BASIS OF PRESENTATION

The accompanying financial statements have been prepared in conformity with accounting practices prescribed or permitted by the Department of Banking and Insurance of the State of New Jersey (“the Department”) and the National Association of Insurance Commissioners (“NAIC”). The NAIC statutory accounting principles are a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America (“GAAP”). The effects on the financial statements of the variances between the statutory basis of accounting and GAAP are presumed to be material.

Accounting changes adopted as of January 1, 2001, to conform to the provisions of the NAIC Accounting Practices and Procedures Manual, are reported as changes in accounting principles. The cumulative effect of changes to accounting principles is reported as an adjustment to surplus as regards policyholders (“surplus”) in the period of the change in accounting principle. The cumulative effect is the difference between the amount of the surplus at the beginning of the year and the amount of surplus that would have been reported at that date if the new accounting principles had been retroactively applied for all prior periods. As a result of these changes, the Company reported a change in accounting principle, as an adjustment that increased surplus by $22.3 million as of January 1, 2001 as follows (in thousands):

Deferral of federal income taxes recoverable

$ 14,615

Elimination of excess statutory reserve

7,087

Other

611

Increase due to change in accounting

$ 22,313

1. Investments in bonds are stated at values (generally amortized cost) adopted and approved by the Valuation of Securities Committee of the NAIC. Investments other than bonds are stated at values (principally market value) adopted and approved by the Valuation of Securities Committee of the NAIC.
   
   
2. Policy acquisition costs, primarily consisting of commissions and premium taxes, are charged to operations as incurred, while the related premiums are taken into income over the periods covered under the policies.
   
   
3. Deferred federal income taxes are provided for temporary differences between financial statement and tax bases of assets and liabilities. Such differences relate principally to unearned premiums, discounting of unpaid losses and loss expenses and deductions allowed for dividends received. Deferred tax assets are limited to amounts that are expected to be realized within one year of the balance sheet date. The deferred tax asset, subject to certain adjustments, is limited to 10% of surplus. Amounts in excess of the limitations are recorded as nonadmitted assets. Changes in the net deferred income taxes are recorded directly to unassigned surplus.
   
   
4. Certain assets designated as “non-admitted” assets (principally premiums in the course of collection over 90 days past due) are not permitted to be included in the statutory statements of admitted assets, liabilities and surplus. Increases or decreases from year to year in non-admitted assets are charged directly to surplus.
   
   
5. Wholly-owned subsidiaries are not consolidated but are recorded at statutory equity value. The net income or loss of wholly-owned subsidiaries is reflected in surplus rather than in income.
   
   
6. Insurance liabilities (reserve for losses and loss adjustment expenses and unearned premiums) are presented net of reinsurance ceded.
   
   
7. Unauthorized reinsurance that is not collateralized is reported as a liability, with a corresponding reduction in surplus.

DISCLOSURE OF CERTAIN RISKS AND UNCERTAINTIES

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

Unpaid Losses and Loss Adjustment Expenses – At December 31, 2001, Princeton carried $598,373,000 of unpaid losses and loss adjustment expenses. Unpaid losses and loss adjustment expenses reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to Princeton. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to Princeton and the payment of that loss. As part of the process in determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes, and economic conditions.

Management believes that its unpaid losses and loss adjustment expenses are fairly stated at December 31, 2001. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, and economic conditions, the estimates are revised accordingly. If Princeton’s ultimate net losses prove to be substantially greater than the amounts recorded at December 31, 2001, the related adjustments could have a material adverse impact on Princeton’s financial condition, results of operations and liquidity.

Princeton sells property and liability insurance in New Jersey, Pennsylvania, Delaware, Maryland and several other states. Of total net premiums written, Princeton wrote 56% and 56% in the medical malpractice and general liability line of business in 2001 and 2000, respectively. Princeton additionally wrote 41% and 33% of total net premiums written in 2001 and 2000, respectively, in the workers’ compensation line of business. In addition, net premiums written in New Jersey represented 51% and 57% of total net premiums written in 2001 and 2000, respectively.

CASH

As prescribed by the Department of Banking and Insurance of the State of New Jersey, cash balances include outstanding checks.

INVESTMENTS

Investment grade bonds are recorded at carrying value. Below investment grade bonds are reported at the lower of amortized cost or market. Amortized cost is computed using the interest method. Accordingly, unrealized changes in the market value thereof are not reflected in the statutory statements of admitted assets, liabilities and surplus. Common stock of wholly-owned subsidiaries is valued using the statutory equity method. Net income (loss) of wholly-owned subsidiaries is reflected in surplus. Other equity securities are recorded at market value, and unrealized gains or losses are reported as direct increases or decreases of surplus. Short-term investments consisting primarily of money market mutual funds, as well as other investments that mature within one year from the purchase date, are carried at cost, which approximates market value. Realized gains and losses on sales of investments are reported in income based on the first-in first-out method. Investment income is recognized when earned. All securities transactions are recorded on the date on which the trade is negotiated (trade date basis).

The cost of mortgage-backed securities is adjusted for unamortized premiums and discounts, which are amortized or accreted using the interest method over the estimated remaining term of the securities, adjusted for anticipated prepayments.

Princeton has a securities lending program administered by Mellon Bank, N. A. (Mellon). Securities are loaned to third parties, primarily major brokerage firms. Borrowers of these securities must deposit collateral equal to 102% in the case of securities of United States issuers, and 105% in the case of securities from non-United States issuers of the market value of any securities loaned, including any accrued interest. The market value of the securities loaned is monitored daily by Mellon, and adjustments to the collateral are made accordingly. Mellon collects for, and credits to the account of Princeton all interest, dividends or other distributions paid with respect to securities loaned to borrowers on behalf of Princeton.

REAL ESTATE AND ELECTRONIC DATA PROCESSING EQUIPMENT

Real estate is carried at cost, net of accumulated depreciation of $3,905,950 at December 31, 2001 and $3,652,000 at December 31, 2000. Depreciation is calculated on the straight-line method over the estimated useful life of the asset. The cost of Princeton’s data processing equipment is capitalized and depreciated over five years using the straight-line method. The accumulated depreciation on such equipment at December 31, 2001 and 2000 was $5,134,000 and $4,526,000, respectively. The Company incurred $862,000 and $771,000 of depreciation expense for real estate and data processing equipment in 2001 and 2000, respectively.

"OCCURRENCE PLUS" POLICIES

Princeton offers “Occurrence Plus” policies to certain classes of insureds. “Occurrence Plus” policies account for a significant portion of the total number of medical liability policies issued.

This policy form is a modified claims-made coverage developed to combine features of both standard occurrence and claims-made insurance. The policy form provides coverage on a claims-made basis in two parts. First, during the annual coverage period of the policy and second, for an extended reporting period after cancellation of the annual coverage for any reason.

For policies issued prior to December 31, 1998 and still inforce as of December 31, 2000 and subsequent, Princeton designates a portion of the total premium collected for such policies for the extended reporting period (tail) coverage. The terms of such coverage are based upon the insured’s last policy inforce date. The majority of the tail coverage premium is collected over the first five years of the insured’s premium charges and is deferred until the tail coverage is effective and determinable, at which time it becomes completely earned and a reserve is established for the estimated exposure of the coverage period.

The reporting endorsement coverage is provided to the insured upon termination of their claims-made coverage. In pre-funding for this policy provision, Princeton has made certain assumptions (based upon historical data such as lapse ratios) related to the timing of when the policyholders will terminate their coverage and thus be provided the extended reporting endorsement. Based upon such assumptions, management and their appointed actuaries have determined that the unearned premium reserve is adequate to fund the future liabilities.

At the request of the New Jersey Department of Insurance, the Company is required to recognize any new occurrence plus business issued subsequent to December 31, 1998 as occurrence, earning premium over one year and establishing a liability for loss reserves.

PREMIUMS AND UNEARNED PREMIUMS

Premiums are reflected as revenues on a pro-rata basis over the terms of the policies. Unearned premiums are calculated on a daily pro-rata basis.

POLICYHOLDERS DIVIDENDS

Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on terms of the individual policies. Certain workers’ compensation policies contain dividend payment provisions which enable the policyholders to participate in the earnings of their segment of the total workers’ compensation line. The participating workers’ compensation premiums written accounted for approximately 0.4 percent of the total premiums written in 2001 and 0.8 percent in 2000.

RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The reserve for losses and loss adjustment expenses represents the estimated indemnity cost and loss adjustment expense necessary to cover the ultimate net cost of investigating, defending, and settling claims. Such estimate is based upon (a) the accumulation of individual case estimates for losses reported prior to the close of the accounting period, and (b) the actuarial estimates of supplemental case reserve development and unreported losses.

Reserves are estimates and may be ultimately settled for a greater or lesser amount. These estimates are adjusted individually and in the aggregate for ultimate loss expectations based upon historical experience patterns and current economic trends. Any change in estimated ultimate liabilities is reflected in current incurred losses and loss adjustment expenses.

FEDERAL INCOME TAX

Princeton participates in filing a consolidated federal income tax return with its ultimate parent company, Medical Liability Mutual Insurance Company.

The method of allocation among companies is subject to a written agreement, approved by the Board of Directors, whereby allocation is made primarily on a separate return basis with current credit for any net operating losses or other items utilized in the consolidated tax return. Intercompany tax balances are settled quarterly.

Deferred federal income taxes are provided for temporary differences between financial statement and tax bases of assets and liabilities. Such differences are related principally to unearned premiums, discounting of unpaid losses and loss expenses and deductions allowed for dividends received. Deferred tax assets are limited to amounts that are expected to be realized within one year of the balance sheet date. The deferred tax asset, subject to certain adjustments, is limited to 10% of surplus. Amounts in excess of the limitations are recorded as nonadmitted assets. Changes in the net deferred income taxes are recorded directly to unassigned surplus.

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