorporate in Delaware, in part to better implement the charter amendment.

ACCOUNTING STANDARD ADOPTED

In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), which establishes financial accounting and reporting standards for
stock-based employee compensation plans. SFAS 123 is effective for fiscal year
beginning in 1996. The Company has adopted the disclosure method of accounting
for SFAS 123. SFAS 123 will not have a material impact on the consolidated
financial statements.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

Information is set forth below concerning the directors of the Company, and
the year in which each director was first elected as a director of the Company.

NAME AGE POSITION WITH THE COMPANY DIRECTOR
SINCE
- ------------------------- --- ----------------------------- --------
Steven D. Germain (2) 43 Director 1995

Thomas J. Jamieson (1)(3) 54 Director 1985

Gordon E. Noble (2) 68 Director 1990

C. Len Pecchenino (1) 69 Director 1988

Craig F. Schwarberg (1)(3) 41 Director 1992

Robert A. Spass 41 Director 1992

Bradley E. Cooper (2)(3) 30 Director 1992

William Gentz 56 President, Chief Executive 1994
Officer and Director

J. Chris Seaman (3) 42 Executive Vice President, Chief 1993
Financial Officer and Director

- ---------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Investment Committee

No arrangement or understanding exists between any director and any other
person pursuant to which any director holds such position. None of the
directors has any family relationship to any other director or executive officer
of the Company.

STEVEN D. GERMAIN was elected to the Company's Board of Directors in
April 1995. From 1988 to 1994 he served as General Counsel to the Centre
Reinsurance Group of Companies. Since 1994 he has served as Managing Director
of Centre ReSource Limited, a company that provides management services to the
Centre Reinsurance Group of Companies. Mr. Germain continues to serve as a
director and as Senior Vice President, General Counsel and Secretary to Centre
Re and as a director, Senior Vice President and Secretary of CentreLine. Mr.
Germain is also a director, President and Chief Executive Officer of Home
Holdings, Inc. and a director of certain of its subsidiaries.

THOMAS J. JAMIESON has been a director of the Company since December 1985.
Since 1971, he has served as President of Jaco Oil Company. He is also active
as an independent investor. Mr. Jamieson has been a director of Berry Oil Co.
since 1993.

GORDON E. NOBLE became a director of the Company in October 1990. Since
July 1990, he has been Chairman and Chief Executive Officer of Commodore
Insurance Services. From January 1986 to January 1989, Mr. Noble served as
Executive Vice President and as a director and member of the Executive Committee
of Sedgwick James, an international insurance brokerage and risk management
firm.

C. LEN PECCHENINO became a director of the Company in May 1988 and was
elected as Chairman in June 1994. He served as the Company's Chief Executive
Officer from September 1991 to February 1992 and as the President and Chief
Executive Officer from February 1994 to May 1994. He also served as the
Chairman from

September 1991 to August 1992. Mr. Pecchenino was President and Chief Operating
Officer of IC Industries, Inc. from November 1985 until he retired in 1986.
From 1984 to November 1985, he was President and Chief Executive Officer of
Pneumo Corporation, which was acquired by IC Industries in October 1984. Prior
to 1984, he was Executive Vice President of Pneumo Corporation. IC Industries
and Pneumo Corporation operated a number of companies in various industries,
including manufacturing, aerospace and retailing.

CRAIG F. SCHWARBERG was appointed to the Board of Directors in March 1992.
From 1991 to the present, Mr. Schwarberg has worked for International Insurance
Advisors, Inc. ("IIA"), serving as a Managing Director through February 1994.
From 1994 to March 1996, Mr. Schwarberg was a director and Chairman of the Board
of NACOLAH Holding Corporation. From 1983 to 1990, he was associated with
Lehman Brothers, a division of Shearson Lehman Brothers Inc. He was an
associate from 1983 to 1986, Vice President from 1986 to 1990 and Senior Vice
President during 1990.

ROBERT A. SPASS was appointed to the Board of Directors in March 1992.
Since 1990, Mr. Spass has served as President and Chief Executive Officer, and a
director, of IIA. From 1994 to the present, Mr. Spass has been a Managing
Partner of Insurance Partners Advisors, L.P. and a director of Unionamerica
Holdings plc, and from 1994 to March 1996 was a director of NACOLAH Holding
Corporation. Since January 1996, he has served as a director of Highlands
Insurance Group, Inc. From 1984 to 1990, Mr. Spass was associated with Salomon
Brothers Inc, where he was an associate from 1984 to 1985, Vice President from
1985 to 1988, and a director from 1988 to 1990. Mr. Spass has served from 1991
to 1995 as a director of Home Holdings, Inc., the parent company to The Home
Insurance Company. From 1990 to 1996 he served as a director of National
Reinsurance Holdings Corp., the holding company for National Reinsurance Corp.
In both these director positions he serves as the designee of III pursuant to
separate shareholder agreements.

BRADLEY E. COOPER became a director of the Company in May 1992. From 1988
to 1990, Mr. Cooper was an analyst at Salomon Brothers Inc. From May 1990 to
February 1994, Mr. Cooper served as Vice President of IIA. From 1994 to the
present, Mr. Cooper has been a Principal of Insurance Partners Advisors, L.P.
Since January 1996, he has served as a director of Highlands Insurance Group,
Inc.

WILLIAM GENTZ became a director of the Company in June 1994. Mr. Gentz has
held the position of President and Chief Executive Officer since mid-1994. Mr.
Gentz joined the Company after seventeen years at Zenith Insurance Company where
he was responsible for marketing, underwriting, loss control, and field
operations for Zenith's workers' compensation operations. Mr. Gentz began his
insurance career in 1958, and from 1958 to 1968 worked in the marketing and
underwriting departments of a variety of insurance companies in the mid-west and
California.

J. CHRIS SEAMAN became a director of the Company in March 1993. Mr. Seaman
has held the positions of Executive Vice President since February 1995 and Chief
Financial Officer since July 1991. Prior to joining the Company, Mr. Seaman was
the CFO of a private company engaged in insurance company acquisitions following
ten years with Ernst & Whinney. Mr. Seaman previously held staff and management
positions at Industrial Indemnity Insurance Company and Allianz of America
Corporation, respectively.

EXECUTIVE OFFICERS

Set forth in the table below are the names, ages and current offices held
by all executive officers of the Company and SNIC. Unless specifically noted,
the positions named are held at both the Company and at SNIC.

NAME AGE POSITION WITH THE COMPANY EXECUTIVE OFFICER
- ---- --- ------------------------- SINCE
-----

William L. Gentz 56 President and Chief Executive Officer 1994
J. Chris Seaman 42 Executive Vice President and 1991
Chief Financial Officer
Arnold J. Senter 54 Executive Vice President and 1997
Chief Operating Officer
Joseph P. Wolonsky 50 Senior Vice President 1989
Thomas I. Boggs, Jr. 50 Senior Vice-President- 1995
Underwriting, SNIC
Karl O. Johnson 65 Senior Vice President, SNIC 1989
Douglas R. Roche 57 Senior Vice President 1990
Robert E. Nagle 48 Senior Vice President, General 1996
Counsel and Secretary
James L. Cinney 56 Senior Vice President, SNIC 1994
Matthew Natalizio 41 Vice President 1994
Sue A. Binder 49 Vice President, SNIC 1992
Harold J. Fedora 46 Vice President, SNIC 1993
Curtis H. Carson 36 Vice President, SNIC 1997
Jack W. Solomon 63 Resident Vice President, SNIC 1991
Robert J. Niebur 61 Resident Vice President, SNIC 1995

Executive officers of the Company are elected by and serve at the
discretion of the Board. No arrangement exists between any executive officer
and any other person or persons pursuant to which any executive officer was or
is to be selected as an executive officer. None of the executive officers has
any family relationship to any nominee for director or to any other executive
officer of the Company. Set forth below is a brief description of the business
experience for the previous five years of all of the executive officers.

WILLIAM L. GENTZ has held the position of President and Chief Executive Officer
since mid-1994. Mr. Gentz joined the Company after seventeen years at Zenith
Insurance Company where he was responsible for marketing, underwriting, loss
control, and field operations for Zenith's workers' compensation operations.
Mr. Gentz began his insurance career in 1958, and from 1958 to 1968 worked in
the marketing and underwriting departments of a variety of insurance companies
in the mid-west and California.

J. CHRIS SEAMAN has held the positions of Executive Vice President since
February 1995 and Chief Financial Officer since July 1991, and has served as a
director of the Company since March 1993. Prior to joining the Company, Mr.
Seaman was the CFO of a private company engaged in insurance company
acquisitions following ten years with Ernst & Whinney. Mr. Seaman previously
held staff and management positions at Industrial Indemnity Insurance Company
and Allianz of America Corporation, respectively.

ARNOLD J. SENTER has held the position of Executive Vice President and Chief
Operating Officer since February 1997. Prior to joining the Company, Mr. Senter
most recently served as Senior Vice President, Southwest and Southeast
Operations, at Zenith National Insurance Company, and had previously held
various operational positions in nearly every functional area for Zenith since
1981. Mr. Senter has 30 years experience with both regional and national
carriers.

JOSEPH P. WOLONSKY has held the position of Senior Vice President and General
Counsel from 1989 to December 1995, and was appointed to the position of Chief
Claims Officer in December of 1992. Prior to joining the Company, Mr. Wolonsky
had 12 years of insurance industry experience as General Counsel to a national
credit life and accident and health general agency, and served as General
Counsel to the Insurance Division of Borg-Warner Corporation.

THOMAS I. BOGGS, JR. was appointed Senior Vice President of Workers'
Compensation Underwriting of SNIC effective March 1995. Previously he was
Assistant Vice President of Fremont Compensation Insurance Company, and held
various underwriting and marketing positions at Fireman's Fund Insurance
Company, Cypress Insurance Company, Industrial Indemnity Insurance Company, and
Safeco.

KARL O. JOHNSON has been responsible for SNIC's Central California Operations
since 1989. He was promoted to Senior Vice President in 1994. Mr. Johnson has
served with various insurance organizations in loss control and marketing
capacities since 1955; he joined the Company in 1987.

DOUGLAS R. ROCHE was appointed Senior Vice President - Management Information
Systems in 1994, prior to which he served as Vice President of Internal
Operations from the time he joined the Company in 1990. From 1987 to 1990, Mr.
Roche sold software and provided systems consulting services to the insurance
industry. From 1969 to 1987 he held a variety of management positions in
various insurance companies' systems analysis operations.

ROBERT E. NAGLE has held the position of Senior Vice President, General Counsel
and Secretary since January 1996. From 1986 until he joined the Company, Mr.
Nagle was corporate counsel and senior corporate counsel for Farmers Group, Inc.

JAMES L. CINNEY has held the position of Senior Vice President - Loss Control of
SNIC since 1994. Before joining the Company, Mr. Cinney was self-employed in
the hospitality industry for one year. Prior to that, he was Vice President,
responsible for Loss Control, at Industrial Indemnity Insurance Company. Mr.
Cinney has 30 years of workers' compensation loss control experience in a
variety of staff and management positions with Industrial Indemnity Insurance
Company, Zenith Insurance Company, Employee Benefits Insurance Company, and
Hanover Cal/Comp Insurance Company.

MATTHEW NATALIZIO has held the position of Vice President - Finance and
Treasurer since 1994. From 1988 until he joined the Company, Mr. Natalizio was
employed by KPMG Peat Marwick LLP.

SUE A. BINDER has held the position of Home Office Claims Manager of SNIC since
1991 and was made a Vice President in 1992. Prior to 1991, Ms. Binder held a
variety of claims department staff and management positions at Fremont Indemnity
Company where she had been employed since 1977.

HAROLD J. FEDORA, JR. has held the position of Vice President - Claims Services
of SNIC since 1993, prior to which he was Calabasas Branch Claims Manager. From
1975 to 1987 Mr. Fedora was employed at several insurance companies in various
claims department staff and management positions.

CURTIS H. CARSON has held the position of Vice President Human Resources since
January 1997. From 1984 until he joined the Company, Mr. Carson was employed by
Farmers Insurance, most recently as Manager Human Resources.

JACK W. SOLOMON has held the position of Vice President of SNIC and Phoenix
Manager since 1995 and was the Sacramento Branch Manager from 1990 until 1995.
Prior to joining the Company, Mr. Solomon had 30 years experience in workers'
compensation underwriting, marketing, and executive level management in a
variety of insurance companies, principally in the mid-west.

ROBERT J. NIEBUR became Resident Vice President of SNIC, in charge of the South
San Francisco branch in July, 1995. Prior to joining the Company, he was
Workers' Compensation Manager for Flinn, Gray & Herterich, an insurance
brokerage, from 1994 to 1995, and operated his own insurance consulting business
from 1993 to 1994. For three years prior to that, Mr. Niebur was an operating
executive with Great States Insurance Company and, earlier, he held various
staff and executive positions over eleven years with Zenith Insurance Company.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act ("Section 16(a)") requires the Company's
Directors and certain of its officers, and persons who own more than ten percent
of a registered class of the Company's equity securities (collectively,
"Insiders"), to file reports of ownership and changes in ownership with the SEC.
Insiders are required by SEC regulations to furnish the Company with copies of
all Section 16(a) forms they file.

Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons that no Forms 5s were
required for those persons, the Company believes that its Insiders complied with
all applicable Section 16(a) filing requirements for fiscal 1996, with the
exception of (i) Douglas R. Roche, an executive officer of the Company, who
filed a late Form 4 in November 1996 to report his purchase in July 1996 of
shares of Common Stock, (ii) Matthew Natalizio, an executive officer of the
Company, who filed a Form 5 in February 1997 to report the granting to him in
May 1996 of shares of restricted stock under the Company's 1995 Plan (as
hereafter defined), which grant was not timely reported on a Form 4, and (iii)
TJS Partners, L.P., a direct ten percent beneficial owner of Common Stock, and
Thomas J. Salvatore, TJS Management, L.P., and TJS Corporation, the indirect
beneficial owners of all securities held by TJS, each of which filed a late Form
4 in July 1996 to report five separate purchases of shares of Common Stock by
TJS in April and May 1996.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth certain information concerning the
compensation for services in all capacities to the Company for the fiscal years
ended December 31, 1996, December 31, 1995 and December 31, 1994, of those
persons who were, at December 31, 1996, (i) the chief executive officer and
(ii) the other four most highly compensated executive officers of the Company.

SUMMARY COMPENSATION TABLE

LONG TERM COMPENSATION
---------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
--------------------------------- ------------ --------- --------
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS(2) OTHER RESTRICTED SECURITIES LTIP ALL OTHER
ANNUAL STOCK UNDERLYING PAYOUTS COMPEN-
COMPEN- AWARDS OPTIONS/ (#) SATION
SATION ($)(3) SARS(#) ($)(4)
($)
- ---------------------------- ---- ------- --------- -------- ---------- ---------- -------- ---------

William L. Gentz (5) 1996 $ 298,300 $ - - $46,874 (6) 17,875 -- 2,250
President and Chief 1995 294,508 203,500 - 53,690 19,175 -- 2,250
Executive Officer 1994 168,755 100,000 - 31,250 - --

J. Chris Seaman 1996 235,298 - -- 36,223 (7) 13,813 -- 2,250
Executive Vice President 1995 215,600 128,500 -- 40,170 39,325 -- 2,250
and Chief Financial Officer 1994 173,690 75,000 -- -- -- -- 2,250

Joseph P. Wolonsky 1996 168,974 - -- 21,306 (8) 8,125 -- 2,250
Senior Vice President 1995 163,700 53,500 -- 24,700 20,050 -- 2,250
and Corporate Counsel 1994 145,200 30,000 -- -- -- -- 2,250

Karl O. Johnson 1996 143,974 - -- 21,306 (9) 8,125 -- 2,007
Senior Vice President 1995 135,200 27,000 -- 16,900 17,300 -- 2,250
1994 131,108 27,000 -- -- -- -- 2,250

Thomas I. Boggs, Jr.(10) 1996 155,800 - -- 21,306 (11) 8,125 -- 2,163
Senior Vice President 1995 115,917 7,000 -- 13,000 12,150 -- 1,098

1994 - - -- -- -- -- --

- --------------
(1) The amounts set forth for fiscal year 1996 include salary and other cash
compensation paid in that year, other than amounts listed in the column
entitled "Bonus."
(2) Bonus amounts represent cash payments and are presented in the year in
which they are earned, although payment typically is made in March of the
subsequent year. Bonus amounts for fiscal year 1996 have not yet been
declared.
(3) Represents the fair market value of the underlying shares on the date of
grant.
(4) Other than as specifically noted, represents the employer's contribution
under the Company's 401(k) Plan.
(5) Mr. Furman K. Stanley resigned as President, Chief Executive Officer and
director of the Company in February 1994. Mr. Pecchenino served as interim
President, Chief Executive Officer and Chairman from February 1994 until
Mr. Gentz's appointment to those positions in June 1994. During his
tenure, Mr. Pecchenino received a total of $136,858 in cash compensation,
with no bonus, long term compensation or other compensation earned or paid.
Mr. Pecchenino was re-appointed as Chairman in June 1994 and continues to
serve in that capacity.
(6) Represents a grant of 9,625 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1996, Mr. Gentz held an aggregate of 19,950 shares of restricted stock
valued at $254,363, based upon the $12.75 per share fair market value of
the Common Stock on such date.

(7) Represents a grant of 7,438 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1996, Mr. Seaman held an aggregate of 15,163 shares of restricted stock
valued at $193,328, based upon the $12.75 per share fair market value of
the Common Stock on such date.
(8) Represents a grant of 4,375 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1996, Mr. Wolonsky held an aggregate of 9,125 shares of restricted stock
valued at $116,344, based upon the $12.75 per share fair market value of
the Common Stock on such date.
(9) Represents a grant of 4,375 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1996, Mr. Johnson held an aggregate of 7,625 shares of restricted stock
valued at $97,219, based upon the $12.75 per share fair market value of the
Common Stock on such date.
(10) Mr. Boggs began his employment with the Company in March 1995.
(11) Represents a grant of 4,375 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1996, Mr. Boggs held an aggregate of 6,875 shares of restricted stock
valued at $87,656, based upon the $12.75 per share fair market value of the
Common Stock on such date.

EMPLOYMENT AGREEMENTS

The Company has in effect employment agreements with the following
officers:

(1) William L. Gentz, President and Chief Executive Officer. Mr. Gentz's
agreement expires on June 1, 1997, but is subject to automatic renewal
in one-year increments unless notification of non-renewal is given
sixty days prior to the expiration of the then-current term. His
salary was set as of June 1, 1994 at $275,000 annually, plus benefits
and incidentals generally provided to officers of the Company, and is
thereafter as determined by the Board. Mr. Gentz's annual salary was
increased to $287,500 effective August 1, 1995. If Mr. Gentz's
employment is terminated by the Company other than for cause, he is
entitled to payments of his salary and benefits for the then-remaining
term of his agreement. In the event of a change in control of the
Company, Mr. Gentz would be deemed terminated without cause and his
employment agreement would be deemed to have a three-year remaining
term.

(2) Matthew Natalizio, Vice President, Finance and Treasurer.
Mr. Natalizio's agreement is open-ended. His compensation and
benefits are determined by the Board. If Mr. Natalizio's employment
is terminated by the Company other than for cause, he is entitled to
payments of his salary and benefits for one year from the date of the
termination. Mr. Natalizio's agreement does not provide any special
rights in the event of a change in control.

(3) Arnold J. Senter, Executive Vice President and Chief Operating
Officer. Mr. Senter's agreement expires on February 17, 2000, but is
subject to automatic renewal in one-year increments unless
notification of non-renewal is given sixty days prior to the
expiration of the then-current term. His salary was set as of
February 17, 1997 at $200,000 annually, plus benefits and incidentals
generally provided to officers of the Company, and is thereafter as
determined by the Board. If Mr. Senter's employment is terminated by
the Company other than for cause, he is entitled to payments of his
salary and benefits for the then-remaining term of his agreement. In
the event of a change in control of the Company, Mr. Senter would be
deemed terminated without cause and his employment agreement would be
deemed to have a three-year remaining term.

CHANGE-IN-CONTROL ARRANGEMENTS

In addition to the rights described above with respect to Mr. Gentz and Mr.
Senter, the only change-in-control arrangement in place is in connection with
the Company's stock incentives. Under the terms of the 1986 Non-Statutory Stock
Option and 1986 Non-Statutory Stock Purchase Plan (the "1986 Plan"), upon a
change of control of the Company, unless replacement options to purchase stock
in the new or recapitalized entity are offered, all option holders will have
thirty days to exercise their outstanding options, excluding those that have
then not yet vested. Under the terms of the 1995 Stock Incentive Plan (the
"1995 Plan"), under similar circumstances, the Option Committee of the Board of
Directors (the "Option Committee") may, in its discretion, allow each person
holding an option or restricted stock who did not receive a replacement equity
incentive grant to exercise that option without regard to its vesting
provisions, or to retain that restricted stock without regard to the Company's
repurchase right, as applicable.

EQUITY INCENTIVE GRANTS

Key employees, including directors who are key employees, chosen by the
Compensation Committee (which acts as the Option Committee under the terms of
the 1986 Plan and 1995 Plan) are eligible to participate in the 1995 Plan.

Under the 1995 Plan, officers and key employees of the Company or its
subsidiaries may be granted options to purchase shares of Common Stock or they
may be given the opportunity to purchase restricted stock of the Company. The
1995 Plan permits the granting both of options that qualify for treatment as
incentive stock options ("Incentive Stock Options") under Section 422 of the
Code, and options that do not qualify as Incentive Stock Options ("Nonqualified
Stock Options").

In 1986, the Company adopted the 1986 Plan, which allowed the Company to
issue to employees of the Company and its subsidiaries Nonqualified Stock
Options and rights to purchase Common Stock. The purchase right aspect of the
1986 Plan was terminated by the Board of Directors in 1989. Following the
adoption of the 1995 Plan, the Board of Directors determined to make no further
grants pursuant to the 1986 Plan.

OPTION GRANTS IN LAST FISCAL YEAR

The following table sets forth information concerning options granted
during fiscal 1996 to each of the executive officers named in the Summary
Compensation Table set forth above under "Executive Compensation."

INDIVIDUAL GRANTS
--------------------------------------------------------------
NAME NUMBER OF % OF TOTAL EXERCISE OR EXPIRATION POTENTIAL REALIZABLE VALUE AT
SECURITIES OPTIONS/ BASE PRICE DATE ASSUMED ANNUAL RATES OF STOCK
UNDERLYING SARS GRANTED TO ($/SH)(1) PRICE APPRECIATION
OPTIONS/SARS EMPLOYEES IN FOR OPTION TERM
GRANTED FISCAL YEAR
(#) -----------------------------------
0%(2) 5% ($)(3) 10% ($)(3)
- ------------------------- --------------- --------------- ------------ ----------- ------ --------- ----------

William L. Gentz 17,875(4) 12.0 4.87 3/01/06 0 54,746 138,738

J. Chris Seaman 13,813(4) 9.3 4.87 3/01/06 0 42,306 107,210

Joseph P. Wolonsky 8,125(4) 5.5 4.87 3/01/06 0 24,884 63,062

Karl O. Johnson 8,125(4) 5.5 4.87 3/01/06 0 24,884 63,062

Thomas I. Boggs, Jr. 8,125(4) 5.5 4.87 3/01/06 0 24,884 63,062

- ---------------
(1) Represents the fair market value of the underlying shares of Common Stock
at the time of the grant.
(2) Unless the stock price increases, which will benefit all shareholders
commensurately, an option holder will realize no gain.

(3) Represents the value of the shares of Common Stock issuable upon the
exercise of the option, assuming the stated rates of price appreciation for
ten years, compounded annually, with the aggregate exercise price deducted
from the final appreciated value. The 5% and 10% rates are established by
the SEC as examples only and are not intended to forecast future
appreciation in the Company's stock price.
(4) Represents a ten-year, incentive stock option grant, vesting at a rate of
20% per year for five years from the date of grant, granted pursuant to the
1995 Plan.

OPTION EXERCISES AND YEAR END VALUE

The following table sets forth information concerning the aggregate number
of options exercised during fiscal 1996 by each of the executive officers named
in the Summary Compensation Table set forth above under "Executive
Compensation," and outstanding options held by each such officer as of
December 31, 1996.

NUMBER OF
SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS/ IN-THE-MONEY OPTIONS/SARS
SARS AT AT
FISCAL YEAR-END(#) FISCAL YEAR-END(1)
------------------ -----------------------
NAME SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
ON EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
- ------------------------------- --------------- ----------- ------------------ -----------------------

William Gentz -- -- 16,335/51,965 $ 123,329/$398,235

J. Chris Seaman -- -- 37,065/31,073 290,880/246,119

Joseph P. Wolonsky -- -- 19,260/18,915 152,913/149,990

Karl O. Johnson -- -- 14,060/21,365 113,473/168,667

Thomas I. Boggs, Jr. -- -- 2,430/17,845 18,347/137,411

- ---------------
(1) Uses a fair market value at December 31, 1996 of $12.75 per share, with the
aggregate exercise price deducted from the total value of the stock
underlying the options.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee during the fiscal year ended December 31, 1996
consisted of Messrs. Noble, Cooper and Germain, each of whom was a non-employee
director. Mr. Cooper is an employee and beneficial owner of less than one
percent of the equity securities of IIA, which was paid in excess of $60,000 by
the Company in fiscal 1996 for investment banking and financial consulting
services. Mr. Germain is an officer and a director of Centre Re, which was
involved in several transactions with the Company during 1996 involving payments
in excess of $60,000. See "Certain Relationships and Related Transactions."

During fiscal 1996, no officers participated in deliberations of the
Company's Compensation Committee concerning executive officer compensation,
except William Gentz, the Company's Chief Executive Officer.

REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS

The Compensation Committee of the Board was comprised of Messrs. Noble,
Cooper and Germain during 1996. The Compensation Committee establishes the
general compensation policies of the Company, establishes the compensation plans
and specific compensation levels for executive officers, and administers the
1986 Plan and the 1995 Plan.

As required by rules designated to enhance the disclosure of the Company's
executive compensation policies and practices, the following is the Compensation
Committee's report submitted to the Board addressing the compensation of the
Company's executive officers for fiscal 1996.

The Compensation Committee of the Board of Directors establishes the
general compensation policies of the Company, establishes the compensation
plans, establishes the specific compensation of Mr. William Gentz, the Company's
Chief Executive Officer, reviews the Chief Executive Officer's recommendations
as to the specific compensation levels for the other executive officers, and
administers the Company's stock incentive plans.

COMPENSATION POLICY AND PROGRAMS. The Compensation Committee's
responsibility is to provide a strong and direct link among shareholder values,
Company performance, and executive compensation through its oversight of the
design and implementation of a sound compensation program that will attract and
retain highly qualified personnel. Compensation programs are intended to
complement the Company's short and long-term business objectives and to focus
executive efforts on the fulfillment of these objectives.

The Compensation Committee, consistent with its standing policy, has
conducted a full review of the Company's executive compensation program and will
repeat this review as it deems necessary. Advisors with expertise in executive
compensation matters are consulted regularly by the Compensation Committee. It
is the Compensation Committee's practice to establish target levels of
compensation for senior officers consistent with that of companies comparable in
size and complexity to the Company, as well as companies that are direct
business competitors of the Company. After considerable review of extensive
data relating to aspects of compensation paid by such groups of companies,
actual compensation of the Company's executive officers is subject to increase
or decrease by the Compensation Committee from targeted levels according to the
Company's overall performance and the individual's efforts and contributions.
As of 1996, as in previous years, a significant portion of executive
compensation is directly related to the Company's financial performance and is
therefore at risk. Total compensation for the Company's senior management is
composed of base salary, near-term incentive compensation in the form of
bonuses, and long-term incentive compensation in the form of stock options and
restricted stock grants. The Compensation Committee retains the discretion to
adjust the formula for certain items of compensation so long as total
compensation reflects overall corporate performance and individual achievement.

BASE SALARY. In establishing base salary levels for senior officer
positions, the Compensation Committee and Mr. Gentz consider levels of
compensation at other similarly situated companies and at direct competitors,
levels of responsibility, and internal issues of consistency and fairness. In
determining the base salary of a particular executive, the Compensation
Committee and Mr. Gentz consider individual performance, including the
accomplishment of short- and long-term objectives, and various subjective
criteria including initiative, contribution to overall corporate performance,
and leadership ability.

In the fiscal year ended December 31, 1995, the annual base salary of
Mr. Gentz began at $275,000 and increased to $287,500 in September, a level
determined to be appropriate by the Compensation Committee based on comparable
chief executive salaries of a peer group of companies and of direct competitors
referred to above, the Company's overall performance and profitability in the
prior fiscal year, and Mr. Gentz's efforts and contributions to the Company.
Mr. Gentz's annual base salary of $287,500 did not increase in the fiscal year
ended December 31, 1996.

BONUSES. The Company's executive officers are eligible for annual bonuses
based upon recommendations made by Mr. Gentz (as to the other executive
officers) and the Compensation Committee (as to Mr. Gentz) as to individual
performance and the Company's achievement of certain operating results.

Amounts of individual awards are based principally upon the results of the
Company's financial performance during the prior fiscal year. The awards for
senior officers are within guidelines established by the Compensation Committee
and Mr. Gentz as a result of their review of total compensation for senior
management of peer companies and competitors. The actual amount awarded within
these guidelines is determined principally by the Compensation Committee's and
Mr. Gentz's assessment of the individual's contribution to the Company's overall
financial performance. Consideration is also given to factors such as the
individual's successful

completion of a special project, any significant increase or decrease in the
level of the participant's executive responsibility, and the Compensation
Committee's and Mr. Gentz's evaluation of the individual's overall efforts and
ability to discharge the responsibilities of his position. In fiscal 1996,
bonuses were paid with respect to fiscal 1995 performance to all of the
continuing executive officers named in the Summary Compensation Table and to
eleven executive officers in total. Bonuses earned related to fiscal 1996 have
not been declared. The Company's practice has been to declare and pay these
bonuses in the second quarter.

In determining Mr. Gentz's bonus, the Compensation Committee gives
particular consideration to the following factors: (1) the Company's
underwriting results; (2) the Company's return on average equity during the
fiscal year; (3) the positive earnings growth of the Company during the fiscal
year; (4) performance of the Company's stock during the fiscal year; and (5) the
efforts and contributions made by Mr. Gentz in discharging his responsibilities
as Chief Executive Officer. In 1996, the Compensation Committee placed
significant weight on the continued improvement in the Company's underwriting
profits and implementation of strategies designed to compete in the open-rating
environment.

STOCK INCENTIVES. The Company currently has in place the 1986 Plan and the
1995 Plan. The Company ceased providing options under the 1986 Plan in
April 1995. The purpose of the 1995 Plan is to provide incentives and reward
the contributions of key employees and officers for the achievement of long-term
Company performance, as measured by earnings per share and the market value of
the Common Stock. The Compensation Committee set guidelines for the number and
terms of stock option or restricted stock awards based on factors similar to
those considered with respect to the other components of the Company's
compensation program, including comparison with the practices of peer group
companies and direct competitors. In the event of unsatisfactory corporate
performance, the Compensation Committee may decide not to award stock options or
restricted stock in any given fiscal year although exceptions to this policy may
be made for individuals who have assumed substantially greater responsibilities
and other similar factors. The awards under the 1995 Plan are designed to align
the interests of executives with those of the shareholders. Generally, stock
options become exercisable in cumulative installments over a period of five
years, but the individual forfeits any installment that has not vested during
the period of his employment. Restricted stock grants generally vest in equal
installments over nine years with unvested shares subject to repurchase by the
Company at no gain to the officer upon the termination of his or her employment.

Under the 1995 Plan, the Compensation Committee during 1996 approved a set
of stock option grants to all executive officers then employed, and restricted
stock grants to thirteen executive officers. These approvals were acted upon by
the Compensation Committee in its capacity as the "Option Committee" under the
terms of the 1995 Plan. Agreements reflecting these option grants and
restricted stock grants have been prepared and delivered to the recipient
employees. The share certificates representing the restricted stock are only
issued when restrictions lapse, hence the bulk of those share grants are not
reflected in the Company's total outstanding shares number.

The Compensation Committee has reviewed the Company's executive
compensation policies and plans in light of the provisions of the Omnibus Budget
Reconciliation Act of 1993 and the rules promulgated under that Act. This
legislation amended Section 162 of the Code by limiting to $1 million the
deductibility of compensation paid to certain executives. Rulemaking has
clarified the impact of the 1993 act on equity incentive plans. It is the
current policy of the Compensation Committee to maximize, to the extent
reasonably possible, the Company's ability to obtain a corporate tax deduction
for compensation paid to executive officers of the Company to the extent
consistent with the best interests of the Company and its shareholders.

BRADLEY E. COOPER
STEVEN D. GERMAIN
GORDON E. NOBLE
MEMBERS OF THE COMPENSATION COMMITTEE

COMPANY PERFORMANCE

The graph below compares the cumulative total shareholder return of the
Company with the cumulative total return on the Nasdaq Stock Market (U.S.
Companies) Index and the Nasdaq Insurance Stocks Index for the period from
June 30, 1995 (the date on which the Company's registration statement under
Section 12 of the Exchange Act became effective) through December 31, 1996.

COMPARISON OF CUMULATIVE TOTAL RETURN

[GRAPH]

Superior National Insurance Group, Inc. Common Stock. . . . . . . $283.33
Nasdaq Insurance Stocks Index . . . . . . . . . . . . . . . . . . $139.12
Nasdaq Stock Market (U.S. Companies) Index. . . . . . . . . . . . $138.97

Assumes that $100 was invested on June 30, 1995 (the date on which the
Company's registration statement under Section 12 of the Exchange Act became
effective) in each of the Company's Common Stock, the Nasdaq Stock Market (U.S.
Companies) Index, and the Nasdaq Insurance Stocks Index, and that all dividends
were reinvested.

The Company believes that the Company's total shareholder return
improved dramatically during 1996 primarily as a result of the increase in the
Company's stock price in the second half of 1996 following the announcement of
the PRIM transaction.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners

The table below sets forth certain information regarding the beneficial
ownership of the Company's voting securities as of March 5, 1997 by each person
who is known by the Company to be the beneficial owner of more than 5% of the
indicated classes of the Company's voting securities. On March 31, 1992, the
Company issued its 14.5% Senior Subordinated Voting Notes due April 1, 2002 (the
"Voting Notes") in connection with a transaction wherein the Company issued its
14.5% Senior Subordinated promissory notes in an aggregate principal amount of
$11 million,

together with warrants to purchase approximately 1,616,886 shares of the
Company's Common Stock. The Company redeemed all of those promissory notes with
a prepayment, effective June 30, 1994, except for the Voting Notes, with
respect to which prepayment is prohibited. The outstanding principal amount of
the Voting Notes is $30,000. The number of votes attaching to the Voting Notes
is equal to the number of shares of Common Stock that may be purchased upon
exercise of the warrants that were issued in that March 31, 1992 transaction
and remain outstanding and are unexercised as of the applicable record date for
a shareholder vote. As of March 5, 1997, the number of votes held by the holder
of the Voting Notes was equivalent to 1,566,465 shares of Common Stock. The
Voting Notes are permitted to vote only in director elections, director
removals, votes on amending that right to vote, and changes to the number of
authorized directors. As a result of the cancellation of a portion of the
relevant warrants, the number of common stock equivalent votes held by the
Voting Notes has decreased somewhat since March 31, 1992. The specific voting
rights of the Voting Notes are set forth in the Company's Amended and Restated
Articles of Incorporation and Bylaws. This table does not reflect the 2,390,438
shares of Common Stock to be issued and sold by the Company pursuant to the
Stock Purchase Agreement upon consummation of the PRIM transaction.

COMMON STOCK(1) VOTING NOTES
------------------------------- ----------------------------
SHARES-
NAME AND ADDRESS SHARES PERCENT(2) EQUIVALENT PERCENT
- -------------------------------------------------- ----------- ------------ -------------- --------

"III" -- -- 1,566,465(3) 100%
International Insurance Investors, L.P.,
a Bermuda limited partnership
c/o International Insurance Investors
(Bermuda) Limited, General Partner
Cumberland House
One Victoria Street
Hamilton HM HX, Bermuda

"IIA" 1,474,306(4) 29.96% -- --
International Insurance Advisors, Inc.
One Chase Manhattan Plaza
44th Floor
New York, New York 10005

"CENTRELINE" 579,356(5) 14.39% -- --
CentreLine Reinsurance Limited,
a Bermuda corporation
Cumberland House
One Victoria Street
Hamilton HM HX, Bermuda

"CENTRE RE" 470,390(6) 12.01% -- --
Centre Reinsurance Limited
One Victoria Street
Seventh Floor
Hamilton HM HX, Bermuda

"TJS" 396,950(7) 11.52% -- --
TJS Partners, L.P.
52 Vanderbilt Avenue, 5th Floor
New York, New York 10017

"BISHOP ESTATE" 388,752(8) 10.14% -- --
Trustees of the Estate of Bernice P. Bishop
567 South King Street
Suite 200
Honolulu, Hawaii 96813

THOMAS J. JAMIESON 245,300(9) 7.12% -- --
Jaco Oil Company
P.O. Box 1807
Bakersfield, California 93303

THE RAVENSWOOD INVESTMENT COMPANY 206,046(10) 5.98% -- --
104 Gloucester Road
Massapequa, New York 11758

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

(1) Includes warrants expiring on April 1, 2002 to purchase 1,566,465 shares of
Common Stock (the "Warrants") and a warrant expiring on June 30, 2001 to
purchase 579,356 shares of Common Stock described more fully in footnote 5,
below. The Warrants were issued on March 31, 1992 in a transaction in
which the Company issued (a) Warrants to purchase approximately 1,616,886
shares of Common Stock and (b) promissory notes in the aggregate principal
amount of $11 million to III and certain members of the Company's
management. The Warrants are exercisable at $4.00 per share. The Warrants
purchased by III, exercisable into 1,474,306 shares of Common Stock, were
originally issued to IIA, as agent for each of the limited partners and the
general partner of III. The Warrants have since been distributed to the
partners of III; however, IIA's revocable agency relationship with such
partners was reestablished after the distribution. See footnote 4 below.
The Company has retired certain Warrants issued to members of management no
longer employed by the Company.
(2) Percent ownership is based on the number of shares outstanding as of March
5, 1997, which number was 3,446,706 shares, plus any shares issuable
pursuant to options or warrants held by the person in question that may be
exercised within 60 days after March 5, 1997.
(3) Robert A. Spass, Craig F. Schwarberg and Bradley E. Cooper, directors of
the Company, beneficially own limited partnership interests in III of
0.583%, 0.225%, and 0.075%, respectively. In addition, Mr. Spass has
voting power over all of the voting capital stock of International
Insurance Investors (Bermuda) Limited, the general partner of III.
(4) Represents Warrants to purchase shares of Common Stock that are held by
IIA, as agent for each of the limited partners and for the general partner
of III, as discussed in footnote 1 above. As agent for such partners, IIA
has the revocable authority to exercise rights set forth in the Warrants
and to vote any shares of Common Stock issuable upon exercise of the
Warrants. Robert A. Spass, a director of the Company, is an officer of IIA
and as such has the authority to exercise these rights. The partners who,
upon revocation of IIA's authority, would be entitled to exercise Warrants
covering more than 5% of the Common Stock are Centre Re and Bishop Estate,
in the share amounts and percentages stated.
(5) Represents a warrant to purchase 579,356 shares of Common Stock issued as
of June 30, 1994 (the "CentreLine Warrant"). CentreLine is an affiliate of
Centre Re. The CentreLine Warrant was issued in connection with an
investment in the Company (and its affiliate, Superior National Capital,
L.P.) by CentreLine and a second Centre Re affiliate, Centre Reinsurance
Services, aggregating $20 million. The CentreLine Warrant is exercisable
at $5.20 per share. Steven D. Germain, a director of the Company, is an
officer and a director of both Centre Re and CentreLine. In addition to
Mr. Germain, each of Steven M. Gluckstern, Michael D. Palm, Laurence Cheng,
David A. Brown and Jay S. Ralph is an officer and a director of both Centre
Re and CentreLine. Messrs. Germain, Gluckstern, Palm, Cheng, Brown and
Ralph disclaim any beneficial interest in the CentreLine Warrant and the
Common Stock issuable upon its exercise, or in the Warrants held by IIA, as
agent for Centre Re, as described in footnote 6 below, or the shares of
Common Stock issuable upon the exercise of such Warrants. However, as
officers and directors of both Centre Re and CentreLine, such persons share
voting and/or investment power over such securities (subject to the agency
appointment described in footnotes 1 and 4 above).
(6) Represents Warrants to purchase shares of Common Stock received upon the
distribution by III to its partners of the Warrants as described in
footnote 1 above. See footnote 4 above for information concerning
Centre Re's agency relationship with IIA with respect to such Warrants and
see footnote 5 above for information concerning

Centre Re's relationships with Steven D. Germain and CentreLine. The
numbers of shares reported for Centre and III (excluding the Voting
Notes) are based on an Amendment No. 1 to Schedule 13G filed with the
SEC in February 1997.

(7) Based on a Form 4 filed with the SEC in July 1996, TJS is the direct
beneficial owner of 396,950 shares of Common Stock. TJS Corporation and
its controlling stockholder, sole director and executive officer, Thomas J.
Salvatore, are the general partners of TJS Management, L.P., the general
partner of TJS Partners, L.P., and exercise voting control and dispositive
power over all 396,950 shares presently owned, and are beneficial owners of
those shares.
(8) Represents Warrants to purchase shares of Common Stock received upon the
distribution by III to its partners of the Warrants as described in
footnote 1 above. Richard S.H. Wong, Oswald K. Stender, Lokelani Lindsey,
Gerard A. Jervis and Henry H. Peters, the trustees of the Bishop Estate,
share voting and/or investment power over securities held by the Bishop
Estate. Mr. Peters is a director of IIA. The number of shares reported
for the Bishop Estate is based on a Schedule 13G with the SEC in February
1996.
(9) Includes 98,050 shares owned of record by Jaco Oil Company, an entity
controlled by Mr. Jamieson.
(10) According to a report on Schedule 13D dated July 5, 1995, The Ravenswood
Investment Company is the direct beneficial owner of 83,546 shares of
Common Stock and has a contractual right to buy 122,500 additional shares
from the receiver of AMS Life Insurance Company, an Arizona insurer in
liquidation. The Company believes that acquisition has occurred. The
general partners of The Ravenswood Investment Company, Robert E. Robotti
and Kenneth R. Wasiak, exercise voting control and dispositive power over
all 206,046 shares presently owned or subject to the contract to purchase,
and are beneficial owners of those shares.

SECURITY OWNERSHIP OF MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of the Common Stock as of March 5, 1997 by (i) each director and
certain executive officers of the Company, individually, and (ii) all directors
and executive officers as a group. This table does not reflect the number of
shares of Common Stock that may be issued and sold by the Company pursuant to
the Stock Purchase Agreement, in which members of the Company's management have
agreed to participate and in which several directors of the Company have certain
interests.

PERCENT OF
NAME SHARES OWNED COMMON STOCK(1)
- --------------------------------------------- -------------- ---------------
William Gentz . . . . . . . . . . . . . . . . 56,445(2) 1.62%

J. Chris Seaman . . . . . . . . . . . . . . . 133,049(3) 3.74%

Joseph P. Wolonsky . . . . . . . . . . . . . 43,502(4) 1.25%

Karl O. Johnson . . . . . . . . . . . . . . . 37,282(5) 1.07%

Douglas R. Roche . . . . . . . . . . . . . . 16,354(6) *

Thomas J. Jamieson . . . . . . . . . . . . . 245,300(7) 7.12%

Gordon E. Noble . . . . . . . . . . . . . . . 10,000 *

C.L. Pecchenino . . . . . . . . . . . . . . . 14,250 *

Robert A. Spass . . . . . . . . . . . . . . . 16,591(8) *

Craig F. Schwarberg . . . . . . . . . . . . . 3,321(9) *

Bradley E. Cooper . . . . . . . . . . . . . . 3,107(10) *

Steven D. Germain . . . . . . . . . . . . . . 1,053,947(11) 23.44%

Directors and Executive Officers as a
Group (22 persons). . . . . . . . . . . . 1,826,782(12) 25.37%

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

(1) Percent ownership is based on the number of shares outstanding as of March
5, 1997, which number was 3,446,706 shares, plus any shares issuable
pursuant to options or warrants held by the person in question which may be
exercised within 60 days after March 5, 1997.
(2) Includes 23,745 shares issuable upon exercise of stock options that are
exercisable within sixty days of March 5, 1997. Also includes 19,950
restricted stock grants awarded under the 1995 Plan in 1995 and 1996, of
which the restrictions have lapsed as to 3,361 shares.
(3) Includes 58,795 shares issuable upon exercise of Warrants and 42,691 shares
issuable upon exercise of stock options, each of which is exercisable
within sixty days of March 5, 1997. Also includes 15,163 restricted stock
grants awarded under the 1995 Plan in 1995 and 1996, of which the
restrictions have lapsed as to 2,557 shares.
(4) Includes 10,582 shares issuable upon exercise of Warrants and 22,645 shares
issuable upon exercise of stock options, both of which are exercisable
within sixty days of March 5, 1997. Also includes 1,000 shares held by his
spouse, the ownership of which is subject to community property laws. Also
includes 9,125 restricted stock grants awarded under the 1995 Plan in 1995
and 1996, of which the restrictions have lapsed as to 1,556 shares.
(5) Includes 4,262 shares issuable upon exercise of Warrants and 16,895 shares
issuable upon exercise of stock options, each of which is exercisable
within sixty days of March 5, 1997. Also includes 7,625 restricted stock
grants awarded under the 1995 Plan in 1995 and 1996, of which the
restrictions have lapsed as to 1,218 shares.
(6) Includes 8,667 shares issuable upon exercise of stock options exercisable
within sixty days of March 5, 1997. Also includes 4,687 restricted stock
grants awarded under the 1995 Plan in 1995 and 1996, of which the
restrictions have lapsed as to 804 shares.
(7) Includes 98,050 shares owned of record by Jaco Oil Company, an entity
controlled by Mr. Jamieson.
(8) Represents 8,000 shares of Common Stock owned directly by Mr. Spass. In
addition, Mr. Spass is the beneficial owner of Warrants held by IIA, as
agent, representing the right to purchase 8,591 shares of Common Stock as
described in footnote 4 of the preceding "Certain Beneficial Owners After
the Stock Issuance" table. Mr. Spass is an officer of IIA and is the
beneficial owner of less than one percent of the equity securities of IIA.
IIA holds, as agent for the partners of III, Warrants to purchase 1,474,306
shares of Common Stock. In addition, see footnote 3 to the preceding
"Certain Beneficial Owners After the Stock Issuance" table concerning Mr.
Spass' voting power with respect to the Voting Notes. The number of shares
reported for Mr. Spass is based on an Amendment No. 1 to Schedule 13G filed
with the SEC in February 1997.
(9) Comprised of Warrants representing the right to purchase 3,321 shares of
Common Stock held by IIA, as agent, as described in footnote 4 of the
preceding "Certain Beneficial Owners After the Stock Issuance" table. In
addition, Mr. Schwarberg is the beneficial owner of less than one percent
of the equity securities of IIA.
(10) Represents 2,000 shares of Common Stock. Also includes Warrants to
purchase 1,107 shares of Common Stock held by IIA, as agent, as described
in footnote 4 of the preceding "Certain Beneficial Owners After the Stock
Issuance" table. In addition, Mr. Cooper is the beneficial owner of less
than one percent of the equity securities of IIA.
(11) Represents (i) 3,600 shares of Common Stock owned directly, (ii) 600 shares
of Common Stock owned indirectly as custodian for the benefit of his
children under the New York Uniform Gift to Minors Act, and (iii) warrants
to purchase Common Stock, consisting of the CentreLine Warrant to purchase
579,356 shares issued to CentreLine and the Warrants held by IIA, as agent
for Centre Re. See the preceding "Security Ownership of Certain Beneficial
Owners" table and footnotes 4 and 5 thereto. Mr. Germain is an officer and
director of both Centre Re and CentreLine. As such, he shares voting
and/or dispositive control over such securities (subject to the termination
of the agency relationship with IIA by Centre Re). Mr. Germain disclaims
any beneficial interest in the CentreLine Warrant, the Warrants held by
IIA, as agent for Centre Re, and the Common Stock issuable upon their
exercise.
(12) Includes (i) 1,136,404 shares issuable upon exercise of warrants and
(ii) 145,498 shares issuable upon exercise of stock options, each of which
is exercisable within sixty days of March 5, 1997. Also includes 76,598
shares subject to the Company's right of repurchase, of which restrictions
have lapsed as to 12,624 shares. Refer to footnotes 8 and 11 for
information regarding beneficial interests in the Warrants and the
Centreline Warrant held by certain directors.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

TRANSACTIONS WITH IIA

Messrs. Spass, Schwarberg and Cooper, directors of the Company, are
employees of IIA and are each the beneficial owner of less than one percent of
IIA's equity securities. Mr. Spass is also an officer and director of IIA. IIA
was acting as advisor to III and SNIG regarding the purchase by III of $10
million of debt securities, including the Voting Notes, in 1992. IIA was paid
$250,000 by the Company during fiscal 1996 for investment banking and financial
consulting services. That payment was made pursuant to a consulting agreement
entered into in 1992 that continues through 1998.

TRANSACTIONS WITH CENTRE RE AND ITS AFFILIATES

Mr. Germain, a director of the Company, is an officer and director of
Centre Re and of CentreLine. Effective January 1, 1996, the Company cancelled
certain reinsurance services provided by Centre Re. The Company accrued a $5.3
million charge related to the cancellation of such reinsurance services.

An affiliate of the Company, Superior National Capital, L.P., a Bermuda
limited partnership, issued an additional 83,337 shares of preferred stock in
1995 for preferred securities dividends to an affiliate of Centre Re in
connection with the transaction described in Footnote 5 to the Security
Ownership of Certain Beneficial Owners table.

TRANSACTIONS WITH IP

Mr. Spass, a director of the Company, and Mr. Steven Gruber, a director
nominee, are executive officers of the ultimate general partner of each of IP
Delaware and IP Bermuda. If the Stock Purchase Agreement is approved and
consummated, IP will acquire 2,124,834 shares of newly issued common stock. In
addition, each of Messrs. Spass and Gruber are executive officers of Insurance
Partners Advisors, L.P. ("IPA"). If the Stock Purchase Agreement is
consummated, IPA will receive a transaction fee from the Company of $625,000
representing a percentage of all of the funds raised to acquire PRIM and to make
a capital contribution to the Pacific Rim Assurance Company. Under certain
circumstances, alternative fees would be paid.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) FINANCIAL STATEMENTS:

Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Income for the Years Ended December 31, 1996,
1995 and 1994
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended December 31,
1996, 1995 and 1994
Notes to Consolidated Financial Statements

(a)(2) FINANCIAL STATEMENT SCHEDULES:

Condensed Financial Information of Registrant, Superior National Insurance
Group, Inc.
Supplemental Insurance Information
Reinsurance
Valuation and Qualifying Accounts and Reserves
Supplemental Property and Casualty Insurance Information

(a)(3) EXHIBITS

EXHIBIT DESCRIPTION
NUMBER -----------
- -------

2.1 Amended and Restated Agreement and Plan of Merger dated as of February
17, 1997 among the Company, SNTL Acquisition Corp., and PRIM*****
2.2 Series A Convertible Debentures and Series 1, 2 and 3 Detachable
Warrant Purchase Agreement, ("Debenture Purchase Agreement") dated
September 17, 1997 among the Company, Prac Limited Partnership and
Allstate Insurance Company****
2.3 First Amendment to Debenture Purchase Agreement, dated as of February
17, 1997*****
2.4 Voting Agreement dated as of February 17, 1997 among the Company and
certain stockholders and debenture holders of PRIM*****

3.1 Articles of Incorporation of the Company, as amended and restated by
the Company and currently in effect*
3.2 Bylaws of the Company, to date*

EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS

10.1 Employment agreement, dated 1st of June 1994, by and between Mr.
William L. Gentz, President and Chief Executive Officer of the
Company, and the Company*
10.2 Employment agreement, dated February 17, 1997, by and between Mr.
Arnold J. Senter, Executive Vice President and Chief Operating Officer
of the Company, and the Company
10.3 1986 Non-Statutory Stock Option and Non-Statutory Stock Purchase
Plan***
10.4 1995 Stock Incentive Plan***

OTHER MATERIAL CONTRACTS

10.5 Aggregate Excess of Loss Cover entered into on the 30th day of August
1991, between Centre Reinsurance Limited (Centre Re) and the Company,
as amended*
10.6 Multi-year Prospective Accident Year Stop Loss Reinsurance Contract
effective the 1st of January 1993, between Centre Reinsurance
International Company and the Company (the "1993 Centre Re Contract")*
10.7 Letter dated March 28, 1996 from the Company canceling the 1993 Centre
Re Contract effective January 1, 1996***
10.8 Workers' Compensation and Employers' Liability Quota Share Insurance
Contract No. 30006A effective January 1, 1994, between the Company and
Zurich Reinsurance Centre, as amended (the "ZRC Contract")*
10.9 Addendum No. 4 to the ZRC Contract effective as of January 1, 1996***
10.10 Addendum No. 1 to the Retrocession Agreement (an ancillary agreement
to the ZRC Contract) effective as of January 1, 1996***
10.11 Lease, dated 27th day of October 1988, by and between Corporate Center
at Malibu Canyon, a California Limited Partnership and the Company,
relating to the lease of the Company's home office and Calabasas
Branch Facilities*
10.12 Lease, dated 27th of July 1993, by and between TOMOE Investment and
Development, Inc. and the Company, relating to the lease of its South
San Francisco Facility*
10.13 Lease, dated 14th of November 1991, by and between Dean Witter
Reynolds and the Company relating to the lease of its Fresno
Facilities*
10.14 Lease, dated 23rd of February 1993, by and between Shaw Avenue
Associates, a California Limited Partnership and the Company relating
to the lease of its Fresno Facilities*
10.15 Lease, dated 14th of February 1994, by and between Contra Costa County
Employees Retirement Association and the Company relating to its
Sacramento Facility*
10.16 Bank Debt, $10 million loan agreement between Imperial Bank and the
Company that was entered into on the 1st day of July 1994 (the
"Imperial Loan")*
10.17 Amendment No. 1 to the Imperial Loan dated March 27, 1995**
10.18 Amendment No. 2 to the Imperial Loan dated October 16, 1995**
10.19 Credit Agreement between the Company and The Chase Manhattan Bank
dated as of November 12, 1996, (the "1996 Credit Agreement"), and
all material exhibits thereto
10.20 Agreement in Principle dated 29th of March 1994 by and between
the Company and Centre, a Bermuda Corporation, or one of its
affiliates*
10.21 Limited Partnership Agreement of Superior National Capital, L.P.
(Capital) with certificate of Limited Partnership and Certificate
of Exempted Partnership, all as filed on the 28th of June 1994,
with the Registrar of Companies of Bermuda*
10.22 Preferred securities purchase agreement, dated 30th day of June
1994, by and between Capital, Superior National Capital Holding
Corporation, the Company and Centre Reinsurance Services
(Bermuda) III Limited*
10.23 Loan agreement, dated 30th of June 1994, whereby Capital agrees
to loan $20,408,163 to the Company*
10.24 Liability Assumption Agreement, dated 30th of June 1994, by and
between the Company and Capital*
10.25 Certificate dated 30th of June 1994, evidencing the issuance of
800,000 Preferred Securities of Capital to Centre Re*
10.26 Note made by the Company in favor of Capital dated 30th of June
1994, in the aggregate principal amount of $20,408,163*
10.27 Purchase warrant, dated as of the 30th of June 1994, entitles
CentreLine Reinsurance Limited to purchase 2,317,426 shares of
the Company's common stock*
10.28 Certificate of Limited Partnership of Superior National
Capital, L.P.*
10.29 Warrant held by International Insurance Advisors, Inc. to
purchase 6,097,130 shares at $1.00 per share dated March 31, 1992
and expiring April 1, 2002*

10.30 Stock Purchase Agreement dated as of September 17, 1996, as
amended and restated effective as of February 17, 1997, among the
Company, Insurance Partners, L.P., Insurance Partners Offshore
(Bermuda), L.P., TJS Partners, L.P., and certain members of the
Company's management*****
10.31 State of California Department of Insurance Amended Certificate
of Authority*
11.1 Statement re computation of per share earnings
21.1 Subsidiaries of the Registrant*

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

* Previously filed as an exhibit to SNIG's Registration Statement on
Form 10 as filed with the Securities and Exchange Commission ("SEC") on
May 1, 1995 (File No. 0-25984).

** Previously filed as an exhibit to Amendment No. 2 to SNIG's Registration
Statement on Form 10/A as filed with the SEC on November 1, 1995 (File
No. 0-25984).

*** Previously filed as an exhibit to SNIG's Annual Report on Form 10-K as
filed with the SEC on March 29, 1996.

**** Previously filed as an exhibit to SNIG's statement on Schedule 13D filed
for Pac Rim Holding Corporation, as filed with the SEC on September 26,
1996.

***** Previously filed as an exhibit to SNIG's statement on Schedule 13D filed
for Pac Rim Holding Corporation, as filed with the SEC on February 27,
1997.

(b) REPORTS ON FORM 8-K: None

(c) The page numbers of the Exhibits filed in response to this
portion of Item 14 are listed on an Index of Exhibits that
follows the signature page.

(d) The response to this portion of Item 14 is presented in response
to Item 8 of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized.

Date: March 10, 1997

Superior National Insurance Group, Inc.

By: /s/ J. Chris Seaman
-------------------------------------
J. Chris Seaman
Executive Vice President and
Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report on Form 10-K has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.

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

/s/ William Gentz Director, President and Chief March 10, 1997
- ----------------------- Executive Officer (Principal
William Gentz Executive Officer)

/s/ J. Chris Seaman Director, Executive Vice President March 10, 1997
- ----------------------- and Chief Financial Officer
J. Chris Seaman (Principal Accounting Officer)

/s/ Steven D. Germain Director March 10, 1997
- -----------------------
Steven D. Germain

/s/ Thomas J. Jamieson Director March 10, 1997
- -----------------------
Thomas J. Jamieson

/s/ Gordon E. Noble Director March 10, 1997
- -----------------------
Gordon E. Noble

/s/ C.L. Pecchenino Director March 10, 1997
- -----------------------
C.L. Pecchenino

/s/ Craig F. Schwarberg Director March 10, 1997
- -----------------------
Craig F. Schwarberg

/s/ Robert A. Spass Director March 10, 1997
- -----------------------
Robert A. Spass

/s/ Bradley E. Cooper Director March 10, 1997
- -----------------------
Bradley E. Cooper

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
----

Independent Auditors' Report.........................................................60

Consolidated Financial Statements:

Consolidated Balance Sheets as of December 31, 1996 and 1995...................F-1
Consolidated Statements of Income for the years ended December 31, 1996,
1995 and 1994............................................................F-2
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994.........................................F-3
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994............................................................F-4
Notes to Consolidated Financial Statements.....................................F-5

Financial Statements Schedules:

Schedule I: Condensed Financial Information of the Registrant, Superior
National Insurance Group, Inc...............................F-24
Schedule II: Valuation and Qualifying Accounts and Reserves.................F-28
Schedule V: Supplemental Insurance Information, Reinsurance and
Supplemental Property and Casualty Insurance Information....F-29

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Superior National Insurance Group, Inc.:

We have audited the consolidated financial statements of Superior National
Insurance Group, Inc. and subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and the financial statement schedules based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Superior National
Insurance Group, Inc. and subsidiaries 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. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.

KPMG Peat Marwick LLP

Los Angeles, California
February 18, 1997

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(In thousands, except share data)

-------- --------
ASSETS 1996 1995
-------- --------

Investments:
Bonds and Notes
Available-for-sale, at market (cost: 1996, $46,549; 1995, $41,800) $ 46,330 $ 42,053
Equity securities, at market
Common stock (cost: 1996, $1,199; 1995, $686) 1,173 689
Funds withheld from reinsurers, at amortized cost
(market: 1995, $117,073) - 114,921
Cash and Invested cash (Restricted cash: 1996, $297; 1995, $2,686) 100,487 4,588
Restricted investment 1,450 1,700
-------- --------
TOTAL INVESTMENTS 149,440 163,951

Reinsurance recoverable:
Paid and unpaid claims and claim adjustment expense 25,274 38,772
Policyholder dividends - 841
Premiums receivable (less allowance for doubtful
accounts of $300 in 1996 and $500 in 1995) 9,390 11,574
Earned but unbilled premiums receivable 5,251 3,150
Accrued investment income 1,035 1,827
Deferred policy acquisition costs 3,042 2,780
Deferred income taxes 9,520 10,085
Funds held by reinsurer 1,948 972
Receivable from reinsurer 93,266 -
Prepaid reinsurance premiums 1,039 752
Prepaid and other 7,364 6,077
-------- --------
TOTAL ASSETS $306,569 $240,781
-------- --------
-------- --------

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expense $115,529 $141,495
Unearned premiums 9,702 10,347
Reinsurance payable 874 370
Long-term debt 98,961 8,530
Policyholder dividends - 8,094
Accounts payable and other liabilities 12,741 7,420
-------- --------
TOTAL LIABILITIES 237,807 176,256

PREFERRED SECURITIES ISSUED BY AFFILIATE; authorized
1,100,000 shares; issued and outstanding 1,013,753 shares in
1996 and 922,137 shares in 1995 23,571 21,045

SHAREHOLDERS' EQUITY
Common stock, no par value; authorized 25,000,000 shares;
issued and outstanding 3,446,492 shares in 1996 and 3,430,373 16,022 15,943
shares in 1995
Unrealized (loss) gain on equity securities, net of taxes (17) 2
Unrealized (loss) gain on available-for-sale investments, net of taxes (145) 167
Paid in capital - warrants 2,206 2,206
Retained earnings 27,125 25,162
-------- --------
NET SHAREHOLDERS' EQUITY 45,191 43,480
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $306,569 $240,781
-------- --------
-------- --------

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

F-1

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(In thousands, except per share amounts)

------- ------- --------
1996 1995 1994
------- ------- --------

REVENUES:
Premiums written, net of reinsurance ceded $87,715 $89,139 $105,946
Net change in unearned premiums 933 596 4,472
------- ------- --------
Net premiums earned 88,648 89,735 110,418
Net investment income 7,769 9,784 9,049
------- ------- --------
TOTAL REVENUES 96,417 99,519 119,467
------- ------- --------

EXPENSES:
Claims and claim adjustment, net of reinsurance
recoveries of $6,064, $2,418 and $8,402 in 1996,
1995 and 1994, respectively 55,638 53,970 78,761
Commissions, net of reinsurance ceding
commissions of $2,030, $1,350 and $5,854 in
1996, 1995 and 1994, respectively 10,426 11,881 10,404
Policyholder dividends (5,927) (5,742) 4,983
Interest 7,527 9,619 8,726
General and administrative
Underwriting 23,712 17,566 11,256
Other (186) 536 340
------- ------- --------
TOTAL EXPENSES 91,190 87,830 114,470

INCOME BEFORE INCOME TAXES, PREFERRED SECURITIES
DIVIDENDS AND ACCRETION, DISCONTINUED
OPERATIONS, AND EXTRAORDINARY ITEM 5,227 11,689 4,997
Income tax expense (benefit) 1,597 (12) 1,398
------- ------- --------
INCOME BEFORE PREFERRED SECURITIES DIVIDENDS AND
ACCRETION, DISCONTINUED OPERATIONS, AND
EXTRAORDINARY ITEM 3,630 11,701 3,599
Preferred securities dividends and accretion, net of
income tax benefit of $858, $767 and $352, in
1996, 1995 and 1994, respectively (1,667) (1,488) (683)
Loss from operations of discontinued property
and casualty operations, net of income tax
benefit of $5,070 in 1995 - (9,842) -
Extraordinary loss on retirement of long-term debt,
net of income tax benefit of $1,042 in 1994 - - (2,022)
------- ------- --------
NET INCOME $ 1,963 $ 371 $ 894
------- ------- --------
------- ------- --------

EARNINGS PER SHARE:
INCOME BEFORE PREFERRED SECURITIES DIVIDENDS AND
ACCRETION, DISCONTINUED OPERATIONS, AND
EXTRAORDINARY ITEM $0.71 $3.41 $1.05
Preferred securities dividends and accretion, net of
income taxes (0.31) (0.43) (0.20)
Loss from operations of discontinued property and
casualty operations, net of income tax benefit - (2.87) -
Extraordinary loss on retirement of long-term debt,
net of income tax benefit - - (0.59)
------- ------- --------
NET INCOME $ 0.40 $ 0.11 $ 0.26
------- ------- --------
------- ------- --------

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

F-2

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Amounts in thousands, except share amounts)

NET
UNREALIZED UNREALIZED
COMMON STOCK GAIN GAIN (LOSS)
---------------------- (LOSS) ON AVAILABLE- PAID IN TOTAL
SHARES NO PAR ON EQUITY FOR-SALE CAPITAL- RETAINED SHAREHOLDERS'
ISSUED VALUE SECURITIES INVESTMENTS WARRANTS EARNING EQUITY
------ ----- ---------- ------------- -------- -------- -------------

-----------------------------------------------------------------------------------------
Balance at December 31, 1993 3,429,873 $15,941 - - $ 216 $23,897 $40,054
-----------------------------------------------------------------------------------------

Net income - - - - - 894 894
Retirement of warrants - - - - (10) - (10)
Issuance of warrants - - - - 2,000 - 2,000
Adjustment for change in
accounting for available-for-
sale investments, net of taxes - - - $ 289 - - 289
Change in unrealized gain (loss)
on available-for-sale
investments, net of taxes - - - (2,863) - - (2,863)
Balance at December 31, 1994 3,429,873 15,941 - (2,574) 2,206 24,791 40,364

Net income - - - - - 371 371
Unrealized gain on equity
securities - - $ 2 - - - 2
Change in unrealized loss on
available-for-sale
investments, net of taxes - - - 2,741 - - 2,741
stock issued under stock option
plan 500 2 - - - - 2
-----------------------------------------------------------------------------------------
Balance at December 31, 1995 3,430,373 15,943 2 167 2,206 25,162 43,480
-----------------------------------------------------------------------------------------

Net Income - - - - - 1,963 1,963
Unrealized gain on equity
securities - - (19) - - - (19)
Change in unrealized loss
on available-for-sale
investments, net of taxes - - - (312) - - (312)
stock issued under stock option
plan 3,100 12 - - - - 12
Common stock issued under stock
incentive 13,019 67 - - - - 67
-----------------------------------------------------------------------------------------
Balance at December 31, 1996 3,446,492 $16,022 $ (17) $ (145) $2,206 $27,125 $45,191
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

F-3

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)

1996 1995 1994
-------- -------- --------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,963 $ 371 $ 894
-------- -------- --------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of bonds and preferred stock (1,581) (3,575) (2,770)
Amortization of long-term debt - - 1,151
(Gain)/loss on sale of investments (31) 525 (35)
(Gain)/loss on sale of Centre Re investments (2,036) (4,891) -
Preferred securities dividends and accretion 2,526 2,255 1,035
Decrease in reinsurance balances receivable 14,339 28,516 2,874
Decrease in premiums receivable 2,184 6,901 208
(Increase) decrease in earned but unbilled premiums receivable (2,101) 3,336 2,580
Decrease (increase) in accrued investment income 792 (491) 138
(Increase) decrease in deferred policy acquisition costs (262) 125 446
Decrease in income taxes receivable - 1,721 -
Decrease (increase) in deferred taxes 735 (5,853) -
(Increase) in funds held by reinsurer (976) (972) -
(Increase) decrease in prepaid reinsurance premiums (287) (88) (537)
(Increase) in other assets (1,287) (1,413) (362)
(Decrease) increase in claims and claim adjustment expense reserves (25,966) (29,763) 220
Decrease in unearned premium reserves (645) (508) (3,935)
(Decrease) increase in reinsurance payable 504 (2,835) 2,161
(Decrease) increase in policyholder dividends payable (8,094) (10,970) 1,163
Decrease in discontinued operations - (4,223) -
Increase (decrease) in accounts payable and other liabilities 5,321 (1,994) 984
-------- -------- --------
Total adjustments (16,865) (24,197) 5,321
-------- -------- --------
Net cash provided by (used in) operating activities (14,902) (23,826) 6,215
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt (2,660) (1,200) (8,165)
Proceeds from long-term debt - - 10,000
Proceeds from Chase Financing 93,091 - -
Proceeds from issuance of preferred securities - - 17,755
Paid-in capital - new warrants issued - - 2,000
Paid-in capital - warrants - - (10)
Paid-in capital - stock options taken 79 2 -
-------- -------- --------
Net cash provided by (used in) financing activities 90,510 (1,198) 21,580
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments held-to-maturity - - (4,179)
Investments available-for-sale (43,257) (4,611) (15,025)
Investments funds withheld from reinsurers (88,568) (204,577) (16,982)
Purchases of common stock (513) (680) -
(Increase) in receivable from reinsurer (93,266) - -
Investments and cash allocated to discontinued operations - (1,581) (19,034)
Sales of bonds and notes: Investments available for sale 25,343 17,643 4,047
Maturities of bonds and notes:
Investments held-to-maturity - 2,250 -
Investments available-for-sale 12,771 3,035 9,179
Sales and maturities of funds withheld from reinsurers 206,548 191,238 14,949
Sales of common stock - - 27
Net decrease (increase) in invested cash 983 26,062 (3,645)
-------- -------- --------
Net cash provided by (used in) investing activities 20,041 28,779 (30,663)
-------- -------- --------
Net increase (decrease) in cash 95,649 3,755 (2,868)
Cash and invested cash at beginning of period 6,288 2,533 5,401
-------- -------- --------
Cash and invested cash at end of period $101,937 $ 6,288 $ 2,533
-------- -------- --------
-------- -------- --------
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 4 $ 4 $ 4
-------- -------- --------
-------- -------- --------
Cash paid during the year for interest $ 641 $ 808 $ 1,222
-------- -------- --------
-------- -------- --------

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

F-4

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
(Dollar amounts in thousands, except share data)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Superior
National Insurance Group, Inc. and all subsidiaries (the Company). The
Company's principal insurance subsidiary, Superior National Insurance Company
(SNIC) is licensed to write workers' compensation insurance and commercial
property and casualty insurance in 17 states and the District of Columbia.

During the third quarter of 1993, the Company adopted a plan to discontinue
underwriting commercial property and casualty risks. Earned premiums reported
in 1996, 1995, and 1994, reflect workers' compensation premium from policies
that were primarily located in California.

The Company's consolidated financial statements have been prepared on the
basis of generally accepted accounting principles that vary in certain respects
from accounting practices prescribed or permitted by state insurance regulatory
authorities. The results of all significant intercompany transactions have been
eliminated.

Certain reclassifications have been made to prior year financial statements
to conform to the 1996 presentation.

REVERSE STOCK SPLIT

Effective May 25, 1995, shareholders of Superior National Insurance Group,
Inc. approved a four-into-one reverse split of the Company's Common Stock. The
purpose of the reverse split was to increase the per-share price of the
Company's Common Stock in order to enhance public trading of the Common Stock
upon the effectiveness of the Company's registration with the Securities and
Exchange Commission. Consequently, the shares of common stock and stock options
information included in the accompanying consolidated financial statements were
prepared assuming the reverse stock split had been outstanding at the beginning
of all periods presented.

CASH AND INVESTED CASH

Cash includes currency on hand and demand deposits with financial
institutions. Invested cash represents short-term, highly liquid investments,
readily convertible to known amounts of cash and near maturity such that there
is insignificant risk of changes in value because of changes in interest rates.
Invested cash is carried at cost, which approximates market.

INVESTMENTS

Investments in debt instruments consist primarily of bonds and
collateralized mortgage obligations. Effective January 1, 1994, the Company
adopted Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (SFAS 115). Under SFAS 115
debt instruments and equities are classified as (i) "held-to-maturity" (carried
at amortized cost); (ii) "trading" (carried at market with differences between
cost and market being reflected in the results of operations); or (iii) if not
otherwise classified, as "available for sale" (carried at market with
differences between cost and market being reflected as a separate component of
shareholders' equity, net of the applicable income tax effect). The premium and
discount on fixed maturities and collateralized mortgage obligations are
amortized using the scientific method. Amortization and accretion of premiums
and discounts on collateralized mortgage obligations are adjusted for principal
paydowns and changes in expected maturities. Current market values of
investments are obtained from published sources. Declines in market value that
are considered other than temporary are charged to operations. The adoption of
SFAS 115 resulted in an

F-5

Notes to Consolidated Financial Statements, Continued

increase in reported shareholders' equity of approximately $289 net of deferred
income taxes in 1994. The Company's adoption of SFAS 115 may result in
substantial fluctuations in reported shareholders' equity.

Upon adoption of SFAS 115 the Company designated assets withheld under
certain reinsurance contracts as held to maturity. The Company does not own any
investments that qualify as derivatives as defined by Statement of Financial
Accounting Standard No. 119, "Disclosure About Derivative Financial Investments
and Fair Value of Financial Investments." Securities not designated as held to
maturity have been designated as available-for-sale. The Company did not have
any investments categorized as trading securities. For determining realized
gains or losses on securities sold, cost is based on average cost.

During 1995, the Financial Accounting Standards Board allowed companies the
opportunity to re-designate their investments between (i) held to maturity;
(ii) trading; and, (iii) available-for-sale without penalty. During the grace
period given by the FASB, the Company re-designated $2 million from held to
maturity to available-for-sale.

Investments in equity securities are carried at market value. Unrealized
gains or losses on equity securities are reflected, net of applicable tax, in
shareholders' equity.

PREMIUMS RECEIVABLE

SNIC records premiums receivable for both billed and unbilled amounts.
Unbilled premiums receivable, which are substantially all earned, primarily
represent SNIC's estimate of the difference between amounts billed on
installment policies and the amount to be ultimately billed on the policy.
Unbilled premiums receivable also include estimated billings on payroll
reporting policies which were earned but not billed prior to year end. SNIC
uses its historical experience to estimate earned but unbilled amounts which are
recorded as premiums receivable. These unbilled amounts are estimates, and
while the Company believes such amounts are reasonable, there can be no
assurance that the ultimate amounts received will equal the recorded unbilled
amounts.

The ultimate collectability of the unbilled receivables can be affected to
a greater degree by general changes in the economy and the regulatory
environment than billed receivables due to the increased time required to
determine the billable amount. The Company attempts to consider these factors
when estimating the receivable for unbilled premiums.

DEFERRED POLICY ACQUISITION COSTS

Acquisition costs, consisting principally of commissions, premium taxes and
certain marketing, policy issuance, and underwriting costs, related to the
production of SNIC's workers' compensation business, are deferred and amortized
ratably over the terms of the policies. If recoverability of such costs is not
anticipated, the amounts not considered recoverable are charged to income. In
determining estimated recoverability, the computation gives effect to the
premium to be earned, related investment income, claims and claim adjustment
expenses, and certain other costs expected to be incurred as the premium is
earned.

Policy acquisition costs incurred and amortized into income are as follows:

1996 1995 1994
-------- -------- --------

Balance as of beginning of year $ 2,780 $ 2,905 $ 3,351
Cost deferred during the year 17,132 18,163 16,300
Amortization charged to expense (16,870) (18,288) (16,746)
-------- -------- --------
Balance at end of year $ 3,042 $ 2,780 $ 2,905
-------- -------- --------
-------- -------- --------

F-6

Notes to Consolidated Financial Statements, Continued

CLAIMS AND CLAIM ADJUSTMENT EXPENSE

Claims and claim adjustment expenses are based on case-basis estimates of
reported claims and on estimates, based on experience and industry data, for
unreported claims and claim adjustment expenses. The provision for unpaid
claims and claim adjustment expenses, net of estimated salvage and subrogation,
has been established to cover the estimated net cost of incurred claims. The
amounts are necessarily based on estimates, and accordingly, there can be no
assurance the ultimate liability will not differ from such estimates.

There is a high level of uncertainty inherent in the evaluation of the
required claims and claim adjustment expense reserves. Management has selected
ultimate claim and claim adjustment expense that it believes will reasonably
reflect anticipated ultimate experience. The ultimate costs of such claims are
dependent upon future events, the outcomes of which are affected by many
factors. Claims reserving procedures and settlement philosophy, current and
perceived social and economic factors, inflation, current and future court
rulings and jury attitudes, and many other economic, scientific, legal,
political, and social factors all can have significant effects on the ultimate
costs of claims. Changes in Company operations and management philosophy also
may cause actual developments to vary from the past.

POLICYHOLDER DIVIDENDS

Prior to open rating, policyholder dividends served both as an economic
incentive to employers for safe operations and as a means of price
differentiation; however, since the inception of open rating in January, 1995
the consumers' preference has been for the lowest net price at a policy's
inception. This is evidenced by the decline in participating policies written
by SNIC as a percent of total policies, such percentage has declined from 65% of
workers' compensation premiums in force at December 31, 1994 to 24% at December
31, 1995, and less than 1% at December 31, 1996. In 1995, as a result of the
diminishing value of Policyholder Dividends SNIC's management declared a
moratorium in the payment of policyholder dividends. In December 1996, the
Company discontinued policyholder dividend payments. Estimated amounts to be
returned to policyholders were accrued when the related premium was earned by
SNIC. Dividends were paid to the extent that a surplus was accumulated from
premiums on workers' compensation policies.

PREMIUM INCOME RECOGNITION

Insurance premiums are earned ratably over the terms of the policies.
Unearned premiums are computed on a daily pro-rata basis.

INCOME TAXES

The Company files a consolidated Federal income tax return which includes
all qualifying subsidiaries.

Deferred income taxes are provided for temporary differences between
financial statement and tax return bases using the asset and liability method,
in accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). Under the asset and liability method
deferred taxes are measured using enacted tax rates in effect for the year in
which those temporary differences are expected to be settled. Tax rate changes
are accounted for in the year in which the tax law is enacted.

EARNINGS PER SHARE ("EPS")

The EPS calculations for the years ended December 31, 1996, 1995 and 1994
were calculated based upon the weighted average number of shares of common stock
after giving effect to the four-into-one reverse stock split, and adjusted for
the effect, if any, of options and warrants considered to be common stock
equivalents. Stock options and warrants are considered to be common stock
equivalents, except when their effect is antidilutive. The calculations assume
the reverse stock split, effective May 25, 1995, had been outstanding at the
beginning of all periods presented. The weighted number of shares outstanding
used in the earnings per share calculations are 5,315,670 shares for 1996,
3,430,373 shares for 1995 and 3,429,873 shares for 1994.

F-7

Notes to Consolidated Financial Statements, Continued

PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Property, equipment, and leasehold improvements are stated at cost, net of
accumulated depreciation and amortization (approximately $5,061 and $4,176 at
December 31, 1996 and 1995, respectively). Depreciation and amortization are
provided principally on the straight-line method over the estimated useful lives
of the assets or, if less, the term of the lease. Property, equipment, and
leasehold improvements are included as a component of "Prepaid and other assets"
on the consolidated balance sheets.

USE OF MANAGEMENT ESTIMATIONS

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the amounts of assets, liabilities, and disclosures of
contingent assets and liabilities at the date of the financial statements. The
Company has provided such estimates for its workers' compensation claims and
claim adjustment expenses; discontinued operations; policyholder dividends; and
deferred taxes balances in its financial statements. While, these estimates are
based upon analyses performed by management, outside consultants and actuaries,
the amounts the Company will ultimately pay may differ materially from the
amounts presently estimated.

STOCK- BASED COMPENSATION

In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), which establishes financial accounting and reporting standards for
stock-based employee compensation plans. SFAS 123 is effective for the fiscal
year beginning in 1996. The Company has adopted the disclosure method of
accounting for SFAS 123.

(2) INVESTMENTS

The amortized cost and market values of bonds and notes classified as
available-for-sale at December 31, 1996 are as follows:

Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ------

AVAILABLE-FOR-SALE:
United States government
agencies and authorities 22,596 62 (174) 22,484
Collateralized mortgage
obligations 12,989 - (134) 12,855
Corporate instruments 9,864 23 (20) 9,867
State and political
subdivisions 1,100 24 - 1,124
--------- ---------- ---------- ------
Total-available-for-sale 46,549 109 (328) 46,330
--------- ---------- ---------- ------
--------- ---------- ---------- ------

The market value of equity securities as of December 31, 1996 are as
follows:

Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ------
EQUITY SECURITIES:
Corporate Instruments $ 1,199 $ 73 $ (99) $1,173
--------- ---------- ---------- ------
Total Equity Securities $ 1,199 $ 73 $ (99) $1,173
--------- ---------- ---------- ------
--------- ---------- ---------- ------

F-8

Notes to Consolidated Financial Statements, Continued

The amortized cost and estimated market values of investments classified as
available for sale at December 31, 1996, by contractual maturity are shown
below. Expected maturities are likely to differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without penalty. Mortgage backed securities are included based upon the
expected payout pattern and duration of the fixed income security. Changes in
interest rates, investor expectations and political agendas could cause the
ultimate payout pattern to differ.

Available for Sale
----------------------
Amortized Market
Cost Value
--------- ------

Due in one year or less 7,458 7,309
Due after one year
through five years 16,641 16,601
Due after five years
through ten years 10,266 10,263
Due after ten years 12,184 12,157
------ ------
Total 46,549 46,330
------ ------
------ ------

The amortized cost and market values of bonds and notes classified as held
to maturity and investments classified as available for sale at December 31,1995
are as follows:

Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ------

AVAILABLE FOR SALE:
United States government
agencies and authorities 22,549 129 (154) 22,524
Collateralized mortgage
obligations 10,753 88 (62) 10,779
Corporate instruments 7,398 214 - 7,612
State and political
subdivisions 1,100 38 - 1,138
--------- ---------- ---------- ------
Total available for sale 41,800 469 (216) 42,053
--------- ---------- ---------- ------
--------- ---------- ---------- ------

The amortized cost and market values of bonds, notes and invested cash for
funds withheld from reinsurers as of December 31, 1995 are as follows:

Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- --------

FUNDS WITHHELD FROM REINSURER:
United States government
agencies and authorities $103,496 $ 2,132 $ (74) $105,554
Collateralized mortgage
obligations 2,306 10 - 2,316
Special revenue 2,118 65 - 2,183
Corporate instruments 7,001 19 - 7,020
--------- ---------- ---------- --------
Total funds withheld from
reinsurers $ 114,921 $ 2,226 $ (74) $117,073
--------- ---------- ---------- --------
--------- ---------- ---------- --------

F-9

Notes to Consolidated Financial Statements, Continued

The market value of equity securities as of December 31, 1995 are as
follows:

Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ------

EQUITY SECURITIES:
Corporate Instruments $ 686 $ 3 $ - $ 689
--------- ---------- ---------- ------
Total Equity Securities $ 686 $ 3 $ - $ 689
--------- ---------- ---------- ------
--------- ---------- ---------- ------

A summary of net investment income for the years ended December 31, are as
follows:

1996 1995 1994
------ ------- ------
Interest on bonds and notes $6,628 $ 9,310 $8,738
Interest on invested cash 1,609 1,297 597
Realized gains (losses) 31 (525) 35
Other - - 3
------ ------- ------
Total investment income 8,268 10,082 9,373
Investment expense 499 298 324
------ ------- ------
Net investment income $7,769 $9,784 $9,049
------ ------- ------
------ ------- ------

Realized gains (losses) on investments for the years ended December 31, are
as follows:

1996 1995 1994
------ ------- ------
Bonds and notes $ 31 $ (525) $ 55
Equity securities - - (20)
------ ------- ------
Total $ 31 $ (525) $ 35
------ ------- ------
------ ------- ------

The changes in unrealized gains (losses) on debt instruments held as
available-for-sale and equity security investments at December 31, are as
follows:

1996 1995 1994
------ ------- ------
Bonds and notes $ (472) $ 4,154 14,637
Equity securities (29) 2 -
------ ------- ------
Total $ (501) $ 4,156 14,637
------ ------- ------
------ ------- ------

Proceeds from sales of investments held as available for sale for the year
ended December 31, 1996, 1995 and 1994 were $25,343, $17,643 and $4,047,
respectively. Gross gains of $44 and gross losses of $13 were realized on
those sales in 1996. Gross gains of $4 and gross losses of $529 were realized
on those sales in 1995. Gross gains of $63 and gross losses of $8 were realized
on those sales in 1994.

Bonds and other securities with a market value of $127,112 at December 31,
1996 and $143,462 at December 31, 1995, were on deposit with various insurance
regulatory authorities. Additionally, see Note (7) regarding investments held
related to reinsurance contracts.

F-10

Notes to Consolidated Financial Statements, Continued

(3) FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table represents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1996 and 1995.
FASB Statement No. 107, Disclosure about Fair Value of Financial Instruments,
defines the fair value of a financial instruments as the amount at which the
instrument could be exchanged in a current transaction between willing parties.

The carrying amounts shown in the table below are included in the
Consolidated Balance Sheets under the indicated options.

1996 1995
---------------- -----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- ---------------------------------------- -------- ------ -------- -------
Financial liabilities:
Chase financing agreement 91,681 91,374 - -
Imperial Bank Debt 7,250 7,541 8,530 $ 8,769
Preferred securities issued by affiliate $23,571 19,998 $21,045 $22,035
------- ------ ------- -------
------- ------ ------- -------

Fair value is estimated based on the quoted market prices for similar
issues or by discounting expected cash flows at the rates currently offered to
the Company for debt of the same remaining maturities.

(4) CLAIM AND CLAIM ADJUSTMENT EXPENSE RESERVES

The activity in the claim and claim adjustment expense reserve account is
summarized as follows:

--------------------------------------
YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
-------- -------- --------

Beginning reserve, gross of reinsurance $141,495 $171,258 $171,038
Less: Reinsurance recoverable on unpaid losses 27,076 31,897 28,971
-------- -------- --------
Beginning reserve, net of reinsurance 114,419 139,361 142,067
Provision for net claims and claim adjustment expenses
For claims occurring in current year 57,614 58,842 72,457
For claims occurring in prior years (1,976) (4,872) 6,304
-------- -------- --------
Total claims and claim adjustment expenses 55,638 53,970 78,761
-------- -------- --------
Payments for net claims and claim adjustment expense:
Attributable to insured events incurred in current year (19,816) (19,732) (23,061)
Attributable to insured events incurred in prior years (59,698) (59,180) (58,406)
-------- -------- --------
Total claims and claim adjustment expense payments (79,514) (78,912) (81,467)
-------- -------- --------
Ending reserves, net of reinsurance 90,543 114,419 139,361
Reinsurance recoverable on unpaid losses 24,986 27,076 31,897
-------- -------- --------
Ending reserves, gross of reinsurance $115,529 $141,495 $171,258
-------- -------- --------
-------- -------- --------

During 1996, the Company continued to experience decreased frequency and
severity with respect to claims incurred during 1996; however adverse develop-
ment on the 1995 accident year began to emerge. The Company's 1996 accident
year net claim and claim adjustment expense ratio for accident year 1996 at the
end of calendar year 1996 was 65.0%, versus 65.6% for accident years 1995 and
1994, at their respective calendar year ends.

In 1996, the Company experienced approximately $2.0 million in favorable
development on net claims and claim adjustment expense reserves estimated at
December 31, 1995. This $2.0 million favorable development is the result of
$8.4 million in favorable development on direct reserves for accident years 1994
and prior. The favorable development was offset in part by $4.1 million adverse
development on direct reserves for accident year

F-11

Notes to Consolidated Financial Statements, Continued

1995, and $2.3 million adverse development on ceded reserves for accident years
1995 and prior. The Company's 1995 accident year net claims and claim
adjustment expense ratio for accident year 1995 at the end of calendar year 1995
was 65.6%, verses 74.6% at the end of the 1996 calendar year. Similar adverse
development has been experienced throughout the California workers' compensation
industry.

During 1995, the Company experienced approximately $8.6 million of favor-
able development on direct claim and claim adjustment expense reserves estimated
at December 31, 1994. Management believes the favorable development resulted
from the Company's improved claims management controls and decreased claim
severity, particularly in the medical component of the workers' compensation
line. Similar favorable development on pre-1995 losses has been experienced
elsewhere in the California workers' compensation industry. Offsetting the
favorable direct development in large part was the re-estimation during 1995 of
reinsurance receivables recorded at December 31, 1994 from approximately $66.2
million to approximately $59.9 million at December 31, 1995.

(5) DISCONTINUED OPERATIONS

During the third quarter of 1993, the Company adopted a plan to discontinue
underwriting commercial property and casualty risks. As a result, the Company
recorded a pre-tax charge to income of $2,991 for estimated operating losses
during the phase-out period.

During the second quarter of 1995, the Company increased its reserves by
approximately $15 million for discontinued operations for accident years 1994
and prior. This increase in claims and claim adjustment expense reserves from
the original estimate at the measurement date resulted from increased frequency
and severity of claims incurred from those years, relative to previous
expectations, which in turn caused an increase in the estimated ultimate claims
and claim adjustment expense reserves related to 1994 and prior years.

At December 31, 1996 and 1995, the net assets and liabilities of
discontinued operations, consisting primarily of reinsurance receivables,
securities, and unpaid claims and claim adjustment expenses, have been
reclassified in the balance sheet at estimated net realizable or payable
value. Management estimates the discontinued operations will be "run off" by
the year 2000. The assets and liabilities of discontinued operations are
summarized below.

--------------------
December 31,
--------------------
1996 1995
------- -------
Assets:
Reinsurance recoverables $ 8,604 $40,495
Investments and other assets 17,261 43
------- -------
Total Assets $25,865 $40,538
------- -------
------- -------
Liabilities:
Claims and claim adjustment expense reserves $25,466 $40,526
Other liabilities 399 12
------- -------
Total liabilities $25,865 $40,538
------- -------
------- -------

F-12

Notes to Consolidated Financial Statements, Continued

(6) INCOME TAXES

Total income tax expense (benefit) for the years ended December 31, 1996,
1995, and 1994, was allocated as follows:

1996 1995 1994
------ ------- ------
Continuing operations $1,597 $ (12) $ 1,398
Dividend accrued on preferred securities (858) (767) (352)
Discontinued operations - (5,070) -
Extraordinary item - - (1,042)
------ ------- -------
Total $ 739 $(5,849) $ 4
------ ------- -------
------ ------- -------

Income tax expense (benefit) from continuing operations for the years ended
December 31, 1996, 1995, and 1994 is composed of the following amounts:

1996 1995 1994
------ ------- ------
Current $ 4 $ 4 $ 4
Deferred 1,593 (16) 1,394
------ ------- -------
Total $1,597 $ (12) $ 1,398
------ ------- -------
------ ------- -------

Taxes computed at the statutory rate of 34% varied from the amounts
reported in the consolidated statements of income at December 31, as follows:

1996 1995 1994
------ ------- ------
Income taxes at statutory rates $1,777 $ 3,974 $1,699
Effect of tax-exempt interest (22) (15) (15)
Effect of meals and entertainment 38 38 37
Research and Development credit (200) - -
Change in valuation allowance for
tax assets - (4,013) (237)
Internal Revenue Service settlement - - 15
Change in AMT credit carryforward - - (101)
Other 4 4 -
------ ------- -------
Total $1,597 $ (12) $ 1,398
------ ------- -------
------ ------- -------

F-13

Notes to Consolidated Financial Statements, Continued

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, are
presented below:

1996 1995
-------- --------

Deferred tax assets:
Original issue discount $ 5,764 $ 22,908
Net operating loss carryforward 29,062 27,961
Alternate minimum tax carryforward 701 701
Unearned premium liability 660 686
Policyholder dividends - 2,326
Unrealized loss on available for sale securities 84 -
Research and development credit 200 -
Other 281 391
-------- --------
Total gross deferred tax assets 36,752 54,973
Less: Valuation allowance - -
-------- --------
Total 36,752 54,973
-------- --------

Deferred tax liabilities:
Loss reserves (9,139) (22,197)
Discontinued operations (1,245) (5,850)
Reinsurance experience refund (15,300) (15,300)
Deferred acquisition costs (1,034) (945)
Direct collection allowance (510) (510)
Unrealized gain on available-for-sale - (86)
Reinsurance payable (4) -
-------- --------
Total gross deferred tax liabilities (27,232) (44,888)
-------- --------
Net deferred tax asset $ 9,520 $ 10,085
-------- --------
-------- --------

Management believes it is more likely than not the existing net deductible
temporary differences will reverse during periods in which the Company generates
net taxable income. However, there can be no assurance the Company will
generate any earnings or any specific level of continuing earnings in future
years. Certain tax planning strategies could be implemented to supplement
income from operations to fully realize recorded tax benefits.

At December 31, 1996, the Company had a tax net operating loss carry
forward of $86.1 million that begins to expire in the year 2006.

(7) REINSURANCE

SNIC cedes claims and claim adjustment expenses to reinsurers under various
contracts that cover individual risks, classes of business, or claims that occur
during specified periods of time. Reinsurance is ceded on pro rata, per-risk
excess-of-loss, and aggregate bases. These reinsurance arrangements provide
greater diversification of risk and limit SNIC's claims arising from large risks
or from hazards of an unusual nature. SNIC is contingently liable to the extent
that any reinsurer becomes unable to meet its contractual obligations.
Therefore, the Company evaluates the financial condition of its reinsurers and
monitors concentrations of credit risks arising from reinsurance activities and
economic characteristics to minimize its exposure to significant losses from
reinsurer insolvencies.

As of December 31, 1996, SNIC was involved in a dispute with reinsurers,
which, if not settled, may be resolved in arbitration. SNIC's dispute exists
with its property and casualty reinsurers as to the existence of coverage
related to a claim in the amount of $850. Management expects to recover the
entire disputed amount. At December 31, 1996, there were no disputes related to
the workers' compensation operations.

Effective June 30, 1991, SNIC entered into an aggregate excess of loss
reinsurance contract (1991 Contract) with Centre Reinsurance Limited (Centre
Re). Under the 1991 Contract, SNIC purchased for $50 million reinsurance for
claims and claim adjustment expense incurred on or prior to June 30, 1991, to
the extent that these

F-14

Notes to Consolidated Financial Statements, Continued

amounts were unpaid at June 30, 1991. The coverage obtained amounted to $87.5
million in excess of SNIC's retention. Additionally, SNIC ceded approximately
$69.1 million of earned premiums to Centre Re through December 31, 1992. Claims
and claim adjustment expenses occurring prior to December 31, 1992 were ceded to
Centre Re in the amount of $165.6 million under the 1991 Contract. Prospective
cessions of premium and claims were terminated by mutual consent of SNIC and
Centre Re effective December 31, 1992; however, all other terms of the 1991
Contract remain in effect until the treaty terminates January 1, 1998.

As a result of the transaction entered into between the Company, Centre Re
and Chase Manhattan Bank (see footnote 8), the reinsurance receivables related
to the 1991 Contract no longer qualify as reinsurance receivables under the
conditions established in SFAS No. 113. Therefore, the receivables have been
reclassified as receivables from reinsurer on the balance sheet.

Effective January 1, 1993, SNIC entered into an aggregate excess of loss
reinsurance contract (1993 Contract) with Centre Re. From SNIC's perspective
the 1993 Contract substantively operated as a one year contract with at least
four one year options to renew that were exercisable solely at the Company's
election during the first five years of the contract. Subsequent to January 1,
1998, the 1993 Contract could have been terminated by either SNIC or Centre Re
upon 30 days notice. The 1993 Contract required the Company to cede not less
than $15 million and not more than $20 million of premium to Centre Re with
respect to any covered accident year. Claims and allocated claim adjustment
expenses occurring during the accident year are ceded to Centre Re in excess of
a variable percentage of earned premium (60%, 56.5% and 57.5% for the 1995, 1994
and 1993 accident years, respectively) and are subject to a limit of 130% of
ceded earned premium, such limit not to exceed $26 million for any accident
year. Effective January 1, 1996, the 1993 Contract was canceled at the Company's
election. The Company accrued $5.3 million related to the cancellation of the
1993 contract.

Reinsurance recoverable of $145.8 million and $165.6 million for the years
ended December 31, 1995 and 1994, respectively, were associated with Centre Re.
Under related reinsurance agreements with Centre Re, the Company held collateral
in the form of funds withheld of $105.7 million and $111.7 million for the years
ended December 31, 1995 and 1994, respectively, and irrevocable letters of
credit of $27.6 million and $62.3 million for the years ended December 31, 1995
and 1994, respectively. Centre Re realized $4.9 million in capital gains in
1995 and none in 1994 and 1993. The investment risk of investments related to
the funds withheld account was Centre Re's. Additionally, investment income on
the funds withheld account inured to the benefit of Centre Re.

Effective January 1, 1994, the Company entered into a 20% quota-share
reinsurance agreement with Zurich Reinsurance Centre (ZRC), an affiliate of
Centre Re. Under the terms of the treaty, the Company is to receive a ceding
commission to cover its costs of acquisition, and ZRC has the option to reduce
its participation level in subsequent years. Policies covered under this
contract include statutory workers' compensation and employers liability in-
force at January 1, 1994, and new and renewal policies occurring on or after
January 1, 1994. On December 31, 1994, ZRC elected to reduce its quota share
participation to 5%; however, all other terms of the treaty remained in effect.

SNIC's contracts are generally entered into on an annual basis. SNIC has
maintained reinsurance treaties with many reinsurers for a number of years. In
general, SNIC's reinsurance contracts are of the treaty variety, and cover
underwritten risks specified in the treaties. SNIC also from time to time
purchases facultative reinsurance covering specific liabilities or policies
underwritten. As of December 31, 1996, ZRC, General Reinsurance Corporation and
Unum Life Insurance Co. account for 36.8%, 24.8% and 15.6%, respectively, of
total amounts recoverable from all reinsurers on paid and unpaid claims and
claim adjustment expenses.

F-15

Notes to Consolidated Financial Statements, Continued

Amounts included in the income and expense accounts in continuing
operations in connection with all ceded reinsurance at December 31, are as
follows:

1996 1995 1994
------ ------- ------
Net Premiums written:
Premiums written $ 99,282 $97,084 $134,769
Premiums ceded (11,567) (7,945) (28,823)
-------- ------- --------
Net premiums written $ 87,715 $89,139 $105,946
-------- ------- --------
-------- ------- --------

Net change in unearned premiums:
Direct $ (645) $ (381) $ (3,935)
Ceded (288) (215) (537)
-------- ------- --------
Net change in unearned premiums $ (933) $ (596) $ (4,472)
-------- ------- --------
-------- ------- --------

Net claims and claim adjustment expenses:
Claims and claim adjustment expenses $ 61,702 $56,388 $ 87,163
Reinsurance recoveries (6,064) (2,418) (8,402)
-------- ------- --------
Net claims and claim adjustment
expenses $ 55,638 $53,970 $ 78,761
-------- ------- --------
-------- ------- --------

Funds withheld interest charges relating to the Centre Re treaties were
recorded in the amount of $6,062, $8,815 and $7,545 for the years ended
December 31, 1996, 1995, and 1994, respectively. Additionally, these interest
charges have been included in the funds withheld liability and interest expense
in the accompanying consolidated financial statements. The funds withheld
liability and interest accrual have been offset against amounts due from
reinsurers. The entire funds withheld investments were returned to Certre Re in
November 1996.

(8) LONG TERM DEBT

The following is a summary of the long-term debt balances at December 31:

1996 1995
-------- --------

Chase Financing Agreement - 6.87% due through 2004 $91,681 $ -
Imperial Bank Debt - 8.25% due through 2001 7,250 8,500
Voting Notes due 2002 30 30
------- ------
Balance at end of period $98,961 $8,530
------- ------
------- ------

Effective June 30, 1994, the Company entered into a $10 million term loan
agreement (the "1994 Loan") with Imperial Bank, which was used to retire
subordinated notes issued during 1992. This term loan is to be fully amortized
over seven years with quarterly payments of $300 plus interest per quarter for
years one and two, $350 plus interest per quarter for years three and four, and
$400 plus interest per quarter for years five, six and seven. Effective July 1,
1995, the borrowing rate was changed from Imperial Bank's prime rate plus one
half percent to a fixed rate of 8% per annum. Additionally, under the amended
terms of the 1994 Loan, the Company could not prepay the Loan until July 1,
1996. At which time, the Loan may be prepaid based upon an agreed upon premium
which varies by year. The premium for 1997 is 3.5%; 1998 is 2.5%; 1999 is 1%;
and 2000 is none.

The Company must adhere to certain requirements and provisions to be in
compliance with the terms of the notes. The provisions require SNIC to maintain
certain financial ratios and Superior National Insurance Group, Inc. the holding
company, to maintain Imperial Bank certificates of deposit in an amount equal to
20% of SNIG's outstanding balance under the 1994 Loan. At December 31, 1996,
the Imperial Bank time certificates of deposit were $1.5 million all of which
was restricted. The Company is in compliance with all loan covenants as of
December 31, 1996.

F-16

Notes to Consolidated Financial Statements, Continued

During 1996, the Company entered into a financing transaction involving
Centre Re and Chase. Chase extended a $93.1 million term loan (net of
transaction costs). The Company used the proceeds from the financing to
purchase from SNIC reinsurance receivables due from Centre Re.

The principal balance of the loan is collateralized by receivables due from
reinsurer and amortizes based upon the payout pattern of the underlying claims
of the reinsurance receivables. The loan amortizes approximately $6.0 million
in 1997, $33.7 million in 1998, $25.6 million in 1999, $15.2 million in 2000
and $(0.8) in 2001, with the remaining $12.0 million due through 2004. The
effective interest rate of the loan will be approximately 6.87%.

On June 30, 1994, the Company retired all of its 14.5% Senior Subordinated
Series A Notes and Series B Notes. Voting Notes of $30 are still outstanding as
of December 31, 1996. As a result of the prepayment of the debt, the Company
recognized an extraordinary loss of $2,022, net of an income tax benefit of
$1,042. For the year ended December 31, 1994, amounts paid to International
Insurance Investors (III), an affiliate of Centre Re, and Company officers for
prepayment penalty related to the early extinguishment of debt are $1,397 and
$153, respectively. Interest expense incurred in 1996, 1995, and 1994, was
$1,465, $804, and $1,181, respectively.

The warrants related to the Series A and B notes remain outstanding and
provide their holders the right to purchase 1,566,465 shares of common stock at
a strike price of $4 per share. The warrants are currently exercisable and
expire on April 1, 2002. The warrants are held by senior management and a
nominee for III.

In February 1995, SNIC entered into an agreement with a national brokerage
house to allow it to enter into $5 million in reverse repurchase transactions
that must be secured by either U.S. treasuries or government agency bonds.
There were no outstanding transactions at December 31, 1996.

The aggregate maturities of the financing agreement; long-term debt and
voting notes are as follows:

Financing Long-term Voting
Fiscal Year Agreement Debt Notes
----------- --------- --------- ------
1997 6,021 1,400 -
1998 33,709 1,450 -
1999 25,555 1,600 -
2000 15,229 1,600 -
2001 (799) 1,200 -
Thereafter 11,966 - 30
--------- --------- ------
91,681 7,250 30
--------- --------- ------
--------- --------- ------

(9) PREFERRED SECURITIES ISSUED BY AFFILIATE

On June 30, 1994, the Company completed the sale of $20 million of
preferred securities and warrants to affiliates of Centre Re in a transaction
approved by the shareholders and the DOI. The preferred securities are
subordinate to the Imperial Bank term debt. A special purpose investment
partnership, Superior National Capital, L.P. (the Limited Partnership), was
formed in Bermuda to issue $20 million face amount of 9.7% redeemable preferred
securities to Centre Reinsurance Services (Bermuda) III, Limited in exchange for
$18 million. CentreLine Reinsurance Limited paid the Company $2 million for
warrants to purchase 579,357 shares of the Company's common shares at $5.20 per
share, representing a fully-diluted 10 percent interest in the Company. The
warrants are currently exercisable and expire on June 30, 2001.

The proceeds received from the sale of preferred securities by the Limited
Partnership were loaned to Superior National Insurance Group, Inc. Interest on
the debt is to be paid to the Limited Partnership, which in turn will make the
required dividend payments on the preferred securities. The Limited Partnership
is accounted for as a subsidiary in the Company's consolidated financial
statements. The debt between Superior National Insurance Group, Inc. and the
Limited Partnership eliminates in consolidation. The preferred securities
issued by the Limited

F-17

Notes to Consolidated Financial Statements, Continued

Partnership and are presented between the liability and shareholders' equity
sections of the balance sheet, net of transaction costs.

The difference between the face value and the carrying value is amortized
over the seven year maturity of the preferred securities using the scientific
method. The amortization, net of tax benefits, and accrued dividends, is
charged to current year income after continuing operations, net of taxes.

The following is a summary of the preferred securities balance as of
December 31:

1996 1995
-------- --------
Beginning balance $21,045 $18,790
Add: Dividends and accretion 2,526 2,255
-------- --------
Balance at end of period $23,571 $21,045
-------- --------
-------- --------

For the first three years, the preferred securities will pay dividends in
the form of additional face value of the preferred securities at the coupon rate
of 9.7%.

(10) STATUTORY SURPLUS AND DIVIDEND RESTRICTIONS

SNIC is domiciled in the State of California and prepares its statutory
financial statements in accordance with accounting practices prescribed or
permitted by the State of California Department of Insurance (DOI). Prescribed
statutory accounting practices include a variety of publications of the National
Association of Insurance Commissioners (NAIC), as well as state laws,
regulations, and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices not so prescribed.

SNIC has been permitted to record its experience rated refund at its
estimated realizable value, which may be different from its current market value
as a result of fluctuations in interest rates and future yields on certain U.S.
Treasury Bonds.

SNIC's statutory policyholders' surplus as reported to regulatory
authorities was $51,998 and $51,895 at December 31, 1996, and 1995,
respectively. SNIC's statutory net income, as reported to regulatory
authorities, was $791, $1,050 and $3,917 for the years ended December 31, 1996,
1995, and 1994 respectively.

Insurance companies are subject to insurance laws and regulations
established by the states in which they transact business. The laws of the
various states establish supervisory agencies with broad administrative and
supervisory powers. Most states have also enacted legislation regulating
insurance holding company systems, including acquisitions, extraordinary
dividends, the terms of affiliate transactions and other related matters. The
Company and SNIC have registered as holding company systems pursuant to such
legislation in California. The NAIC has formed committees and appointed
advisory groups to study and formulate regulatory proposals on such diverse
issues as the use of surplus debentures, and accounting for reinsurance
transactions. It is not possible to predict the future impact of changing state
and federal regulation on the operations of the Company and SNIC.

The Risk Based Capital Model (RBC) for property and casualty insurance
companies was adopted by the NAIC in December 1993, and starting in 1995,
companies were required to report their RBC ratios to the NAIC. SNIC has
calculated and met its RBC requirement.

Insurance companies are also subject to restrictions affecting the amount
of stockholder dividends and advances that may be paid within any one year
without the prior approval of the DOI. The California Insurance Code provides
that amounts may be paid as dividends on an annual noncumulative basis
(generally based on the greater of (1) net income for the preceding year or
(2) 10% of statutory surplus as regards policyholders as of the preceding
December 31) without prior notice to, or approval by, the DOI. At December 31,
1996, SNIC could pay

F-18

Notes to Consolidated Financial Statements, Continued

approximately $5.2 million in dividends and advances to the Company without the
DOI's prior approval based on 10% of reported statutory surplus.

In 1995, SNIC made an extraordinary dividend distribution of 100% of its
shares in Superior (Bermuda) Limited to Superior National Insurance Group, Inc.,
after receiving prior approval from the DOI, constituting $15 million of SNIC's
statutory capital and surplus. Cash dividends of $850 were paid in 1994.

(11) EMPLOYEE BENEFIT PLANS

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options. As discussed below
in management's opinion, the alternative fair value accounting provided for
under FAS No. 123, "Accounting for Stock Based Compensation" requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of the grant, no compensation expense is recognized.

The Company has two fixed option plans the 1986 Stock Option Plan (the
"1986 Plan") and the 1995 Stock Incentive Plan (the "1995 Plan"). The terms of
the 1986 Plan permit the Company, at the Board of Directors discretion, to grant
options to its management to purchase 225,000 shares of common stock. Options
granted under the 1986 Plan are not intended to qualify as incentive stock
options within the meaning of section 422 of the Internal Revenue Code (the
"Code"). The 1995 Plan permits granting of both options that qualify for
treatment as incentive stock options under Section 422 of the Code, and options
that do not qualify as incentive stock options. Under the 1995 Plan, officers
and key employees of the Company may be granted options to purchase shares of
common stock of the Company or may be given the opportunity to receive
restricted stock of the Company. Under the 1995 Plan the number of shares of
common stock that may be granted, either through the exercise of options or the
issuance of restricted stock, is 625,000 shares. Under both plans, the exercise
price of each option equals the market price of the Company's stock on the date
of grant and options have a maximum term of ten years. The Board of Directors
may grant options at any point during a year and the options generally vest over
five years.

Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions. The risk free interest rate used is in the calculation is the 10
year Treasury Note rate on the date the options were granted. The risk free
interest rate used for options granted during 1996 ranged from 6.0% to 6.79% and
options granted during 1995, the risk free interest rate ranged from 6% to
7.11%. The volatility factors for the expected market price of the common stock
of 70% and 77% were used for options granted in 1996 and 1995 respectively. A
weighted average expected life of ten years was used as the Company has little
history of options being exercised prior to their expiration.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that do not have vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the value of an estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

F-19

Notes to Consolidated Financial Statements, Continued

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized into expense over the options' vesting period. The
Company's pro forma information follows (in thousands except for earnings per
share information):

1996 1995
------- ------
Pro forma net income $ 1,842 $ 338
Pro forma earnings per share
Primary $ 0.41 0.10
Fully Diluted $ 0.38 0.10

A summary of the Company's stock option activity, and related information
for the years ended December 31, follows:

1996 1995
----------------------------- -----------------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
----------------------------- -----------------------------

Stock options outstanding
beginning of year 252,500 $ 4.19 138,750 $ 4.47
Stock options granted 146,516 5.46 135,000 5.20
Stock options exercised (3,100) 4 (500) 4
Stock options canceled (6,400) 4.61 (20,750) 4
Stock options outstanding,
end of year 389,516 $ 5.13 252,500 $ 4.90
------- ------ ------- ------
------- ------ ------- ------
Exercisable at end of year 102,200 - 56,690 -
Weighted-average fair value
of options granted during the year $ 4.41 $ 4.40

Exercise prices for options outstanding as of December 31, 1996 ranged from
$4 to $7.70. The weighted-average remaining contractual life of those options
is 9 years.

The following is a summary of the transactions under the 1986 stock option
plan for the years ended December 31:

1996 1995 1994
------------------------ ------------------------ ------------------------
Number Option Number Option Number Option
of Shares Price of Shares Price of Shares Price
------------------------ ------------------------ ------------------------

Stock options outstanding
beginning of year 127,500 $4.00-$5.20 138,750 $4.00-$5.20 146,250 $ 4.00
Stock options granted - - 10,000 5.20 57,500 5.00-5.20
Stock options exercised (3,100) 4.00 (500) 4.00 - -
Stock options canceled (4,400) 4.00-5.20 (20,750) 4.00 (65,000) 4.00
------- ------- -------
Stock options outstanding,
end of year 120,000 $4.00-$5.20 127,500 $4.00-$5.20 138,750 $4.00-$5.20
------- ----------- ------- ----------- ------- -----------
------- ----------- ------- ----------- ------- -----------

F-20

Notes to Consolidated Financial Statements, Continued

At December 31, 1996, 58,200 vested options were exercisable and no
additional options or purchase rights will be granted under the 1986 plan.

1996 1995
---------------------- -----------------
STOCK OPTIONS: Number Option Number Option
of Shares Price of Shares Price
--------- ---------- --------- ------
Options outstanding at
beginning of the year 125,000 $5.20 - -
Options granted 146,516 $5.20-7.70 125,000 $5.20
Options canceled (2,000) 5.20 - -
------- -------
Options outstanding at end of year 269,516 $5.20-7.70 125,000 $5.20
------- ---------- ------- -----
------- ---------- ------- -----

1996 1995
---------------------- -----------------
RESTRICTED STOCK: Number Option Number Option
of Shares Price of Shares Price
--------- ---------- --------- ------
Shares outstanding at
beginning of year 36,350 $5.20 - -
Shares granted 45,934 4.87-6.25 36,350 $5.20
Shares issued (13,019) 4.87-5.20 - -
------- -------
Shares outstanding at end of year 69,265 $4.87-6.25 36,350 $5.20
------- ---------- ------- -----
------- ---------- ------- -----

At December 31, 1996, 44,000 vested options were exercisable and 243 of the
restricted shares granted in 1996 were vested, but were not issued. Shares
available for future grants under the 1995 Plan at December 31, 1996 were
286,219.

Effective January 1, 1990, the Company implemented a 401(k) Plan (the
"Plan") which is available for substantially all employees and under which the
Company matches a percentage of the participant's compensation. The employer
contributions are discretionary and vest over a five year period. The employer
contributions for plan years 1996, 1995, and 1994 were $170, $150, and $82,
respectively.

The Company has no formal post-employment retirement benefit plans;
however, the Company has entered into severance contracts with certain former
employees for which approximately $48, $322 and $284 of accrued expenses were
recorded at December 31, 1996, 1995, and 1994, respectively.

(12) COMMITMENTS

The Company and its subsidiaries occupy offices under various operating
leases. The future minimum lease payments at December 31, 1996, are as
follows:

1997 $1,931
1998 1,589
1999 1,604
2000 391
2001 43

Rental expenses totaled approximately $1,918, $1,772 and $1,780 for the
years ended December 31, 1996, 1995, and 1994, respectively.

F-21

Notes to Consolidated Financial Statements, Continued

In a transaction associated with the sale of Senior Subordinated Notes to
III, the Company and SNIC agreed to pay International Insurance Advisors, Inc.,
agent for each of the III limited partners and for the general partner of III, a
consulting fee in the amount of $250 beginning on April 1, 1993, and on each
April 1 thereafter, to and including April 1, 1998. The retirement of the 1992
Notes in 1994 did not affect the obligation of the Company and SNIC to pay the
consulting fee.

(13) LITIGATION

The Company is subject to various litigation which arises in the ordinary
course of business. Management is of the opinion that such litigation will not
have a material adverse effect on the consolidated financial position of the
Company or its consolidated results of operations.

(14) PREPAID AND OTHER ASSETS

A summary of prepaid and other assets at December 31, are as follows:

1996 1995
------- -------
Furniture and fixtures, net $ 1,260 $ 1,151
Data processing equipment, net 3,560 2,767
Prepaid and advances 1,091 1,540
Other 1,453 619
------- -------
$ 7,364 $ 6,077
------- -------
------- -------

(15) ACCOUNTS PAYABLE AND OTHER LIABILITIES

A summary of accounts payable and other liabilities at December 31, are as
follows:

1996 1995
------- -------
Escheatment payable $ 333 $ 1,423
Rent and lease liability 527 662
Accounts payable 8,683 5,275
Other liabilities 3,198 60
------- -------
$12,741 $ 7,420
------- -------
------- -------

(16) SUBSEQUENT EVENT

On September 17, 1996 the Company entered into a definitive agreement to
acquire Pac Rim Holding Corporation (PRIM) for approximately $54 million in
cash. The ultimate price per share to be paid was based on a formula that was
based upon the size of PRIM's loss reserves at the time of the scheduled
transaction closing in December 1996. The transaction was expected to yield $3
to $3.10 a share to PRIM shareholders. As a result of the DOI's triennial audit
of PRIM, it was required to strengthen its claim and claim adjustment expense
reserve by $12 million. The magnitude of the reserve strengthening necessitated
renegotiation of the terms of the original definitive agreement. On February
18, 1997 a revised purchase agreement was announced by the Company and PRIM.
Under the terms of the agreement the Company will acquire PRIM for the aggregate
consideration of approximately $42 million in cash. PRIM shareholders will
receive approximately $20 million ($2.11 per share); $20 million will be paid to
PRIM's convertible debenture holders; and approximately $2 million will be paid
to PRIM's warrant and option holders.

F-22

Notes to Consolidated Financial Statements, Continued

The Company will finance the acquisition with a combination of common stock
and bank debt. Under an agreement reached September 17, 1996, a group of
investors including Insurance Partners, L.P., TJS Partners, L.P., and the
Company's management have agreed to purchase $18 million of newly issued common
stock (2,390,438 shares) at $7.53 per share, based upon the September 1996
market price of the Company's common stock. The Company expects the remaining
$24 million of the purchase price will be funded by a $44 million bank loan to
be provided by a syndicate of banks led by Chase Manhattan Bank. Approximately
$6.6 million of the loan proceeds will be used to redeem the Company's
outstanding long- term debt. Approximately $10 million of the loan proceeds
will be contributed to the capital of PRIM's wholly owned subsidiary, Pacific
Rim Assurance Company. The above described transaction is subject to both
shareholder and regulatory approval.

F-23

SCHEDULE I.1
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
BALANCE SHEET
(Amounts in thousands, except share data)

DECEMBER 31,
1996 1995
-------- -------

ASSETS
Investments:
Bonds and Notes at market (amortized cost: $1,497 in 1995) $ - $ 1,500
Cash and invested cash (certificates of deposit and other short-term instruments) 1,787 2,889
-------- -------
Total Investments 1,787 4,389
Accrued investment income 1 9
Receivable from reinsurer 110,527 -
Investment in subsidiaries 72,788 67,695
Intercompany receivable 91 91
Deferred income taxes 4,957 1,526
Other 1,087 94
-------- -------
Total Assets $191,238 $73,804
-------- -------
-------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Long-term debt $98,961 $8,530
Intercompany Liability 23,465 -
Accounts payable and other liabilities 50 749
-------- -------
Total liabilities 122,476 9,279
-------- -------

Preferred securities issued by affiliate; authorized 1,100,000 shares; issued and
outstanding 1,013,753 shares in 1996 and 922,137 shares in 1995 23,571 21,045

Shareholders' Equity:

Common stock, no par value; authorized 25,000,000 shares: issued and outstanding
3,446,492 shares in 1996 and 3,430,373 shares in 1995 16,022 15,943
Unrealized gain (loss) on investments, net of income taxes (162) 169
Paid in capital - warrants 2,206 2,206
Retained earnings 27,125 25,162
-------- -------
Total shareholders' equity 45,191 43,480
-------- -------
Total liabilities and shareholders' equity $191,238 $73,804
-------- -------
-------- -------

SEE NOTES TO CONDENSED FINANCIAL INFORMATION

F-24

SCHEDULE I.2

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
STATEMENTS OF INCOME
(Amounts in thousands)

TWELVE MONTHS ENDED
DECEMBER 31,
-------------------------------------
------- ------- -------
1996 1995 1994
------- ------- -------

REVENUES:
Net investment income $ 89 $ 330 $ 90
------- ------- -------
Total revenues 89 330 90

EXPENSES:
Interest expense 1,465 804 1,108
General and administrative expenses (446) 304 116
------- ------- -------
Total expenses 1,019 1,108 1,224
------- ------- -------
Loss from operations before federal income tax expense, equity in net
income of subsidiaries, extraordinary item and preferred securities
dividends and accretion (930) (778) (1,134)
Income tax expense 858 767 1,394
------- ------- -------
Loss from operations before equity in net income of subsidiaries,
extraordinary item, taxes, and preferred securities dividend and accretion (1,788) (1,545) (2,528)
Equity in net income of subsidiaries 5,418 3,404 6,127
Extraordinary loss on retirement of long-term debt, net of income tax benefit
of $1,042 in 1994 - - (2,022)
Preferred securities dividends and accretion, net of income tax benefit of
$858, $767 and $352 in 1996,1995 and 1994 respectively (1,667) (1,488) (683)
------- ------- -------
Net income $ 1,963 $ 371 $ 894
------- ------- -------
------- ------- -------

SEE NOTES TO CONDENSED FINANCIAL INFORMATION

F-25

SCHEDULE I.3

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
STATEMENTS OF CASH FLOWS
(Amounts in thousands)

TWELVE MONTHS ENDED
DECEMBER 31,
---------------------------------------
1996 1995 1994
--------- -------- --------

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income $ 1,963 $ 371 $ 894
--------- ------- --------
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amortization of bonds and preferred stock - (1) 55
Amortization of long-term debt - - 1,151
Income from subsidiaries (5,418) (3,404) (6,127)
Loss on sale of investments 5 - 68
Preferred securities dividends and accretion 2,525 2,255 1,035
Decrease in accrued investment income 8 1 11
Increase in current income taxes - 1,721 -
(Decrease) increase in other assets (994) (11) 157
(Decrease) increase in accounts payable and other liabilities 19,334 78 (271)
--------- ------- --------
Total adjustments 15,460 639 (3,921)
--------- ------- --------
Net cash provided by (used in) operating activities 17,423 1,010 (3,027)
--------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt - - (8,164)
Repayment of bank loans - Imperial Bank (1,250) (1,200) -
Repayment of bank loans - Chase (1,410) - -
Proceeds from long-term debt - - 10,000

Proceeds from Chase financing 93,091 - -

Proceeds from issuance of preferred securities - - 17,755
Paid-in capital - new warrants issued - - 2,000
Paid-in capital - warrants - - (10)
Paid-in capital - stock options 78 2 -
--------- ------- --------
Net cash provided by (used in) financing activities 90,509 (1,198) 21,581
--------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments - (1,496) -
Dividends received from subsidiaries - - 850

(Increase) in receivable from reinsurer (110,527) - -

Sales of bonds and notes:
Investments available for sale 1,493 - 923
Capital contribution to subsidiaries - (1,500) (15,000)
Sales of common & preferred stock - - 24
Net (increase) decrease in invested cash - - 668
--------- ------- --------
Net cash provided by (used in) investing activities (109,034) (2,996) (12,535)
--------- ------- --------
Net increase (decrease) in cash (1,102) (3,184) 6,019
Cash and Invested cash at beginning of period 2,889 6,073 54
--------- ------- --------
Cash and Invested cash at end of period $ 1,787 $ 2,889 $ 6,073
--------- ------- --------
--------- ------- --------
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 1 $ 1 $ 1
--------- ------- --------
--------- ------- --------
Cash paid during the year for interest $ 641 $ 808 $ 1,222
--------- ------- --------
--------- ------- --------

SEE NOTES TO CONDENSED FINANCIAL INFORMATION

F-26

SCHEDULE I.4

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
NOTES TO CONDENSED FINANCIAL INFORMATION

1. BASIS OF PRESENTATION

In accordance with the requirements of Regulation S-X of the Securities and
Exchange Commission, the financial statements of the registrant are
condensed and omit many disclosures presented in the consolidated financial
statements and the notes thereto.

2. LONG TERM DEBT

The following is a summary of the long-term debt balances at December 31:

1996 1995
------- ------
Chase Financing Agreement - 6.87% due through 2004 $91,681 $ -
Imperial Bank Debt - 8.25% due through 2001 7,250 8,500
Voting Notes due 2002 30 30
------- ------
Balance at end of period $98,961 $8,530
------- ------
------- ------

Maturities of long-term debt for the next five years are as follows:

Financing Long-term Voting
Fiscal Year Agreement Debt Notes
- ----------- --------- --------- ------
1997 $ 6,021 $ 1,400 $ -
1998 33,709 1,450 -
1999 25,555 1,600 -
2000 15,229 1,600 -
2001 (799) 1,200 -
Thereafter 11,966 - 30
--------- --------- ------
$ 91,681 $ 7,250 $ 30
--------- --------- ------
--------- --------- ------

3. DIVIDENDS FROM SUBSIDIARIES

During 1996 and 1995, there were no dividends paid to Superior National
Insurance Group by its consolidated subsidiaries. During 1994, a cash
dividend of $850,000 was paid to Superior National Insurance Group by its
consolidated subsidiaries.

4. CONTINGENCIES

The Company is subject to various litigation which arises in the ordinary
course of business. Based upon discussions with counsel, management is of
the opinion that such litigation will not have a material adverse effect on
the consolidated financial position of the Company or its consolidated
results of operations.

5. RECONCILIATION - RECEIVABLE FROM REINSURER

The following is a reconciliation between the Condensed Financial
Information of Registrant Balance Sheet and the Consolidated Balance Sheet
for Receivable from reinsurer.

Receivable
from Reinsurer
--------------

Balance per Consolidated Balance Sheet $ 93,266
Add: Elimination for Discontinued Operations 17,261
--------------
Balance per Condensed Balance Sheet $ 110,527
--------------
--------------

F-27

SCHEDULE II
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(Amounts in thousands)

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -------------------------------- ---------- --------------------------- ---------- ---------
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS OTHER AT END
OF PERIOD AND EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
---------- ------------ ---------- ---------- ---------

Year ended December 31, 1996
Allowance for possible losses on
premiums receivable $500 $1,369 - $(1,569) $300
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

Allowance for possible losses on
reinsurance recoverable - - - - -
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

YEAR ENDED DECEMBER 31, 1995
Allowance for possible losses on
premiums receivable $900 $1,531 - $(1,931) $500
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

Allowance for possible losses on
reinsurance recoverable - - - - -
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

YEAR ENDED DECEMBER 31, 1994
Allowance for possible losses on
premiums receivable $900 $2,697 - $(2,697) $900
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

Allowance for possible losses on
reinsurance recoverable - - - - -
---------- ------------ ---------- ---------- ---------
---------- ------------ ---------- ---------- ---------

F-28

SCHEDULE V. 1
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTAL INSURANCE INFORMATION
(Amounts in thousands)

COLUMN COLUMN COLUMN COLUMN COLUMN COLUMN
A B C D E F
- ---------------- ----------- -------------- -------- ------------ -------
DEFERRED FUTURE POLICY UNEARNED OTHER POLICY PREMIUM
POLICY BENEFITS PREMIUM CLAIMS AND REVENUE
ACQUISITION LOSSES, CLAIMS BENEFITS
COSTS AND LOSS PAYABLE
EXPENSES

1996
Workers
Compensation $3,042 $115,529 $9,702 $ - $ 88,648
------ -------- ------- ------- --------
------ -------- ------- ------- --------
1995
Workers'
Compensation $2,780 $141,495 $10,347 $ - $ 89,735
------ -------- ------- ------- --------
------ -------- ------- ------- --------
1994
Workers'
Compensation $2,905 $171,258 $10,728 $ - $110,418
------ -------- ------- ------- --------
------ -------- ------- ------- --------

COLUMN COLUMN COLUMN COLUMN COLUMN COLUMN
A G H I J K
- ---------------- ----------- -------------- ------------ ------------ --------
NET BENEFITS, AMORTIZATION OTHER PREMIUMS
INVESTMENT CLAIMS, OF DEFERRED OPERATING WRITTEN
INCOME LOSSES AND POLICY EXPENSES
SETTLEMENT ACQUISITION
EXPENSES COSTS

1996
Workers
Compensation $7,769 $ 55,638 $16,870 $24,609 $ 87,715
------ -------- ------- ------- --------
------ -------- ------- ------- --------
1995
Workers'
Compensation $9,784 $ 53,970 $18,288 $21,314 $ 89,139
------ -------- ------- ------- --------
------ -------- ------- ------- --------
1994
Workers'
Compensation $9,049 $ 78,761 $16,746 $13,980 $105,946
------ -------- ------- ------- --------
------ -------- ------- ------- --------

F-29

SCHEDULE V. 2

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
REINSURANCE
(In thousands)

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- ------------------------------- -------- --------- --------- -------- ----------
PERCENTAGE
ASSUMED OF
CEDED TO FROM AMOUNT
GROSS OTHER OTHER NET ASSUMED
DESCRIPTION AMOUNT COMPANIES COMPANIES AMOUNT TO NET
- ------------------------------- -------- --------- --------- -------- ----------

YEAR ENDED DECEMBER 31, 1996
Premiums:
Workers' compensation insurance $ 97,270 $11,280 $2,658 $ 88,648 3.0%
-------- ------- ----- -------- ------
Total Premiums $ 97,270 $11,280 $2,658 $ 88,648 3.0%
-------- ------- ----- -------- ------
-------- ------- ----- -------- ------

YEAR ENDED DECEMBER 31, 1995
Premiums:
Workers' compensation insurance $ 96,630 $ 7,730 $ 835 $ 89,735 0.9%
-------- ------- ----- -------- ------
Total premiums $ 96,630 $ 7,730 $ 835 $ 89,735 0.9%
-------- ------- ----- -------- ------
-------- ------- ----- -------- ------

YEAR ENDED DECEMBER 31, 1994
Premiums:
Workers' compensation insurance $138,704 $28,286 $ - $110,418 $ -
-------- ------- ----- -------- ------
Total premiums $138,704 $28,286 $ - $110,418 $ -
-------- ------- ----- -------- ------
-------- ------- ----- -------- ------

F-30

SCHEDULE V. 3

SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTAL PROPERTY AND CASUALTY INSURANCE INFORMATION
(AMOUNTS IN THOUSANDS)

COLUMN COLUMN COLUMN COLUMN COLUMN COLUMN COLUMN
A B C D E F G
- -------------- ----------- ---------- ----------- -------- ------- ----------
DISCOUNT
IF ANY,
DEDUCTED
RESERVES IN RESERVES
FOR UNPAID FOR UNPAID
DEFERRED CLAIMS AND CLAIMS AND
POLICY CLAIMS CLAIM NET
ACQUISITION ADJUSTMENT ADJUSTMENT UNEARNED EARNED INVESTMENT
COSTS EXPENSES EXPENSES PREMIUM PREMIUM INCOME
----------- ---------- ----------- -------- ------- ----------

1996
Workers'
Compensation $ 3,042 $115,529 $ - $ 9,702 $ 88,648 $7,769
------- -------- ------- ------- -------- ------
------- -------- ------- ------- -------- ------

1995
Workers'
Compensation $ 2,780 $141,495 $ - $10,347 $ 89,735 $9,784
------- -------- ------- ------- -------- ------
------- -------- ------- ------- -------- ------

1994
Workers'
Compensation $ 2,905 $171,258 $ - $10,728 $110,418 $9,049
------- -------- ------- ------- -------- ------
------- -------- ------- ------- -------- ------

COLUMN COLUMN COLUMN COLUMN COLUMN
A H I J K
- -------------- ------------------------- -------------- ---------- --------
CLAIMS AND CLAIM AMORTIZATION
ADJUSTMENT EXPENSES OF PAID
INCURRED RELATED TO: DEFERRED CLAIMS AND
------------------------- POLICY CLAIM
CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUM
YEAR YEAR COSTS EXPENSES WRITTEN
--------- --------- -------------- ---------- --------

1996
Workers'
Compensation $57,614 $(1,976) $16,870 $79,514 $ 87,715
------- -------- ------- ------- --------
------- -------- ------- ------- --------

1995
Workers'
Compensation $58,842 $(4,872) $18,288 $78,912 $ 89,139
------- -------- ------- ------- --------
------- -------- ------- ------- --------

1994
Workers'
Compensation $72,457 $ 6,304 $16,746 $81,467 $105,946
------- -------- ------- ------- --------
------- -------- ------- ------- --------

F-31

INDEX OF EXHIBITS

EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
- ------ ----------- ------

2.1 Amended and Restated Agreement and Plan of Merger dated as of February 17, 1997
among the Company, SNTL Acquisition Corp., and PRIM . . . . . . . . . . . . . . . . . . . . . . *****

2.2 Series A Convertible Debentures and Series 1, 2 and 3 Detachable Warrant
Purchase Agreement ("Debenture Purchase Agreement"), as amended effective
as of February 17, 1997 among the Company, Prac Limited Partnership and
Allstate Insurance Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *****

2.3 First Amendment to Debenture Purchase Agreement, dated as of February 17, 1997. . . . . . . . . *****

2.4 Voting Agreement dated as of February 17, 1997 among the Company and
certain stockholders and debenture holders of PRIM. . . . . . . . . . . . . . . . . . . . . . . *****

3.1 Articles of Incorporation of the Company, as amended and restated by the
Company and currently in effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

3.2 Bylaws of the Company, to date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS

10.1 Employment agreement, dated 1st of June 1994, by and between Mr. William L.
Gentz, President and Chief Executive Officer of the Company, and the Company. . . . . . . . . . . . . *

10.2 Employment agreement, dated February 17, 1997, by and between Mr. Arnold
J. Senter, Executive Vice President and Chief Operating Officer of the
Company, and the Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10.3 1986 Non-Statutory Stock Option and Non-Statutory Stock Purchase Plan . . . . . . . . . . . . . . . . ***

10.4 1995 Stock Incentive Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ***

OTHER MATERIAL CONTRACTS

10.5 Aggregate Excess of Loss Cover entered into on the 30th day of August 1991,
between Centre Reinsurance Limited (Centre Re) and the Company, as amended. . . . . . . . . . . . . . *

10.6 Multi-year Prospective Accident Year Stop Loss Reinsurance Contract effective
the 1st of January 1993, between Centre Reinsurance International Company and
the Company (the "1993 Centre Re Contract") . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

10.7 Letter dated March 28, 1996 from the Company canceling the 1993 Centre Re
Contract effective January 1, 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ***

10.8 Workers' Compensation and Employers' Liability Quota Share Insurance
Contract No. 30006A effective January 1, 1994, between the Company and
Zurich Reinsurance Centre, as amended (the "ZRC Contract"). . . . . . . . . . . . . . . . . . . . . . *

10.9 Addendum No. 4 to the ZRC Contract effective as of January 1, 1996. . . . . . . . . . . . . . . . . . ***

10.10 Addendum No. 1 to the Retrocession Agreement (an ancillary agreement to the
ZRC Contract) effective as of January 1, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . ***

10.11 Lease, dated 27th day of October 1988, by and between Corporate Center at
Malibu Canyon, a California Limited Partnership and the Company, relating to
the lease of the Company's home office and Calabasas Branch Facilities. . . . . . . . . . . . . . . . *

10.12 Lease, dated 27th of July 1993, by and between TOMOE Investment and
Development, Inc. and the Company, relating to the lease of its South
San Francisco Facility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

10.13 Lease, dated 14th of November 1991, by and between Dean Witter Reynolds and
the Company relating to the lease of its Fresno Facilities. . . . . . . . . . . . . . . . . . . . . . *

10.14 Lease, dated 23rd of February 1993, by and between Shaw Avenue Associates, a
California Limited Partnership and the Company relating to the lease of its Fresno Facilities . . . . *

10.15 Lease, dated 14th of February 1994, by and between Contra Costa County
Employees Retirement Association and the Company relating to its Sacramento Facility. . . . . . . . . *

10.16 Bank Debt, $10 million loan agreement between Imperial Bank and the Company
that was entered into on the 1st day of July 1994 (the "Imperial Loan") . . . . . . . . . . . . . . . *

10.17 Amendment No. 1 to the Imperial Loan dated March 27, 1995 . . . . . . . . . . . . . . . . . . . . . . **

10.18 Amendment No. 2 to the Imperial Loan dated October 16, 1995 . . . . . . . . . . . . . . . . . . . . . **

10.19 Credit Agreement between the Company and The Chase Manhattan Bank dated
as of November 12, 1996 (the "1996 Credit Agreement"), and all material exhibits thereto. . . . . . .

10.20 Agreement in Principle dated 29th of March 1994 by and between the Company
and Centre Re, a Bermuda Corporation, or one of its affiliates. . . . . . . . . . . . . . . . . . . . *

10.21 Limited Partnership Agreement of Superior National Capital, L.P. (Capital)
with certificate of Limited Partnership and Certificate of Exempted Partnership, all as
filed on the 28th of June 1994, with the Registrar of Companies of Bermuda. . . . . . . . . . . . . . *

10.22 Preferred securities purchase agreement, dated 30th day of June 1994, by and
between Capital, Superior National Capital Holding Corporation, the Company
and Centre Reinsurance Services (Bermuda) III Limited . . . . . . . . . . . . . . . . . . . . . . . . *

10.23 Loan agreement, dated 30th of June 1994, whereby Capital agrees
to loan $20,408,163 to the Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

10.24 Liability Assumption Agreement, dated 30th of June 1994, by and between the Company and Capital . . *

10.25 Certificate dated 30th of June 1994, evidencing the issuance of 800,000 Preferred
Securities of Capital to Centre Re. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

10.26 Note made by the Company in favor of Capital dated 30th of June 1994, in the
aggregate principal amount of $20,408,163 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

10.27 Purchase warrant, dated as of the 30th of June 1994, entitles CentreLine
Reinsurance Limited to purchase 2,317,426 shares of the Company's common stock. . . . . . . . . . . *

10.28 Certificate of Limited Partnership of Superior National Capital, L.P. . . . . . . . . . . . . . . . *

10.29 Warrant held by International Insurance Advisors, Inc. to purchase 6,097,130
shares at $1.00 per share dated March 31, 1992 and expiring April 1, 2002 . . . . . . . . . . . . . *

10.30 Stock Purchase Agreement dated as of September 17, 1996, as amended and
restated effective as of February 17, 1997, among the Company, Insurance
Partners, L.P., Insurance Partners Offshore (Bermuda), L.P., TJS Partners,
L.P., and certain members of the Company's management . . . . . . . . . . . . . . . . . . . . . . . *****

10.31 State of California Department of Insurance Amended Certificate of Authority. . . . . . . . . . . . *

11.1 Statement re: Computation of per share earnings . . . . . . . . . . . . . . . . . . . . . . . . . .

21.1 Subsidiaries of the Registrant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *

- -----------
* Previously filed as an exhibit to SNIG's Registration Statement on
Form 10 as filed with the Securities and Exchange Commission ("SEC")
on May 1, 1995 (File No. 0-25984).

** Previously filed as an exhibit to Amendment No. 2 to SNIG's
Registration Statement on Form 10/A as filed with the SEC on
November 1, 1995 (File No. 0-25984).

*** Previously filed as an exhibit to SNIG's Annual Report on Form 10-K as
filed with the SEC on March 29, 1996 (File No. 0-25984)

**** Previously filed as an exhibit to SNIG's statement on Schedule 13D
filed for Pac Rim Holding Corporation as filed with the SEC on
September 26, 1996.

***** Previously filed as an exhibit to SNIG's statement on Schedule 13D
filed for Pac Rim Holding Corporation as filed with the SEC on
February 27, 1997.