The following is a discussion of the financial condition of PMA Capital Corporation and its consolidated subsidiaries ("PMA Capital" or the "Company," which also may be referred to as "we" or "us") as of December 31, 2008, compared with December 31, 2007, and the results of operations of PMA Capital for 2008 and 2007, compared with the immediately preceding year. The balance sheet information is as of December 31 for each respective year. The statement of operations and cash flow information is for the year ended December 31 for each respective year.

This discussion and analysis should be read in conjunction with our audited Consolidated Financial Statements and Notes thereto presented in Item 8 of this Form 10-K ("Consolidated Financial Statements"). You should also read our discussion of Critical Accounting Estimates beginning on page 57 for an explanation of those accounting estimates that we believe are most important to the portrayal of our financial condition and results of operations and that require our most difficult, subjective and complex judgments.

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements, which involve risks and uncertainties. See "Item 1A - Risk Factors" and the "Cautionary Note Regarding Forward-Looking Statements" on page 65 for a list of factors that could cause our actual results to differ materially from those contained in any forward-looking statement.

We are a holding company whose operating subsidiaries provide insurance and fee-based services. The PMA Insurance Group earns revenue and generates cash primarily by writing insurance policies and collecting insurance premiums. Direct premiums written at The PMA Insurance Group were $517.9 million in 2008, compared to $510.3 million in 2007 and $431.6 million in 2006. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, we are able to invest the available premiums and earn investment income. The types of payments that we make at The PMA Insurance Group are:

· losses we pay under insurance policies that we write;

· loss adjustment expenses, which are the expenses of settling claims;

· acquisition and operating expenses, which are direct and indirect costs of acquiring both new and renewal business, including commissions paid to agents and brokers and the internal expenses to operate the business segment; and

· dividends and premium adjustments that are paid to policyholders of certain of our insurance products.

These items are further described elsewhere in this discussion and in "Item 1-Business."

Losses and LAE are the most significant payment items affecting our insurance business and represent the most significant accounting estimates in our consolidated financial statements. We establish reserves representing estimates of future amounts needed to pay claims with respect to insured events that have occurred, including events that have not been reported to us. We also establish reserves for LAE, which represent the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. Changes in reserve estimates may be caused by a wide range of factors, including inflation, changes in claims and litigation trends and legislative or regulatory changes. We incur a charge to earnings in the period the reserves are increased. In 2008 and 2007, we recorded charges to increase loss reserves for prior years at our discontinued operations, as discussed under "Discontinued Operations" beginning on page 41 of this MD&A.

Our Fee-based Business earns revenues by providing claims adjusting, managed care and risk control services to customers and by placing insurance business with other third party insurance and reinsurance companies. Payments made at this segment primarily consist of operating expenses, which include internal expenses to operate the business and commissions paid to sub-producers. The Fee-based Business segment was created for reporting purposes in 2007 following our acquisition of Midlands Management Corporation. In 2008, we acquired PMA Management Corp. of New England, Inc. Revenues and income increased in 2008 primarily as a result of these acquisitions.

In 2007, we began reporting the results of our Run-off Operations as discontinued operations. The sale of our Run-off Operations is currently pending regulatory approval from the Pennsylvania Insurance Department. In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets" ("SFAS 144"), the balance sheets have been presented with the gross assets and liabilities of discontinued operations in separate lines and the statements of operations have been presented with the net results from discontinued operations, shown after the results from continuing operations. For comparative purposes, we have reclassified our prior period

financial presentation to conform to these changes. In 2008, we recorded an after-tax charge of $8.5 million as a result of a $13.0 million capital contribution made to our Run-off Operations in order to comply with a commitment made to an independent rating agency. We continue to work with the buyer and the Pennsylvania Insurance Department to complete this sale.

Consolidated Results

We recorded net income of $5.7 million in 2008, compared to a net loss of $42.5 million in 2007 and net income of $4.1 million in 2006. Operating income, which we define as net income (loss) excluding realized gains (losses) and the results from discontinued operations, increased to $21.5 million for 2008, compared to $14.4 million in 2007 and $4.5 million in 2006.

In 2008, net income included an after-tax loss of $12.8 million from discontinued operations, which resulted from a $13.0 million capital contribution to increase the statutory capital of our Run-off Operations in addition to prior year adverse loss development that we expect will reduce the amount of cash we will receive at the closing of the sale of our Run-off Operations.

The net loss in 2007 included an after-tax loss of $57.3 million from discontinued operations. The loss from discontinued operations included an after-tax impairment charge of $40.0 million related to the anticipated sale of our Run-off Operations. It also included an after-tax reserve charge of $14.3 million for prior year adverse loss development at our Run-off Operations.

Income from continuing operations included the following after-tax net realized investment gains and losses:

(dollar amounts in thousands)                         2008         2007       2006
Net realized investment gains (losses) after tax:
Sales of investments                                $  2,928     $ (1,084 )   $ 570
Other than temporary impairments                      (5,981 )       (136 )       -
Change in fair value of trading securities                 -        2,093         -
Other                                                    (18 )       (507 )     235
Net realized investment gains (losses) after tax    $ (3,071 )   $    366     $ 805

Consolidated revenues were $494.2 million in 2008, compared to $455.8 million in 2007 and $432.6 million in 2006. The increase in consolidated revenues in 2008, compared to 2007, primarily reflected an increase in fee-based revenues of $32.7 million and growth in net premiums earned of $12.0 million. Included in the fee-based revenue increase were increases in claims service revenues of $23.3 million and commission income of $9.4 million. The increases in claims service revenues and commission income were primarily due to revenues resulting from our acquisition of Midlands, while the growth in net premiums earned mainly reflected an increase in direct premium production, which was due to increases in renewal premiums and larger account business. The increase in consolidated revenues in 2007, compared to 2006, primarily reflected growth in net premiums earned of $10.8 million and an increase in fee-based revenues of $9.2 million. The growth in net premiums earned in 2007 was mainly due to an increase in our renewal retention rate, while the increase in fee-based revenues was primarily due to revenues resulting from our acquisition of Midlands in the fourth quarter of 2007.

In addition to providing consolidated net income (loss), we also provide segment operating income (loss) because we believe that it is a meaningful measure of the profit or loss generated by our operating segments. Operating income, which we define as GAAP net income (loss) excluding net realized investment gains (losses) and results from discontinued operations, is the financial performance measure used by our management and Board of Directors to evaluate and assess the results of our businesses. Net realized investment activity is excluded because
(i) net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains and losses that do not relate to the operations of the individual segments. Operating income does not replace net income (loss) as the GAAP measure of our consolidated results of operations.

The following is a reconciliation of our segment operating results to GAAP net income (loss). See Note 17 of our Consolidated Financial Statements for additional information.

(dollar amounts in thousands)                     2008          2007          2006

Components of net income (loss):
Pre-tax operating income (loss):
The PMA Insurance Group                         $  46,713     $  38,045     $  26,082
Fee-based Business                                  7,205         3,724         2,802
Corporate and Other                               (20,651 )     (19,564 )     (21,580 )
Pre-tax operating income                           33,267        22,205         7,304
Income tax expense                                 11,730         7,822         2,783
Operating income                                   21,537        14,383         4,521
Realized gains (losses) after tax                  (3,071 )         366           805
Income from continuing operations                  18,466        14,749         5,326
Loss from discontinued operations, net of tax     (12,777 )     (57,277 )      (1,275 )
Net income (loss)                               $   5,689     $ (42,528 )   $   4,051

We provide combined ratios and operating ratios for The PMA Insurance Group below. The "combined ratio" is a measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses, plus acquisition and operating expenses and policyholders' dividends, all divided by net premiums earned. A combined ratio of less than 100% reflects an underwriting profit. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, we invest the available premiums. Underwriting results do not include investment income from these funds. Given the long-tail nature of our liabilities, we believe that the operating ratios are also important in evaluating our business. The operating ratio is equal to the combined ratio less the net investment income ratio, which is computed by dividing net investment income by net premiums earned.

Segment Results

The PMA Insurance Group

Summarized financial results of The PMA Insurance Group were as follows:

(dollar amounts in thousands)          2008          2007          2006

Net premiums written                 $ 414,731     $ 395,325     $ 373,697

Net premiums earned                    390,711       378,870       368,099
Net investment income                   35,431        37,936        34,855
Other revenues                           2,138             -             -
Total revenues                         428,280       416,806       402,954

Losses and LAE                         270,825       263,199       262,297
Acquisition and operating expenses     103,647       106,771       110,065
Dividends to policyholders               6,306         7,790         3,532
Total losses and expenses              380,778       377,760       375,894

Operating income before income
 taxes and interest expense             47,502        39,046        27,060

Interest expense                           789         1,001           978

Pre-tax operating income             $  46,713     $  38,045     $  26,082

Combined ratio                            97.5 %        99.7 %       102.1 %
Less: net investment income ratio          9.1 %        10.0 %         9.5 %
Operating ratio                           88.4 %        89.7 %        92.6 %

The PMA Insurance Group recorded pre-tax operating income of $46.7 million in 2008, compared to $38.0 million in 2007 and $26.1 million in 2006. The increases for both 2008 and 2007, compared to the immediately preceding year, were due primarily to improved underwriting results, as reflected in our lower combined ratios. The increase in 2008, compared to 2007, was also impacted by a pre-tax gain of $2.1 million on the sale of a property that housed one of our branch offices, which moved to a new, more modern, leased facility.

Premiums

Direct premium production increased in 2008 and 2007, compared to the immediately preceding year. We define direct premium production as direct premiums written, excluding fronting premiums and premium adjustments. The increase in direct premium production for 2008, compared to 2007, primarily reflected increases in renewal premiums and increases in larger account business. The increase in direct premium production for 2007, compared to 2006, was mainly due to increases in renewal business.

The following is a reconciliation of our direct premium production to direct premiums written:

(dollar amounts in thousands)     2008          2007          2006

Direct premium production       $ 506,187     $ 459,952     $ 425,679
Fronting premiums                  34,832        59,840        14,790
Premium adjustments               (23,097 )      (9,469 )      (8,842 )
Direct premiums written         $ 517,922     $ 510,323     $ 431,627

The PMA Insurance Group's premiums written were as follows:

(dollar amounts in thousands)      2008           2007          2006

Workers' compensation:
Direct premiums written         $  455,130     $  457,360     $ 382,945
Premiums assumed                    11,352         14,250        24,342
Premiums ceded                     (89,653 )     (109,940 )     (62,908 )
Net premiums written            $  376,829     $  361,670     $ 344,379
Commercial lines:
Direct premiums written         $   62,792     $   52,963     $  48,682
Premiums assumed                       135            226           483
Premiums ceded                     (25,025 )      (19,534 )     (19,847 )
Net premiums written            $   37,902     $   33,655     $  29,318
Total:
Direct premiums written         $  517,922     $  510,323     $ 431,627
Premiums assumed                    11,487         14,476        24,825
Premiums ceded                    (114,678 )     (129,474 )     (82,755 )
Net premiums written            $  414,731     $  395,325     $ 373,697

Direct workers' compensation premiums written were $455.1 million in 2008, compared to $457.4 million in 2007 and $382.9 million in 2006. The decline in direct workers' compensation premiums written for 2008, compared to 2007, was due to a reduction in fronting premiums and higher return premium adjustments, which were largely offset by an increase in direct premium production. The premium adjustments, which increased by $13.7 million for workers' compensation business in 2008, primarily reflect favorable loss experience on loss-sensitive products where the insured shares in the underwriting result of the policy. We write these retrospective products because we believe they provide us with greater certainty in achieving our targeted underwriting results as the customer shares in the underwriting result of the policy with us. The increase in direct workers' compensation premiums written for 2007, compared to 2006, was primarily due to an increase in fronting premiums and, to a lesser extent, an increase in direct premium production. Our renewal retention rate on existing workers' compensation accounts was 87% for both 2008 and 2007, compared to 85% for 2006. Excluding fronting business, we wrote $116.1 million of new workers' compensation business in 2008, compared to $101.1 million in 2007 and $83.5 million in 2006.

Fronting premiums were $34.8 million in 2008, compared to $59.8 million in 2007 and $14.8 million in 2006. The decrease in fronting premiums in 2008, compared to 2007, was primarily the result of the termination of our agreement with Midwest in March 2008. The decline in the Midwest business was partially offset by new fronting business of $24.4 million produced under arrangements we entered into during 2008. The increase in fronting premiums in 2007, compared to 2006, was due to an increase in the Midwest business. Our agreement with Midwest became effective September 1, 2006 and terminated on March 2, 2008.

We entered into two fronting arrangements in the third quarter of 2008. The workers' compensation business produced under these arrangements is primarily located in the southeastern part of the United States and California. We retain approximately 10% of the underwriting results on one of the arrangements and approximately 20% of the underwriting results on the other. We also earn an administrative fee based upon the direct premiums earned under each agreement as well as fees for providing claims services on the business placed under one of the arrangements. All of the participating reinsurers have current A.M. Best financial strength ratings of "A-" (Excellent) or higher. Total direct premiums written under these two arrangements were $22.5 million in 2008. We expect that direct premiums written under these arrangements will be between $70 million and $100 million on an annualized basis, and we expect that the fees from these arrangements will fully replace the fees from our expired agreement with Midwest.

Under our agreement with Midwest, it underwrote and serviced workers' compensation policies in California using our approved forms and guidelines. During the term of the agreement, we retained between 0% and 10% of the underwriting results on this business. We also earned an administrative fee based upon the actual amount of premiums earned pursuant to the agreement. Total direct premiums written under this agreement were $10.4 million in 2008, compared to $59.8 million in 2007 and $14.8 million in 2006.

In 2008, pricing on our rate-sensitive workers' compensation business, which represents approximately 59% of our total workers' compensation business, decreased by 6%, compared to declines of 4% in 2007 and 2% in 2006. For workers' compensation coverages, the premium charged on fixed-cost policies is primarily based upon the manual rates filed with state insurance departments. In 2008, workers' compensation manual rates for business in our principal marketing territories decreased by 7%, compared to declines of 4% in 2007 and 3% in 2006. These changes in manual rates generally reflect the effects of average medical and indemnity cost fluctuations in recent years. Manual rate changes directly affect the prices that we can charge for our rate-sensitive workers' compensation products.

Our pricing on rate-sensitive workers' compensation business written in 2008 decreased 22% in New York and 18% in Florida. The pricing reductions in both New York and Florida were mainly driven by manual loss cost changes filed by each respective state's rating bureau. These two states collectively represent about 16% of our overall rate-sensitive workers' compensation business written during 2008. Exclusive of business written in New York and Florida, our pricing on rate-sensitive workers' compensation business decreased 3% in 2008.

Pricing on our rate-sensitive workers' compensation business in Pennsylvania declined 5% in 2008. In Pennsylvania, we were affected by a 10.2% reduction in loss costs, which was approved by the Pennsylvania Insurance Department and became effective on April 1, 2008. While this resulted in lower filed loss costs in Pennsylvania, we have continued our practice of underwriting our business with a goal of achieving a reasonable level of profitability on each account. We continue to determine our business pricing through schedule charges and credits that we file and use to limit the effect of filed loss cost changes and have not experienced a decrease in premiums equal to the reduction in filed rates. We also believe the nature of our loss-sensitive and alternative market books of business, which represent approximately 41% of our Pennsylvania workers' compensation business, mitigates the impact of reductions in filed loss costs.

Direct premiums written for commercial lines of business other than workers' compensation, such as commercial auto, general liability, umbrella, multi-peril and commercial property lines (collectively, "Commercial Lines"), increased by $9.8 million in 2008, compared to 2007. Our renewal retention rate on existing Commercial Lines accounts in 2008 was 89%, and new business was $19.4 million. Direct premiums written for Commercial Lines increased by $4.3 million in 2007, compared to 2006. Our renewal retention rate on existing Commercial Lines accounts in 2007 was 89% and new business was $13.4 million, compared to 84% and $6.9 million, respectively, in 2006. Overall pricing on Commercial Lines decreased 6% in 2008 and 2% in 2007, and increased modestly in 2006, compared to the immediately preceding year.

Total premiums assumed decreased by $3.0 million in 2008 and $10.3 million in 2007, compared to the immediately preceding year. The declines for both periods were primarily due to reductions in the involuntary residual market business assigned to us. Although our total direct premiums written in both 2008 and 2007 increased, we believe the declines in assumed premiums assigned to us were a result of more business written in the traditional market and less business assigned to the total involuntary market pool. Companies that write premiums in certain states generally must share in the risk of insuring entities that cannot obtain insurance in the voluntary market. Typically, an insurer's share of this residual market business is assigned on a lag based on its market share in terms of direct premiums in the voluntary market. These assignments are accomplished either by direct assignment or by assumption from pools of residual market business.

Total premiums ceded decreased by $14.8 million in 2008 and increased by $46.7 million in 2007, compared to the immediately preceding year. Premiums ceded for workers' compensation decreased by $20.3 million in 2008, compared to 2007, primarily due to lower premiums ceded under fronting arrangements, which were partially offset by an increase in the amount of workers' compensation business sold to captive accounts, where a substantial portion of the direct premiums are ceded. Premiums ceded for workers' compensation increased by $47.0 million in 2007, compared to 2006, primarily due to our agreement with Midwest, under which we ceded $57.3 million in 2007, compared to $14.8 million in 2006. Premiums ceded for Commercial Lines increased by $5.5 million in 2008, compared to 2007, mainly resulting from increased direct premium writings. Premiums ceded for Commercial Lines slightly declined in 2007, compared to 2006, mainly resulting from changes in the contractual terms of our property quota share treaty.

In total, net premiums written increased 5% in 2008, compared to 2007. The increase in net premiums written for 2008 primarily reflected the increase in direct premium production, which was partially offset by the return premium adjustments. Net premiums written increased 6% in 2007, compared to 2006. The increase in net premiums written for 2007 was mainly due to the increase in direct premium production, which was partially offset by the decrease in premiums assumed.

Net premiums earned increased 3% in both 2008 and 2007, compared to the immediately preceding year. Generally, trends in net premiums earned follow patterns similar to net premiums written, adjusted for the customary lag related to the timing of premium writings within the year. In periods of increasing premium writings, the dollar increase in premiums written will typically be greater than the increase in premiums earned, as was the case in both 2008 and 2007. Direct premiums are earned principally on a pro rata basis over the terms of the policies. However, with respect to policies that provide for premium adjustments, such as experience or exposure-based adjustments, such premium adjustment may be made subsequent to the end of the policy's coverage period and will be recorded as earned premium in the period in which the adjustment is made.

Losses and Expenses

The components of the GAAP combined ratios were as follows:


                                               2008       2007       2006

              Loss and LAE ratio                69.3 %     69.5 %      71.3 %
              Expense ratio:
                Acquisition expense             17.1 %     19.4 %      20.0 %
              Operating expense                  9.5 %      8.7 %       9.8 %
              Total expense ratio               26.6 %     28.1 %      29.8 %
              Policyholders' dividend ratio      1.6 %      2.1 %       1.0 %
              Combined ratio                    97.5 %     99.7 %     102.1 %

The loss and LAE ratio improved 0.2 points in 2008, compared to 2007. The improved loss and LAE ratio primarily benefited from favorable development in our loss-sensitive business, which resulted in the retrospective premium adjustments recorded in 2008. Although pricing changes coupled with payroll inflation for rate-sensitive workers' compensation business were below overall estimated loss trends, our current accident year loss and LAE ratio continued to benefit from changes in the type of workers' compensation products selected by our insureds. We estimate our medical cost inflation to be 6.5% during 2008, compared to our estimate of 7% in 2007. This decline reflects a decrease in utilization as well as our enhanced network and managed care initiatives. However, we expect that medical cost inflation will continue to be a significant component of our overall loss experience.

The loss and LAE ratio improved 1.8 points in 2007, compared to 2006. The improved loss and LAE ratio primarily reflected a lower current accident year loss and LAE ratio in 2007, compared to 2006. While our underwriting criteria remained consistent in 2007, our current accident year loss and LAE ratio continued to benefit from changes in the type of workers' compensation products selected by our insureds and a reduced amount of integrated disability and . . .