SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    Form 10-K

                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

For the fiscal year ended December 31, 1998     Commission file number  1-10995

                             Capital Re Corporation
             (Exact name of registrant as specified in its charter)

           Delaware                                                52-1567009
  (State or other jurisdiction                                 (I.R.S. Employer
of incorporation or organization)                            Identification No.)

1325 Avenue of the Americas, New York, N.Y.                          10019
 (Address of principal executive offices)                         (Zip Code)

Registrant's telephone number, including area code:               212-974-0100

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $.01 par value, and
Capital Re LLC 7.65% Cumulative
Monthly Income Preferred Shares, Series A
(guaranteed by Capital Re Corporation)             New York Stock Exchange, Inc.
(Title of Class)                                    (Name of each exchange on
                                                         which registered)

           Securities registered pursuant to Section 12(g) of the Act:

                                      None
                                (Title of Class)

Indicate by check mark whether registrant (1) has filled 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 such  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 disclosure 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  amendments  to
this Form 10-K. [ ]

     The approximate  aggregate market value of the voting and non-voting common
equity held by  non-affiliates  of the  registrant  as of February  26, 1999 was
$338,229,048.  The number of shares of Common Stock  outstanding  as of February
26, 1999 was 32,045,119.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the  registrant's  1999  definitive  Proxy  Statement for the annual
shareholders meeting to be held May 20, 1999 (which is expected to be filed with
the  Commission  within 120 days after the end of the  Registrant's  1998 fiscal
year) are incorporated by reference into Part III of this Report.


<PAGE>


                                     PART I

Item 1. Business.

A.  GENERAL:

(1)  Company Overview and Business Strategy -

Capital Re Corporation  (the "Company" or "Capital Re") is an insurance  holding
company  for  a  group  of  reinsurance   companies  that  provide   value-added
reinsurance products in several specialty insurance markets. The Company has two
principal  divisions:  financial  guaranty and  financial  risks.  The financial
guaranty division is composed of municipal and non-municipal  financial guaranty
reinsurance  and credit default swaps.  The financial risks division is composed
of mortgage guaranty  reinsurance,  trade credit reinsurance,  title reinsurance
and financial  solutions.  The Company's  financial guaranty and financial risks
divisions  contributed  43.7%  and  56.3%,  respectively,  of 1998 net  premiums
written.  In both of its  principal  areas of  business,  the  Company  seeks to
provide  innovative  reinsurance  solutions  to  satisfy  the  diverse  risk and
financial management demands of its primary clients. Theses solutions often take
the form of complex reinsurance  arrangements that provide value other than pure
risk management (i.e., financial statement benefit, regulatory relief and rating
agency qualified  capital).  The Company believes that its future growth will be
generated  through  application of its core credit expertise to new products and
markets in its two existing divisions.

The  Company  participates  in its  business  lines  through  five  wholly-owned
insurance   subsidiaries  and  two  joint  venture  vehicles.  Its  wholly-owned
subsidiaries are: Capital Reinsurance Company ("Capital  Reinsurance"),  Capital
Credit Reinsurance Company Ltd. ("Capital Credit"), Capital Mortgage Reinsurance
Company ("Capital  Mortgage"),  KRE Reinsurance Ltd. ("KRE"),  and Capital Title
Reinsurance Company ("Capital Title"). The Company owns a fifty percent economic
interest in ACE Capital Re Ltd.  ("ACRE"),  a  non-consolidated,  Bermuda  based
joint venture  vehicle.  The Company's  joint venture partner in ACRE is Bermuda
based ACE Bermuda Insurance, Ltd. ("ACE Bermuda"). The Company also owns a fifty
percent  interest in Lenders  Residential  Asset Company LLC (formerly,  Lenders
Mortgage  Alliance Company LLC) ("LRAC"),  a  non-consolidated  Delaware limited
liability company.

     Capital  Reinsurance's  financial  strength  is rated AAA by  Standard  and
Poor's,  a division  of The McGraw  Hill  Companies,  Inc.  ("S&P"),  and Aa2 by
Moody's Investors Service,  Inc.  ("Moody's"),  and its claims-paying ability is
rated triple-A by Fitch IBCA ("Fitch").  KRE's financial strength is rated AA by
S&P, and its  claims-paying  ability is rated AA+ by Duff & Phelps Credit Rating
Co. ("Duff & Phelps").  The financial  strength of Capital Credit is rated A+ by
S&P.  The  financial  strength of Capital  Mortgage is rated AA by S&P.  Capital
Title's financial strength is rated AA- by S&P, and its claims paying ability is
rated AA- by Duff & Phelps. On December 16, 1998, the financial strength ratings
by S&P of KRE, Capital Credit, Capital Mortgage and Capital Title were placed on
"CreditWatch" with negative implications. See "Business of Capital Re--Ratings."

The  Company's  financial  guaranty  division  conducts its  business  primarily
through  Capital  Reinsurance  and KRE.  Capital  Reinsurance  is a professional
reinsurance  company  dedicated to serving the U.S.  domestic and  international
financial  guaranty  insurance  markets and has established  itself as a leading
specialty  reinsurer  (by market  share) of financial  guaranties  of investment
grade  debt  obligations,   principally  municipal  debt  obligations.   Capital
Reinsurance's  focus on the municipal bond reinsurance  business  recognizes the
fact that historically municipal bond insurance has been a proven revenue source
in the financial  guaranty  insurance market which, when managed  properly,  can
provide  predictable  revenues from (i) an associated  deferred  premium revenue
account,  (ii) installment  premiums from business already  originated and (iii)
interest  income on the  Company's  investment  portfolio.  Capital  Reinsurance
applies a "zero loss" standard to its underwriting process, which is premised on
a general policy of reinsuring only those  obligations that are investment grade
on the date  reinsured  and where  there is no  expectation  of loss on the risk
reinsured.   Nevertheless,   losses  can  be   expected   to  occur  in  Capital
Reinsurance's   existing  and  future



                                       2
<PAGE>


reinsurance  and credit default swap  portfolios.  At the same time,  consistent
with its "zero loss" underwriting policies,  Capital Reinsurance has pursued the
reinsurance of investment grade  non-municipal debt obligations and directed its
capacity to the reinsurance of financial guaranties of asset-backed  securities.
In  the  case  of  both  municipal  bond  reinsurance  and  the  reinsurance  of
non-municipal debt obligations,  Capital Reinsurance has emphasized  facultative
reinsurance,  which Capital  Reinsurance  believes better permits it to maintain
portfolio diversification, pricing discipline and conformity to its underwriting
policies,  because  through  facultative  reinsurance the reinsurer may exercise
control over risks assumed as they are accepted only on a risk-by-risk basis. In
addition,  Capital  Reinsurance  sells municipal and  non-municipal  credit risk
protection on a facultative  basis to a wide variety of  counterparties  through
credit  default swap  transactions.  Credit  default swaps are  underwritten  in
accordance   with  the  same  "zero  loss"  standard  that  applies  to  Capital
Reinsurance's municipal and non-municipal financial guaranty business.

KRE, a Bermuda based insurer,  also assumes  financial  guaranty risk, both as a
retrocessionaire  of Capital  Reinsurance  and  directly  from  certain  primary
financial guaranty insurers.

The Company's  financial risks division conducts its business  primarily through
Capital Mortgage,  Capital Credit,  Capital Title,  KRE, ACRE and LRAC.  Capital
Mortgage  is  a  leading  reinsurer  of  mortgage  guaranty  insurance.  Capital
Mortgage's strategy is based on the development of creative reinsurance programs
targeted to the individual capital, risk and portfolio management demands of the
primary  mortgage   guaranty   insurers.   Mortgage   guaranty   reinsurance  is
underwritten with the expectation that losses will occur regularly.  In order to
optimize capital utilization, the business plan of Capital Mortgage includes the
reinsurance  of  mortgage  guaranty   insurance  business  by  KRE,  both  as  a
retrocessionaire of Capital Mortgage and directly from primary mortgage guaranty
insurers.

The Company  writes trade  credit  reinsurance  in the U.S.  and Europe  through
Capital  Credit.  Trade  credit  insurance  protects  those  who sell  goods and
services  on credit  terms  against  default  by the  purchaser  on its  payment
obligations.  Trade credit  reinsurance is a logical  extension of the Company's
underwriting  focus,  relying on credit  analysis and portfolio  diversification
techniques similar to those employed in financial guaranty and mortgage guaranty
reinsurance.  Capital Credit's strategy is to build a limited portfolio of trade
credit  reinsurance  business from the leading  European and U.S.  primary trade
credit insurers,  which  outperforms the overall market by combining quota share
and structured excess of loss  participations.  Portfolio losses will also occur
regularly in the Company's trade credit reinsurance business.

Capital Title is a New York domiciled, monoline insurance company formed in 1996
to provide title  reinsurance.  Prior to the formation of Capital  Title,  there
were  no  dedicated  title  reinsurers,   and  only  intra-industry  facultative
reinsurance was available to support large commercial title insurance  policies.
Capital  Title  provides  coverages  designed  to aid title  insurers in meeting
capital adequacy concerns and to achieve desired  claims-paying  ability ratings
from nationally recognized rating agencies.  Capital Title derives business from
relationships  with primary title  insurers,  financial  institutions  active in
commercial  real estate  lending and  professionals  involved in the real estate
industry.  Capital  Title  offers  excess  of loss and quota  share  reinsurance
products  on  both  a  treaty  and  facultative   basis.  Title  reinsurance  is
underwritten  without the expectation of any significant loss;  however,  losses
can be  expected  to occur in Capital  Title's  existing  and  future  reinsured
portfolio. KRE provides retrocessional support to Capital Title.

The Company's  financial solutions business is written through KRE and ACRE. The
financial solutions business is focused on providing highly structured solutions
to problems of financial  and risk  management  through  reinsurance,  including
credit enhancement,  excess of loss and surplus management covers. The principle
target market is life,  accident and health  insurers and  reinsurers,  although
specialty  property  and  casualty  markets  also  provide  opportunities.   The
underwriting   process  places  significant   emphasis  on  actuarial  analysis.
Transactions  are  underwritten to be risk remote or finite,  standards that are
compatible  with the  Company's  "zero  loss"  financial  guaranty  underwriting
standard.  Losses can be expected to occur in the Company's  existing and future
financial solutions portfolio.

                                       3
<PAGE>

LRAC provides marketing and consulting  services to mortgage lenders with regard
to the  origination  and closing of  residential  mortgages and the sale of such
mortgages into the capital markets.  In addition,  by providing direct access to
lenders, it generates markets for the sale of the Company's other products.

The Company  also owns RGB  Underwriting  Agencies  Ltd.  ("RGB"),  a Lloyd's of
London  ("Lloyd's")  managing  agency which  presently  manages four  syndicates
operating in the Lloyd's insurance market, and CRC Capital Ltd. ("CRC Capital"),
a  corporate  name at  Lloyd's,  which  provides  underwriting  capacity  to the
syndicates  managed by RGB. The Company has commenced a plan of  divestiture  of
its Lloyd's  operations.  Accordingly,  commencing  in 1998,  the Company  began
reflecting its  participation in Lloyd's as a discontinued  operation.  All 1998
and prior year  figures  presented  herein  reflect  Lloyd's  as a  discontinued
operation. See "Discontinued Operations."

The Capital Re corporate group also includes  Capital Re Solutions  Incorporated
(formerly,   Capital  Re  Management   Corporation),   a  New  York  reinsurance
intermediary,  ACE Capital Re Managers Ltd., a Bermuda based management company,
and Capital Re LLC, a Turks & Caicos  Islands  finance  subsidiary  organized in
1993 to issue $75 million of Company guaranteed mandatorily redeemable preferred
stock,  the  proceeds of which were loaned to Capital Re.  Capital Re  Financial
Products Corporation, a newly formed Delaware business corporation,  and Capital
Risk Assurance Company ("Capital Risk"), a newly formed Maryland surety insurer,
intend to commence business in 1999.

Set forth below is a chart showing the  subsidiaries  and  affiliates of Capital
Re:


        [GRAPHIC OF CHART OF SUBSIDIARIES AND AFFILIATES OF CAPITAL RE]


In managing its  investment  portfolio,  the Company  places a high  priority on
credit and liquidity.  At December 31, 1998,  79.5% of the Company's  investment
portfolio consisted  exclusively of fixed income securities rated AAA or A-1+ by
S&P or Aaa or P-1 by Moody's,  or issued by the U.S.  Government or its agencies
or  instrumentalities.  Overall  portfolio  weighted average quality is AA+. The
Company  employs a modified  total return  investment  strategy,  and investment
guidelines  are  established  and  approved by the  Investment  Committee of the
Company's Board of Directors.  The investment  guidelines permit  investments in
investment  grade and  limited  amounts of  non-investment  grade  fixed  income
securities,  including  non-dollar  denominated bonds,  emerging market debt and
other financial instruments. See "Business of Capital Re--Investments."

The Company has a common and  preferred  equity  investment  in CGA Group,  Ltd.
("CGA  Group"),  a  Bermuda  holding  company  which  owns  Commercial  Guaranty
Assurance,  Ltd. ("CGA Ltd."), a Bermuda insurance  company,  and CGA Investment
Management, Inc. ("CGAIM"), a Delaware corporation.  CGA Ltd. provides financial
guaranty




                                       4
<PAGE>


insurance of commercial real estate securities,  including  commercial  mortgage
backed securities.  CGA Ltd. also provides financial guaranty insurance of other
financial obligations,  primarily asset-backed  securities,  by targeting market
segments and originating structures which are outside of the traditional markets
of the major AAA/Aaa rated financial guaranty insurers.  For a discussion of the
Company's investment in CGA Group, see "Management's  Discussion and Analysis of
Financial Condition and Results of Operations" in Part II hereof.

(2)  Recent Developments -

On February 19, 1999, the Company and ACE Bermuda  entered into a Stock Purchase
Agreement (the "Stock Purchase  Agreement") pursuant to which ACE Bermuda agreed
to purchase $75 million of the Company's Common Stock at a per share price equal
to the lesser of (i) the fully  diluted book value per share of the Common Stock
at December 31, 1998 and (ii) 1.15 multiplied by the average of the five highest
closing prices of the Common Stock between February 19, 1999 and April 15, 1999,
as reported on the New York Stock  Exchange  composite  tape. The closing of the
sale was  subject to the  satisfaction  of  certain  conditions,  including  the
affirmation  by  Moody's  of  the  Aaa  financial  strength  rating  of  Capital
Reinsurance.  On  March  10,  1999,  Moody's  downgraded  Capital  Reinsurance's
financial  strength  rating to Aa2.  The  Company  and ACE  Bermuda  executed an
amendment to the Stock Purchase  Agreement on March 16, 1999, which modified the
per share  price to equal the  lesser of (i) the fully  diluted  book  value per
share of the Common  Stock at December 31, 1998 and (ii) the average of the five
highest  closing prices of the Common Stock between March 12, 1999 and April 15,
1999.  As of the date of this  Annual  Report,  the Company  estimates  that ACE
Bermuda  will own between  11% and 12.6% of the  outstanding  Common  Stock upon
consummation of the issuance.  Closing  remains  subject to the  satisfaction of
certain customary  conditions,  including the receipt of all required regulatory
approvals;  accordingly,  it is not  certain  when or if the  closing  will take
place.  Under the  Stock  Purchase  Agreement,  as  amended,  for so long as ACE
Bermuda  continues  to hold at  least  8% of the  voting  capital  stock  of the
Company,  it will have the right to nominate two members to the Company's  board
of directors.  In addition,  the Company has agreed to file a shelf registration
statement  covering the shares of Common Stock owned by ACE Bermuda and maintain
the effectiveness of such registration statement for a period of no greater than
three years from the closing date.

(3)  Financial Guaranty Division -

(a)  Overview of Financial Guaranty Insurance Market -

Financial  guaranty  insurance is a type of credit  enhancement in the form of a
surety or  insurance  which is  regulated  under the  insurance  laws of various
jurisdictions.  The insurance provides an unconditional and irrevocable guaranty
which indemnifies the insured against  nonpayment of principal and interest when
due by an obligor on an insured  debt  obligation.  The two  largest  nationally
recognized  rating  agencies,  S&P and Moody's,  assign the  financial  strength
rating of a financial guaranty  insurance company to the obligations  insured by
that company. Because all of the major U.S. primary financial guaranty insurance
companies have triple-A  financial  strength ratings from these rating agencies,
bonds insured by those companies are rated triple-A.

Both  issuers  of and  investors  in  financial  instruments  may  benefit  from
financial guaranty insurance. Issuers benefit because the insurance may have the
effect of lowering an issuer's  cost of borrowing in the public and private debt
markets.  The  borrowing  costs are  lowered  to the extent  that the  insurance
premium  is less  than the  value of the  difference  between  the  yield on the
AAA/Aaa insured  obligation and the yield on the obligation if sold on the basis
of its uninsured credit rating.  Financial guaranty insurance also increases the
marketability of obligations issued by infrequent or unknown issuers.  Investors
benefit from increased  liquidity in the secondary  market,  reduced exposure to
price  volatility  caused by  changes in the  credit  quality of the  underlying
insured issue, and added  protection  against loss in the event of the obligor's
default on its obligation. Upon nonpayment by an obligor, the financial guaranty
insurance  company is  obligated  to pay the  principal  of and  interest on the
insured  obligation in accordance  with the original  payment  schedule as if no
default had occurred.

                                       5
<PAGE>


The majority of financial guaranty insurance premiums are paid in full at policy
inception,  although on certain financial guaranties, such as guaranties of most
non-municipal  obligations,  premiums  are  paid  on an  installment  basis  and
typically  earned  in  the  period  paid.   Financial   guaranty   premiums  are
non-refundable  and those paid in full are earned  over the term of the  related
insured  obligation.  Because most obligations insured by the financial guaranty
insurers have long maturities, the portion of premiums earned on a policy in any
year represents a relatively small percentage of initial premium received.  This
methodology  generates a predictable  contribution to revenues over time that is
relatively  independent of new business written in any given year. Premium rates
are generally  calculated as a percentage of the principal amount of the insured
obligation or the principal and interest scheduled to come due during the stated
term of the  insured  obligation.  A number of  factors  are  considered  in the
setting of premium  rates  including the type of credit  obligation,  collateral
security, maturity and rating agency capital charge.

The financial  guaranty  insurance  market consists of two main product sectors:
municipal  bond  insurance  and  insurance of  non-municipal  debt  obligations.
Municipal bond insurance  provides credit enhancement of debt obligations issued
by or on behalf of states or their  political  subdivisions  (counties,  cities,
towns and villages, utility districts, public universities and hospitals, public
housing  and  transportation  authorities)  and other  public  and  quasi-public
entities (including  non-U.S.  sovereigns and subdivisions  thereof).  Insurance
provided to the  municipal  bond market has been and  continues  to be the major
source of revenue for the financial guaranty insurance industry.

The volume of long-term  municipal  debt  issuances and municipal bond insurance
has increased significantly since 1983. In 1985, pending federal tax legislation
relating to  municipal  bonds  prompted an unusual rise in total  long-term  new
issue  municipal bond volume.  The market for new issues returned to more normal
volumes in 1987 and grew steadily  through 1991. In 1992 and 1993,  historically
low interest  rates  prompted a dramatic  increase in new issue volume,  in part
arising from the refinancing of refunding activity.  This increase ended in 1994
as rising interest rates and other market uncertainties developed throughout the
year.  Growth in new issue  volume  regained  momentum in 1995  through  1998 as
market conditions  improved in a lower interest rate  environment.  Furthermore,
insurance  penetration again reached an historic high in 1998,  exceeding 50% of
issuances.

The table  below  sets  forth the volume of  long-term  municipal  bonds and the
volume of insured  long-term  municipal  bonds  issued over the period from 1989
through 1998.

                      New Total          New Insured         New Insured Volume
       Year             Volume              Volume          as a Percent of New
                    (in billions)       (in billions)           Total Volume
     --------------------------------------------------------------------------
       1989           125.0                 31.1                  24.9
     --------------------------------------------------------------------------
       1990           127.8                 33.5                  26.2
     --------------------------------------------------------------------------
       1991           172.4                 51.9                  30.1
     --------------------------------------------------------------------------
       1992           234.6                 80.8                  34.4
     --------------------------------------------------------------------------
       1993           292.3                107.9                  36.9
     --------------------------------------------------------------------------
       1994           165.0                 61.5                  37.3
     --------------------------------------------------------------------------
       1995           160.0                 68.5                  42.8
     --------------------------------------------------------------------------
       1996           185.0                 85.7                  46.3
     --------------------------------------------------------------------------
       1997           220.7                107.5                  48.7
     --------------------------------------------------------------------------
       1998           285.9                145.3                  50.8
     --------------------------------------------------------------------------

     Source:  Figures  for 1989 are based upon data  provided by The Bond Buyer,
     February 6, 1998, and figures for 1990-1998 are based upon data provided by
     The Bond Buyer,  February  9, 1999.  Amounts  under the New Insured  Volume
     column include only the insured portion of an issue.  Amounts under the New
     Total  Volume and New Insured  Volume  columns  represent  gross  principal
     amounts issued or insured, as the case may be, during such year.

                                       6
<PAGE>


The primary  financial  guaranty  insurers also insure municipal bond investment
vehicles,  such as unit  investment  trusts and mutual  funds,  and  outstanding
municipal bonds trading in the secondary market.

The non-municipal  financial guaranty insurance market is newer and more diverse
than the municipal bond insurance market.  The types of securities  supported by
guaranties  of  non-municipal  debt  obligations  include  various  asset-backed
securities,  including  consumer  and  trade  receivable-backed  securities  and
commercial  and  residential  mortgage-backed  securities,  corporate  bonds and
mutual funds. Although this market has been slower to develop than the municipal
market,  demand for this type of insurance is being stimulated by innovations in
both domestic and foreign capital  markets coupled with increasing  investor and
issuer awareness of the value provided by financial guaranties.

As of December 31, 1998 there were four triple-A  rated  primary U.S.  financial
guaranty insurance companies active in the business:  MBIA Insurance Corporation
("MBIA"),  AMBAC  Indemnity  Company  ("AMBAC"),  Financial  Guaranty  Insurance
Company ("FGIC") and Financial  Security  Assurance Inc.  ("FSA").  In 1997, ACA
Financial Guaranty Corporation ("ACA") commenced  operations.  ACA is a single-A
rated  financial  guaranty  insurer  focusing  on the  insurance  of  marginally
investment   grade  and   non-investment   grade  municipal  and   non-municipal
securities.  Further, CGA Ltd., a Bermuda based financial guaranty insurer which
commenced  operations in June 1997,  provides  financial  guaranty  insurance of
structured  securities,   including  commercial  real  estate  and  asset-backed
securities.

(b)  Financial Guaranty Reinsurance Market -

Reinsurance  is a  transaction  whereby the  reinsurer  agrees to indemnify  the
primary  insurance  company against part or all of the loss which the latter may
sustain  under a policy  which it has  issued.  The  reinsurer  may also  assume
reinsurance from other reinsurers  ("retrocessions").  In the event of loss, the
reinsured generally remains liable on its obligation to indemnify the insured.

The  two  major  kinds  of  reinsurance  are  treaty  and  facultative.   Treaty
reinsurance  requires the reinsured to cede and the reinsurer to assume specific
classes  of risk  underwritten  by the  ceding  company  over a period  of time,
typically one year. Facultative reinsurance is the reinsurance of part or all of
one or more  reinsurance  policies which is subject to separate  negotiation for
each  cession.  It  offers  the  option of  accepting  or  rejecting  individual
submissions by a ceding company as  distinguished  from the obligation to accept
specified classes of risk as a treaty reinsurer. Ceding companies generally will
seek facultative  agreements when treaty terms preclude the cession or inclusion
of a particular  risk,  when the capacity of the treaty program is  insufficient
for a given risk (for  instance,  when policy limits are in excess of the treaty
limits) or when special  coverage is needed to comply with  regulatory  or other
capacity restrictions.

Reinsurance is written on a proportional or non-proportional basis. Proportional
reinsurance includes: (i) quota share reinsurance, whereby the assumed risk is a
fixed  percentage  of the  reinsured's  risk,  (ii) surplus  share  reinsurance,
whereby the  percentage  of risk  assumed is a multiple of the  reinsured's  net
retention up to a stated  maximum,  and (iii) variable quota share  reinsurance,
whereby the  percentage of assumed risk increases with the risk size to a stated
maximum. There are many possible variations of these three types of proportional
reinsurance. Non-proportional reinsurance includes: (i) risk assumption per risk
and per occurrence in excess of a reinsured's retention,  subject to a specified
limit, and (ii) stop loss or aggregate excess of loss  reinsurance,  whereby the
reinsurer  assumes an aggregate  loss  incurred over a specific time period (for
specific risks) above the reinsured's retention of loss incurred, up to a stated
maximum.

The  purposes of  reinsurance  in the  financial  guaranty  industry  are to (i)
increase the insurance  capacity of the reinsured,  (ii) assist the reinsured in
meeting applicable regulatory and rating agency requirements,  (iii) augment the
reinsured's  financial strength,  and (iv) manage the reinsured's risk exposure.
State insurance laws and  regulations,  as well as the rating  agencies,  impose
minimum  capital  requirements  on financial  guaranty  companies,  limiting the
aggregate  amount of insurance  which may be written and the maximum size of any
single risk which may be insured.

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<PAGE>


Reinsurance  allows the reinsured to increase its capacity to write new business
by  effectively  reducing the  reinsured's  gross  liability on an aggregate and
single  risk  basis.  Furthermore,  primary  insurers  manage  the risk of their
insured  portfolios  based  on  internal  underwriting  criteria  and  portfolio
management guidelines.  Reinsurance is instrumental in achieving those portfolio
risk management goals. There are currently two domestic  reinsurance  companies,
Capital  Reinsurance  and  Enhance  Reinsurance  Company,  specializing  in  the
reinsurance of financial guaranties.  Several non-U.S.  multiline insurers and a
small number of domestic multiline insurers also participate in this reinsurance
market.  Based upon the 1998 annual  statutory  statements  filed by each of the
U.S. primary financial guaranty insurers,  the Company believes that the Company
and its principal  competitor  assumed most of the reinsurance ceded by the U.S.
primary financial guaranty insurers in 1998.

The size and growth of the financial guaranty reinsurance market is dependent on
(i) the size of the primary insurance  market,  (ii) the percentage of aggregate
risk that the primary insurers cede to the reinsurers, (iii) regulatory,  rating
agency and other  external  risk  retention  limitations  imposed on the primary
insurers and (iv) the price and availability of substitute  highly rated capital
facilities.

(c)  Credit Default Swap Market -

Credit default swaps are  transactions  whereby one party, in consideration of a
fixed  payment,  agrees to make a  specified  payment to another  party upon the
occurrence  of one or more  specified  credit events with respect to a reference
entity.  The Company,  through Capital  Reinsurance,  entered the credit default
swap  business in early 1996.  Although  structured  as  financial  derivatives,
credit  default  swaps  are  functionally   equivalent  to  financial   guaranty
insurance,  and Capital  Reinsurance  underwrites  and manages this  business in
tandem with,  and in accordance  with the same policies and  procedures  as, its
financial guaranty business.  Capital Reinsurance engages in credit default swap
with numerous counterparties, including U.S. and European money center banks and
investment banks.

(4)  Financial Risks Division -

(a)  Mortgage Guaranty Reinsurance Market -

The purposes of reinsurance in the mortgage guaranty  insurance  industry are to
(i) increase the insurance capacity of the reinsured,  (ii) assist the reinsured
in meeting applicable  regulatory and rating agency requirements,  (iii) augment
the  reinsured's  financial  strength  and  (iv)  manage  the  reinsured's  risk
exposure.

Mortgage  guaranty  insurance  is  a  specialized  class  of  credit  insurance,
providing  protection to mortgage  lending  institutions  against the default of
borrowers on mortgage loans which at the time of the advance had a loan-to-value
("LTV")  ratio in excess of 80%. The market for mortgage  guaranty  insurance is
competitively shared by three sectors:  governmental  agencies,  principally the
Federal Housing Administration  ("FHA") and the Veterans  Administration ("VA"),
private mortgage guaranty insurers, and the lending institutions which choose to
self-insure against the risk of loss on high LTV mortgage loans.

The private mortgage  insurance  industry,  composed of only monoline  insurance
companies,  as required by law,  provides two basic types of  coverage:  primary
insurance,  which protects  lenders  against  default on individual  residential
mortgage loans by covering losses on such loans to a stated coverage percentage;
and pool insurance,  which protects lenders against  aggregate default levels in
an underlying  pool of individual  mortgages by covering the full amount of loss
(less the proceeds from any primary insurance  coverage that may be in place) on
individual  residential  mortgage loans in such pool of loans, with an aggregate
limit usually expressed as a percentage of the initial loan balances of the pool
of loans.  Primary  insurance and pool insurance are used to facilitate the sale
of mortgage loans in the secondary  mortgage market,  principally to the Federal
Home Loan Mortgage  Corporation  ("Freddie Mac") and Federal  National  Mortgage
Association  ("Fannie Mae"). Freddie Mac and Fannie Mae provide indirect funding
for approximately half of all mortgage loans originated in the U.S. In addition,
pool  insurance  is often used to provide  credit  support  for  mortgage-backed
securities and other  secondary  mortgage market

                                       8
<PAGE>


transactions.  There are seven private  mortgage  guaranty  insurers writing new
business:  General Electric  Mortgage  Insurance  Company  ("GEMICO");  Mortgage
Guaranty Insurance Company; PMI Mortgage Insurance Co. ("PMI");  United Guaranty
Residential Insurance Company; Commonwealth Mortgage Assurance Company ("CMAC");
Republic Mortgage  Insurance Company;  and Triad Mortgage Insurance Company.  In
1998 CMAC  entered into an agreement  to acquire  Amerin  Guaranty  Corporation,
which had been the fifth largest mortgage guaranty insurer.  CMAC's  acquisition
of Amerin is expected to be completed in the spring of 1999.

Mortgage guaranty insurers do not underwrite risk to a "zero loss"  underwriting
standard  as  in  the  financial  guaranty  insurance  industry;   rather,  they
underwrite with a view to target loss ratios ranging from 45% to 60%. A critical
factor to  successfully  underwriting  this class of  business is the ability to
consistently  control the quality and diversity of insurance in force,  avoiding
catastrophic  losses from regional  depressions and declines in residential real
estate prices, by effective geographic and product dispersion.

Except for the Company, the third-party reinsurance capacity for the industry is
provided almost exclusively by European  multiline insurers and reinsurers,  who
offer modest amounts of traditional  reinsurance products.  The primary mortgage
insurers also utilize various internal risk sharing  arrangements with their own
affiliates.  In recent years,  the primary  mortgage  insurers have  established
numerous  risk and profit  sharing  mechanisms  with  lenders.  As a result of a
ruling  by the  Comptroller  of the  Currency  in 1997,  federal  banks  are now
permitted to establish operating  subsidiaries,  known as lender-owned captives,
to reinsure a portion of the mortgage  insurance  issued on loans  originated or
purchased by the bank or its lending affiliates.

The  growing  use of  lender-owned  captives  that  assume risk from the primary
mortgage insurers has materially altered mortgage guaranty insurance industry in
that the  primary  insurers  now cede a  significant  percentage  of  premium to
lender-owned  captives leaving less premiums  available to purchase  reinsurance
from third parties. In general,  lender-owned  captive reinsurance  transactions
are structured as  non-proportional  arrangements with the lender-owned  captive
assuming  risk on an excess of loss basis,  although some  lender-owned  captive
transactions are structured as proportional reinsurance.  The growing popularity
of lender-owned  captive arrangements has reduced the mortgage guaranty insurers
use of third party reinsurance for their risk management needs.

Both  Fannie  Mae and  Freddie  Mac have  recently  taken  positions  that place
increased pressure on the mortgage guaranty insurance  industry.  In early 1999,
Fannie  Mae  reduced  the amount of  insurance  coverage  required  for loans it
purchases.  Fannie Mae has also  introduced  certain  products  that may further
decrease the need for mortgage guaranty insurance.  The reduced risk and revenue
opportunities for the mortgage guaranty  insurance industry caused by the recent
actions of Fannie Mae and  Freddie Mac further  lessen the  industry's  need for
third-party reinsurance.

Low loss  ratios,  higher  premiums  and  streamlined  operations  have  allowed
mortgage   insurers  to  bolster  capital  thereby   diminishing  the  need  for
reinsurance  support.  The  mortgage  insurers,  however,  continue  to  utilize
non-captive  reinsurance to optimize financial results and/or meet rating agency
capitalization requirements.  The Company, which through Capital Mortgage is the
only dedicated mortgage guaranty reinsurer, has been able to capitalize on these
factors by providing  sophisticated mortgage reinsurance products in addition to
the quota share reinsurance products historically offered. Moreover, the Company
has begun to develop new  reinsurance  products  specifically  for  lender-owned
captives  that will enable such captives to have greater  financial  flexibility
while providing risk management and other financial benefits.

Rating agencies currently impose more stringent  requirements on risk-to-capital
ratios for mortgage  guaranty insurers than the 25:1 ratio imposed by applicable
law. Generally, S&P and Moody's require that AA rated mortgage guaranty insurers
operate  at a  risk-to-capital  ratio of less  than  20:1.  The  maintenance  or
improvement of high quality (AA or better)  financial  strength ratings directly
influences  an  insurer's  ability to  compete in the market and access  capital
resources to support its book of business.  One new product  offered by mortgage
insurers,  known as GSE pool insurance, is extremely capital consumptive and, in
an  effort to  operate  at a ratio  below  20:1,  some  mortgage  insurers  have
approached the third-party  reinsurance market. The Company has begun to develop
sophisticated

                                       9
<PAGE>


reinsurance  products designed to provide capital relief and solve rating agency
concerns arising from the GSE pool insurance product.

(b)  Trade Credit Reinsurance Market-

Trade credit  insurance  protects sellers of goods and services from the risk of
non-payment  of trade  receivables  and is a large,  well-established  specialty
insurance product,  particularly in Western Europe.  Policyholders are generally
covered for  short-term  exposures  (generally  less than 180 days and averaging
60-90 days) to insolvency or payment defaults by domestic and/or foreign buyers.
Some export credit policies also cover political events which can disrupt either
the flow of goods and  services  or payment for goods and  services.  Specialist
underwriters  dominate the market,  using sophisticated  information  management
systems  to  provide  rapid  approval  of  policy  requests  while   maintaining
underwriting  controls.  Trade credit  insurance  relies on credit  analysis and
portfolio  diversification  techniques  similar to those  employed in  financial
guaranty and mortgage  guaranty  insurance.  Results are heavily  dependent upon
macroeconomic  conditions,  with  typical loss ratios of 30-50%  during  healthy
economies and rising to 80-100% during recessions.

The  trade  credit  reinsurance  market  is  led  by  traditional  international
multiline reinsurers,  principally Munich Re and Swiss Re, who have been able to
maintain  their  dominant  market  position  in  part  through  their  ownership
interests in many of the leading primary companies. Capital Credit has attempted
to  identify  areas of  opportunity  where its  specialty  focus  provides  some
advantage  over  the  traditional   players.   Revenue  targets  have  been  set
conservatively with the intention of selectively  choosing  participations.  The
product mix combines quota share and structured excess  participations  that are
geared to produce results that outperform the overall credit insurance market.

Although trade credit reinsurance represents the bulk of its portfolio,  Capital
Credit has written  reinsurance in several related  specialty  areas,  including
international  bonding and political  risk  reinsurance.  Capital  Credit ceased
writing specialty reinsurance in early 1999.

(c)  Title Reinsurance Market-

Title  insurance is currently  written by seven  national and dozens of regional
companies  throughout the United States, all of which are required by statute to
be monoline insurers.  Title insurance  essentially provides the acquirer or the
mortgagee of real  property  with two forms of coverage.  The first assures that
the search and examination of the real estate records upon which the acquirer or
mortgagee  is  relying  for good and clean  title  was  properly  performed.  In
insuring  that a  process  was in fact  properly  done and  recorded,  the title
insurer is providing risk  exclusion.  The second form of coverage  assures that
all previously  existing  mortgages and liens will be paid off from the proceeds
of the sale or  refinancing  of the  property.  In  insuring  that the  existing
mortgages  and liens are  extinguished,  the title  insurer  is  providing  risk
assumption.

Capital  Title  was  formed to take  advantage  of the  strategic  opportunities
presented by the recent trends in the title insurance  business discussed above.
Specifically,  reinsurance  needs are becoming more complex as primary  insurers
strive  to react  to the  trends  detailed  above  by  diversifying  reinsurance
recoverable  risk,  optimizing  financial  results and maintaining  high quality
claims-paying ability or financial strength ratings. Risk syndication and access
to larger,  independent  pools of capital to support  ever  increasing  industry
exposure  is an  important  issue as the  industry  begins to compete in a rated
environment.  To address  the  concerns  of rating  agencies  and the  resulting
capital adequacy and  profitability  issues,  title insurers are adjusting their
business practices,  especially with regard to commercial  transactions.  Rating
agencies,  lenders, and regulators are increasingly  concerned with the level of
risk being  taken by  insurers  on large  commercial  transactions.  Single-risk
limits on the order of 20% to 30% of  policyholders  surplus have been,  and are
likely  to  continue  to be,  imposed  on  insurers.  Accordingly,  third  party
reinsurance,  such as that  provided  by Capital  Title,  to build  single  risk
capacity and as an overall capital substitute, has become important.

                                       10
<PAGE>


Capital Title applies its financial,  reinsurance,  rating agency,  underwriting
and legal expertise to provide reinsurance  solutions tailored to the particular
rating agency,  financial,  regulatory and risk management needs of each primary
title insurer.  Capital Title represents an independent source of capacity in an
industry  which  has  historically  relied  on a closed  system  of  reinsurance
capacity  provided by the  industry's  primary  insurers.  Capital  Title offers
several  specific  products to the title  insurance  industry,  all of which are
derived  from two  basic  reinsurance  product  types,  excess of loss and quota
share.



                                       11
<PAGE>


B.   BUSINESS OF CAPITAL RE:

(1)  Insurance in Force -

The  information  below  is  presented  on  a  consolidated  basis  for  Capital
Reinsurance,  Capital  Mortgage,  KRE, Capital Credit and Capital Title,  unless
expressly indicated  otherwise.  The information includes estimates derived from
the accounting and statistical records of Capital Reinsurance, Capital Mortgage,
KRE,  Capital Credit and Capital Title.  The Company did not write any financial
solutions business prior to 1997;  accordingly,  no information  relating to the
financial  solutions line is presented for 1996.  Capital  Reinsurance's  credit
default  swap income and  exposure is  included  as part of  financial  guaranty
premium and exposure.  The table below sets forth gross and net premiums written
and net premiums earned by line of business.

                          Premiums by Line of Business

                             (dollars in thousands)

                                                  Year Ended December 31,
                                            ====================================
                                             1998           1997         1996
================================================================================
Gross Premiums Written:
--------------------------------------------------------------------------------
Financial Guaranty Division:
--------------------------------------------------------------------------------
     Municipal                               $55,280       $52,778       $48,411
--------------------------------------------------------------------------------
     Non-Municipal                            39,872        16,674        10,902
--------------------------------------------------------------------------------
Financial Risks Division:
--------------------------------------------------------------------------------
     Mortgage                                 66,802        70,752        53,683
--------------------------------------------------------------------------------
     Credit                                   35,298        23,025        15,070
--------------------------------------------------------------------------------
     Title                                     5,713         4,024         1,752
--------------------------------------------------------------------------------
     Financial Solutions                      10,976         2,689             0
--------------------------------------------------------------------------------
Total Gross Premiums Written                $213,941      $169,942      $129,818
================================================================================

================================================================================
Net Premiums Written:
--------------------------------------------------------------------------------
Financial Guaranty Division:
--------------------------------------------------------------------------------
     Municipal                               $52,269       $50,157       $36,707
--------------------------------------------------------------------------------
     Non-Municipal                            39,772        16,599        10,902
--------------------------------------------------------------------------------
Financial Risks Division:
--------------------------------------------------------------------------------
     Mortgage                                 66,725        70,480        40,936
--------------------------------------------------------------------------------
     Credit                                   35,142        22,955        14,891
--------------------------------------------------------------------------------
     Title                                     5,713         4,024         1,752
--------------------------------------------------------------------------------
     Financial Solutions                      10,976            60             0
--------------------------------------------------------------------------------
Total Net Premiums Written                  $210,593      $164,275      $105,188
================================================================================

================================================================================
Net Premiums Earned:
--------------------------------------------------------------------------------
Financial Guaranty Division:
--------------------------------------------------------------------------------
     Municipal                               $42,956       $29,748       $27,540
--------------------------------------------------------------------------------
     Non-Municipal                            20,705        11,402         7,199
--------------------------------------------------------------------------------
Financial Risks Division:
--------------------------------------------------------------------------------
     Mortgage                                 59,347        53,246        43,882
--------------------------------------------------------------------------------
     Credit                                   28,688        17,207        12,239
--------------------------------------------------------------------------------
     Title                                     5,713         3,628         1,576
--------------------------------------------------------------------------------
     Financial Solutions                      10,976            60             0
--------------------------------------------------------------------------------
Total Net Premiums Earned                   $168,385      $115,291       $92,436
================================================================================


                                       12
<PAGE>


     The following charts set forth certain information regarding gross premiums
written on insurance  ceded to the Company by its largest ceding company clients
in each material line of business in 1998, 1997, and 1996.

          Gross Premiums Written by Primary Financial Guaranty Insurer
                             (dollars in thousands)

                                   Year Ended December 31,
                  ==============================================================
                    1998                     1997                    1996
================================================================================
Primary      Gross       Percent      Gross       Percent       Gross    Percent
Insurer     Premiums     of Total    Premiums    of Total     Premiums  of Total
            Written      Written     Written                  Written
--------------------------------------------------------------------------------
AMBAC        $9,458        10%        $4,797         7%         $8,766       15%
--------------------------------------------------------------------------------
CGA          12,763        13            108         0               0        0%
--------------------------------------------------------------------------------
FGIC          4,683         5         15,559        22          15,388       26
--------------------------------------------------------------------------------
FSA          25,567        27         19,518        28           8,590       14
--------------------------------------------------------------------------------
MBIA(1)      33,538        35         28,063        40          25,681       43
--------------------------------------------------------------------------------
Other         9,143        10          1,047         2             888        1
--------------------------------------------------------------------------------

================================================================================
Total       $95,152       100        $69,452       100%        $59,313      100%
================================================================================
(1) 1996 and 1997 premiums for MBIA include  business  ceded by Capital  Markets
Assurance Company, which was acquired by MBIA in 1998.

           Gross Premiums Written by Primary Mortgage Guaranty Insurer
                             (dollars in thousands)

                                   Year Ended December 31,
                  ==============================================================
                          1998                  1997                1996
================================================================================
Primary              Gross     Percent    Gross    Percent    Gross      Percent
Insurer             Premiums  of Total   Premiums of Total   Premiums   of Total
                     Written              Written            Written
--------------------------------------------------------------------------------
PMI                  13,427     20%      $15,176     21%      $13,897        26%
--------------------------------------------------------------------------------
CMAC                 31,217     47        26,879     38        20,553        38
--------------------------------------------------------------------------------
GEMICO                8,829     13         9,908     14         7,686        14
--------------------------------------------------------------------------------
Commercial              952      1         4,173      6         4,490         8
General Union
--------------------------------------------------------------------------------
Other                12,377     19        14,616     21         7,057        14
--------------------------------------------------------------------------------

================================================================================
Total               $66,802    100%      $70,752    100%      $53,683       100%
================================================================================




                                       13
<PAGE>

                 Gross Premiums Written by Primary Title Insurer
                             (dollars in thousands)

                                       Year Ended December 31,
                  ==============================================================
                         1998                 1997                  1996
================================================================================
Primary           Gross      Percent     Gross     Percent    Gross      Percent
Insurer          Premiums   of Total    Premiums  of Total   Premiums   of Total
                 Written                Written              Written
--------------------------------------------------------------------------------
Commonwealth      $1,536       27%       $1,243       31%        $536        31%
--------------------------------------------------------------------------------
United General     2,503       44         1,600       40        1,061        61
--------------------------------------------------------------------------------
Other              1,674       29         1,181       29          155         8
--------------------------------------------------------------------------------

================================================================================
Total             $5,713      100%       $4,024      100%      $1,752      100%
================================================================================


                Gross Premiums Written by Primary Credit Insurer
                             (dollars in thousands)

                                      Year Ended December 31,
                  ==============================================================
                           1998                1997                1996
================================================================================
Primary               Gross    Percent   Gross     Percent   Gross       Percent
Insurer             Premiums  of Total  Premiums  of Total  Premiums    of Total
                     Written            Written             Written
--------------------------------------------------------------------------------
AIU                  $8,697      25%      $5,903      23%      $4,176       28%
--------------------------------------------------------------------------------
HERMES                2,775       8        2,989      12        3,513        23
--------------------------------------------------------------------------------
HSB                   4,663      13          120       0            0         0
--------------------------------------------------------------------------------
NCM                   4,557      13        4,358      17        3,838        25
--------------------------------------------------------------------------------
Trade Indemnity       2,327       7        2,667      10          501         3
--------------------------------------------------------------------------------
Other                12,279      35        6,988      38        3,042        20
--------------------------------------------------------------------------------

================================================================================
Total                35,298     100%     $23,025     100      $15,070       100
================================================================================


The  following  table sets  forth the  Company's  gross  premiums  written,  net
premiums  written and net premiums  earned  relating to its  reinsured  U.S. and
non-U.S.  risks for each of the three years ended  December 31,  1998,  1997 and
1996.



                                       14
<PAGE>

                  U.S. and Non-U.S. Premiums Written and Earned
                             (dollars in thousands)

                                                                U.S.%  Non-U.S.%
                                  U.S.     Non-U.S.    Total    Total   Total
================================================================================
Year Ended December 31, 1998
--------------------------------------------------------------------------------
Gross Premiums Written          $169,620    $43,321   $213,941   79.3%     20.7%
--------------------------------------------------------------------------------
Net Premiums Written             166,420     44,174    210,594   79.0      21.0
--------------------------------------------------------------------------------
Net Premiums Earned              135,395     33,005    168,400   80.4      19.6
================================================================================

================================================================================
Year Ended December 31, 1997
--------------------------------------------------------------------------------
Gross Premiums Written          $130,396    $39,561   $169,957   76.7%     23.3%
--------------------------------------------------------------------------------
Net Premiums Written             125,016     39,273    164,289   76.1      23.9
--------------------------------------------------------------------------------
Net Premiums Earned               93,770     21,535    115,305   81.3      18.7
================================================================================

================================================================================
Year Ended December 31, 1996
--------------------------------------------------------------------------------
Gross Premiums Written          $104,605    $25,214   $129,818   80.6%     19.4%
--------------------------------------------------------------------------------
Net Premiums Written              80,298     24,890    105,188   76.3      23.7
--------------------------------------------------------------------------------
Net Premiums Earned               76,803     15,634     92,437   83.1      16.9
================================================================================


(2)  Detail on Financial Guaranty Insurance in Force -

The following table shows the Company's ten largest municipal financial guaranty
single risk exposures by consolidated  net par in force as of December 31, 1998.
Collectively, these ten exposures accounted for 13.21% (consolidated net par) of
the Company's reinsured financial guaranty portfolio.

         Ten Largest Municipal Financial Guaranty Single Risk Exposures
                                Net Par in Force
                             (dollars in thousands)
--------------------------------------------------------------------------------
                                  Credit (1)             As of December 31, 1998
--------------------------------------------------------------------------------
California General Obligation Bonds                              $993,505
-------------------------------------------------------------------------
Massachusetts State GO & Bay Transportation Bonds                 919,338
-------------------------------------------------------------------------
New York City General Obligation Bonds                            910,339
-------------------------------------------------------------------------
New Jersey Transportation Trust Fund Authority                    862,191
-------------------------------------------------------------------------
Washington Public Power Supply System                             681,683
-------------------------------------------------------------------------
Long Island Power                                                 679,236
-------------------------------------------------------------------------
Los Angeles County California Metro Transportation                668,644
-------------------------------------------------------------------------
New York City Municipal Water Finance Authority                   661,353
-------------------------------------------------------------------------
New York State General Obligation Bonds                           604,942
-------------------------------------------------------------------------
Denver Colorado Airport System Revenue Bonds                      560,163
-------------------------------------------------------------------------

(1)  All  subject  to non  proportional  Excess of Loss  ("EOL")  retrocessional
     program  and/or Annual Debt Service  ("ADS")  retrocessional  program.  See
     "Business  of  Capital   Re--Retrocessional   Arrangements,   Soft  Capital
     Facilities and Intercompany Capital Supports."



                                       15
<PAGE>


The  following  table shows the Company's  ten largest  non-municipal  financial
guaranty exposures by consolidated net par in force as of December 31, 1998. The
top nine exposures are asset backed securities, each of which may represent risk
to one or more asset  securitizations.  In  addition,  asset  backed  securities
serviced  by a single  seller/servicer  have been  listed as a single  exposure,
regardless  of whether such  securities  belong to the same or  different  asset
classes. Collectively, these ten exposures accounted for 6.87% (consolidated net
par) of the Company's reinsured financial guaranty portfolio.

             Ten Largest Non-Municipal Financial Guaranty Exposures
                                Net Par in Force
                             (dollars in thousands)
--------------------------------------------------------------------------------
                                                                   Net Par
Seller/Servicer or Issuer,            Asset Class/Credit        in Force as of
    as applicable                                              December 31, 1998
--------------------------------------------------------------------------------
The Money Store                   Residential Mortgages/Automobile   $680,509
                                  Loans
--------------------------------------------------------------------------------
Arcadia Financial Ltd.            Automobile Loans                   593,531
--------------------------------------------------------------------------------
Takefuji Corporation              Consumer Receivables               401,000
--------------------------------------------------------------------------------
United Companies Financial
 Corporation                      Residential Mortgages              399,471(1)
--------------------------------------------------------------------------------
ContiMortgage                     Residential Mortgages              399,341
--------------------------------------------------------------------------------
IMC Mortgage                      Residential Mortgages              321,075
--------------------------------------------------------------------------------
Commerzbank                       Collateralized Loan Obligations    300,000
--------------------------------------------------------------------------------
Chevy Chase Bank                  Residential Mortgages/Automobile   287,304
                                  Loans
--------------------------------------------------------------------------------
Advanta                           Residential Mortgages/Automobile   270,664
                                  Loans
--------------------------------------------------------------------------------
Government Development Bank for   Bank                               267,000
Puerto Rico(2)
--------------------------------------------------------------------------------

(1) Of this  amount,  $276  million in net par is reinsured on an excess of loss
basis.

(2) Pursuant to this  transaction,  the Company has  guaranteed a triple-A rated
financial  guaranty  insurer's  financial  guaranty  obligations with respect to
certain bonds issued by the  Government  Development  Bank for Puerto Rico.  The
execution for this transaction is a credit default swap.

Although the Company generally does not write financial guaranty  reinsurance on
obligations  that are  non-investment  grade at the time  reinsured,  the credit
ratings of certain  obligations  may be reduced after the date such  obligations
are  reinsured.  The  Company  monitors  its  exposure to  non-investment  grade
obligations  and in this regard  relies in part on  information  provided by its
ceding  companies,   particularly  with  respect  to  certain  municipal  treaty
business.  The Company is familiar on an ongoing basis with the criteria used by
S&P and Moody's  for  determining  the  investment  grade  status of the various
credit  sectors  reinsured by the Company.  These  criteria are specific to, and
vary  considerably  depending  on,  the  line of  business  and  type of  credit
reinsured. In certain cases, the Company and/or its cedants may obtain access to
information  on  individual  credits  indicating  that  those  credits no longer
conform to the rating  agencies'  investment  grade  criteria,  even through the
rating  agencies may not have yet  reviewed  those  credits to  determine  their
investment  grade  status.  In such cases,  the  Company  and/or its cedants may
determine that certain  individual  credits are below  investment grade quality.
Based upon these procedures,  the Company believes that  approximately  1.25% of
the  reinsured  financial  guaranty  portfolio  (based  on net par  amount),  or
approximately $0.7 million, was rated below investment grade (i.e., not rated at
least BBB- or Baa3 by either S&P or Moody's, or, if not rated,  determined to be
below  investment  grade in the opinion of the ceding company or the Company) at
December  31,  1998.  The  following  table  sets  forth  the   distribution  of
consolidated net book of business by rating as of December 31, 1998.


                                       16
<PAGE>

  [THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.]

      Distribution of Financial Guaranty Net Book of Business by Rating(1)
                             As of December 31, 1998
                             (dollars in thousands)

                    NIG                               1.2%

                    AAA                               9.9%

                    BBB                              18.2%

                    AA                               19.4%

                    A                                51.3%

Capital  Reinsurance  has  developed  several  non-proportional   retrocessional
programs  which  supplement  its financial  guaranty  single risk capacity for a
number of selected large volume issuers of municipal bonds. In some cases, these
arrangements  are effected on an excess of loss basis and involve the  retention
by  Capital  Reinsurance  of a first  loss  exposure  (liability  for all losses
related  to a  particular  risk  up to a  stated  dollar  amount).  Under  these
arrangements,  Capital  Reinsurance's  potential  annual payment  liability (the
annual amount of claims payments which Capital  Reinsurance is obligated to pay)
related to an issue default during the period of such first loss exposure may be
several times Capital  Reinsurance's net average annual debt service exposure to
such reinsured issue.


_____________________________________
(1) Non-rated  securities are allocated among  investment  grade securities on a
pro rata basis.


                                       17
<PAGE>


The financial guaranty reinsured portfolio of the Company contained exposures in
each of the fifty  states,  the  District of  Columbia,  Puerto Rico and several
foreign   countries.   The  following  table  sets  forth  the  distribution  of
consolidated net book of business by state as of December 31, 1998.


  [THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.]

        Distribution of Financial Guaranty Net Book of Business by State
                             As of December 31, 1998
                             (dollars in thousands)
                               Total: $57,093,361

                  State                       Distribution
                  -----                       ------------

               Washington                         2.45%

               Ohio                               2.51%

               Puerto Rico                        2.73%

               Mass.                              3.20%

               Ill.                               3.31%

               N.J.                               3.52%

               Penn.                              3.92%

               Florida                            5.16%

               Texas                              5.16%

               New York                           9.72%

               California                        10.74%

               Others                            47.57%

(3)  Exposure under Credit Default Swaps -

As of December 31, 1998, the Company had  approximately  $6.8 billion of nominal
exposure as a counterparty to credit default swap  agreements.  This exposure is
included in the  information  provided in "Business of Capital Re - Insurance In
Force."

(4)  Marketing -

The  majority of the  Company's  business is derived from  relationships  it has
established  and  maintains  with the major  U.S.  primary  financial  guaranty,
mortgage guaranty and title insurers. European trade credit insurers, U.S. title
insurers,  United Kingdom  mortgage  guaranty  insurers and Australian  mortgage
guaranty insurers also provide a significant  portion of the Company's business.
These  relationships  provide business  opportunities  for the Company on both a
treaty and facultative basis.

The Company's  international  retrocessional  relationships  enable it to access
international  sources of reinsurance.  These  relationships  link the Company's
technical   expertise  in  financial  guaranty  and  related   reinsurance  risk
underwriting  with the market  knowledge  and capital  strength of the Company's
international  retrocessionaires.  See "Business of Capital Re -- Retrocessional
Arrangements, Soft Capital Facilities and Intercompany Capital Supports."

For the year ended December 31, 1998,  intermediaries  and brokers had accounted
for 27.3% of U.S.  gross premiums  written and 77.3% of non-U.S.  gross premiums
written.  The  Company's  relationships  with  these  brokers  do not

                                       18
<PAGE>


commit or  obligate  the  Company  to accept  business  submitted  by them.  All
applications  for reinsurance  from both new and existing  ceding  companies are
subject to review and acceptance by the Company in accordance with the Company's
underwriting  guidelines.  Brokers  are  compensated  based on a  percentage  of
premium,  which varies from  transaction to transaction.  Certain U.S.  domestic
mortgage   guaranty,   non-municipal   and  other   special   risk   reinsurance
opportunities may also be produced by reinsurance intermediaries and brokers.

Capital  Mortgage and KRE derive their mortgage  guaranty  reinsurance  business
principally   through  direct   relationships  with  primary  mortgage  guaranty
insurance  companies.   Reinsurance  intermediaries  and  brokers  are  used  in
accessing reinsurance  opportunities in the United Kingdom and the international
market.  Capital Credit has developed credit reinsurance business  opportunities
principally through  reinsurance  brokers and intermediaries.  Capital Title has
developed  substantially  all  of  its  business  opportunities  through  direct
contacts with primary title insurers.  The financial  solutions line of business
has developed its opportunities through both direct contact with life and health
and property-casualty insurers and through reinsurance intermediaries.

(5)  Underwriting Guidelines, Policies and Procedures -

(a)  Financial Guaranty Reinsurance -

The underwriting process for the Company's financial guaranty insurance business
is premised on the Company's policy of reinsuring  investment grade obligations.
Capital Reinsurance  underwrites risks on a "zero loss" basis, meaning that each
reinsured policy  obligation has been evaluated by Capital  Reinsurance  under a
standard  of no loss  expectation.  However,  losses  in  Capital  Reinsurance's
reinsured portfolio can be expected to occur, and there can be no assurance that
these losses will not have a material adverse effect on financial  condition and
results of  operations.  See "Business of Capital  Re--Losses  and Reserves." In
addition, Capital Reinsurance's ongoing review of its portfolio does not involve
any commitment by rating  agencies or ceding  companies to provide credit rating
information on each assumed obligation.

Capital  Reinsurance  has organized its  underwriting  procedures to provide for
multiple levels of credit review and analysis.  Facultative  submissions,  which
form the majority of Capital Reinsurance's  business,  are initially reviewed by
one of  Capital  Reinsurance's  underwriting  analysts  who  performs a detailed
evaluation  of each  individual  submission  to assure  compliance  with Capital
Reinsurance's underwriting guidelines and rating agency and regulatory criteria.
The  analyst's  recommendation  is  presented  to one of  Capital  Reinsurance's
Underwriting  Committees for  consideration.  There are separate  committees for
municipal,  non-municipal and non-U.S.  financial  guaranty risks. The Company's
Chief  Underwriting  Officer  must  approve  the  decision  of the  Underwriting
Committee  before  the risk is  written  by  Capital  Reinsurance.  The Board of
Directors  of the  Company  also  reviews  underwriting  policy  and trends on a
quarterly basis.

Capital  Reinsurance has established treaty reinsurance  relationships with most
of the U.S. primary financial guaranty insurance companies. Ceding insurers must
be financially  strong.  Generally,  each ceding company must also adhere to the
underwriting  standard of no loss expectation on financial  guaranty  insurance.
Prior to initiating any treaty relationship,  and on an annual basis thereafter,
Capital Reinsurance conducts a review of the ceding company. Capital Reinsurance
evaluates  the ceding  company's  capital  position,  in-force book of business,
reserves, cash flow,  profitability and financial strength. The ceding company's
underwriting process is analyzed to determine compliance with established credit
guidelines  and legal  documentation  requirements.  Management  of each  ceding
company is reviewed in the areas of credit control,  monitoring and surveillance
practices,   claims  administration  and  remedial  management.   After  Capital
Reinsurance  completes  its ceding  company  review,  a report is  prepared  and
presented  to  Capital   Reinsurance's   senior   management.   All  new  treaty
relationships must be approved by the appropriate Underwriting Committee and the
Chief Underwriting Officer before the treaty is accepted by Capital Reinsurance.
Treaty results and  compliance are reviewed by Capital  Reinsurance on quarterly
and annual bases.

                                       19
<PAGE>


Capital  Reinsurance also conducts its own due diligence and credit surveillance
of underlying  credits in accordance  with  internally  developed and maintained
standards.  Capital  Reinsurance's Chief Underwriting Officer formulates Capital
Reinsurance's underwriting policy and is responsible for its administration. The
Board  of   Directors  of  Capital   Reinsurance   regularly   reviews   Capital
Reinsurance's underwriting policy.

The underwriting staff is also responsible for the ongoing monitoring and review
of ceding  company  underwriting  practices  and financial  results.  The annual
underwriting  reviews of the ceding companies  described above measure adherence
to the ceding company's own underwriting  standards and monitor the relationship
of pricing to risk on  business  being  reinsured  by Capital  Reinsurance.  The
reviews  are also used to monitor  pricing by product  line,  bond type and risk
classification  in  an  effort  to  allocate  capital  effectively  to  specific
portfolios and product areas that are considered to have a greater potential for
profitability.

Capital  Reinsurance's  ongoing credit management of its reinsured  portfolio is
overseen by the Chief  Underwriting  Officer  and the  underwriting  staff.  The
underwriting   analysts   recommend   appropriate   bond   and   credit   sector
representations and distributions.  Capital  Reinsurance's  single and aggregate
risk  underwriting  policies,  while complying with regulatory and rating agency
requirements,   reflect  Capital  Reinsurance's  capital  resources,   liquidity
capabilities and retrocessional programs. Portfolio diversification is monitored
regularly to improve the balance of  geographic  distribution,  credit  quality,
bond type and maturity.

(b)  Mortgage Guaranty Reinsurance -

Unlike  the  "zero  loss"  standard  applied  in  financial  guaranty  insurance
underwriting,  mortgage guaranty  insurance is underwritten with the expectation
of  loss.  Under  normal  economic  conditions  and in a  stable  interest  rate
environment,  loss ratios in this line of business  are  generally in the 15% to
40% range and are associated  with  frictional  unemployment,  divorce and other
social factors.  By avoiding  geographic  concentrations  and employing  prudent
underwriting, mortgage insurers are better able to manage their risk.

Capital Mortgage has established underwriting standards,  procedures and closely
monitored controls. A senior Mortgage Underwriting Committee, comprised of three
voting  members,  including the Chief  Underwriting  Officer,  must approve each
underwriting   submission.   Submissions  are  made  through  preparation  of  a
comprehensive  underwriting report, which is derived from (i) extensive meetings
with  senior  management  and staff of the ceding  company,  (ii)  underwriting,
actuarial  and financial  analysis of detailed  information  including  historic
mortgage performance,  portfolio composition,  origination  procedures,  quality
control, loss mitigation and claims management,  and (iii) reinsurance structure
and profitability analysis.

Generally,  ceding  companies  must  demonstrate  their  capability  to  monitor
economic trends in markets in which they are providing insurance and to exercise
underwriting discipline.  Capital Mortgage seeks to identify insurers having the
capability to prospectively  analyze economic trends in various markets based on
local and regional market factors,  political  developments  and global resource
factors,  such as energy  prices.  The ceding  company is  required  to maintain
analytical personnel dedicated to reviewing trends in local residential property
markets.  Capital  Mortgage  closely  examines  analytical  methods by which the
ceding company follows  pricing  adequacy and loss  development  patterns of its
insurance  in force.  Ceding  company  loss  mitigation  and  claims  management
procedures are evaluated and analyzed.  The ceding  company must  demonstrate an
adequate  investigative  capability,  engaging in a  systematic  review of early
payment defaults to detect fraud or potential defects in underwriting systems.

Capital  Mortgage's  underwriting  staff  reviews all  reinsurance  in force and
recommends portfolio balancing targets (e.g., amount of risk in force by region,
underwriting  year,  ceding company,  loan type).  On-site reviews of all ceding
companies are conducted on at least an annual  basis,  encompassing  a review of
overall company organization,  financial performance,  developments in sales and
marketing,  underwriting  systems and operations,  actuarial services and claims
management.  Underwriting  department analysts are charged with following rating
agency  reviews

                                       20
<PAGE>


and industry developments,  including a detailed review of semi-annual portfolio
reports submitted by each ceding company to the rating agencies.

(c)  Trade Credit Reinsurance -

Credit  sales expose the seller to numerous  risks  ranging from the ability and
willingness of the buyer to make payments according to agreed terms to political
events which could  disrupt the  relationship  between the seller and the buyer.
Credit  insurance is available in a variety of forms,  and in varying degrees of
comprehensiveness,  to cover  many of the  potential  risks  encountered  by the
seller of goods and  services.  There are two  broad  areas of risk  assumed  in
credit insurance and,  consequently,  reinsurance:  commercial risks,  including
bankruptcy  of the buyer and  political  risks,  which  can  interfere  with the
fulfillment of an otherwise valid contract. Credit insurance underwriters manage
risk by modifying the terms of coverage,  by  diversifying  exposures to control
aggregations of risks to particular buyers,  industries, or territories,  and by
developing sophisticated databases of credit and political information. Up until
early 1999, the Company also wrote a limited  portfolio of other specialty lines
related to trade credit reinsurance.  All risks reinsured by the Company must be
approved  by  an  International   Underwriting   Committee  composed  of  senior
underwriting  staff,  including  the Chief  Underwriting  Officer.  The  Company
performs  extensive  diligence of prospective ceding companies to identify those
expected to produce superior  underwriting  results,  structures its reinsurance
participation to eliminate unacceptable risks and actively monitors exposures to
identify  any  deterioration  in risk  profile  and control  aggregation  across
participations.

(d)  Title Reinsurance -

Similar to the "zero loss"  standard  applied in  financial  guaranty  insurance
underwriting,  title reinsurance is underwritten  without the expectation of any
significant  loss.  Capital Title's  underwriting  decisions are, in major part,
based on the  underwriting  audits  of its  ceding  companies,  focusing  on (i)
underwriting policies,  guidelines and procedures and the experience and quality
of underwriting  personnel,  including knowledge of localized issues and quality
control,  (ii)  financial  performance  and  stability,   reserve  adequacy  and
liquidity,  (iii) claims  handling  procedures and personnel and loss management
techniques and  procedures,  with  particular  emphasis on salvage,  (iv) record
keeping and title plant to ensure that all are well  maintained  and up to date,
(v) agent and branch  office review  procedures,  and (vi) trust fund and escrow
account  procedures.  Preference  is  given  to those  companies  whose  overall
policies,  procedures  and  personnel  exhibit a strong  commitment  to  quality
underwriting and loss management.

Capital Title  automatically  accepts for  reinsurance  all policies  which fall
within the parameters of its various treaties.  However,  policies which contain
certain  enumerated types of extraordinary  risks will have to be submitted on a
special  acceptance  basis  and  separately   underwritten  by  Capital  Title's
underwriting  staff.  Such  extraordinary  risks may include  insured  interests
created by, under or concerning  bankruptcy or state insolvency laws, federal or
state securities laws, mineral  interests,  Indian lands, wet lands, tide lands,
and mechanic's lien issues.

In designing and  recommending  various excess of loss  reinsurance  strategies,
Capital  Title  pays  particular   attention  to  each  ceding   company's  loss
experience,  including  frequency,  severity and type of loss, at various policy
sizes and levels of business.  In conjunction  therewith,  salvage practices and
procedures are considered.

Capital Title is also called upon to provide facultative reinsurance capacity to
the industry,  particularly on larger  commercial  transactions  and securitized
pools of real estate.  Capital Title maintains an underwriting staff experienced
in handling these types of transactions  and familiar with the particular  risks
attendant thereto.

(e)  Financial Solutions -

The underwriting process used in the financial solutions line places significant
emphasis on actuarial  analysis.  Transactions are either underwritten on a risk
remote  basis  or are  subject  to an  aggregate  limit  of  liability  for  the
reinsurer,  standards  that  are  compatible  with  the  Company's  "zero  loss"
financial guaranty  underwriting  standard.

                                       21
<PAGE>


Moreover,  many  financial  solutions  transactions  provide  for the payment of
additional  premium to the reinsurer in the event of poor loss experience on the
reinsured  business and for the payment of a profit  commission to the reinsured
in the event of favorable  loss  experience.  Losses can be expected to occur in
the Company's existing and future financial solutions portfolio.

(6)  Retrocessional  Arrangements,  Soft  Capital  Facilities  and  Intercompany
     Capital Supports -

The  Company's   business   strategy  places  emphasis  on  the  development  of
retrocessional  relationships  which  provide the Company with a higher level of
reinsurance  risk  capacity  and  serve  as  a  means  of  accessing  additional
reinsurance  opportunities.  The Company's  retrocessional  strategy  emphasizes
building single-risk  capacity and risk management.  The Company retroceded 1.6%
or $3.3 million of its gross premiums  written in 1998,  1.7% or $3.5 million of
its  gross  premiums  written  in 1997 and 19.0% or $24.6  million  of its gross
premiums written in 1996.

In 1992, Capital  Reinsurance  entered into a portfolio first loss and excess of
loss  reinsurance  agreement with Centre  Reinsurance  Company of New York, a AA
rated reinsurer. The agreement,  which covered the entire reinsured portfolio of
Capital  Reinsurance,  provided  protection against currently  unforeseen losses
which,  should  they occur,  would,  in the  absence of the  reinsurance  cover,
require a  significantly  greater  loss reserve in the year of  occurrence.  The
cover also provided  Capital  Reinsurance  with  catastrophic  loss  protection.
Capital  Credit  entered  into a similar  cover in 1992 with AXA Re Finance S.A.
Under these arrangements, as of December 31, 1998, Capital Reinsurance has ceded
$19.5 million in premium and Capital Credit has ceded $4.25 million in premium.

On January 31, 1994, Capital Reinsurance entered into an agreement with Deutsche
Bank AG for a credit  facility  of up to $75  million  specifically  designed to
provide rating agency  qualified  capital to further  support the  claims-paying
resources of Capital Reinsurance.  On March 22, 1999, the amount of the facility
was increased to $100 million. The agreement expires on January 27, 2006.

As part of its original capital  structure,  in 1994 Capital Mortgage  purchased
$30  million of  portfolio  excess of loss  reinsurance.  Additionally,  in 1994
Capital  Reinsurance  established  a  $100  million  portfolio  excess  of  loss
reinsurance arrangement.

The Company creates specialized retrocessional structures for establishing large
financial guaranty single risk capacity,  which the Company believes improve its
competitive  position with the primary financial  guaranty insurance market. The
Company believes that its ability to offer the primary financial guaranty market
reinsurance  capacity  for the largest  insurable  debt issues is a  significant
marketing   benefit,   which   allows  it  to  access   additional   reinsurance
opportunities.  The Company's retrocessional treaty programs are its EOL Program
and  ADS   Program.   The  EOL  Program  was  a   structured,   non-proportional
retrocessional  treaty which (i) produced  single risk  capacity for the largest
issuers   of   insurable    municipal   bonds,   (ii)   allowed    international
retrocessionaires  to  participate  at a variety of risk levels,  (iii) improved
transactional profitability for the Company and (iv) complied with the Company's
external risk  limitations.  The EOL Program was active through the end of 1991,
and  currently  no new  business  is being  ceded to it.  The ADS  Program  is a
proportional  treaty  covering  annual  payment  obligations  of the  Company on
certain of its large financial guaranty  exposures.The ADS Program was effective
as of January 1, 1992.

Capital  Credit acts as a captive  retrocessionaire  for Capital  Reinsurance in
connection with reinsurance opportunities that might otherwise be constrained in
the context of Capital Reinsurance's regulatory limitations. Capital Reinsurance
ceded to Capital  Credit $1.8 million,  $3.1 million and $0 million in premiums,
and $.3 billion, $.7 billion and $.8 billion in par amounts, for the years ended
December  31, 1998,  1997 and 1996,  respectively.  KRE provides  retrocessional
capacity to Capital  Reinsurance,  Capital Mortgage,  Capital Credit and Capital
Title.  Capital  Reinsurance  ceded to KRE $1.8  million,  $2.0 million and $1.1
million in premiums,  and $0 billion, $0 billion and $.3 billion in par amounts,
for the years ended December 31, 1998, 1997 and 1996, respectively.

                                       22
<PAGE>


Capital Credit and Capital Reinsurance have terminated, as of December 31, 1998,
on a cut-off  basis,  a  reinsurance  arrangement  whereby  Capital  Reinsurance
supported Capital Credit's business by providing $25 million in aggregate excess
coverage  to it. In  addition,  Capital  Credit  and  Capital  Reinsurance  have
terminated,  as of December 31, 1998, on a cut-off basis, an aggregate excess of
loss reinsurance agreement pursuant to which Capital Reinsurance covered 100% of
Capital  Credit's  losses on its trade credit and specialty  book in excess of a
40% loss ratio, up to a $3.5 million annual limit.  Capital Re supports  Capital
Credit's A+ rating via a $50 million guaranty of Capital Credit's liabilities.

Approximately $85 million of per policy coverage is provided to Capital Title by
KRE pursuant to a Per Policy Excess of Loss Retrocession  Agreement.  Under this
agreement,  KRE covers an amount of loss paid by Capital Title arising from each
of its policies equal to $90 million minus Capital  Title's  retention under the
agreement. Capital Title's retention under the agreement is equal to the greater
of: (i) $5 million, and (ii) 20% of Capital Title's policyholder's  surplus. $25
million of additional  coverage is provided by KRE to Capital Title  pursuant to
an Excess of Loss Retrocession Agreement. Under this agreement, KRE covers up to
$25 million of loss paid by Capital Title arising from its policies in excess of
the lesser of: (i) 100% of Capital  Title's  net  written  premium  and (ii) the
amount by which  Capital  Title's  statutory  capital  exceeds $25  million.  In
addition,  Capital  Reinsurance  and KRE are  parties  to a  Guaranty  Agreement
pursuant to which Capital  Reinsurance  has guaranteed all of KRE's  obligations
arising  under all  reinsurance  contracts  issued or  assumed  by KRE  covering
business other than business classified by KRE as mortgage guaranty reinsurance,
credit  reinsurance  and  financial  guaranty  reinsurance,  to the extent  such
obligations  are  associated  with the first $18 million of premium per calendar
year  written by KRE with  respect to such  business.  As of December  31, 1998,
Capital  Reinsurance  ceased to guaranty any KRE obligations  assumed after such
date other than treaty title obligations reinsured by KRE. On December 31, 1999,
the guaranty will  terminate in its entirety with regard to  obligations  of KRE
assumed after such date.  However,  KRE has purchased  $100 million of excess of
loss protection from ACE Bermuda Insurance, Ltd. with respect to its liabilities
under the Per Policy Excess of Loss Retrocession Agreement described above.

Capital Mortgage and KRE are parties to a Capital Support Agreement  pursuant to
which Capital Mortgage has agreed,  subject to certain limitations,  to maintain
the net worth of KRE at $15 million and KRE has agreed to maintain the net worth
of Capital Mortgage at $25 million.

(7)  Competition -

(a)  Financial Guaranty Reinsurance -

Capital   Reinsurance   competes  directly  with  one  U.S.  financial  guaranty
reinsurer,   Enhance   Reinsurance   Company,   and   indirectly   with  various
international  multiline  reinsurers  and  insurers.  Based upon the 1998 annual
statutory  statements  filed  by each of the  primary  U.S.  financial  guaranty
insurers,  the Company  believes that the Company and its  principal  competitor
assumed most of the  reinsurance  ceded by the primary U.S.  financial  guaranty
insurers in 1998.

U.S. multiline  insurance  companies generally do not provide reinsurance to the
financial  guaranty  insurance  industry.  Although  applicable  state insurance
regulations  have mandated a  specialized  form for the  transaction  of primary
financial guaranty insurance,  multiline insurers may participate as reinsurers.
However,  the Company believes,  based upon its own experience,  that almost all
U.S.  multiline  insurers have declined to participate in this market  primarily
because of their lack of the special expertise and underwriting skills necessary
for this line of reinsurance.

Numerous  non-U.S.   insurers  participate  in  financial  guaranty  reinsurance
treaties. Competition from international multiline reinsurance companies is best
understood  in the  context  of the  financial  guaranty  reinsurance  market in
general.  Cooperative channels of reinsurance capacity have developed throughout
the reinsurance market in order to spread financial guaranty risk across a broad
spectrum of insurers.  As a result,  international  companies  which may

                                       23
<PAGE>


compete  with  Capital   Reinsurance   are  frequently   Capital   Reinsurance's
retrocessionaires  and ceding  companies.  As the global  market  evolves,  this
interaction may become more pronounced.

Competition in the financial  guaranty  reinsurance  business is based upon many
factors,  including overall financial strength,  pricing, service and evaluation
of claims-paying  ability by the major rating agencies,  including S&P. S&P will
grant credit against a primary  company's  capital  requirements and single risk
limits for reinsurance  ceded,  provided the reinsurer  meets S&P  claims-paying
ability  standards.  The primary company  receives a 100% credit for reinsurance
ceded subject to the reinsurer's  maintenance of a AAA financial strength rating
from S&P. A 70% credit is assigned if the  reinsurer  is rated AA and 30% if the
reinsurer is rated A.

Capital Reinsurance also faces competition  indirectly from other triple-A rated
financial   institutions  which  provide  capital  substitutes  to  the  primary
financial guaranty insurance companies.  Several international  commercial banks
have developed  credit  facilities and letter of credit products that qualify as
rating agency  capital and therefore  provide  primary  insurers with  increased
insurance capacity for rating agency purposes. However, these banking facilities
cannot provide regulatory capital or credit against  liabilities.  Further,  the
current  lack of  substantial  triple-A  bank  credit  has  reduced  banks  as a
competitive force in the reinsurance  market.  Competition is also a function of
the ease with which primary  insurers can raise capital in the private or public
equity markets.  Increased  primary capital increases the ability of insurers to
retain risk and the need for  reinsurance in general is diminished.  The Company
believes that primary  insurers have recently  increased  their primary  capital
base and that  increased  competition  from foreign  insurers is occurring.  AXA
Group Cie., one of France's largest insurers,  established a subsidiary in 1995,
AXA Re Finance  S.A.,  in an effort to compete more  effectively  with  triple-A
rated U.S. financial guaranty  reinsurers.  In 1998, RAM Re, a Bermuda domiciled
financial guaranty reinsurance company,  commenced  operations.  RAM Re is rated
AAA by S&P and Aa3 by Moody's.  In addition,  several multiline  reinsurers have
begun assuming  certain forms of financial  guaranty  reinsurance  over the past
year.

(b)  Mortgage Guaranty Reinsurance -

Capital  Mortgage is not aware of any other U.S.  professional  reinsurer  which
specializes in mortgage guaranty reinsurance.  Several U.S. multiline reinsurers
offer capacity to the mortgage guaranty market but their  participation has been
limited. Substantially all of the external reinsurance capacity for the mortgage
guaranty  insurance  industry is provided by  European  multiline  insurers  and
reinsurers,  who offer  modest  amounts  of  traditional  reinsurance  products.
Capital Mortgage  believes that those reinsurance  providers  typically lack the
orientation and flexibility to address the current risk management,  capital and
financial problems of the mortgage guaranty insurance industry.

In recent years,  the primary mortgage  insurers have established  numerous risk
and  profit  sharing  mechanisms  with  lenders.  As a result of a ruling by the
Comptroller  of the  Currency  in  1997,  federal  banks  are now  permitted  to
establish operating subsidiaries,  known as lender-owned captives, to reinsure a
portion of the mortgage insurance issued on loans originated or purchased by the
bank or its lending  affiliates.  The growing use of lender-owned  captives that
assume risk from the primary mortgage  insurers has materially  altered mortgage
guaranty  insurance industry in that the primary insurers now cede a significant
percentage of premium to lender-owned  captives leaving less premiums  available
to purchase reinsurance from third parties.

Like financial guaranty reinsurance,  competition is also a function of the ease
with which  primary  insurers can raise  capital in the private or public equity
markets.  Increased  primary capital increases the ability of insurers to retain
risk and reduces the need for reinsurance in general.

(c)  Trade Credit Reinsurance -

The trade credit reinsurance market is led by traditional multiline insurers and
reinsurers, principally Munich Re and Swiss Re, which have been able to maintain
their dominant market position in part through their ownership interests in many
of the leading primary companies. In addition to the market leaders, there are a
large  number  of mainly

                                       24
<PAGE>


European  and  U.S.  reinsurers  that  compete  for  the  business.   Reciprocal
reinsurance  arrangements between primary companies are widespread,  thus adding
to the degree of competition in the industry.

(d)  Title Reinsurance -

Capital  Title is the only U.S.  professional  reinsurer  which  specializes  in
third-party title reinsurance.  To date, substantially all title reinsurance has
been  provided by the large  title  insurance  companies,  except for some minor
excess  coverage.  The  global  reinsurance  market  has not been  tapped to any
significant extent by title insurers.

(e)  Financial Solutions -

The financial solutions line of business is generally highly  competitive,  with
many life and health and property-casualty  reinsurers offering products similar
to, or in direct competition with, those offered by KRE and ACRE.  Nevertheless,
KRE and ACRE have focused (i) in certain  sub-markets having little or no direct
competition  and (ii) on  bespoke  transactions.  KRE and ACRE  typically  avoid
commodity-type products and "bidding" situations.

(8)  Ratings -

(a)  Financial Guaranty Reinsurance -

The  financial  strength of Capital  Reinsurance  is rated AAA by S&P and Aa2 by
Moody's. In addition,  Capital  Reinsurance's claims paying ability is rated AAA
by Fitch. Prior to March 10, 1999, the financial strength of Capital Reinsurance
had been rated Aaa by Moody's;  however,  on March 10, 1999,  Moody's downgraded
the  financial  strength  rating of Capital  Reinsurance  to Aa2. The  financial
strength  rating  of a  reinsurer  is  particularly  important  in the  area  of
financial  guaranty  reinsurance,  because  that  rating  affects  the amount of
capital credit the rating  agencies will allow to a ceding company in connection
with a cession to that  reinsurer.  S&P will permit a AAA rated  ceding  company
100% credit for a cession only if the reinsurer is also triple A rated.  Moody's
does not have  published  standards for  determining  the amount of credit a Aaa
rated ceding company will be permitted for a cession to an Aa2 rated  reinsurer;
however,  the  rating  of the  reinsurer  is an  important  element  in  Moody's
determination of the amount of permitted credit.

The ceding  commission  payable by Capital  Reinsurance under certain of Capital
Reinsurance's  reinsurance  agreements with two of its financial guaranty ceding
companies will increase as a result of the recent rating action by Moody's.  The
increase will apply to in-force and future  business  ceded by those  companies.
The financial  impact of the  increased  ceding  commission  with respect to the
in-force business at December 31, 1998 is not expected to exceed $2.0 million in
1999. Generally,  Capital Reinsurance's  reinsurance  agreements with its ceding
companies give the ceding  companies an option to reassume  business  previously
ceded to Capital Reinsurance upon certain adverse rating actions; however, those
options to fully reassume were not triggered by Capital Reinsurance's March 10th
downgrade.  Additionally,  one of the two ceding companies referred to above may
reassume a minor portion of its  previously  ceded  business based on the recent
rating  action  alone;  however,  that  company has not  indicated  that it will
exercise the option.  The Company does not believe that the recent  downgrade of
its financial  strength rating by Moody's will have a material adverse affect on
its long-term business prospects.

The major rating  agencies have  developed and published  rating  guidelines for
rating financial guaranty  reinsurers.  These criteria follow the standards used
to evaluate  the  financial  strength  of primary  monoline  financial  guaranty
insurers.  The financial  strength ratings assigned by S&P and Moody's are based
upon  factors  relevant  to  policyholders  and are  not  directed  towards  the
protection of investors in Capital Re. The financial  strength  rating  criteria
used by S&P and  Moody's  focus on the  following  factors:  capital  resources,
financial strength;  demonstrated management expertise in financial guaranty and
traditional  reinsurance,  credit  analysis,  systems  development,   marketing,
capital markets and investment operations;  and a minimum policyholders' surplus
comparable  to primary

                                       25
<PAGE>


company  requirements,  with capital sufficient to meet projected growth as well
as access to such  additional  capital as may be  necessary  to continue to meet
standards for capital adequacy.

S&P has published  standards as to capital charges and single risk categories to
which Capital  Reinsurance and other triple-A rated financial  guaranty insurers
and  reinsurers  must adhere in order to maintain their highest  ratings.  These
standards   weight   numerous   factors  to  types  of  obligations   which  are
significantly  more  complex  than an  insurance-in-force-to-capital  ratio.  In
addition,  capital adequacy is tested against an economic model that simulates a
growth period followed by an economic  depression  which assumes no new business
is written.

(b)  Mortgage Guaranty Reinsurance -

A  reinsurer's  financial  ability to pay claims is the standard of value to its
primary insurance market.  Certain national mortgage lenders and a large segment
of the mortgage  securitization  market,  including  Fannie Mae and Freddie Mac,
generally will not purchase mortgages or  mortgage-backed  securities unless the
private mortgage  insurance on such mortgages has been issued by an insurer with
a  financial  strength  rating  of at least  AA-  from S&P or at least  Aa3 from
Moody's or a  claims-paying  ability rating of at least AA-from Duff & Phelps or
Fitch. As a result,  each of the seven U.S. primary mortgage  guaranty  insurers
has a financial  strength  or  claims-paying  ability  rating of at least AA and
generally seeks similarly rated reinsurance security.

Capital Mortgage and KRE each have a AA financial  strength rating from S&P, and
KRE also has a AA+  claims-paying  ability  rating  from  Duff  and  Phelps.  On
December 16, 1998, the S&P ratings for both Capital Mortgage and KRE were placed
on "CreditWatch" with negative implications.  To The extent the S&P ratings were
downgraded  below the AA category,  the credit received by the ceding  companies
for the  reinsurance  provided by Capital  Mortgage and KRE would be  discounted
under S&P's capital adequacy models. In addition,  certain of Capital Mortgage's
and KRE's  reinsurance  contracts  provide that the ceding company may recapture
business  previously  ceded to the  reinsurer if the  reinsurer  fails to either
maintain  an S&P  rating of at least AA- or  provide  the  ceding  company  with
comparable security.  In the event of a downgrade below AA-, the companies would
be subject to additional costs incurred in providing AA- security.  Both Capital
Mortgage and KRE have  identified  potential new sources of reinsurance  premium
which  would not be as  dependent  on AA ratings as the  traditional  sources of
business. Both companies will seek to develop these opportunities in 1999.

(c)  Title Reinsurance -

Capital Title is rated AA- by S&P and Duff & Phelps.  The S&P rating for Capital
Title is currently on  "CreditWatch"  with negative  implications.  Although the
rating agencies have not published explicit rules regarding rating agency credit
for  reinsurance  in the title  insurance  area, in practice,  the primary title
insurers  receive 100% credit for cessions to Capital Title.  Title insurers are
only beginning to obtain claims- paying ability ratings; the general standard of
creditworthiness  that seems to be developing in the title insurance industry is
A.

(d)  Other Ratings -

In 1997,  Capital Credit received an A+ financial strength rating from S&P.  The
S&P rating for  Capital  Credit is  currently  on  "CreditWatch"  with  negative
implications. The Company's senior debt is rated A by S&P and A1 by Moody's, and
the MIPS issued by the Company's finance  subsidiary,  Capital Re LLC, are rated
BBB+ by S&P and a2 by Moody's.

Capital Reinsurance,  Capital Mortgage,  KRE and Capital Title have not received
ratings from A.M.  Best  Company,  Inc.  ("A.M.  Best"),  a major rating  agency
covering the insurance  industry.  A.M. Best rates insurance  companies

                                       26
<PAGE>

annually and  provides  statistical  reports on their  financial  condition  and
history.  However,  A.M.  Best has not rated  financial  guaranty  insurers  and
reinsurers.  Because the financial strength ratings discussed above from S&P and
Moody's and the claims-paying ability ratings discussed above from Duff & Phelps
and Fitch are generally  considered far more important than A.M. Best ratings in
the markets in which those companies  compete,  the Company believes the absence
of an A.M.  Best  rating  has no  impact  on the  Company's  business  or on its
competitive position.

(9)  NAIC-IRIS Ratios -

The  National  Association  of  Insurance  Commissioners'  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  could  lead to  inquiries  from
individual  state insurance  commissioners  as to certain aspects of a company's
business.

For the year ended December 31, 1998, Capital Reinsurance had one unusual value,
which was an increase in net  writings,  and  Capital  Mortgage  had two unusual
values,  both of which were related to the establishment of a reserve by Capital
Mortgage's subsidiary, KRE, in connection with KRE's reinsurance of three issues
of asset backed securities serviced by Commercial Financial Services, Inc.

(10) Losses and Reserves -

In the financial  guaranty  reinsurance  business,  case basis loss reserves are
required  to be  established  under  generally  accepted  accounting  principles
("GAAP") and statutory accounting practices ("SAP") when a payment default on an
insured  obligation  is  probable  and the  amount of the  probable  loss can be
reasonably  estimated.  Moreover,  under its various  reinsurance  treaties  and
facultative  agreements,  Capital  Reinsurance  is obligated  to  establish  and
maintain SAP case basis loss reserves.  Under GAAP, the amount of the case basis
loss reserve is  calculated  as the present  value of the losses  expected to be
incurred  through the full term of the  obligation,  including  loss  adjustment
expenses,  net of anticipated  salvage and  subrogation.  Under current Maryland
insurance law, case basis loss reserves may not be discounted under SAP.

In the mortgage  guaranty  reinsurance  business,  the Company's  reserves are a
function of the reserving  methodologies of the primary insurance companies from
which mortgage guaranty risk is assumed. A significant period of time may elapse
between the occurrence of the borrower's default on mortgage payments (the event
a  potential  future  claim),  the  reporting  of such  default  to the  primary
insurance company,  the primary company's  notification of loss to the reinsurer
and the eventual  payment of the claim related to the default.  To recognize the
liability for unpaid mortgage  guaranty  losses related to defaulted  mortgages,
primary mortgage  guaranty  insurers  establish loss reserves in respect of such
defaults based upon the claim rate and estimated average claim amount.  Included
in these loss reserves are loss adjustment  expense ("LAE") and Incurred But Not
Reported  Reserves.  These  reserves are estimates and there can be no assurance
that they  will  prove  adequate  to cover  ultimate  loss  developments  on the
reported  defaults.  The reserving  process is premised on the  assumption  that
historical   experience   relating  to  mortgage  defaults,   adjusted  for  the
anticipated effect of current economic  conditions and projected future economic
trends,  provides a reasonable  basis for  estimating  future  events.  However,
estimation of loss reserves is a difficult  process,  especially in light of the
rapidly changing  economic  conditions that have affected certain regions of the
United  States.  Additionally,   economic  conditions  that  have  affected  the
development  of the  loss  reserves  in the  past  may  not  necessarily  affect
development patterns in the future.

For the  trade  credit  reinsurance  business,  loss  reserves  are  established
according to management's loss  expectations  which are based on historical loss
development  patterns experienced by the ceding companies on similar business as
well as management's view of current  macroeconomic  conditions in the countries
in which the policies apply.

                                       27
<PAGE>


For the specialty reinsurance business,  loss reserves are established according
to management's loss expectations which are based on historical loss development
patterns experienced by the ceding companies on similar business.

For the title reinsurance business,  case basis loss reserves are required to be
established  under GAAP and SAP when a loss under a  reinsured  title  policy is
probable and the amount of the probable loss can be reasonably estimated.

For the financial solutions business,  reserves are set according to the type of
product reinsured. Generally, for quota share reinsurance transactions, reserves
equal the present  value of future  policy  benefits  less the present  value of
future policy premiums.  For other  transactions,  reserves are set according to
the expectation of future payments to be made under the agreement.

The Chief  Financial  Officer of the Company is responsible  for determining the
appropriate  timing  and amount of loss  reserves  after  consultation  with the
Company's Chief Executive Officer and Chief Underwriting  Officer. In making his
determination,  the Chief  Financial  Officer  will also  confer with the ceding
company  which  originally  insured  the  obligation.  The  Company  may, in its
discretion,  establish a loss  reserve  independent  of the  originating  ceding
company.

As of December 31, 1998, the Company had established a net $84.6 million in GAAP
case basis loss and LAE  reserves  (of which  $18.2  million  is  classified  as
incurred  but  not  reported  reserves  in  the  Company's  statutory  financial
statements).  The Company  believes its loss and LAE reserves are adequate.  The
following  table  sets  forth  for the  periods  indicated  certain  information
regarding the Company's loss experience.

<TABLE>
<CAPTION>
                                                                Year Ended December 31
                                                                (dollars in thousands)
                                                      ==========================================
                                                          1998           1997             1996
================================================================================================
<S>                                                      <C>            <C>              <C>
GAAP Net Premiums Earned                                 168,385        115,291          92,436
-----------------------------------------------------------------------------------------------
Net Reserve for Unpaid Losses and LAE at
   Beginning of Period (including foreign currency
   revaluation)                                           22,459         18,068          10,259
-----------------------------------------------------------------------------------------------
Incurred Losses and LAE                                   75,182         15,633           9,483
-----------------------------------------------------------------------------------------------
Paid (Recovered) Losses and LAE                           13,184         10,836           1,969
-----------------------------------------------------------------------------------------------
Unrealized Foreign Currency Loss on Reserve
   Revaluation                                               210           (406)            296
-----------------------------------------------------------------------------------------------
Net Reserve for Unpaid Losses and LAE at
   End of Period (including foreign currency
   revaluation)(1)                                        84,667         22,459          18,069
-----------------------------------------------------------------------------------------------
Ratio of Losses Incurred and LAE to GAAP
   Net Premiums Earned                                     44.64%         13.56%          10.26%
================================================================================================
</TABLE>

(1)  Net of reinsurance recoverable on ceded losses of (in thousands) $3,292,
     $5,527 and $1,833 for the years ended December 31, 1998, 1997 and 1996,
     respectively.

In addition,  as of December 31, 1998,  the Company had  established a net $17.8
million  in  accident  and  health  reserves  and a net zero  dollars in annuity
benefit  reserves.  The Company  believes  its annuity  benefit and accident and
health reserves are adequate.

(11) Investments -

                                       28

<PAGE>

In managing its  investment  portfolio,  the Company  places a high  priority on
credit quality and liquidity. Investment policy is set by the Board of Directors
and specific  investments  are managed by two outside  advisers:  Lazard  Freres
Asset Management, Inc. and Goldman Sachs Asset Management (the "Advisers").  The
Advisers act as investment  managers of the Company's  portfolio under contracts
terminable  on 30  days'  notice.  Performance  of the  Advisers  and  the  fees
associated  with  these   arrangements   have  been  and  will  continue  to  be
periodically  reviewed by the Board of Directors of the Company. All investments
made  by the  Advisers  for the  Company  are in  accordance  with  the  general
requirements  and  guidelines  for  investments  established  by  the  Board  of
Directors and Investment  Committee thereof,  including  guidelines  relating to
average maturities, duration and quality, in accordance with applicable law. All
investments in municipal  bonds and certain asset backed  securities are subject
to prior  approval  by the  Capital  Reinsurance  underwriting  department.  The
Company's  current  investment  policy  permits the purchase of both  investment
grade  and  non-investment   grade  fixed  income   securities,   provided  that
non-investment  grade fixed income  securities may be rated no lower than "B" at
the time of purchase.  Further,  total investment in non-investment  grade fixed
income securities may not exceed 3% of the aggregate portfolio.

At December 31, 1998,  79.5% of the  Company's  investment  portfolio  consisted
exclusively of fixed income securities rated AAA or A-1+ by S&P or Aaa or P-1 by
Moody's, or issues by the U.S. Government or its agencies or  instrumentalities.
Overall weighted average credit quality is AA+.

The  Company's   investment   guidelines   allow  tactical   purchases  of  high
yield/emerging  market debt  securities  at the  discretion  of the Advisers and
within  the  constraints  established  by the Board of  Directors.  The  overall
portfolio  performance,  however,  remains  benchmarked  to  composite  domestic
benchmarks.   No  assurance  can  be  given  that  the  Company's   strategy  of
diversification  will prove  successful,  or that losses will not be incurred in
excess of those realized under the prior investment strategy.

<TABLE>
<CAPTION>
                                      Aggregate Investment Portfolio by Maturity
                                                  as of December 31
                                               (dollars in thousands)
                           =========================================================================================
                                      1998                             1997                           1996
====================================================================================================================
                            Carrying        Percentage       Carrying       Percentage       Carrying     Percentage
                              Value          of Total          Value         of Total          Value       of Total
Maturity of                                 Investment                      Investment                    Investment
Investments                                  Portfolio                       Portfolio                     Portfolio
--------------------------------------------------------------------------------------------------------------------
<S>                           <C>               <C>            <C>              <C>            <C>             <C>
Due in One Year or            $104,982          8.9%           $87,757          8.7%           $76,606         8.5%
  Less
--------------------------------------------------------------------------------------------------------------------
Due After One Year             127,040         10.8%           112,001         11.1%           117,503        13.0%
  Through Five Years
--------------------------------------------------------------------------------------------------------------------
Due After Five Years           151,639         12.9%           128,094         12.6%            74,723         8.3%
  Through Ten Years
--------------------------------------------------------------------------------------------------------------------
Due After Ten Years            791,377         67.4%           683,239         67.6%           632,270        70.2%
--------------------------------------------------------------------------------------------------------------------
Total Investment            $1,175,038          100%        $1,011,091          100%          $901,102         100%
  Portfolio
====================================================================================================================
</TABLE>

                                       29

<PAGE>

          Aggregate Investment Portfolio and Yield by Type of Security
                             as of December 31, 1998
                             (dollars in thousands)

<TABLE>
<CAPTION>
                                                              Carrying      Estimated      Weighted Average
                                                                Value          Fair             Yield
Investment Category                                                           Value         to Maturity(1)
===========================================================================================================
<S>                                                            <C>           <C>                  <C>
Long-Term Investments:
-----------------------------------------------------------------------------------------------------------
     Municipal Obligations                                     $526,685      $526,685             5.96%
-----------------------------------------------------------------------------------------------------------
     Corporate Securities                                       162,142       162,142             6.84%
-----------------------------------------------------------------------------------------------------------
     U.S. Government and Agency Obligations                     115,675       115,675             5.62%
-----------------------------------------------------------------------------------------------------------
     Mortgage-Backed Securities                                 193,620       193,620             6.62%
-----------------------------------------------------------------------------------------------------------
     Emerging Markets                                            11,661        11,661             7.50%
-----------------------------------------------------------------------------------------------------------
     Other Asset-Backed Securities                               67,549        67,549             6.46%
-----------------------------------------------------------------------------------------------------------
     Other                                                        9,559         9,559            10.80%
-----------------------------------------------------------------------------------------------------------
Total Long-Term Investments                                   1,086,891     1,086,891             6.26%
-----------------------------------------------------------------------------------------------------------
Short-Term Investments                                           88,147        88,147             5.03%
===========================================================================================================

===========================================================================================================
Total Investment Portfolio                                   $1,175,038    $1,175,038             6.17%
===========================================================================================================
</TABLE>

(1)  Represents yield to maturity on long-term  investments and current yield on
     short-term  investments.  All  percentages  are stated on a pre-tax  basis,
     based on contractual maturity periods. Expected maturities will differ from
     contractual  maturities  because  borrowers  may have the  right to call or
     prepay obligations with or without call or prepayment penalties.

At December 31, 1998,  approximately  $193.6  million or 16.5% of the  Company's
investment portfolio was comprised of mortgage-backed securities ("MBS"). Of the
MBS portfolio,  approximately  $167.5 million or 86.5% was backed by agencies or
entities sponsored by the U.S. government as to the full amount of principal and
interest.  As of December 31,  1998,  the entire MBS  portfolio  was invested in
triple A rated securities.

Prepayment  risk is an  inherent  risk of holding  MBS.  However,  the degree of
prepayment  risk is particular to the type of MBS held.  The Company  limits its
exposure to prepayments by purchasing less volatile types of MBS. As of December
31, 1998, $3.6 million or  approximately  1.9% of the MBS portfolio was invested
in  collateralized  mortgage  obligations  ("CMOs") which are  characterized  as
planned  amortization class CMOs ("PACs").  PACs are securities whose cash flows
are  designed  to  remain  constant  over  a  variety  of  mortgage   prepayment
environments.  Other  classes in the CMO security are  structured  to accept the
volatility of mortgage prepayment changes,  thereby insulating the PAC class. Of
the  remaining  MBS  portfolio,  $190.0  million,  or  98.1%,  was  invested  in
mortgage-backed  pass-throughs or sequential CMOs.  Pass-throughs are securities
in which the monthly cash flows of principal  and interest  (both  scheduled and
prepayments) generated by the underlying mortgages are distributed on a pro-rata
basis to the holders of securities. A sequential MBS is structured to divide the
CMO security into sequentially  ordered classes.  Receipt of principal  payments
within classes is contingent on the retirement of all previously paying classes.
Generally,  interest  payments are made  currently  on all classes.  While these
securities  are more  sensitive  to  prepayment  risk  than  PACs,  they are not
considered highly volatile securities.  While the Company may consider investing
in any tranche of a sequential  MBS, the individual  security's  characteristics
(duration,  relative value,  underlying  collateral,  etc.) along with aggregate
portfolio  risk  management  determine  which tranche of sequential  MBS will be
purchased.  At December 31, 1998, the Company had no securities such as interest
only securities,  principal only  securities,  or MBS purchased at a substantial
premium to par that have the potential for loss of a significant  portion of the
original  investment  due to changes in the  prepayment  rate of the  underlying
loans supporting the security.

                                       30

<PAGE>


(12) Data Processing -

The Company believes that its data processing  system is adequate to support its
current needs and that such system has the capacity to support a greater  volume
of reinsurance business.

The Company uses  microcomputers on a Novell,  Windows NT and UNIX network.  The
network has six  fileservers  which provide for disk duplexing and complete data
and application  redundancy.  System applications files and databases are backed
up to tape  daily.  Backup  tapes are shipped to an  off-site  storage  facility
weekly  and  on-site  backup is stored in a  fire-proof  safe  outside  the data
center. For a discussion of Year 2000 issues,  see "Management's  Discussion and
Analysis of Financial Condition and Results of Operations" in Part II hereof.

(13) Employees -

As of December 31,  1998,  the Company  employed 67 persons,  of whom 44 were in
administration,  legal,  finance and  management,  12 were in  underwriting  and
technical support and 11 were in management information services.  None of these
employees is covered by collective bargaining  agreements.  The Company believes
that its employee relations are excellent.

(14) Executive Officers -

The executive  officers of the Company and their present ages and positions with
the Company are set forth below.

<TABLE>
<CAPTION>
  Name                       Age       Position and Term of Office
  ----                       ---       ---------------------------

<S>                          <C>       <C>
  Jerome F. Jurschak         51        Chairman  of the  Board  and  Chief  Executive  Officer
                                       (effective December 1998, officer since 1988)

  Joseph W. Swain III        46        President  and  Chief  Operating   Officer   (effective
                                       December 1998, officer since 1988)

  David A. Buzen             39        Executive  Vice President and Chief  Financial  Officer
                                       (officer since 1988)

  Alan S. Roseman            42        Executive   Vice   President,   General   Counsel   and
                                       Secretary (officer since 1989)

  Laurence C.D. Donnelly     40        Executive Vice President (officer since 1988)

  Susan L. Hooker            49        Executive Vice President (officer since 1990)
</TABLE>

                                       31

<PAGE>

(15) Regulatory Status of Insurance Subsidiaries -

Capital  Reinsurance  is licensed as a surety,  property  and  casualty  insurer
(including mortgage guaranty insurance) in the State of Maryland and is licensed
or  authorized  to  transact  insurance  business  in the  States  of New  York,
Michigan,  Florida and California and is an approved or accredited  reinsurer in
the States of Alaska, Colorado,  Illinois, North Carolina,  Pennsylvania,  Texas
and Wisconsin and in the Islands of Bermuda. Under its New York license, Capital
Reinsurance  is  authorized to write surety  insurance and to reinsure  risks of
every kind or description permitted by its charter (including financial guaranty
risks). Notwithstanding the breadth of its New York license, Capital Reinsurance
has  committed  to the New  York  Insurance  Department  that it will act in the
United  States  only as a  reinsurer  and  intends to  reinsure  only  financial
guaranty and related special risks  consistent  with its business  strategy as a
financial guaranty reinsurer.

On May 7, 1998,  Capital  Risk was  incorporated  under the laws of the State of
Maryland.  On October 29, 1998,  it was  authorized  by the  Maryland  Insurance
Administration,  the same regulatory authority that oversees Capital Reinsurance
in Maryland,  to write surety business under the laws of Maryland.  Capital Risk
has received no authorizations to transact insurance business in any other state
and it has not been  accredited or qualified as a reinsurer by any other state's
insurance  regulatory  authority.  Under its license to write surety business in
Maryland,  Capital  Risk may  write  primary  financial  guaranty  insurance  in
Maryland  consistent with its business plan to support the objectives of Capital
Reinsurance and its affiliates.

Capital Mortgage is licensed as a mortgage  guaranty insurer in the State of New
York and is thereby  authorized  to  transact  solely the  business  of mortgage
guaranty insurance.  Capital Mortgage is an approved or accredited  reinsurer in
the States of Arizona,  Illinois,  North Carolina,  Pennsylvania  and Wisconsin.
Capital  Title is  licensed  as a title  insurer in the State of New York and is
thereby  authorized to transact solely the business of title insurance.  Capital
Title is also licensed or authorized to transact title insurance business in the
States of  Michigan  and  Texas.  Capital  Title is an  approved  or  accredited
reinsurer in the States of  Connecticut,  Florida,  Louisiana,  Maryland,  North
Carolina, South Carolina and Virginia.

Capital  Reinsurance  and  Capital  Risk are subject to the  insurance  laws and
regulations of the State of Maryland and Capital  Mortgage and Capital Title are
subject to the insurance  laws of the State of New York.  Additionally,  Capital
Reinsurance,  Capital  Mortgage and Capital Title are subject to the laws of the
other jurisdictions in which they are licensed to transact business. In general,
such  insurance  laws and  regulations  are primarily for the  protection of the
policyholders  of these companies,  i.e., their ceding insurers,  and ultimately
the policyholders of those ceding insurers.

These laws and regulations,  as well as the level of supervisory  authority that
may  be  exercised  by  the  various  state  insurance   departments,   vary  by
jurisdiction,  but generally require  reinsurance  companies to maintain minimum
standards  of business  conduct and  solvency,  including  the  satisfaction  of
minimum capital  requirements,  and certain  financial tests, the maintenance of
deposits  of  securities  with state  insurance  departments  for the benefit of
ceding insurers and the filing of certain  reports with regulatory  authorities.
Capital  Reinsurance,  Capital  Mortgage and Capital  Title are required to file
quarterly and annual SAP financial  statements in each  jurisdiction  where they
are licensed and with the National Association of Insurance  Commissioners,  and
are subject to certain risk limits and other statutory  restrictions  concerning
the types and quality  of, and  limitations  on,  investments.  Capital  Risk is
similarly required to file quarterly annual SAP financial  statements,  but only
in Maryland and with the National Association of Insurance Commissioners.

The  operations  and  accounts of Capital  Reinsurance,  Capital  Risk,  Capital
Mortgage and Capital Title are subject to periodic  examination by the insurance
departments  of the  jurisdictions  in which they are  licensed,  authorized  or
accredited.  The Maryland Insurance Administration,  the regulatory authority of
the  domiciliary  jurisdiction  of Capital  Reinsurance,  conducts  a  triennial
examination  of insurance  companies  domiciled in  Maryland.  During 1997,  the
Maryland Insurance  Administration completed its field work in connection with a
triennial examination of

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<PAGE>

Capital  Reinsurance  for the period from  January 1, 1994 though  December  31,
1996.  The Report on  Financial  Examination,  which was issued by the  Maryland
Insurance  Administration  on May 29, 1998 in connection with such  examination,
did  not  contain  any  materially  adverse  findings.  The  Maryland  Insurance
Administration has completed its field work on its Organization Examination,  as
of September 24, 1998, on Capital Risk.  The final report has not been issued by
the Maryland Insurance  Administration.  The New York Insurance Department,  the
regulatory  authority  of the  domiciliary  jurisdiction  of  Capital  Mortgage,
conducts a triennial  examination of insurance  companies domiciled in New York.
During  1997,  the New York  Insurance  Department  completed  its field work in
connection with a triennial  examination of Capital Mortgage for the period from
January 1, 1994 though  December 31, 1996. The report on the examination has not
yet  been  issued.  During  the  latter  half of 1998,  the New  York  Insurance
Department,  the regulatory authority of the domiciliary jurisdiction of Capital
Title,  completed its field work in connection  with a triennial  examination of
Capital Title for the period form March 6, 1996 to December 31, 1997. The report
on the examination has not yet been issued.

Although  the  rates  and  policy  terms of  primary  insurance  agreements  are
generally  closely  regulated  by state  insurance  departments,  the  terms and
conditions of reinsurance  agreements generally are not subject to regulation by
any regulatory  authority with respect to rates or policy terms.  However,  as a
practical  matter,  the rates charged by the primary  insurers have an effect on
the rates that can be charged by reinsurers  and, with respect to reinsurance of
financial guaranty, mortgage guaranty and title primary insurers licensed in the
States of California, Florida and New York, certain terms must often be included
in the  reinsurance  agreement  in order for such  primary  insurers  to receive
credit for the reinsurance on their statutory financial statements.

Capital  Credit and KRE are  insurance  companies  registered  and  licensed  as
general  insurers  under the laws of the Islands of Bermuda.  Each is subject to
the  Insurance  Act of 1978,  as amended,  of the Islands of Bermuda.  It is the
policy of the  government of Bermuda that the insurance  industry be essentially
self-regulating  and the Insurance Act is drawn to require  certification by the
appropriate  officers and  professionals  of each company of compliance with the
applicable  statutory  standards.  Capital Credit and KRE are required under the
Act to  prepare  annual  statutory  financial  statements  and file a  statutory
financial  return,  including a  declaration  of  compliance  with the statutory
ratios (premium to statutory surplus ratio, five-year operating ratio and change
in  statutory  surplus  ratio)  and  a  general  business  solvency  certificate
demonstrating compliance with the Insurance Act's minimum solvency ratio.

(16) Insurance Holding Company Regulations -

The Company,  Capital  Reinsurance,  Capital Risk,  Capital Mortgage and Capital
Title are subject to regulation under the insurance  holding company statutes of
Maryland,  the  domiciliary  state of Capital  Reinsurance and Capital Risk, New
York, the domiciliary  state of Capital Mortgage and Capital Title, and of other
jurisdictions in which they are licensed. The insurance holding company laws and
regulations  vary from  jurisdiction to jurisdiction,  but generally  require an
insurance holding company, such as the Company, and insurers and reinsurers that
are subsidiaries of insurance holding companies, to register with the applicable
state regulatory  authorities and to file with those authorities certain reports
describing,  among  other  information,  their  capital  structure,   ownership,
financial  condition,  certain  inter-company  transactions and general business
operations. The insurance holding company statutes also require prior regulatory
agency approval or, in certain  circumstances,  prior notice of certain material
inter-company  transfers of assets and certain  transactions  between  insurance
companies,  their parent companies and affiliates. The insurance holding company
statutes impose standards on certain  transactions  between affiliated companies
within the holding company structure,  which include,  among other requirements,
that all  transactions  be fair and  reasonable and have terms no less favorable
than terms that would result from  transactions  between parties  negotiating at
arm's length and that those exceeding  specified limits receive prior regulatory
approval.

                                       33

<PAGE>

(17) Maryland and New York Insurance Acquisitions Disclosure and Control Acts -

Under the Maryland  Insurance Code and New York Insurance  Laws,  unless certain
filings  are made with the  Insurance  Commissioner,  no person may  acquire any
voting security, or security convertible into a voting security, of an insurance
holding  company,  such as the  Company,  which  controls a Maryland or New York
insurance company,  as applicable,  such as Capital  Reinsurance,  Capital Risk,
Capital Mortgage or Capital Title, or merge with such holding company,  if, as a
result of such  transaction,  such person would "control" such insurance holding
company.  Under  current  law, the  transaction  may not proceed  without  prior
approval  or  exemption  by the  Insurance  Commissioner  unless  following  the
required  provision of certain  information to the Insurance  Commissioner,  the
Insurance Commissioner affirmatively approves the acquisition within a specified
time period. "Control" is presumed to exist if a person, directly or indirectly,
owns or controls 10% or more of the voting  securities of another  person.  This
presumption may be rebutted by establishing by a preponderance  of evidence that
control does not exist in fact.

(18) Restrictions on Dividends -

(a)  Maryland Law:

The  principal  source of cash for the payment of debt service and  dividends by
the Company is the receipt of dividends from Capital Reinsurance.  Under current
Maryland  insurance  law,  as it applies to Capital  Reinsurance,  any  proposed
payment of a dividend or  distribution in excess of certain amounts is called an
"extraordinary  dividend."  "Extraordinary  dividends"  must be reported to, and
approved  by, the  Maryland  Commissioner  prior to payment.  An  "extraordinary
dividend" is defined to be any dividend or distribution to stockholders, such as
the Company,  which  together with  dividends  paid during the preceding  twelve
months  exceeds  10% of an  insurance  company's  policyholders'  surplus at the
preceding December 31. Further,  an insurer may not pay any dividend or make any
distribution  to its  shareholders,  such as the  Company,  unless  the  insurer
notifies the  Commissioner  of the proposed  payment  within five  business days
following declaration and at least ten days before payment. The Commissioner may
declare  that  such  dividend  not  be  paid  if he  finds  that  the  insurer's
policyholders surplus would be inadequate after payment of the dividend or could
lead the  insurer to a  hazardous  financial  condition.  Based on the  Maryland
restrictions,  at December 31, 1998, the maximum amount  available  during 1999,
with  notice  to,  but  without  prior   approval  of  the  Maryland   Insurance
Administration,  for payment of dividends by Capital  Reinsurance to the Company
which would not be characterized as  "extraordinary  dividends" is approximately
$32.3 million.

(b)  New York Law:

Capital Mortgage is subject to the dividend  restrictions imposed under sections
4105 and 6502(b)(2) of the New York  Insurance Law. Those sections  provide that
dividends  may  only  be  declared  and   distributed  out  of  earned  surplus.
Additionally,  no dividend may be declared or  distributed  in an amount  which,
together with all dividends  declared or  distributed  by the company during the
preceding twelve months,  exceeds the lesser of 10% of the company's  surplus to
policyholders as shown by its last Annual  Statutory  Statement on file with the
New York  Department,  or 100% of adjusted  net  investment  income  during such
period, unless, upon prior application therefor,  the superintendent  approves a
greater  dividend  distribution  based upon his finding  that the  company  will
retain  sufficient  surplus to support its  obligations  and  writings.  "Earned
surplus" is defined as the portion of the company's  surplus that represents the
net earnings,  gains or profits,  after  deduction of all losses,  that have not
been  distributed to  shareholders as dividends or transferred to stated capital
or  capital  surplus  or  contingency  reserves  or  applied  to other  purposes
permitted  by law but  does  not  include  unrealized  appreciation  of  assets.
"Adjusted net  investment  income" is defined as net  investment  income for the
twelve months immediately preceding the declaration of the dividend increased by
the  excess,  if any,  of net  investment  income  over  dividends  declared  or
distributed   during  the  period   commencing   thirty-six  months  before  the
declaration of the current dividend and ending twelve months prior thereto.

                                       34

<PAGE>

Capital Title is subject to the dividend  restrictions  imposed  under  sections
4105  and  6407 of the New York  Insurance  Law.  Those  sections  provide  that
dividends may only be declared and distributed out of earned surplus and only if
such  dividends  do not  reduce  the  company's  surplus to less than 50% of its
outstanding  capital shares,  i.e., the value of its outstanding  common equity.
Additionally,  no dividend may be declared or  distributed  in an amount  which,
together with all dividends  declared or  distributed  by the company during the
preceding  twelve  months,  exceeds  10% of the  company's  outstanding  capital
shares, unless, after deducting such dividends,  it has a surplus at least equal
to 50% of its  statutory  reinsurance  reserve  or a surplus  at least  equal to
$250,000,  whichever is greater.  "Earned  surplus" is defined as the portion of
the company's  surplus that is not attributable to contributions to surplus made
in the  preceding  five years or to  appreciation  in the value of the company's
investments not sold or otherwise disposed of.

(c)  Bermuda Law:

Capital  Credit paid its first  dividend  to the Company in October  1998 in the
amount of $4.0 million. KRE has never declared nor paid dividends. Under Bermuda
Law and the  Bye-Laws of Capital  Credit and KRE,  dividends  may be paid out of
their profits (defined as accumulated realized profits less accumulated realized
losses).  Distributions  to  shareholders  may also be paid out of their surplus
limited by the requirements that they must at all times (i) maintain the minimum
share capital  required  under Bermuda Law, and (ii) have relevant  assets in an
amount  equal to or greater  than 75% of  relevant  liabilities,  all as defined
under Bermuda Law.

(19) Credit for Reinsurance -

Through  the  "credit  for  reinsurance"   mechanism,   Capital  Re's  insurance
subsidiaries  are indirectly  subject to the effects of regulatory  requirements
imposed by  jurisdictions  in which ceding  primary  insurers are  licensed.  In
general, a ceding insurer will ordinarily enter into reinsurance agreements only
if the  ceding  insurer  can  obtain  credit for  reinsurance  on its  statutory
financial  statements.  Credit  is  allowed  when  the  reinsurer  is  licensed,
authorized or accredited in a jurisdiction where the ceding company is domiciled
or, in some cases,  licensed.  In addition,  many jurisdictions allow credit for
reinsurance  ceded to a reinsurer that is licensed in another  jurisdiction  and
which meets certain financial  requirements,  provided, in some instances,  that
the jurisdiction has substantially  similar reinsurance credit law requirements.
Alternatively,  most  jurisdictions  permit a ceding  insurer to take credit for
reinsurance  on its  statutory  financial  statements  if the  reinsurer  is not
licensed,  accredited or authorized if the reinsurer  provides  security against
the reserves ceded in the form of a letter of credit,  funds withheld or through
a trust fund mechanism.  Capital  Reinsurance is licensed or meets the financial
requirements in each of the  jurisdictions  in which the primary U.S.  financial
guaranty  insurers  are  domiciled.  Capital  Mortgage  is licensed or meets the
financial requirements in each of the jurisdictions in which the primary private
U.S.  mortgage  guaranty  insurers are  domiciled.  Capital Title is licensed or
meets the financial  requirements in each of the  jurisdictions  in which it has
ceding companies and that impose such requirements.  Capital Risk is licensed in
Maryland.

(20) SAP Reserves -

(a)  Financial Guaranty Contingency Reserve -

Capital  Reinsurance  maintains  the  contingency  reserves  which  the  Company
believes are required by the New York,  California and Florida insurance laws to
provide credit for reinsurance to ceding financial guaranty insurers licensed in
New York,  California  and Florida.  Under those laws,  all  financial  guaranty
insurers, or their reinsurers, are required to maintain a contingency reserve to
protect  policyholders  against the impact of excessive  losses occurring during
adverse economic cycles.

Under the New York Insurance Law, for financial guaranty policies written on and
after July 1, 1989,  contributions  are  required to be made to the  contingency
reserve  equal  to the  greater  of 50% of  premiums  written  for the  relevant
category of insurance or a percentage of the principal guaranteed,  varying from
0.55% to 2.50%, depending upon the

                                       35

<PAGE>

type of obligation.  Contributions to the contingency reserve are required to be
made  as  follows:   (a)  for  municipal   bonds,   special  revenue  bonds  and
substantially   equivalent   obligations,   by  quarterly   payments   equal  to
one-eightieth of the total reserve  required over a 20 year period;  (b) for all
other  obligations,  by quarterly  payments equal to  one-sixtieth  of the total
reserve required over a 15 year period. Contributions may be discontinued if the
required total  contingency  reserve for all categories of obligations  has been
reached.  The contingency  reserves must be maintained for the period  specified
above,  except that withdrawals by the insurer may be permitted,  with the prior
written approval of or written notice to the Superintendent of Insurance,  under
specified  circumstances  in the event that the actual  incurred loss experience
exceeds certain thresholds or if the reserve  accumulated is deemed excessive in
relation to the insurer's outstanding insured obligations.

As of December 31, 1998, 1997 and 1996, the contingency  reserve (as required by
Maryland  (Capital  Reinsurance's  domiciliary  state) and New York) recorded on
Capital Reinsurance's  statutory financial statements was $129.7 million, $103.9
million and $87.4 million, respectively.

(b)  Mortgage Guaranty Contingency Reserve:

Under the New York  Insurance Law,  Capital  Mortgage is required to establish a
contingency reserve in an amount equal to 50% of earned premiums.  Contributions
to the contingency reserve made during each calendar year must be maintained for
a period of one hundred and twenty months,  except that  withdrawals may be made
by the insurer with the prior approval of the Superintendent of Insurance in any
year in which the actual  incurred  losses  exceed 35% of  corresponding  earned
premiums.

(c)  Title Reinsurance Reserve:

Under the New York  Insurance  Law,  Capital  Title is required  to  establish a
reinsurance  reserve in an amount equal to  one-eightieth  of one percent of the
exposure  assumed by it. Capital Title may release from the reinsurance  reserve
five percent of the amount  added to the  reinsurance  reserve  during each year
following the year in which the sum was added.

(21) Single and Aggregate Risk Limitations -

(a)  Financial Guaranty Business -

The New York  Insurance  Law  limits  the  single  and  aggregate  risks  that a
financial  guaranty  insurer  may  insure on a net  basis.  Capital  Reinsurance
complies with the single and aggregate risk limits of the New York Insurance Law
for financial guaranty insurers.  For example, the New York Insurance Law limits
the insured  average  annual debt service on insured  municipal  bonds,  special
revenue bonds and substantially  equivalent obligations with respect to a single
entity and backed by a single revenue  source (net of qualifying  collateral and
reinsurance)  to not more  than 10% of the sum of the  insurer's  policyholders'
surplus and contingency  reserves.  In addition,  insured principal of municipal
bonds  attributable  to any  single  risk,  net  of  qualifying  collateral  and
reinsurance,  is  limited  to not  more  than  75% of the  sum of the  insurer's
policyholders'  surplus and  contingency  reserves.  Single risk  limits,  which
generally are more  restrictive  than the municipal bond single risk limit,  are
also specified for several other categories of insured obligations. The New York
Insurance  Law also  limits the  aggregate  insured  outstanding  principal  and
interest  of  guaranteed   obligations,   net  of  qualifying   collateral   and
reinsurance,  to certain multiples of the insurer's  policyholders'  surplus and
contingency  reserve.  Aggregate  risk limits vary for  different  categories of
insured obligations.

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<PAGE>

(b)  Mortgage Guaranty Business:

Capital  Mortgage is subject to the various  limitations and requirements of the
New York Insurance Law governing mortgage guaranty insurance.  For example,  the
aggregate  risk  (i.e.,  total  liability  under  its  aggregate  insurance  and
reinsurance policies) that a mortgage guaranty insurer may insure on a net basis
cannot exceed  twenty-five  times its  policyholders'  surplus.  The regulations
promulgated under the New York Insurance Laws also contain detailed  limitations
on the  conduct of  mortgage  pool  insurance  business  by a New York  licensed
mortgage guaranty insurer.

(c)  Title Business:

Capital Title is subject to the various  limitations and requirements of the New
York Insurance Law governing title insurance. For example, Capital Title may not
assume  any  single  risk in  excess of the sum of its  capital,  policyholders'
surplus, statutory premium reserves and voluntary reserves.

C.   DISCONTINUED OPERATIONS

The  Company  has  commenced a plan of  divestiture  of its Lloyd's  operations.
Accordingly,  commencing in 1998, the Company began reflecting its participation
in  Lloyd's as a  discontinued  operation.  Following  is a  description  of the
Company's Lloyd's operations.

(1)  Overview of Lloyd's of London Insurance Market -

Lloyd's is a long established  insurance  marketplace where many varied forms of
insurance are sold by syndicates,  which, until 1994, were annual joint ventures
of participating capital providers known as "Names."  Participation as a Name on
a syndicate  carries  with it  unlimited  liability  for the Name's share of any
insurance losses incurred by the syndicate (each Name participating  severally).
In 1994,  the rules  relating to  membership  in Lloyd's  were  changed to allow
limited liability corporate capital vehicles to enter the Lloyd's marketplace as
capital  providers.  Typically,  Lloyd's  syndicates  now  comprise a mixture of
limited and unlimited liability capital combining in the annual joint venture.

Several  of the  underwriting  years of the late  1980's and early  1990's  were
particularly  unprofitable for many of the syndicates operating at Lloyd's. This
proved  to be  financially  disastrous  for some of the  Names  on the  affected
syndicates  due to the  unlimited  liability of their  participation.  In August
1996,  Lloyd's  implemented  its  "Reconstruction  and Renewal"  proposals which
involved a new company, Equitas, being authorized to reinsure the liabilities of
the 1992 and prior years of account of most of the  syndicates  at Lloyd's.  The
funding  to give  effect  to these  proposals  came from a  variety  of  sources
including the premiums on the liabilities assumed by Equitas as well as a series
of levies  charged to entities that had  historically  provided  services to the
Lloyd's insurance market (including managing agencies and insurance brokers).

The Company  participates in life,  marine and non-marine  syndicates  through a
dedicated corporate capital vehicle, CRC Capital, thereby limiting the liability
of the Company.  RGB provides  accounting,  reporting  and  ancillary  insurance
services to the syndicates managed by it and on which the Company participates.

For the 1998 year of account,  the  Company  committed  approximately  (pound)44
million  of  capital,  in the form of a letter  of  credit,  to five  syndicates
managed by RGB, which supported  approximately (pound)88 million of underwriting
capacity, and, for the 1999 year of account, the Company committed approximately
(pound)47.5  million  of  capital,  in the form of a letter of  credit,  to four
syndicates  managed by RGB, which supports  approximately  (pound)95  million of
underwriting capacity.

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<PAGE>

(2)  Competition -

There is significant  competition  in all classes of business  transacted by the
syndicates  managed  by  RGB  emanating  from  a  number  of  different  markets
worldwide.  Depending  upon the class of  business,  competition  comes from the
London  market,  other  Lloyd's  syndicates,  Institute  of London  Underwriters
companies,  and major  international  insurers and  reinsurers.  With respect to
international  risks,  competition  also comes  from  domestic  insurers  in the
country of origin of the insured.

(3)  Losses and Reserves -

In the Lloyd's business,  case basis loss reserves are established for all known
losses.  Notice  of a claim is given by the  cedant  to its  broker  who in turn
provides notice to the lead  underwriter  and, once the claim has been agreed by
the lead  underwriter,  it in turn provides  notice of such claim to the Lloyd's
claims  notification  system,  which is common to all  syndicates  operating  at
Lloyd's.

For developed  underwriting  years,  a provision for ultimate  losses is made by
applying statistical  projection  techniques to incurred losses. For undeveloped
years,  Bornhuetter-Ferguson  techniques  are applied  based on a  weighting  of
incurred and expected loss ratios to estimate ultimate losses. Ultimate premiums
are also  estimated by the same methods.  Reserves for incurred but not reported
("IBNR")  losses are  calculated  as the earned  portion  of  ultimate  premiums
applied to ultimate losses less paid losses and case reserves.

For paid losses and case reserves,  the reinsurance  recoverables are calculated
by applying reinsurance to those specific losses.  Reinsurance  recoverables are
provided  against  IBNR  losses  based on  techniques  similar  to those used to
calculate ultimate losses for undeveloped years.

(4)  Regulatory Status -

The  Company and certain of its UK  subsidiaries  are subject to the  regulatory
jurisdiction  of the  Council  of  Lloyd's  (the  "Council")  as a result of the
acquisition by the Company of RGB and the  establishment of CRC Capital.  Unlike
other financial markets in the UK, Lloyd's is not currently subject to direct UK
government  regulation  through the UK Financial Services Act 1986 but, instead,
is self  regulating  by virtue of the Lloyd's Act  1971-1982  through  bye-laws,
regulations and codes of conduct made by the Council,  which governs the market.
Under the Council  there are two  boards,  the Market  Board and the  Regulatory
Board.  The former is led by working  members of the Council and is  responsible
for strategy and the provision of services such as premium and claims  handling,
accounting  and policy  signing.  The Regulatory  Board is  responsible  for the
regulation of the market, compliance and the protection of policyholders.  There
are no  provisions in the Lloyd's Acts,  the bye-laws or the  regulations  which
provide for any  liabilities of CRC Capital or RGB to be met by the Company.  In
addition,  a managing  agency is  required to comply  with  various  capital and
solvency  requirements  and to  submit  to  regular  monitoring  and  compliance
procedures. CRC Capital, as a corporate member of Lloyd's, is required to commit
an amount  broadly  equal to 50  percent  of its  underwriting  capacity  on the
syndicates to support its underwriting on those syndicates.

In 1997, the UK Government  announced reforms for the regulation of the domestic
financial  services industry by proposing  amendments to the Financial  Services
Act 1986. The proposed changes involve the consolidation of all  self-regulating
investment  organizations and the Securities and Investments Board into a single
statutory  regulator,  the  Financial  Services  Authority  (the "FSA").  The UK
Government  has declared that Lloyd's will be brought into a similar  regulatory
scheme to that applying to insurance companies and proposed to give the FSA wide
powers over the Lloyd's  market.  The FSA is currently  seeking  comments on its
proposed approach.

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<PAGE>

(5)  Lloyd's "Controller" Regulations -

Under the Lloyd's  regulations,  the  approval  of the Council  must be obtained
before any person can be a "controller"  of a Lloyd's  corporate  member or of a
managing  agency.  The Company  has been  approved  as a  "controller."  Lloyd's
imposes an absolute  prohibition  on any  company  being a 10%  controller  of a
corporate  member without first  notifying  Lloyd's and receiving their consent.
This prohibition is qualified in respect of becoming a 20%, 33%, 50% or majority
controller in that the corporate  member must do all that lies within its powers
to  comply  with  Lloyd's  requirements.  In these  latter  circumstances,  this
essentially  means  that  notice  must have been given to the  Council  that the
relevant  threshold  will be exceeded and the Council has not objected.  Persons
seeking to become  controllers  may be  required  to deliver a  declaration  and
undertaking  to  Lloyd's,  in the form  prescribed  by Lloyd's,  unless  Lloyd's
exempts such person from this  requirement.  As a  "controller,"  the company is
required to give certain  undertakings,  directed  principally  towards ensuring
that  there is no direct  interference  in the  conduct of the  business  of the
managing agency.

Under English law, if any person that holds or  subsequently  becomes the holder
of more than 5 percent  of the  Company's  stock  also  owns any  interest  in a
Lloyd's broker or is a partner or a director of a Lloyd's  broker,  that Lloyd's
broker risks losing its Lloyd's  license.  For these purposes  "Lloyd's  broker"
includes the holding company of a corporate  Lloyd's  broker,  any company which
controls (a test based on one-third  voting rights or control of the board) such
a  Lloyd's  broker  or its  holding  company  or,  if the  Lloyd's  broker  is a
partnership,  any person who controls (on a similar test) such a Lloyd's  broker
or one of its partners.





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<PAGE>

Item 2. Properties.

Capital Re Corporation, Capital Reinsurance, Capital Mortgage, Capital Title and
Capital  Re  Solutions  Incorporated  maintain  offices  at 1325  Avenue  of the
Americas,  New York, New York 10019.  The office comprises the entire 18th floor
of the building,  approximately 23,000 square feet of space. The companies began
occupying  these  offices in April 1993.  Prior to that,  Capital Re and Capital
Reinsurance  maintained  offices at 787 Seventh Avenue,  New York, New York. The
offices at 787 Seventh Avenue were sublet to a third party upon the move to 1325
Avenue  of the  Americas.  The  Company  has  exercised  an  option  to lease an
additional  9,000  square  feet of space on the 17th floor at 1325 Avenue of the
Americas commencing on March 5, 1999. The Company also rents approximately 2,000
square feet of office space at Hasilwood House, 60 Bishopgate, London, England.

Item 3. Legal Proceedings.

There are no  material  lawsuits  pending,  or to the  knowledge  of the Company
threatened,  to which the  Company or any of its  subsidiaries  is a party or of
which any of their properties is the subject.

Item 4. Submission of Matters to a Vote of Security Holders.

Not applicable.

                                     PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

The  Registrant's  common stock trades on the New York Stock  Exchange under the
symbol "KRE." The high and low sales prices for, and the cash dividends declared
on, the  Registrant's  common stock for each quarter  within the two most recent
fiscal years are as follows: (1)

---------------------------------------------
Quarter                      Dividends
                          Paid Per Share
---------------------------------------------
--------------------------------------------------------------------------------
                                                    High             Low
--------------------------------------------------------------------------------
1998
1st Quarter                    $0.04               $33.22           $28.97
2nd Quarter                    $0.04               $38.69           $31.34
3rd Quarter                    $0.04               $37.75           $24.50
4th Quarter                    $0.04               $25.94           $15.50
--------------------------------------------------------------------------------
1997
1st Quarter                    $0.04               $23.69           $20.63
2nd Quarter                    $0.04               $27.13           $19.50
3rd Quarter                    $0.04               $30.50           $25.03
4th Quarter                    $0.04               $31.44           $27.97
--------------------------------------------------------------------------------

(1)  High and low sale  prices and  dividends  have been  adjusted  to reflect a
     two-for-one  stock split of the Company's common stock effected on June 30,
     1998.

Information concerning  restrictions on the payment of dividends is set forth in
Item 1 above,  under the  caption  "Business  of  Capital Re -  Restrictions  on
Dividends."

As of March 24, 1999,  there were 44 stockholders  of record of the Company's
Common Stock.

                                       40

<PAGE>

Item 6. Selected Financial Data.

Capital Re Corporation and Subsidiaries
Selected Financial Data

<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                     --------------------------------------------------------------------------------
(Dollars in thousands except per         1998              1997             1996             1995             1994
share amounts)
---------------------------------------------------------------------------------------------------------------------
<S>                                  <C>               <C>              <C>              <C>              <C>
Summary of Operations
Gross Premiums Written               $   213,941       $   169,943      $   129,818      $   107,599      $    94,851
Net Premiums Written                     210,594           164,275          105,188           89,508           82,795
Net Premiums Earned                      168,385           115,291           92,436           60,097           58,850
Net Investment Income                     64,854            56,498           51,558           46,654           40,113
Net Realized Gains                        (1,506)            8,037            1,471               53            1,780
Total Revenues                           234,945           181,461          146,278          107,085          101,462
Net Income from Continuing
   Operations                             44,187            70,818           57,014           45,527           39,806
Net Income                                41,542            70,052           56,524           45,527           39,806
---------------------------------------------------------------------------------------------------------------------
Balance Sheet
Investment Portfolio                   1,175,038         1,007,923          901,102          771,767          638,751
Total Assets                           1,508,893         1,345,842        1,157,061          981,885          810,040
Net Deferred Premium Revenue             356,263           314,054          265,070          252,318          222,907
Long-term Debt                            74,856            74,819           74,782           74,744           90,706
Company Obligated Mandatorily
Redeemable Preferred Securities
   of Capital Re LLC                      75,000            75,000           75,000           75,000           75,000
Stockholders' Equity                     610,826           568,943          489,346          411,943          325,514
---------------------------------------------------------------------------------------------------------------------
Per Share Data
Basic Earnings Per Share from
   Continuing Operations                    1.39              2.23             1.82             1.54             1.35
Diluted Earnings Per Share from
   Continuing Operations                    1.35              2.18             1.79             1.53             1.34
Basic Earnings Per Share                    1.30              2.21             1.81             1.54             1.35
Diluted Earnings Per Share                  1.27              2.16             1.77             1.53             1.34
Cash Dividends Per Share                    0.16              0.15             0.13             0.11             0.10
Book Value Per Share                       19.13             17.88            15.43            13.91            11.01
---------------------------------------------------------------------------------------------------------------------
Statutory Surplus and Reserves
Unearned Premium Reserve                 417,114           358,399          307,236          278,980          242,574
Contingency Reserve                      211,455           162,250          123,363           89,685           63,591
Policyholders' Surplus                   395,771           435,118          443,451          412,884          401,743
Total Policyholders' Surplus
   and Reserves                        1,024,340           955,767          874,050          781,549          707,908
=====================================================================================================================
</TABLE>

                                       41

<PAGE>

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

General

Capital Re Corporation  (the  "Corporation")  was  incorporated  in the State of
Delaware  in  December  1991,  and is the  successor  by  merger  to a  Maryland
corporation  incorporated  in 1986.  The  Corporation  is an  insurance  holding
company and has five wholly owned operating  subsidiaries.  Capital  Reinsurance
Company ("Capital Reinsurance"),  domiciled in the State of Maryland,  commenced
operations in January 1988.  Capital  Reinsurance  is engaged in the business of
financial  guaranty  reinsurance,  primarily  the  reinsurance  of municipal and
non-municipal  bond  insurance  obligations.   Capital  Reinsurance  also  sells
municipal and non-municipal  credit risk protection  through credit default swap
transactions.  Capital Mortgage Reinsurance Company ("Capital Mortgage"),  a New
York domiciled company,  commenced operations in February 1994. Capital Mortgage
reinsures only residential  mortgage guaranty insurance  obligations,  which are
originated  principally  in the  United  States  and  the  United  Kingdom.  KRE
Reinsurance Ltd. ("KRE"), a Bermuda domiciled company,  commenced  operations in
March 1994.  KRE is engaged in the business of  reinsuring  financial  guaranty,
mortgage  guaranty and trade  credit  insurance,  both as a direct  reinsurer of
third party primary insurers and as a retrocessionaire  of Capital  Reinsurance,
Capital Mortgage, Capital Credit Reinsurance Company Ltd. ("Capital Credit") and
Capital  Title  Reinsurance   Company  ("Capital  Title").   KRE  also  provides
integrated financial solutions,  in the form of structured reinsurance products,
to accident and health  insurers and specialty  property and casualty  insurers.
Capital Credit, also a Bermuda domiciled insurance company, commenced operations
in February  1990.  Capital  Credit  reinsures  trade credit and political  risk
insurance  concentrated  in  Western  Europe  and  the  United  States  and is a
retrocessionaire of Capital  Reinsurance and Capital Mortgage.  Capital Title, a
New York  domiciled  insurance  company,  commenced  operations  in March  1996.
Capital Title is engaged in the business of reinsuring title insurance policies.

For marketing  purposes,  the Corporation  aggregates its  reinsurance  lines of
business  into two  divisions:  financial  guaranty  and  financial  risks.  The
financial guaranty division is composed of municipal and non-municipal financial
guaranty  reinsurance and credit default swaps.  The financial risks division is
composed of mortgage  guaranty  reinsurance,  trade  credit  reinsurance,  title
reinsurance and financial solutions.

In November  1996, the  Corporation  acquired 100% of the issued shares of Tower
Street Holdings  Limited (now known as RGB Holdings,  Ltd.), the holding company
for RGB  Underwriting  Agencies  Ltd.  ("RGB").  RGB is a  managing  agency  and
presently manages four syndicates operating in the Lloyd's of London ("Lloyd's")
insurance  market.  In connection  with its  acquisition of RGB, the Corporation
established a corporate name at Lloyd's.  In 1998, the  Corporation  commenced a
plan  of  divestiture  of its  Lloyd's  operations,  and  those  operations  are
presented as a discontinued operation. Pending divestiture, the Corporation will
continue to support its commitments to Lloyd's.  For comparative  purposes,  all
prior period financial statements have been restated.

In December 1996, the Corporation entered into a joint venture with GCR Holdings
Ltd.  ("GCR")  to form a Bermuda  based  insurer,  Capital  Global  Underwriters
Limited  ("CGUL"),  which specializes in financial lines  reinsurance.  In April
1997, EXEL Limited ("EXEL")  acquired GCR. In March 1998, EXEL sold its share of
CGUL to Bermuda  based ACE  Bermuda  Insurance,  Ltd.,  and CGUL was renamed ACE
Capital Re Ltd. The  Corporation,  through KRE,  owns a  fifty-percent  economic
interest in ACE  Capital Re Ltd.  and  controls  9.9% of its voting  stock.  The
Corporation  accounts for its investment in ACE Capital Re Ltd. under the equity
method.

Results of Operations

Year Ended December 31, 1998 versus Year Ended December 31, 1997

On June 30,  1998,  the  Corporation  completed a two for one stock split of its
outstanding common shares.  Prior period financial results have been restated to
reflect the stock split.  Additionally,  as mentioned above,  the  Corporation's
investment  in Lloyd's,  which was  previously  consolidated,  is reflected as a
discontinued operation

                                       42

<PAGE>

since in 1998 the  Corporation  commenced a plan of  divestiture  of its Lloyd's
operations.  All  prior  period  results  have  been  restated  for  comparative
purposes.

Net income  from  continuing  operations  for the year ended  December  31, 1998
decreased 37.6% to $44.2 million from $70.8 million for the same period of 1997.
On a per share basis,  basic and diluted net income from  continuing  operations
decreased to $1.39 and $1.35, respectively, for the year ended December 31, 1998
from $2.23 and $2.18,  respectively,  for the same period of 1997,  or 37.7% and
38.1%, respectively.

Net income  including income or loss from  discontinued  operations for the year
ended  December 31, 1998  decreased to $41.5  million from $70.1 million for the
same  period of the prior  year.  On a per share  basis,  basic and  diluted net
income including income or loss from discontinued  operations decreased to $1.30
and $1.27,  respectively,  for the year ended  December  31, 1998 from $2.21 and
$2.16, respectively, for the same period of 1997, or, in each case, 41.2%.

Net operating  income from  continuing  operations  (net income from  continuing
operations  excluding  realized gains and losses and foreign  exchange gains and
losses)  decreased  31.5% to $45.1 million for the year ended  December 31, 1998
from $65.9 million for the same period in 1997. On a per share basis,  basic and
diluted net operating income from continuing  operations  decreased to $1.42 and
$1.38, respectively,  for the year ended December 31, 1998 from $2.07 and $2.03,
respectively, for the same period of 1997, or 31.4% and 32.0%, respectively.

The decrease in the year end 1998  financial  results was  primarily  due to two
separate financial guaranty losses.  First, the Corporation  established a $10.0
million  pre-tax case basis loss reserve for losses  arising from the bankruptcy
of the Delaware  Valley  Obligated  Group, a unit of Pittsburgh  based Allegheny
Health, Education and Research Foundation  ("Allegheny").  Under the reinsurance
treaty with its ceding company,  the  Corporation has reinsured  Allegheny bonds
with an  outstanding  principal  amount  of  $14.6  million.  In  November,  the
Corporation made loss and loss adjustment payments of $1.0 million in respect of
the  Allegheny  bonds.  As a result,  the  aggregate  case  basis  loss and loss
adjustment  expense  reserve for Allegheny as of December 31, 1998  decreased to
$9.0  million.   The  Corporation  expects  that  the  reserve  will  cover  all
anticipated  present value losses  arising from its exposure to  Allegheny.  The
second loss was a $44.1 million pre-tax increase in Capital Re's case basis loss
reserve for losses arising from the  reinsurance of three issues of asset-backed
securities  serviced by  Commercial  Financial  Services,  Inc.  ("CFS").  As of
December 31, 1998, the  Corporation  had $153.3  million in reinsured  principal
outstanding  to the CFS  securities.  The $44.1 million  reserve  represents the
Corporation's  best estimate of all currently  anticipated and probable  losses.
Notwithstanding  the Allegheny and CFS losses, the Corporation's  total revenues
increased  to $234.9  million for the year ended  December  31, 1998 from $181.5
million in 1997, or 29.4%,  principally due to growth in net premiums earned and
net investment income.

Gross  premiums  written  increased  25.9% to $213.9  million for the year ended
December 31, 1998 from $169.9 million for the same period of 1997. This increase
was primarily due to growth in  non-municipal  bond reinsurance  business.  This
growth  was due to a  significant  increase  in  premiums  written in the credit
default  swaps  sector  of that  business.  The  Corporation  has  expanded  its
traditional  municipal and  non-municipal  financial  guaranty bond  reinsurance
lines of business to include  credit  default  swaps. A credit default swap is a
transaction  whereby one counterparty  pays a periodic fee in fixed basis points
on  a  notional  amount  in  return  for  a  contingent  payment  by  the  other
counterparty  in the event one or more defined credit events occurs with respect
to one or more third party  reference  securities  or loans.  A credit  event is
defined as failure to pay, bankruptcy, cross acceleration (generally accompanied
by a failure to pay), repudiation,  restructuring,  or similar nonpayment event.
Credit default swap premium grew to $6.8 million for the year ended December 31,
1998  from  $0.7  million  in  the  prior  year.  In  addition,  growth  in  the
non-municipal  bond  reinsurance  line was  attributable to a large  reinsurance
transaction  the  Corporation  entered into in the fourth  quarter of 1998 which
provided  credit  enhancement of $74.6 million of investment  grade asset backed
securities.  The Corporation  received upfront premium of $10.4 million for this
transaction.  Mortgage guaranty  reinsurance premium decreased in 1998 from 1997
due to an increase in mortgage  prepayments  caused by lower  interest  rates as
well as the Corporation's shift away from assuming quota share

                                       43

<PAGE>

mortgage  guaranty  reinsurance  business to assuming  structured excess of loss
mortgage guaranty reinsurance business.

In 1997,  the  Corporation  added a financial  solutions  line of business.  The
financial solutions business is focused on providing highly structured solutions
to problems of financial  and risk  management  through  reinsurance,  including
credit enhancement, excess of loss and surplus management covers. Gross premiums
written  attributable to the financial solutions line increased to $11.0 million
for the year ended  December  31, 1998 from $2.7  million for the same period of
1997. The following  table shows gross premiums  written by line of business for
the years ended December 31, 1998 and December 31, 1997.

                                      Gross Premiums Written
                                            Year Ended
                                           December 31,
                                      1998             1997
                                      ----             ----
                                         (dollars in millions)

Financial Guaranty Division:
   Municipal                          $55.2            $52.7
   Non-Municipal                       39.9             16.7

Financial Risks Division:
   Mortgage                            66.8             70.8
   Credit                              35.3             23.0
   Financial Solutions                 11.0              2.7
   Title                                5.7              4.0
                                     ------           ------

Total Gross
Premiums Written                     $213.9           $169.9

Net premiums  written  increased  by 28.2% to $210.6  million for the year ended
December 31, 1998 from $164.3 million for the same period in 1997. This increase
is commensurate with the increase in gross premiums written explained above. The
following  table shows net  premiums  written by line of business  for the years
ended December 31, 1998 and December 31, 1997.

                                       Net Premiums Written
                                            Year Ended
                                            December 31,
                                       1998             1997
                                       ----             ----
                                      (dollars in millions)

Financial Guaranty Division:
   Municipal                          $52.3            $50.2
   Non-Municipal                       39.8             16.6

Financial Risks Division:
   Mortgage                            66.7             70.5
   Credit                              35.1             23.0
   Financial Solutions                 11.0              0.1
   Title                                5.7              4.0
                                     ------           ------

Total Net
Premiums Written                     $210.6           $164.3



                                       44

<PAGE>

For the year ended December 31, 1998,  net premiums  earned  increased  46.1% to
$168.4 million from $115.3 million for the comparable 1997 period. This increase
was  primarily  due  to  growth  in  net  premiums   earned  in  the  municipal,
non-municipal  (including credit default swaps), credit, and financial solutions
lines of business.  For the year ended  December 31, 1998,  net refunded  earned
premium  increased to $16.5 from $4.8 million for the comparable period in 1997.
Excluding the effects of net refunded  municipal  earned  premium,  net premiums
earned  increased  37.5% to $151.9  million for the year ended December 31, 1998
from  $110.5  million  for  the  year  ended  December  31,  1997.  A  refunding
extinguishes the Corporation's reinsurance liability for the refunded obligation
and the  Corporation  then  recognizes  revenue equal to the  remaining  related
deferred premium revenue.  Net premiums earned from credit default swaps,  which
are earned as written, increased to $6.8 million for the year ended December 31,
1998 from $0.7 million in the prior year.  For the years ended December 31, 1998
and  1997,   ceded  earned   premium  was  $13.7  million  and  $17.7   million,
respectively.  The following table shows net premiums earned by line of business
for the years ended December 31, 1998 and December 31, 1997.

                                       Net Premiums Earned
                                           Year  Ended
                                           December 31,
                                      1998             1997
                                      ----             ----
                                       (dollars in millions)

Financial Guaranty Division:
 Municipal                            $43.0            $29.8
 Non-Municipal                         20.7             11.4

Financial Risks Division:
  Mortgage                             59.3             53.2
  Credit                               28.7             17.2
  Financial Solutions                  11.0              0.1
  Title                                 5.7              3.6
                                     ------           ------

Total Net
Premiums Earned                      $168.4           $115.3

For the year ended December 31, 1998, net investment  income  increased 14.9% to
$64.9 million from $56.5 million for the  comparable  period in 1997.  Growth in
investment income was primarily  attributable to a larger  investment  portfolio
caused by an increase in invested  assets  from  positive  operating  cash flows
during the twelve months ended December 31, 1998. In addition,  the  Corporation
recognized  net realized  losses of $1.5 million for the year ended December 31,
1998 compared to net realized gains of $8.0 million for the same period in 1997.
The net  realized  losses  recorded  in 1998  were a  result  of a $7.5  million
write-down of the  Corporation's  investment in CGA Group, Ltd. ("CGA") based on
the  Corporation's  estimate of a permanent  impairment in the carrying value of
that investment.

Loss and loss adjustment  expenses increased to $86.6 million from $15.6 million
for the years ended  December 31, 1998 and 1997,  respectively.  The increase in
losses recorded for the year ended December 31, 1998 was primarily  attributable
to the $10.0 million  Allegheny  loss and the $44.1  million CFS loss  explained
above, as well as expected loss development  commensurate with the growth in net
premiums  earned.  Ceded  losses for the years ended  December 31, 1998 and 1997
were $4.8 million and $6.6 million,  respectively.  The loss ratio was 51.4% for
the  year  ended  December  31,  1998  compared  to 13.6 % for the  prior  year.
Excluding  the  Allegheny  and CFS  losses,  the loss  ratio for the year  ended
December 31, 1998 was 19.3%.

Total expenses, including loss and loss adjustment expenses, increased 114.4% to
$180.1  million for the year ended  December 31, 1998 from $84.0 million for the
same period of 1997.  This increase was primarily  attributable to the Allegheny
and CFS losses as well as the  amortization of acquisition  expenses  associated
with the increased level of


                                       45

<PAGE>

premiums earned and normal expected loss development  from the credit,  mortgage
and financial lines businesses.  The expense ratios for the years ended December
31,  1998 and 1997 were  47.8% and  47.6%,  respectively.  The  combined  ratio,
excluding expenses associated with non-insurance operations,  increased to 99.2%
for the year ended December 31, 1998 from 61.2% for the comparable  1997 period.
This  increase  is a  result  of the  Allegheny  and CFS  losses  as well as the
Corporation's mix of business,  which is producing more business from lines with
relatively   higher  combined  ratios  than  that  of  the  financial   guaranty
reinsurance  business.  For the year ended December 31, 1998, the combined ratio
excluding the Allegheny and CFS losses was 67.1%.

For the year ended December 31, 1998, the total federal tax provision  decreased
to $10.7  million from $26.6  million for the same period in 1997.  In addition,
the effective tax rate  decreased to 19.4% for the year ended  December 31, 1998
from 27.3% for the same period of 1997.

Year Ended December 31, 1997 versus Year Ended December 31, 1996

Net income  from  continuing  operations  for the year ended  December  31, 1997
increased 24.1% to $70.8 million from $57.0 million for the same period of 1996.
The Corporation  adopted Statement of Financial Standards No. 128, "Earnings per
Share" ("FAS 128"),  as of December 31, 1997.  FAS 128 requires the  calculation
and presentation on the face of the income statement of basic earnings per share
and, if  applicable,  diluted  earnings per share.  Basic  earnings per share is
calculated  based  on  the  weighted  average  common  shares  outstanding.  All
potentially dilutive securities such as stock options and convertible securities
are excluded  from the basic  earnings  per share  calculation.  In  calculating
diluted  earnings  per share,  the number of shares is  increased to include all
potentially  dilutive  securities,   including  stock  options  and  convertible
securities.  On a per share basis,  basic and diluted net income from continuing
operations  increased  to $2.23  and  $2.18,  respectively,  for the year  ended
December  31,  1997 from $1.82 and $1.79,  respectively,  for the same period of
1996, or 22.5% and 21.8%, respectively.

Net income  including income or loss from  discontinued  operations for the year
ended  December 31, 1997  increased to $70.1  million from $56.5 million for the
same  period of the prior  year.  On a per share  basis,  basic and  diluted net
income including income or loss from discontinued  operations increased to $2.21
and $2.16,  respectively,  for the year ended  December  31, 1997 from $1.81 and
$1.77,  respectively,  for  the  same  period  of  1996,  or  22.1%  and  22.0%,
respectively.

In addition,  net operating  income from continuing  operations (net income from
continuing  operations  excluding  realized gains and losses) increased 18.1% to
$65.9  million for the year ended  December 31, 1997 from $55.8  million for the
same period in 1996.  On a per share  basis,  basic and  diluted  net  operating
income increased to $2.07 and $2.03,  respectively,  for the year ended December
31, 1997 from $1.78 and $1.75,  respectively,  for the same  period of 1996,  or
16.3% and 16.0%,  respectively.  Growth in net premiums earned to $115.3 million
from $92.4  million,  or 24.8%,  was the principal  cause of the increase in net
income.  Growth in net premiums  earned was a result of growth in the  financial
guaranty,  mortgage,  trade  credit  and other  specialty  reinsurance  lines of
business.

Gross  premiums  written  increased  30.9% to $169.9  million for the year ended
December  31,  1997 from  $129.8  million  for the same  period  in 1996.  Gross
premiums written  increased  across all product lines. In addition,  in 1997 the
Corporation  added  a  financial  solutions  line  of  business.  The  financial
solutions  business  is focused on  providing  highly  structured  solutions  to
problems of financial and risk management through reinsurance,  including credit
enhancement,  excess of loss and surplus  management covers. The following table
shows gross  premiums  written by line of business for the years ended  December
31, 1997 and December 31, 1996.

                                       46

<PAGE>

                                      Gross Premiums Written
                                            Year Ended
                                           December 31,
                                      1997             1996
                                      ----             ----
                                      (dollars in millions)

Financial Guaranty Division:
   Municipal                          $52.7            $48.3
   Non-Municipal                       16.7             10.9

Financial Risks Division:
   Mortgage                            70.8             53.7
   Credit                              23.0             15.1
   Financial Solutions                  2.7              0.0
   Title                                4.0              1.8
                                     ------           ------

Total Gross
Premiums Written                     $169.9           $129.8

Net premiums  written  increased  by 56.3% to $164.3  million for the year ended
December 31, 1997 from $105.2 million for the same period in 1996. This increase
is commensurate  with the increase in gross premiums written  explained above as
well as the  recording  of a large  ceded  premium  installment  on a  municipal
portfolio  paid in the fourth  quarter of 1996.  The  following  table shows net
premiums  written by line of business for the years ended  December 31, 1997 and
December 31, 1996.

                                      Net Premiums Written
                                             Year Ended
                                         December 31,
                                      1997             1996
                                      ----             ----
                                      (dollars in millions)

Financial Guaranty Division:
   Municipal                          $50.2            $36.7
   Non-Municipal                       16.6             10.9

Financial Risks Division:
   Mortgage                            70.5             40.9
   Credit                              22.9             14.9
   Financial Solutions                  0.1              0.0
   Title                                4.0              1.8
                                        ---              ---

Total Net
Premiums Written                     $164.3           $105.2

For the year ended December 31, 1997,  net premiums  earned  increased  24.8% to
$115.3 million from $92.4 million for the comparable 1996 period.  This increase
was primarily  due to growth in net premiums  earned across all product lines of
business.  For the year ended  December 31, 1997,  net refunded  earned  premium
decreased to $4.8 from $5.8 million for the comparable period in 1996. Excluding
the effects of net refunded earned premium,  net premiums earned increased 27.6%
to $110.5  million for the year ended  December 31, 1997 from $86.6  million for
the year ended  December 31, 1996. A refunding  extinguishes  the  Corporation's
reinsurance  liability  for the refunded  obligation  and the  Corporation  then
recognizes revenue equal to the remaining related deferred premium revenue.  For
the years ended  December  31,  1997 and 1996,  ceded  earned  premium was $17.7
million and $14.7


                                       47

<PAGE>

million,  respectively. The following table shows net premiums earned by line of
business for the years ended December 31, 1997 and December 31, 1996.

                                        Net Premiums Earned
                                            Year Ended
                                           December 31,
                                      1997             1996
                                      ----             ----
                                      (dollars in millions)

Financial Guaranty Division:
   Municipal                          $29.8            $27.5
   Non-Municipal                       11.4              7.2

Financial Risks Division:
   Mortgage                            53.2             43.9
   Credit                              17.2             12.2
   Financial Solutions                  0.1              0.0
   Title                                3.6              1.6
                                     ------            -----

Total Net
Premiums Earned                      $115.3            $92.4

For the year ended December 31, 1997, net  investment  income  increased 9.5% to
$56.5 million from $51.6 million for the  comparable  period in 1996.  Growth in
investment income was primarily  attributable to a larger  investment  portfolio
caused by an increase in invested  assets  from  positive  operating  cash flows
during the twelve months ended December 31, 1997. In addition,  the  Corporation
recognized  net realized  gains of $8.0 million for the year ended  December 31,
1997 compared to $1.5 million for the same period in 1996.

Loss and loss adjustment  expenses  increased to $15.6 million from $9.5 million
for the years ended December 31, 1997 and 1996,  respectively.  Losses  recorded
for the year ended December 31, 1997 were primarily  attributable  to the normal
loss  development  in the  mortgage  guaranty  and credit  reinsurance  lines of
business.  Ceded losses for the years ended December 31, 1997 and 1996 were $6.6
million and $6.5 million, respectively.

Total expenses,  including loss and loss adjustment expenses, increased 22.8% to
$84.0  million for the year ended  December  31, 1997 from $68.4  million in the
same period of 1996.  This increase was primarily  attributable  to  commissions
associated  with the  increased  level  of  premiums  written  and  normal  loss
development  from the mortgage and credit  lines of business.  Furthermore,  the
combined ratio,  excluding expenses  associated with  non-insurance  operations,
increased  to 61.2% for the year  ended  December  31,  1997 from  60.7% for the
comparable 1996 period. This increase is an expected result of the Corporation's
mix of business,  which is producing  more business  from lines with  relatively
higher combined ratios than that of the financial guaranty reinsurance business.
For the year ended December 31, 1997, the total federal tax provision  increased
to $26.6  million from $20.9  million for the same period in 1996.  In addition,
the effective tax rate  increased  slightly to 27.3% for the year ended December
31, 1997 from 26.8% in the same period of 1996.

Liquidity and Capital Resources

The Corporation relies on dividends from Capital  Reinsurance and Capital Credit
to fund its  payment of  dividends  on its  capital  stock and  interest  on its
outstanding  debt.  The major sources of liquidity for Capital  Reinsurance  are
funds generated from reinsurance  premiums,  net investment  income and maturing
investments.  Capital  Reinsurance  is domiciled in the State of Maryland,  and,
under Maryland

                                       48

<PAGE>

insurance  law, the amount of the surplus of Capital  Reinsurance  available for
distribution  as dividends  is subject to certain  statutory  restrictions.  The
amount  available for  distribution  from Capital  Reinsurance  during 1999 with
notice to, but without prior approval of, the Maryland Insurance Commissioner is
limited to 10% of Capital  Reinsurance's  policyholders'  surplus as of December
31, 1998, or approximately $32.3 million.  For the year ended December 31, 1998,
Capital Reinsurance paid $8.0 million in dividends to the Corporation.

Capital Credit's major sources of liquidity are funds generated from reinsurance
premiums,  net investment income and maturing  investments.  Capital Credit is a
Bermuda domiciled insurer whose distributions are governed by Bermuda law. Under
Bermuda law and the by-laws of Capital Credit,  dividends may be paid out of the
profits of the company (defined as accumulated realized profits less accumulated
realized losses).  Distributions to shareholders may also be paid out of Capital
Credit's surplus limited by requirements that such company must at all times (i)
maintain the minimum  share  capital  required  under  Bermuda law and (ii) have
relevant  assets  in an  amount  equal  to  or  greater  than  75%  of  relevant
liabilities,  all as defined  under Bermuda law.  Capital  Credit paid its first
dividend to the Corporation in October 1998 in the amount of $4.0 million.

Capital Mortgage is subject to the dividend  restrictions imposed under New York
insurance law.  Accordingly,  dividends may only be declared and distributed out
of earned surplus (as defined under New York insurance  law).  Additionally,  no
dividend may be declared or distributed by Capital  Mortgage in an amount which,
together with all dividends  declared or distributed by Capital  Mortgage during
the preceding twelve months, exceeds the lesser of 10% of such company's surplus
to policyholders  as shown by its last Annual  Statutory  Statement on file with
the New York insurance department, or 100% of adjusted net investment income (as
defined under New York  insurance  law) during such period,  unless,  upon prior
application,  the New  York  Superintendent  of  Insurance  approves  a  greater
dividend  distribution  based upon his finding that Capital Mortgage will retain
sufficient surplus to support its obligations and writings.  KRE's dividends and
distributions to its sole shareholder, Capital Mortgage, are governed by Bermuda
law and are  subject  to the same  restrictions  as  those  for  Capital  Credit
described in the preceding paragraph. To date, Capital Mortgage and KRE have not
declared  nor paid any  dividends.  The  maximum  dividend  payable  by  Capital
Mortgage  during 1999 is $0 since its earned  surplus  was ($9.2)  million as of
December 31, 1998.

Capital  Title  is  subject  to the New  York  insurance  laws  and  regulations
governing  title  insurers.  Accordingly,  dividends  may only be  declared  and
distributed  out of earned  surplus as defined under New York  insurance law and
only if such  dividends do not reduce the company's  surplus to less than 50% of
its  outstanding  capital  shares,  i.e.,  the value of its  outstanding  common
equity.  Additionally,  no dividend may be declared or  distributed in an amount
which, together with all dividends declared or distributed by the company during
the preceding twelve months,  exceeds 10% of the company's  outstanding  capital
shares, unless, after deducting such dividends,  it has a surplus at least equal
to 50% of its  statutory  reinsurance  reserve  or a surplus  at least  equal to
$250,000, whichever is greater. Capital Title did not pay a dividend in 1998. As
of December 31,  1998,  Capital  Title's  maximum  amount  payable as a dividend
during 1999 is approximately $3.6 million.

In January 1994, the Corporation formed and capitalized, through the purchase of
common shares,  Capital Re LLC.  Capital Re LLC exists solely for the purpose of
issuing preferred and common shares and lending the proceeds of such issuance to
the Corporation to fund its business operations. In January 1994, Capital Re LLC
issued  $75.0  million of company  obligated  mandatorily  redeemable  preferred
securities,  the  proceeds  of  which  were  loaned  to  the  Corporation.   The
Corporation  has,  among  other  undertakings,  unconditionally  guaranteed  all
legally declared and unpaid  dividends of Capital Re LLC. The company  obligated
mandatorily  redeemable  preferred  securities  were issued at $25 par value per
share and pay monthly dividends at a rate of 7.65% per annum.

In June 1997, Capital  Reinsurance  invested  approximately  $10.9 million for a
minority ownership interest in CGA. CGA was formed to provide financial guaranty
insurance  ("Policies")  of structured  securities,  including  commercial  real
estate and asset backed transactions.  CGA's initial capitalization consisted of
$150.5  million of paid-in  capital and $60 million of  committed  capital.  The
Corporation's  investment  consists  of  an  aggregate  of  $10.0  million  in B
Preferred  Stock and Common Stock of CGA and $1.0 million in A Preferred  Stock.
In connection with its investment in the B Preferred Stock,  Capital Reinsurance
has a commitment to invest an additional $7.5 million (the

                                       49

<PAGE>

"Capital  Commitments")  in CGA to the  extent  that  such  investment  would be
necessary  in  order  for  CGA's  operating   subsidiary,   Commercial  Guaranty
Assurance,  Ltd. ("CG  Assurance")  to maintain its triple-A  rating from Duff &
Phelps  Credit  Rating  Company  ("D&P").  Additionally,  KRE has a $20  million
outstanding  excess  of  loss  reinsurance  agreement  with CG  Assurance  which
responds  when  CG  Assurance's  credit  losses  under  Policies  reach  certain
catastrophic  levels  (including  Policies  issued in favor of the funding banks
described below). Also in June 1997, Capital  Reinsurance  invested $0.1 million
in St. George Holdings Ltd. ("St. George"). In response to market value declines
in the  insured  portfolios  of CGA and the  resulting  potential  stress on its
triple A rating from Duff & Phelps,  the  Corporation  performed  an analysis to
determine  the  appropriate  valuation  of its  investment  in CGA for the  1998
year-end reporting period. The Corporation  determined the investment in CGA had
suffered a permanent  impairment  as defined  under the  guidelines of Generally
Accepted Accounting  Principles ("GAAP").  Based on its analysis the Corporation
recorded a $7.5 million write-down.

As part of its  business  plan,  through its  operating  subsidiaries  (the "St.
George  Investment  Subsidiaries"),   St.  George  purchases  investment  grade,
asset-backed  securities  to  be  held  to  maturity,   selectively  resold,  or
repackaged   with  CG  Assurance   Policies   and  then  resold  (the   "Managed
Portfolios").  The securities purchases are funded by bank loans advanced to the
St.  George  Investment  Subsidiaries.  CG Assurance  issues  Policies to secure
repayment to the funding banks.  Under certain of the bank loan agreements,  the
St. George Investment Subsidiaries are required to provide additional collateral
to the extent the market  values of the Managed  Portfolios  fall below  certain
thresholds.  Failure to satisfy the  collateral  requirements  may result in the
liquidation  of the Managed  Portfolios  and, to the extent that  proceeds  from
liquidation are insufficient to repay the bank loans, the St. George  Investment
Subsidiaries must pay any shortfall.  If the St. George Investment  Subsidiaries
cannot pay the amount then due, CG  Assurance  is  obligated to pay such amounts
under its Policies issued in favor of the funding banks.

Due to  unprecedented  market  conditions  relating to credit spreads during the
third and fourth  quarters of 1998, the market values of the Managed  Portfolios
declined.  As of September 30, 1998, the market values of the Managed Portfolios
with collateral  threshold triggers were not then below the collateral threshold
triggers.  Subsequent to September 30, market values  further  declined  through
mid-October and, as of October 18, 1998, CG Assurance's  management  prepared an
estimate of market values of the Managed  Portfolios,  which  indicated  that if
such market  values were  validated  at the  October  30,  1998  valuation  date
provided  for in the  bank  loan  agreements,  substantial  collateral  would be
required  in the  case  of the  Managed  Portfolios  subject  to the  collateral
threshold triggers. As a result, certain institutional investors in CGA provided
credit  enhancements  on various  securities  in the Managed  Portfolios  in the
aggregate  principal amount of $382 million.  Of that aggregate amount,  Capital
Reinsurance  credit  enhanced  $74.6  million of  investment-grade  asset-backed
securities. Capital Reinsurance also credit enhanced the two other institutional
investors  that provided  credit  enhancement  on the  securities in the Managed
Portfolios. Capital Reinsurance was paid a market rate premium for providing the
reinsurance support. Market values of the Managed Portfolios have improved since
October and,  currently,  the market values of the Managed  Portfolios are above
the relevant collateral threshold triggers. Throughout this period, CG Assurance
was, and continues to be, rated triple-A by D&P.

The  Corporation's  Board of  Directors  authorized  a  quarterly  common  stock
dividend rate of $0.04 per share, or $0.16 annually. For the year ended December
31, 1998,  common stock  dividends  were declared and paid in the amount of $5.1
million or $0.16 per share.

Cash flows from  operations  for the years  ended  December  31,  1998 and 1997,
consisting of reinsurance premiums collected net of expenses,  investment income
and income taxes,  were $161.9  million and $143.4  million,  respectively.  The
Corporation  believes that current levels of cash flow from  operations  provide
the  Corporation  with  sufficient  liquidity to meet its operating  needs.  The
Corporation's  non-operating  cash  outflows  are  primarily  dedicated  to  (i)
fixed-income  investment  activity,  (ii) the payment of dividends on its common
shares, (iii) payments of interest on long-term debt and (iv) the payment of its
loan obligations to Capital Re LLC.

                                       50

<PAGE>

At December 31, 1998, cash and investments were approximately  $1.18 billion, an
increase of $162.9 million,  or 15.9%,  from $1.02 billion at December 31, 1997.
In managing its investment portfolio,  the Corporation places a high priority on
quality and liquidity.  As of December 31, 1998, the entire investment portfolio
was invested in highly rated fixed income securities.

At  December  31,  1998,   approximately   $193.6  million,  or  16.5%,  of  the
Corporation's  investment  portfolio was composed of mortgage-backed  securities
("MBS"). Of the MBS portfolio, approximately $167.5 million, or 86.5%, is backed
by agencies or entities  sponsored by the U.S.  government as to the full amount
of principal and interest. As of December 31, 1998, the entire MBS portfolio was
invested in triple A rated securities.

Prepayment  risk is an  inherent  risk of holding  MBS.  However,  the degree of
prepayment  risk is particular to the type of MBS held. The  Corporation  limits
its exposure to  prepayments  by purchasing  less  volatile  types of MBS. As of
December 31, 1998, $3.6 million, or approximately 1.9%, of the MBS portfolio was
invested in collateralized mortgage obligations ("CMOs") which are characterized
as planned  amortization  class CMOs ("PACs").  PACs are  securities  whose cash
flows are  designed to remain  constant  over a variety of  mortgage  prepayment
environments.  Other  classes in the CMO security are  structured  to accept the
volatility of mortgage prepayment changes,  thereby insulating the PAC class. Of
the  remaining  MBS  portfolio,  $190.0  million,  or  98.1%,  was  invested  in
mortgage-backed  pass-throughs or sequential CMOs.  Pass-throughs are securities
in which the monthly cash flows of principal  and interest  (both  scheduled and
prepayments) generated by the underlying mortgages are distributed on a pro-rata
basis to the holders of securities. A sequential MBS is structured to divide the
CMO security into sequentially  ordered classes.  Receipt of principal  payments
within classes is contingent on the retirement of all previously paying classes.
Generally,  interest  payments are made  currently  on all classes.  While these
securities  are more  sensitive  to  prepayment  risk  than  PACs,  they are not
considered  highly  volatile  securities.  While the  Corporation  may  consider
investing  in  any  tranche  of a  sequential  MBS,  the  individual  security's
characteristics  (duration,  relative value, underlying collateral,  etc.) along
with aggregate  portfolio risk management  determine which tranche of sequential
MBS will be purchased.  At December 31, 1998, the  Corporation had no securities
such as interest only securities, principal only securities, or MBS purchased at
a  substantial  premium to par that have the potential for loss of a significant
portion of the original  investment due to changes in the prepayment rate of the
underlying loans supporting the security.

Capital Reinsurance is party to a credit facility with Deutsche Bank AG (the "DB
Credit  Facility")  pursuant  to which  Deutsche  Bank AG  provides up to $100.0
million  specifically  designed to provide  rating agency  qualified  capital to
further support Capital Reinsurance's  claims-paying  resources.  This agreement
expires  January 27, 2006. The  Corporation has not borrowed under the DB Credit
Facility.

In addition, on August 20, 1996, the Corporation entered into a credit agreement
with Chase  Manhattan Bank for the provision of a $25.0 million credit  facility
(the  "Chase  Facility")  which is  available  for general  corporate  purposes.
Furthermore,  on August 26, 1996,  the  Corporation  utilized $16 million of the
Chase Facility for purposes of paying subordinated notes that came due. Interest
on the bank note issued under the Chase Facility is payable quarterly based upon
the  Corporation's  chosen  interest  rate  option  under the terms of the Chase
Facility. In November 1996, the Corporation utilized the remaining $9 million of
the Chase Facility for purposes of acquiring RGB.

On March 10, 1999, Moody's Investors Service, Inc. ("Moody's") announced that it
had downgraded the financial strength rating of Capital  Reinsurance to Aa2 from
Aaa. This action ended a review process that began on November 5, 1998.  Moody's
cited  increased  competition  in the monoline  financial  guaranty  reinsurance
industry,  an increased  risk profile in business  assumed and rising  operating
leverage  as  reasons  for  the  downgrade.  Under  certain  of its  reinsurance
agreements  with  two  of  its  financial  guaranty  ceding  companies,  Capital
Reinsurance  has agreed to increase  the ceding  commission  payable  under such
agreements as a result of the rating action by Moody's.  The increase will apply
to in-force and future business ceded by those  companies.  The financial impact
of the  increased  ceding  commission  with respect to the in-force  business at
December  31,  1998  is not  expected  to  exceed  $2.0  million  in  1999.  The
reinsurance  agreements with the two ceding  companies also give those companies
an


                                       51

<PAGE>

option to reassume business previously ceded to Capital Reinsurance upon certain
adverse  rating  actions;  however,  those options to fully reassume will not be
triggered by Capital  Reinsurance's March 10th downgrade.  Additionally,  one of
the ceding  companies  may  reassume a minor  portion  of its  previously  ceded
business  based on this  rating  action  alone;  however,  that  company has not
indicated that it will exercise the option.

On December 16, 1998,  Standard & Poor's ("S&P") affirmed the triple A financial
strength rating of Capital Reinsurance. In addition, S&P placed on Credit Watch,
with negative  implications,  the financial strength ratings of Capital Mortgage
(double  "A"),  KRE (double  "A"),  Capital Title (double "A" minus) and Capital
Credit  (single  "A" plus).  S&P took this  action as a result of its  perceived
uncertainty resulting from changes in management that occurred in December 1998.
Should S&P ultimately decide to downgrade the subsidiaries'  financial  strength
ratings,  certain  reinsurance  contracts could become subject to  cancellation.
However, the Corporation does not believe that a downgrade,  if any, would be of
the magnitude that would result in such cancellations.

In February  1999,  ACE Bermuda  Insurance,  Ltd., a subsidiary  of ACE Limited,
agreed to invest $75  million in the  Corporation  through a purchase  of common
stock.  The  proceeds  will be used to augment the surplus of the  Corporation's
operating  subsidiaries.  Under the stock purchase  agreement,  as amended,  the
purchase  price is  determined as the lower of (i) fully diluted GAAP book value
per share at December 31, 1998 (or $18.87 per share) and (ii) the average of the
highest five consecutive market closing prices of the Corporation's common stock
from March 12, 1999 through  April 15, 1999.  Closing is contingent on customary
conditions and the  affirmation of the S&P's financial  strength  ratings of the
Corporation's major subsidiaries.

Market Risk

The main objectives in managing the investment portfolios of the Corporation and
its operating subsidiaries are to maximize after-tax investment income and total
investment  returns while  minimizing  credit risks in order to provide  maximum
support to the reinsurance  underwriting  operations.  Investment strategies are
developed  based  on  many  factors  including   underwriting  results  and  the
Corporation's resulting tax position,  regulatory requirements,  fluctuations in
interest rates and consideration of other market risks. Investment decisions are
managed by  outside  investment  professionals  under  discretionary  investment
management  agreements  and based on guidelines  established  by management  and
approved by the board of directors.

Market risk represents the potential for loss due to adverse changes in the fair
value  of  financial   instruments.   The  market  risks  related  to  financial
instruments of the Corporation and its operating  subsidiaries  primarily relate
to the investment  portfolio,  which exposes the Corporation to risks related to
interest  rates  and,  to  a  lesser  extent,  credit  quality  and  prepayment.
Analytical  tools and  monitoring  systems  are in place to assess each of these
elements of market risk.

Interest  rate risk is the  price  sensitivity  of a fixed  income  security  to
changes in interest rates.  Management  views these  potential  changes in price
within the overall context of asset and liability management. Wherever possible,
the  duration  of asset and  liability  portfolios  are  matched.  However,  the
duration of most of the asset  portfolio  is managed  according  to the level of
expected return and volatility  deemed tolerable by management.  The duration of
the liability  portfolio does not lend itself to active duration  management due
to the low frequency,  high severity  losses in a majority of the  Corporation's
reinsured  businesses.  Other factors are considered in determining the duration
of the asset  portfolio,  which the Corporation  believes  mitigates the overall
effect of interest risk for the Corporation.

The following table provides  information about the Corporation's fixed maturity
investments  at  December  31,  1998 that are  sensitive  to changes in interest
rates.  The table presents cash flows of principal  amounts and related weighted
average  interest rates by expected  maturity dates. The cash flows are based on
the  earlier  of the call  date or the  maturity  date or,  for  mortgage-backed
securities,  expected payment patterns.  Actual cash flows could differ from the
expected amounts.



                                       52

<PAGE>

                           Long-term Fixed Maturities
                    Expected Cash Flows of Principal Amounts
                              (Dollars in millions)

<TABLE>
<CAPTION>
                                                                                                                Amortized    Market
                                                     1999      2000      2001      2002      2003   Thereafter    Cost       Value
                                                   --------  --------  --------  --------  -------- ----------  --------    --------

<S>                                                    <C>       <C>      <C>        <C>      <C>      <C>        <C>         <C>
Tax-exempt                                             $1.6      $1.8     $15.0      $9.6     $30.9    $431.0     $489.9      $526.7

    Average Interest Rate                               7.3%      5.7%      7.2%      7.3%      6.5%      5.7%        --          --

Taxable-other than mortgage-backed                     17.4      28.7      46.8      37.1      24.6     202.1      356.7       366.6
securities

    Average Interest Rate                               7.1%      7.0%      7.7%      6.7%      6.5%      5.8%        --          --

Mortgage-backed securities                             31.8      25.6      21.3      18.0      17.3      76.3      190.3       193.6

    Average Interest Rate                               7.0%      7.0%      7.0%      6.9%      6.9%      6.9%        --          --
                                                   --------  --------  --------  --------  --------  --------   --------    --------

Total                                                 $50.8     $56.1     $83.1     $64.7     $72.8    $709.4   $1,036.9    $1,086.9
                                                   --------  --------  --------  --------  --------  --------   --------    --------
</TABLE>

The Corporation and its operating  subsidiaries  have  consistently  invested in
high quality marketable  securities.  As a result, the Corporation believes that
it has minimal credit quality risk. Taxable bonds in the Corporation's  domestic
portfolio  consist of U.S.  Treasury,  government  agency,  mortgage-backed  and
corporate securities. At December 31, 1998, approximately 20.7% of taxable bonds
were issued by the U.S. Treasury or U.S.  government  agencies and approximately
83.6%  were  rated AA or better by  Moody's  or S&P.  Of the tax  exempt  bonds,
approximately 99.0% were rated AA or better with more than 90.1% rated AAA. Less
than 1.5% of the  Corporation's  bond  portfolio was below  investment  grade at
December 31, 1998. At December 31, 1998, both taxable and tax exempt bonds had a
weighted average maturity of approximately 8.9 years.

The Corporation's  taxable bond portfolio includes  mortgage-backed  securities,
which comprised 17.8% of the portfolio at year-end 1998.  Prepayment risk refers
to the changes in prepayment  patterns  that can either  shorten or lengthen the
expected  timing of the principal  repayments  and thus the average life and the
effective  yield  of  a  security.   Such  risk  exists   primarily  within  the
Corporation's portfolio of mortgage-backed  securities.  The Corporation invests
primarily in those classes of  mortgage-backed  securities that are less subject
to prepayment risk.

All of the above risks are  monitored  on an ongoing  basis.  A  combination  of
in-house  systems and proprietary  models and externally  licensed  software are
used to analyze  individual  securities as well as each  portfolio.  These tools
provide  management  with  information  to assist them in the  evaluation of the
market risks of the portfolio.




                                       53

<PAGE>

The Year 2000

The Corporation is actively pursuing its Year 2000 analysis and preparation. The
Year 2000 issue involves  potential  complications  related to computer systems,
machinery and  electronics  that contain  computer code,  whether in software or
embedded  within  microchips,  that recognize years in two digit code, e.g. "98"
for the year 1998.  Software or microchips  that recognize the Year 2000 as "00"
or any year  thereafter in its two digit  equivalent,  threatens  date sensitive
calculations by potentially  misapplying the date (e.g. "00" could be applied as
1900 rather than 2000). Any coding that causes a date recognition  error of this
sort is commonly referred to as a Year 2000 bug.

State of Readiness

The Corporation has assembled a team consisting of officers and employees of the
finance  and  information  systems  departments  to  oversee  the  Corporation's
readiness for the Year 2000. The group has already  completed the first phase of
its  analysis  in  which  a  comprehensive  list of all  the  Corporation's  own
information   technology   systems  and   general   technology   was   prepared.
Additionally,  the Corporation's clients and vendors were reviewed and a listing
was prepared of those with  information  systems or other  technology upon which
the  Corporation  may rely and those which may be affected by the Year 2000 bug.
The  Corporation has made inquiries as to Year 2000 readiness with these clients
and vendors and has received  responses from a majority of them. It is currently
evaluating these responses.  However,  all of the Corporation's ceding companies
that have thus far responded report that they expected to be Year 2000 compliant
by year-end 1998. The Corporation is now performing testing and remediation,  as
necessary,  on its information  technology systems,  its general systems and any
other  technology that may be affected by the Year 2000 bug. This process is not
yet complete, but is expected to be completed by mid-1999.

The following is a summary of the Corporation's internal readiness status:

     o    In-house Applications:  All key in-house applications have been tested
          and are Year 2000 compliant.

     o    Accounting  Software:   Vendors  for  the  major  accounting  software
          packages  used  by the  Corporation  have  stated  that  the  software
          versions the Corporation uses are Year 2000 compliant.

     o    Administration/Human Resources; Operating System Software; Network/Lan
          Utilities; Desktop Hardware: Ninety-five percent of these applications
          will be Year 2000 compliant.

     o    General  Office  Services:.  These  systems  will all be  upgraded  by
          mid-1999.

The Corporation has not had to defer any of its expected information  technology
or  other  technology  installations,   updates  or  enhancements  in  order  to
accommodate its Year 2000 review and remediation work.

Costs

Due to the youthfulness of the  Corporation's  information  technology and other
systems, testing and remediation have been fairly uncomplicated.  Moreover, none
of  the  Corporation's   technology  is  mainframe  computer  based.  Mainframes
traditionally  use older coding  methodologies  and, thus, are more likely to be
double digit dated coded. No external  consultants have been retained.  Internal
information  technology  personnel have overseen and implemented the testing and
remediation  of the  systems  and  technology.  The  amount of  additional  time
allocable to  employees'  efforts has been  nominal.  All system  upgrade  costs
incurred would have been incurred by the Corporation as part of routine software
upgrades and all patches  have been  provided  without any material  cost to the
Corporation.  The Corporation does not expect any material  additional costs and
expects that, including the cost


                                       54

<PAGE>

allocation of internal  personnel,  the overall testing and remediation  will be
less than $50,000 as originally anticipated.  The costs are being funded through
operating cash flows and will be expensed as incurred.

The Risk of the Corporation's Year 2000 Issues

A Year 2000 bug issue may manifest itself as (i) a failure of the  Corporation's
software,  systems  and  general  technology,  (ii) a failure of a  client's  or
vendor's  software or systems  which  would  impact the  Corporation,  and (iii)
insurance  claims against the  Corporation  due to Year 2000 issues.  Management
believes that the likelihood  that a failure of the  Corporation's  software and
systems  would have a material  effect on the  business  of the  Corporation  is
minimal.  The  information  technology and other systems are not critical to the
carrying-on  of  the   Corporation's   business.   Additionally,   all  critical
accounting,  financial reporting and human resources functions can be maintained
on a  manual  basis  for a  period  of  time  without  materially  impeding  the
operations of the  Corporation.  Similarly,  a failure of clients and vendors to
properly  provide  data  or  services  will  also  not  materially   affect  the
Corporation's ability to continue its operations. Such a failure would likely be
temporary  and  could be  compensated  for in the  short-term  by  using  manual
alternatives  to tracking  business  with our  clients or  vendors.  Reinsurance
losses pose the most  reasonably  likely worst case scenario for the Corporation
arising out of Year 2000 bugs. The issue would  originate with a default on debt
service  obligations  of bond  issuers  due to the  issuer's  own Year  2000 bug
difficulties.  In the event of such a default,  the Corporation's  clients,  the
ceding  companies,  will be required to make debt service  payments on behalf of
the defaulting issuers.  The Corporation will have to make prompt payment to its
clients  for its agreed  upon  portion of such  losses.  Such  defaults  by bond
issuers  would  generally  be of a technical  nature,  arising out of  temporary
inabilities to process payments or calculate payment amounts.  Additionally, the
defaulted debt service obligations would generally not require our clients,  the
ceding  insurers,  to make debt service  payments on behalf of the issuers for a
prolonged  period.  Once issuers or payment  agents have cured any errors,  they
would resume debt service  payment and  reimburse  the insurers for all payments
made.  Hence, the reasonable worst case scenario for the Corporation  under such
circumstances would involve liquidity pressure which should ease quickly.  There
is no way to quantify the  potential  exposure  under this scenario as there has
never been any event similar to the Year 2000. Consequently,  it is difficult to
make  assumptions  based  on  the  Corporation's   business.   However,  as  the
Corporation's  operating  units affected by such an occurrence  already meet the
rating  agency  stress test  requirements  designed  to simulate  depression-era
conditions, the Corporation believes it can withstand temporary defaults of that
magnitude based on the Year 2000 bug.

Contingency Plans

The  Corporation  does not have a prescribed  contingency  plan relative to Year
2000  bug  issues.  The  Corporation  does not  predict  that a  failure  of its
information  technology  systems will materially affect daily operations or have
an  immediate  impact on the  Corporation's  ability  to conduct  business.  All
internal financial reporting of the Corporation may be conducted by hand. As for
any failure of a bond issuer that has been  reinsured  by the  Corporation,  the
Corporation  expects to handle such matters in the ordinary  course of business.
As the  Corporation  is a  reinsurer,  payments  are  requested  in  bulk by the
Corporation's ceding insurers, and payment of reinsurance proceeds would be made
in bulk.  The  Corporation  is not required to make payment to  individual  bond
obligees.  Ultimately,  all  recovery  efforts in the event of any Year 2000 bug
related  event  can  either  be  handled   internally,   or  would  require  the
intervention of hardware,  software or other technology vendors. The Corporation
maintains a list of the appropriate contacts at such vendors in the event such a
need arises.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The information concerning quantitative and qualitative disclosures about market
risk is set forth in Item 7 hereof.

Item 8. Financial Statements and Supplementary Data.


                                       55



<PAGE>


                     Capital Re Corporation and Subsidiaries

                    Audited Consolidated Financial Statements



                          Year ended December 31, 1998




                                    Contents

Report of Independent Auditors.............................................   57
Consolidated Balance Sheets................................................   58
Consolidated Statements of Income..........................................   60
Consolidated Statements of Comprehensive Income............................   61
Consolidated Statements of Stockholders' Equity............................   62
Consolidated Statements of Cash Flows......................................   63
Notes to Consolidated Financial Statements.................................   64


                                       56
<PAGE>

                         Report of Independent Auditors


Board of Directors and Stockholders
Capital Re Corporation

We have  audited  the  accompanying  consolidated  balance  sheets of Capital Re
Corporation  and  Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income,  comprehensive income,  stockholders' equity,
and cash flows for each of the three  years in the  period  ended  December  31,
1998. These financial  statements are the  responsibility  of the  Corporation's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  consolidated  financial  position  of  Capital Re
Corporation and  Subsidiaries at December 31, 1998 and 1997 and the consolidated
results of their  operations and their cash flows for each of the three years in
the period ended  December 31,  1998,  in  conformity  with  generally  accepted
accounting principles.


/s/ Ernst & Young LLP

February 22, 1999
except for Note 7, as to which the date is
March 10, 1999



                                       57
<PAGE>

                     Capital Re Corporation and Subsidiaries
                           Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                    1998                 1997
                                                                                -------------------------------
                                                                              (Dollars in Thousands Except Share
                                                                                             Amounts)
<S>                                                                             <C>                  <C>       
Assets
Fixed maturity securities available for sale, at market (amortized
   cost: $1,036,862 in 1998 and $887,205 in 1997)                               $1,086,891           $  932,423
Short-term investments, at cost, which approximates market                          88,147               75,500
                                                                                -------------------------------
Total investments                                                                1,175,038            1,007,923

Cash                                                                                 9,893               14,103
Accrued investment income                                                           15,371               13,761
Deferred acquisition costs                                                         135,029              127,637
Prepaid reinsurance premiums                                                        49,603               59,942
Reinsurance recoverable on ceded losses                                              3,292                5,527
Funds held under reinsurance contracts                                               5,033                3,926
Premiums receivable                                                                 17,117                8,116
Amounts receivable on ceded annuity reserves                                        53,869               58,635
Property and equipment, at cost (net of accumulated depreciation and
   amortization of $1,286 in 1998 and $1,525 in 1997)                                1,937                1,939
Investment in affiliates                                                            15,080               21,858
Net assets of discontinued operations                                               11,695               17,046
Other assets                                                                        15,936                5,429



                                                                                -------------------------------
Total assets                                                                    $1,508,893           $1,345,842
                                                                                ===============================
</TABLE>

See accompanying notes to consolidated financial statements.



                                       58
<PAGE>

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                    1998                 1997
                                                                                -------------------------------
                                                                              (Dollars in Thousands Except Share
                                                                                             Amounts)
<S>                                                                             <C>                  <C>       
Liabilities
Deferred premium revenue                                                        $  405,866           $  373,996
Reserve for losses and loss adjustment expenses                                     87,960               27,986
Profit commission liability                                                         57,389               35,670
Ceded balances payable                                                                 120                   92
Annuity benefit reserves                                                            53,869               58,635
Accident and health reserves                                                        17,843               16,367
Bank note payable                                                                   25,000               25,000
Long-term debt                                                                      74,856               74,819
Deferred federal income taxes payable                                               79,237               72,879
Other liabilities                                                                   20,927               16,455
                                                                                -------------------------------
Total liabilities                                                                  823,067              701,899
                                                                                -------------------------------

Company obligated mandatorily redeemable preferred securities
   of Capital Re LLC                                                                75,000               75,000

Stockholders' equity:
   Preferred stock--$.01 par value per share:
     25,000,000 shares authorized; no shares issued or outstanding                      --                   --
   Common stock--$.01 par value per share:
     75,000,000 shares authorized; and 31,929,119 and 31,826,874 shares
       issued and outstanding in 1998 and 1997                                         324                  322
   Additional paid-in capital                                                      227,280              224,999
   Retained earnings                                                               355,693              319,253
   Treasury stock; 428,000 shares in 1998 and 1997
                                                                                    (4,891)              (4,891)
   Other comprehensive income
      Net unrealized gain on fixed maturity securities available for                32,520               29,392
     sale
      Net unrealized loss on foreign currency translation                             (100)                (132)
                                                                                -------------------------------
   Accumulated other comprehensive income                                           32,420               29,260
                                                                                -------------------------------
Total stockholders' equity                                                         610,826              568,943
                                                                                -------------------------------
Total liabilities, preferred securities of Capital Re LLC and
   stockholders' equity                                                         $1,508,893           $1,345,842
                                                                                ===============================
</TABLE>


                                       59
<PAGE>

                     Capital Re Corporation and Subsidiaries
                        Consolidated Statements of Income

<TABLE>
<CAPTION>
                                                                                Year ended December 31,
                                                                      1998                1997               1996
                                                                  -------------------------------------------------
                                                                   (Dollars in Thousands Except Per Share Amounts)
<S>                                                               <C>                 <C>                 <C>      
Revenues
Gross written premiums                                            $ 213,941           $ 169,943           $ 129,818
Ceded premiums                                                       (3,347)             (5,668)            (24,630)
                                                                  -------------------------------------------------
Net written premiums                                                210,594             164,275             105,188
Increase in deferred premium revenue                                (42,209)            (48,984)            (12,752)
                                                                  -------------------------------------------------
Earned premiums                                                     168,385             115,291              92,436
Net investment income                                                64,854              56,498              51,558
Net realized (losses)/gains                                          (1,506)              8,037               1,471
Other income                                                          2,394                 777                 813
Equity income in affiliates                                             818                 858                  --
                                                                  -------------------------------------------------
Total revenues                                                      234,945             181,461             146,278
                                                                  -------------------------------------------------
Expenses
Losses and loss adjustment expenses                                  86,564              15,633               9,483
Acquisition costs                                                    56,825              54,788              39,725
Increase in deferred acquisition costs                               (7,392)            (16,273)             (9,011)
Profit commission expense                                            19,225               5,111               6,008
Other operating expenses                                             11,764              11,206               9,898
Foreign exchange (gains)/losses                                         (45)                408                (385)
Interest expense                                                      7,412               7,399               6,895
Minority interest in Capital Re LLC                                   5,738               5,738               5,738
                                                                  -------------------------------------------------
Total expenses                                                      180,091              84,010              68,351
                                                                  -------------------------------------------------
    Income before provision for federal income taxes
        from continuing operations                                   54,854              97,451              77,927
Provision for federal income taxes:
   Current                                                            5,939              18,173               9,424
   Deferred                                                           4,728               8,460              11,489
                                                                  -------------------------------------------------
Total provision for federal income taxes                             10,667              26,633              20,913
                                                                  -------------------------------------------------
Net income from continuing operations                                44,187              70,818              57,014
Loss from discontinued operations                                    (2,645)               (766)               (490)
                                                                  -------------------------------------------------
Net Income                                                        $  41,542           $  70,052           $  56,524
                                                                  -------------------------------------------------
Per share data
Net income from continuing operations per share:
   Basic                                                          $    1.39           $    2.23           $    1.82
   Diluted                                                        $    1.35           $    2.18           $    1.79
Net income per common share:
   Basic                                                          $    1.30           $    2.21           $    1.81
   Diluted                                                        $    1.27           $    2.16           $    1.77
Weighted average number of shares outstanding:
   Basic                                                             31,885              31,746              31,312
   Diluted                                                           32,645              32,505              31,892

Cash dividend per common share                                    $    0.16           $    0.15           $    0.13
</TABLE>


See accompanying notes to consolidated financial statements.


                                       60
<PAGE>

                     Capital Re Corporation and Subsidiaries
                 Consolidated Statements of Comprehensive Income

<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                                         1998             1997             1996
                                                                      -------------------------------------------
                                                                                 (Dollars in Thousands)
<S>                                                                   <C>              <C>               <C>     
Net Income                                                            $ 41,542         $ 70,052          $ 56,524
Other comprehensive income, net of tax:
Change in net unrealized gain on fixed maturity securities
        available for sale                                               3,128           12,790            (5,947)
Change in foreign exchange translation                                      32             (254)              122
                                                                      -------------------------------------------
Other Comprehensive Income/(Loss)                                        3,160           12,536            (5,825)
                                                                      -------------------------------------------
Comprehensive Income                                                  $ 44,702         $ 82,588          $ 50,699
                                                                      ===========================================
</TABLE>


See accompanying notes to consolidated financial statements


                                       61
<PAGE>

                     Capital Re Corporation and Subsidiaries
                 Consolidated Statements of Stockholders' Equity


<TABLE>
<CAPTION>
                                                                                                     Net Unrealized
                                                                                                     Gain (Loss) on
                                                                                                     Fixed Maturity
                                                                      Additional                       Securities  
                                                  Preferred  Common    Paid-in   Retained    Treasury  Available   
                                                    Stock     Stock    Capital   Earnings      Stock    for Sale   
                                                  -----------------------------------------------------------------
                                                           (Dollars in Thousands Except Per Share Amounts)
<S>                                                <C>         <C>    <C>        <C>         <C>        <C>
Balance, December 31, 1995                         $           $300   $191,504   $201,228    $(3,638)   $ 22,549   
   Net income                                                                      56,524                          
   Issuance of common stock (1,706,240 shares)                   16     25,477                                     
   Exercise of stock options, including tax
     benefit (397,174 shares)                                     4      5,384                                     
   Purchase of treasury stock, at cost (14,000                                                  (232)              
     shares)
   Fixed maturity securities available for sale,
     net of tax ($3,202)                                                                                  (5,947)  
   Foreign currency translation adjustments                                                                        
   Dividend ($.13 per common share)                                                (3,945)                         
                                                  -----------------------------------------------------------------
Balance, December 31, 1996                                      320    222,365    253,807     (3,870)     16,602   
                                                  -----------------------------------------------------------------
   Net income                                                                      70,052                          
   Exercise of stock options, including tax
     benefit (161,950 shares)                                     2      2,634                                     
   Purchase of treasury stock, at cost (48,600                                                (1,021)              
     shares)
   Fixed maturity securities available for sale,
     net of tax ($6,887)                                                                                  12,790   
   Foreign currency translation adjustments                                                                        
   Dividend ($.15 per common share)                                                (4,606)                         
                                                  -----------------------------------------------------------------
Balance December 31, 1997                                       322    224,999    319,253     (4,891)     29,392   
                                                  -----------------------------------------------------------------
   Net income                                                                      41,542                          
   Exercise of stock options, including tax
     benefit
    (102,245 shares)                                              2      2,281                                     
   Fixed maturity securities available for sale,                                                           3,128   
     net of tax ($1,684)
   Foreign currency translation adjustments                                                                        
   Dividend ($.16 per common share)                                                (5,102)                         
                                                  -----------------------------------------------------------------
Balance December 31, 1998                          $           $324   $227,280   $355,693   $ (4,891)   $ 32,520   
                                                  =================================================================
</TABLE>


<TABLE>
<CAPTION>
                                                       Net
                                                    Unrealized
                                                   (Loss) Gain
                                                    on Foreign           Total
                                                     Currency         Stockholders'
                                                   Translation           Equity
                                               -----------------------------------
                                                  (Dollars in Thousands Except
                                                       Per Share Amounts)
<S>                                                  <C>               <C>      
Balance, December 31, 1995                                             $411,943 
   Net income                                                            56,524
   Issuance of common stock (1,706,240 shares)                           25,493
   Exercise of stock options, including tax
     benefit (397,174 shares)                                             5,388
   Purchase of treasury stock, at cost (14,000                             (232)
     shares)
   Fixed maturity securities available for sale,
     net of tax ($3,202)                                                 (5,947)
   Foreign currency translation adjustments            122                  122
   Dividend ($.13 per common share)                                      (3,945)
                                               -----------------------------------
Balance, December 31, 1996                             122              489,346
                                               -----------------------------------
   Net income                                                            70,052
   Exercise of stock options, including tax
     benefit (161,950 shares)                                             2,636
   Purchase of treasury stock, at cost (48,600                           (1,021)
     shares)
   Fixed maturity securities available for sale,
     net of tax ($6,887)                                                 12,790
   Foreign currency translation adjustments           (254)                (254)
   Dividend ($.15 per common share)                                      (4,606)
                                               -----------------------------------
Balance December 31, 1997                             (132)             568,943
                                               -----------------------------------
   Net income                                                            41,542
   Exercise of stock options, including tax                          
     benefit                                                         
    (102,245 shares)                                                      2,283
   Fixed maturity securities available for sale,                          3,128
     net of tax ($1,684)                                             
   Foreign currency translation adjustments             32                   32
   Dividend ($.16 per common share)                                      (5,102)
                                               -----------------------------------
Balance December 31, 1998                            $(100)            $610,826
                                               ===================================
</TABLE>


See accompanying notes to consolidated financial statements.


                                       62
<PAGE>

                     Capital Re Corporation and Subsidiaries
                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                    1998                 1997                 1996
                                                              -----------------------------------------------------
                                                                               (Dollars in Thousands)
<S>                                                           <C>                  <C>                  <C>        
Operating activities
Net income                                                    $    41,542          $    70,052          $    56,524
Adjustments to reconcile net income to net cash
   provided by operating activities:
     Net amortization of investment security discounts             (1,012)                 348                  293
     Provision for deferred federal income taxes                    4,674                7,518               11,489
     Acquisition costs deferred                                   (56,825)             (54,788)             (39,725)
     Amortization of deferred acquisition costs                    49,433               38,516               30,714
     Equity income in affiliates                                     (818)                (858)                  --
     Change in accrued investment income                           (1,610)              (1,474)              (2,806)
     Change in premiums receivable                                 (9,001)              (2,322)              12,113
     Change in deferred premium revenue, net                       42,209               48,984               12,752
     Change in reserve for losses and loss adjustment
       expenses, net                                               62,209                4,390                7,810
     Net realized losses/(gains) on investments                     1,506               (8,037)              (1,471)
     Change in ceded balances payable                               8,098                2,103               (9,594)
     Change in accident and health reserves                         1,476               16,367                   --
     Other                                                          7,209               15,908               18,186
     Discontinued operations, net                                  12,846                6,730               (2,162)
                                                              -----------------------------------------------------
Net cash provided by operating activities                         161,936              143,438               94,122
                                                              -----------------------------------------------------

Investing activities
Fixed maturity securities available-for-sale:
   Purchases                                                     (775,087)          (1,868,917)            (741,415)
   Sales                                                          622,897            1,789,418              589,143
   Maturities                                                       9,635                   --                6,280
Purchases of short-term investments, net                          (12,647)                 (76)               8,686
Investment in affiliates                                               --              (11,000)             (10,000)
Other investing activities                                           (615)             (43,500)              42,211
Discontinued operations, net                                       (7,320)              (5,553)             (24,354)
                                                              -----------------------------------------------------
Net cash used in investing activities                            (163,137)            (139,627)            (129,451)
                                                              -----------------------------------------------------
Financing activities
Net proceeds from sale of stock                                        --                   --               25,493
Net proceeds from exercise of stock options                         2,283                2,636                5,388
Net proceeds from issuance of notes payable                            --                   --                9,000
Purchase of treasury stock, at cost                                    --               (1,021)                (232)
Dividends paid                                                     (5,102)              (4,606)              (3,945)
Discontinued operations, net                                         (190)                 (23)               8,395
                                                              -----------------------------------------------------
Net cash (used in) provided by financing activities                (3,009)              (3,014)              44,099
                                                              -----------------------------------------------------
(Decrease)/increase in cash                                        (4,210)                 797                8,769
Cash at beginning of year                                          14,103               13,306                4,537
                                                              -----------------------------------------------------
Cash at end of year                                           $     9,893          $    14,103          $    13,306
                                                              =====================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                       63
<PAGE>

1.   Business and Organization

Capital Re Corporation  (the  "Corporation")  was  incorporated  in the State of
Delaware  in  December  1991,  and is the  successor  by  merger  to a  Maryland
corporation  incorporated  in 1986.  The  Corporation  is an  insurance  holding
company and has five wholly-owned  operating  subsidiaries.  Capital Reinsurance
Company ("Capital Reinsurance"),  domiciled in the state of Maryland,  commenced
operations in January 1988.  Capital  Reinsurance  is engaged in the business of
financial  guaranty  reinsurance,  primarily  the  reinsurance  of municipal and
nonmunicipal  bond  obligations.  Capital  Reinsurance  also sells municipal and
nonmunicipal  credit risk protection  through credit default swap  transactions.
Capital Mortgage Reinsurance Company ("Capital Mortgage"),  a New York domiciled
company,  commenced operations in February 1994. Capital Mortgage reinsures only
residential  mortgage  guaranty  insurance   obligations  which  are  originated
principally in the United States and the United Kingdom.  KRE Reinsurance,  Ltd.
("KRE"), a Bermuda domiciled company, commenced operations in March 1994. KRE is
engaged in the business of reinsuring financial guaranty, mortgage guaranty, and
trade  credit  insurance  both as a  direct  reinsurer  of third  party  primary
insurers and as a  retrocessionaire  of Capital  Reinsurance,  Capital Mortgage,
Capital Credit  Reinsurance  Company,  Ltd. ("Capital Credit") and Capital Title
Reinsurance Company ("Capital Title").  KRE also provides  integrated  financial
solutions in the form of structured  reinsurance products to accident and health
insurers and specialty  property and casualty insurers.  Capital Credit,  also a
Bermuda  domiciled  insurance  company,  commenced  operations in February 1990.
Capital Credit reinsures trade credit and political risk insurance  concentrated
in Western  Europe  and the United  States,  and is also a  retrocessionaire  of
Capital  Reinsurance and Capital  Mortgage.  Capital Title, a New York domiciled
insurance company,  commenced operations in March 1996. Capital Title is engaged
in the business of reinsuring title insurance policies.

In November  1996, the  Corporation  acquired 100% of the issued shares of Tower
Street Holdings  Limited (now known as RGB Holdings,  Ltd.), the holding company
for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a Lloyd's managing agency and
presently  manages four syndicates  operating in the Lloyd's of London insurance
market. In connection with its acquisition of RGB, the Corporation established a
corporate  name  at  Lloyd's.  In  1998  the  Corporation  commenced  a plan  of
divestiture of its Lloyd's  operations  and those  operations are presented as a
discontinued  operation.  See Note 3. Pending divestiture,  the Corporation will
continue to support its  commitments  to Lloyd's.  See Note 16. For  comparative
purposes, all prior period financial statements have been restated.

In June 1997, the Corporation invested  approximately $10.9 million in CGA Group
Ltd ("CGA"),  a Bermuda domiciled  insurance company formed to provide financial
guaranty insurance of structured  securities,  including  commercial real estate
and asset-backed  transactions.  The Corporation's investment was in the form of
common and preferred shares.

In December  1996,  the  Corporation  entered  into a joint  venture with Global
Capital Reinsurance  Limited,  ("GCR") to form a Bermuda based insurer,  Capital
Global  Underwriters  Limited  ("CGUL"),  which  specializes in financial  lines
reinsurance.  In April 1997,  GCR was acquired by EXEL  Limited.  In March 1998,
EXEL sold its share of CGUL to Bermuda  based ACE Bermuda  Insurance,  Ltd.  and
CGUL was renamed ACE Capital Re Ltd. The  Corporation,  through KRE,  owns a 50%
economic  interest in ACE Capital Re Ltd. and controls 9.9% of its voting stock.
The  Corporation  accounts for its  investment in ACE Capital Re Ltd.  under the
equity method.


                                       64
<PAGE>

2.   Significant Accounting Policies

Basis of Presentation

The  accompanying  consolidated  financial  statements  include the accounts and
operations of the Corporation and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.

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

The 1997 and 1996 financial  statements  have been  reclassified to conform with
the 1998 presentation.

Significant accounting policies are as follows:

     Discontinued  Operations:  During 1998, the Corporation commenced a plan of
     divestiture of it Lloyd's operations. As a result, the related subsidiaries
     of the  Corporation  have been  classified as  discontinued  operations and
     prior period results have been restated for  comparative  purposes.  Unless
     otherwise noted, all footnote  disclosures  reflect  continuing  operations
     only.

     Investments in Securities:  The Corporation accounts for its investments in
     fixed maturity  securities in accordance with FASB Statement No. 115 ("SFAS
     115"),  "Accounting for Certain Investments in Debt and Equity Securities".
     Management  determines the appropriate  classification of securities at the
     time of  purchase.  At  December  31,  1998 and 1997  investments  in fixed
     maturity securities were designated as available-for-sale.

     The   Corporation   invests  in   mortgage-backed   securities,   including
     collateralized mortgage obligations.  The Corporation recognizes income for
     these  securities  using a constant  effective  yield based on  anticipated
     prepayments and the estimated economic life of the securities.  When actual
     prepayments  differ   significantly  from  anticipated   prepayments,   the
     effective  yield is  recalculated  to reflect  actual  payments to date and
     anticipated future payments. The net investment in the security is adjusted
     to the amount  that would have  existed  had the new  effective  yield been
     applied since the acquisition of the security.  That adjustment is included
     in net investment income. Short-term investments are carried at cost, which
     approximates market value. Realized gains and losses on sale or maturity of
     investments  and  declines in value judged to be  other-than-temporary  are
     determined by specific identification and included in net realized gains.

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


                                       65
<PAGE>

2.   Significant Accounting Policies (continued)

     Premium Revenue Recognition:  All premiums are earned over the terms of the
     risks covered under the  Corporation's  reinsurance  contracts.  Generally,
     premiums  are  received  either  in  full  at  contract   inception  or  in
     installments over the life of the covered risk. Financial guaranty premiums
     are  typically  received  entirely at contract  inception.  For purposes of
     earnings  recognition,  premiums are  allocated to each year in the term of
     the guaranty and are earned  pro-rata over the period of risk.  Receipts of
     installment premiums for financial guaranty and all other lines of business
     are generally earned on monthly pro-rata basis over the installment period.

     Deferred  Acquisition Costs:  Acquisition costs include only those expenses
     that relate to, and vary with, premium production,  including  commissions,
     brokerage and costs of underwriting  and marketing  personnel.  Acquisition
     costs are  deferred  and  amortized  over the  period in which the  related
     premiums are earned.  Ceding  commission  income on premiums ceded to other
     reinsurers reduces  acquisition costs.  Anticipated losses, loss adjustment
     expenses and the  remaining  costs of servicing  the  reinsured  issues are
     considered in determining the recoverability of acquisition costs.

     Losses  and  Loss  Adjustment  Expenses:  The  liability  for loss and loss
     adjustment   expenses  is  determined   according  to   management's   loss
     expectations  which are based on historical  loss  development  patterns as
     well  as  reports  and  individual  case  estimates  received  from  ceding
     companies  where  applicable.  An estimate is also  provided for losses and
     loss  adjustment  expenses for  incurred  but not  reported  losses for the
     mortgage  guaranty and trade  credit  lines of  business.  Incurred but not
     reported  losses are not  estimated  for the  financial  guaranty and title
     reinsurance  lines of business since they are  underwritten  to a zero loss
     standard.  Financial  guaranty  loss  and  loss  adjustment  expenses  were
     discounted using an average rate of 5.5% in 1998 and 6.4% in 1997.

     Contingent  Commissions:  Under the terms of certain  of the  Corporation's
     reinsurance  contracts,  the  Corporation  is  obligated  to pay the ceding
     company a contingent  commission  based upon a specified  percentage of the
     net  underwriting   profits.   As  of  December  31,  1998  and  1997,  the
     Corporation's  liability for the present value of expected  future payments
     is  shown  on the  balance  sheet  under  the  caption  "Profit  commission
     liability."

     Stock Based  Compensation:  The Corporation grants stock options to certain
     employees for a fixed number of shares with an exercise  price equal to the
     fair value of the shares at the date of grant. The Corporation accounts for
     stock option grants in accordance with APB Opinion No. 25,  "Accounting for
     Stock Issued to Employees,"  and,  accordingly,  recognizes no compensation
     expense for the stock option grants.


                                       66
<PAGE>

2.   Significant Accounting Policies (continued)

     Income Taxes:  In accordance  with FASB Statement No. 109,  "Accounting for
     Income Taxes,"  deferred federal income taxes are provided on the temporary
     difference  between the tax basis of an asset or liability and its reported
     amount in the  financial  statements  that will  result  in  deductible  or
     taxable  amounts in future years when the  reported  amount of the asset or
     liability  is  recovered  or settled.  Such  temporary  differences  relate
     principally to premium revenue recognition, deferred acquisition costs, and
     contingency  reserve.  The Internal Revenue Code permits  companies writing
     financial guaranty insurance and mortgage guaranty insurance to deduct from
     taxable income amounts added to the statutory contingency reserve,  subject
     to certain  limitations.  The amounts  deducted must be included in taxable
     income in the  tenth or  twentieth  year  following  the year of  deduction
     dependent on the type of  business,  or in the event that  incurred  losses
     exceed certain  statutorily  established levels and the contingency reserve
     is released to cover such excess losses. However, the tax benefits obtained
     from  such  deductions  must  be  invested  in   noninterest-bearing   U.S.
     Government tax and loss bonds. The Corporation records purchases of tax and
     loss bonds as payments of federal income taxes.

     Earnings Per Share:  Basic  earnings per share is  calculated  based on the
     weighted  average  common  shares  outstanding.  All  potentially  dilutive
     securities  such as stock options are excluded from the basic  earnings per
     share calculation. In calculating diluted earnings per share, the number of
     shares  outstanding  is  increased  to  include  all  potentially  dilutive
     securities.  Basic and  diluted  net income  per share of common  stock are
     computed by dividing net income by the applicable  weighted  average number
     of shares of common stock outstanding during each year.

     For the years  ended  1998,  1997 and  1996,  and in order to arrive at the
     number of weighted  average diluted shares  outstanding of 32,645,  32,505,
     and 31,892,  employee stock option awards in the amount of 760, 759 and 580
     were added to weighted average common shares outstanding for basic earnings
     per share of 31,885,  31,746,  and  31,312,  respectively.  All figures are
     reported in thousands.


                                       67
<PAGE>

3.   Discontinued Operations

As mentioned in Note 1, the  Corporation  has commenced a plan of divestiture of
its Lloyd's  operations.  The sale is expected to be completed  during 1999. The
Corporation's commitments to Lloyd's are described in Note 16.

The results were as follows:

                                                Years Ending December 31,
                                            1998           1997           1996
                                         --------------------------------------
                                                  (Dollars in Thousands)
Total Revenues                           $ 56,437       $ 20,263        $  138
Total Losses and Expenses                  59,089         21,063           628
                                         --------------------------------------
Loss Before Taxes                          (2,652)         (800)          (490)
Income Taxes                                   (7)          (34)             0
                                         --------------------------------------
Loss from Discontinued Operations        $ (2,645)      $  (766)        $ (490)


The assets and liabilities of the  discontinued  operations at December 31, 1998
were:

Cash and Investments                      $ 20,689
Deferred Acquisition Costs                  19,727
Reinsurance Balances                        50,052
Other Assets                                40,768
                                         ----------
   Total Assets                           $131,236

Deferred Premium Revenue                   $54,990
Loss and LAE Reserves                       55,664
Other Liabilities                           14,727
                                         ----------
   Total Liabilities                      $125,381

Net Assets                                  $5,855
Payable to Capital Re Corp                   5,840
                                         ----------
Net Assets of Discontinued Operation      $ 11,695


                                       68
<PAGE>

4.   Accounting Developments

In June 1997, the FASB issued SFAS No. 130,  "Reporting  Comprehensive  Income,"
which is effective for fiscal years  beginning after December 15, 1997. SFAS No.
130 establishes  standards for the reporting item, termed comprehensive  income,
which  will  combine  net  income  and  certain  items  that   directly   affect
stockholders'  equity,  such  as net  unrealized  gain/loss  on  fixed  maturity
securities available for sale and foreign currency translation adjustments.  The
Corporation has elected to report  comprehensive income in a separate statement.
SFAS No.  130 will have no impact  on the  financial  condition  or  results  of
operations of the Corporation.

In June 1997, the FASB also issued SFAS No. 131,  "Disclosures about Segments of
an  Enterprise  and Related  Information",  which is effective  for fiscal years
beginning  after  December  15, 1997,  and  supersedes  SFAS No. 14,  "Financial
Reporting for Segments of a Business  Enterprise."  SFAS No. 131 establishes new
standards for defining how operating  segments are  determined and requires more
comprehensive disclosures about the Corporation's reportable operating segments.
The Corporation's segment information is reported in Note 10.

In June 1998,  The FASB issued  Statement No. 133,  "Accounting  for  Derivative
Instruments  and Hedging  Activities,"  which is required to be adopted in years
beginning  after June 15,  1999.  The  Statement  will  require  the  Company to
recognize all derivatives on the balance sheet at fair value.  Derivatives  that
are not hedges must be adjusted to fair value through income.  If the derivative
is a hedge,  depending on the nature of the hedge,  changes in the fair value of
derivatives  will  either be offset  against the change in the fair value of the
hedged assets,  liabilities,  or firm commitments through earnings or recognized
in other comprehenstive  income until the hedged item is recognized in earnings.
The  ineffective  portion  of a  derivative's  change  in  fair  value  will  be
immediately recognized in earnings.  Management has determined that it is likely
that its credit  default swap  business will be subject to the  requirements  of
SFAS 133. The  Corporation is in the process of  determining  what the effect of
Statement 133 will be on its earnings and financial position.

5.   Statutory Accounting Practices

The  financial  statements  are prepared on the basis of GAAP,  which differs in
certain  respects  from  accounting  practices  prescribed  or  permitted by the
Maryland Insurance  Administration and the Insurance  Department of the State of
New York (the  insurance  departments  in the  states  of  domicile  of  Capital
Reinsurance and Capital  Mortgage and Capital Title,  respectively),  as well as
the statutory  requirements  of the Minister of Finance of the Island of Bermuda
(place of domicile of Capital Credit and KRE).  Statutory  accounting  practices
for the Corporation's insurance subsidiaries differ from GAAP as follows:

     Acquisition costs are charged to current operations as incurred rather than
     as related premiums are earned;

     A  contingency  reserve is computed on the basis of statutory  requirements
     regardless of when loss contingencies actually exist;

     A title  statutory  premium  reserve  is  established  based  upon  assumed
     exposure regardless of when loss contingencies actually exist;


                                       69
<PAGE>

5.   Statutory Accounting Practices (continued)

     Federal  income taxes are only provided on taxable  income for which income
     taxes are currently  payable,  while under GAAP,  deferred income taxes are
     provided with respect to temporary differences;

     Purchases  of tax and loss bonds are  reflected as admitted  assets,  while
     under GAAP they are recorded as federal income tax payments;

     Financial  guaranty premiums are earned in direct proportion to the payment
     of debt service rather than pro-rata over the period of risk;

     Investments in fixed maturity  securities are reported at amortized cost or
     market value based on the National  Association of Insurance  Commissioners
     ("NAIC") rating;  under GAAP, these fixed maturity  investments are carried
     in accordance with SFAS 115 (see Note 2);

     Certain assets  designated as "nonadmitted  assets" are charged directly to
     statutory capital and surplus, but are reflected as assets under GAAP.


The following is a reconciliation  of the  Corporation's  consolidated  GAAP net
income and  stockholders'  equity to the  corresponding  consolidated  statutory
amounts for its insurance subsidiaries:

                                                    Year ended December 31,
                                                 1998        1997        1996
                                              ---------------------------------
                                                    (Dollars in Thousands)

Consolidated GAAP net income                  $ 41,542    $ 70,052    $ 56,524
Premium revenue recognition                    (14,168)       (899)    (14,851)
Deferred acquisition costs                      (7,392)    (16,273)     (9,011)
Deferral of income taxes                         4,728       8,460      11,489
Tax and loss bonds                                           1,581       4,848
Interest expense and minority interest in
   Capital Re LLC                               13,150      13,137      12,633
Other, including noninsurance subsidiaries      (5,219)     (5,876)     (4,091)
                                              =================================
Consolidated statutory net income             $ 32,641    $ 70,182    $ 57,541
                                              =================================


                                       70
<PAGE>

5.   Statutory Accounting Practices (continued)

                                                               December 31,
                                                             1998        1997
                                                         ----------------------
                                                          (Dollars in Thousands)

GAAP stockholders' equity                                $ 610,826    $ 568,943
Premium revenue recognition                                (60,851)     (44,345)
Deferred acquisition costs                                (135,029)    (127,637)
Unrealized gain on fixed maturity securities
   available-for-sale                                      (50,029)     (45,218)
Deferral of income taxes                                    79,237       72,879
Tax and loss bonds                                          18,737
Contingency reserve                                       (211,455)    (162,250)
Long-term debt and Company obligated mandatorily
    redeemable preferred securities of Capital Re LLC      174,856      174,819
Net assets of discontinued operations                      (11,695)     (17,046)
Other, including noninsurance subsidiaries                     (89)      (3,764)
                                                         ----------------------
Consolidated statutory policyholders' surplus            $ 395,771    $ 435,118
                                                         ======================


6. Insurance in Force--Financial Guaranty and Mortgage Guaranty

Financial Guaranty: At December 31, 1998, the Corporation's  reinsured financial
guaranty  portfolio  included the reinsured  portfolios of Capital  Reinsurance,
Capital Credit and KRE, net of eliminations and was broadly  diversified by bond
type,   geographic   location  and  maturity  schedule,   with  no  single  risk
representing  more  than  1.72%  of the  Corporation's  net  par in  force.  The
Corporation limits its exposure to losses from reinsured financial guarantees by
underwriting primarily investment grade obligations and retroceding a portion of
its risks to other insurance companies.

Net financial guaranty par in force was approximately  $57.0 billion at December
31, 1998.  The  composition at December 31, 1998, by type of issue and the range
of final maturities, was as follows:
                                                             Range of Final
       Type of Issue                     Net Par in Force      Maturities
       -------------------------------------------------------------------------
                                                (Dollars in Billions)
       Tax-backed                                   $15.8       1-40 years
       Utility                                       15.0       1-40 years
       Nonmunicipal                                  13.0       1-35 years
       Special revenue                                6.4       1-40 years
       Health care                                    6.1       1-40 years
       Housing                                         .7       1-40 years
                                                    -----
                                                    $57.0
                                                    =====


                                       71
<PAGE>

6.   Insurance in Force--Financial Guaranty and Mortgage Guaranty (continued)


The reinsured portfolio contained exposures in each of the 50 states. Net par in
force at December 31, 1998, by state, was as follows:

       State                                   Net Par in Force
       ---------------------------------------------------------
                                            (Dollars in Billions)

       California                                    $ 6.1
       New York                                        5.6
       Florida                                         2.9
       Texas                                           2.9
       Pennsylvania                                    2.2
       New Jersey                                      2.0
       Illinois                                        1.9
       Massachusetts                                   1.8
       Puerto Rico                                     1.6
       Ohio                                            1.4
       Washington                                      1.4
       Others (each less than 2%)                     27.2
                                                     -----
                                                     $57.0
                                                     =====


As part of its financial  guaranty  business,  the  Corporation  participates in
credit default swap transactions whereby one counterparty pays a periodic fee in
fixed basis points on a notional  amount in return for a  contingent  payment by
the other  counterparty  in the event one or more defined  credit  events occurs
with respect to one or more third party reference secuirities or loans. A credit
event is defined as failure to pay,  bankruptcy,  cross acceleration  (generally
accompanied  by  a  failure  to  pay),  repudiation,  restructuring  or  similar
nonpayment  event. The total notional amount of credit default swaps outstanding
at  December  31,  1998 and  included in the  Corporation's  financial  guaranty
exposure above was $6.8 billion.

Mortgage Guaranty: At December 31, 1998, the Corporation's net mortgage guaranty
insurance in force  (representing  the current principal balance of all mortgage
loans that are  currently  reinsured)  and direct  primary net risk in force was
approximately $7.6 billion and $2.4 billion, respectively. California represents
the Corporation's largest U.S. risk concentration at approximately 23%, however,
its total U.S. distribution of mortgage guaranty risk in force parallels that of
the U.S. primary mortgage insurance industry.


                                       72
<PAGE>

7.   Financial Strength Ratings

On March 10, 1999, Moody's Investors Service, Inc. ("Moody's") announced that it
had downgraded the financial strength rating of Capital  Reinsurance to Aa2 from
Aaa. This action ended a review process that began on November 5, 1998.  Moody's
cited  increased  competition  in the monoline  financial  guaranty  reinsurance
industry,  an increased  risk profile in business  assumed and rising  operating
leverage as the  reasons for the  downgrade.  Under  certain of its  reinsurance
agreements  with  two  of  its  financial  guaranty  ceding  companies,  Capital
Reinsurance  has agreed to increase  the ceding  commission  payable  under such
agreements as a result of the rating action by Moody's.  The increase will apply
to in-force and future business ceded by those  companies.  The financial impact
of the  increased  ceding  commission  with respect to the in-force  business at
December  31,  1998  is not  expected  to  exceed  $2.0  million  in  1999.  The
reinsurance  agreements with the two ceding  companies also give those companies
an option to reassume  business  previously  ceded to Capital  Reinsurance  upon
certain  adverse rating actions;  however,  those options to fully reassume will
not be triggered by Capital  Reinsurance's  March 10th downgrade.  Additionally,
one of the ceding companies may reassume a minor portion of its previously ceded
business  based on this  rating  action  alone;  however,  that  company has not
indicated that it will exercise the option.

On December 16, 1998,  Standard & Poor's ("S&P") affirmed the triple A financial
strength rating of Capital Reinsurance.  In addition, S&P placed on Credit Watch
with negative  implications,  the financial strength ratings of Capital Mortgage
(double  `A'),  KRE (double `A'),  Capital  Title (double  `A'minus) and Capital
Credit  (single  `A' plus).  S&P took this  action as a result of its  perceived
uncertainty resulting from changes in management that occurred in December 1998.
Should S&P ultimately decide to downgrade the subsidiaries'  financial  strength
ratings,  certain  reinsurance  contracts could become subject to  cancellation.
However, the Corporation does not believe that a downgrade,  if any, would be of
the magnitude that would result in such cancellations.



                                       73
<PAGE>

8.   Investments in Securities

The following  summarizes the Corporation's  aggregate  investment  portfolio at
December 31, 1998:

<TABLE>
<CAPTION>
                                                                   Gross        Gross
                                               Amortized        Unrealized   Unrealized         Estimated
                                                  Cost             Gains        Losses          Fair Value
                                              ------------------------------------------------------------
                                                                (Dollars in Thousands)
<S>                                           <C>              <C>           <C>                <C>       
  Fixed maturity securities available-for-sale:
       U.S. Treasury securities and
         obligations of U.S. government
         agencies                             $  109,323       $    6,646    $    (294)         $  115,675
       Obligations of states and
         political subdivisions                  489,932           37,091         (338)            526,685
       Corporate securities                      158,739            3,972         (569)            162,142
       Mortgage-backed securities                190,284            3,362          (26)            193,620
       Asset-backed                               66,159            1,466          (76)             67,549
       Emerging markets                           12,247              103         (689)             11,661
       Other                                      10,178                3         (620)               9559
                                              ------------------------------------------------------------
  Total available-for-sale                     1,036,862           52,643       (2,612)          1,086,891

  Short-term investments                          88,147                                            88,147
                                              ------------------------------------------------------------
  Total investments                           $1,125,007       $   52,643    $  (2,612)         $1,175,038
                                              ============================================================
</TABLE>


The following  summarizes the Corporation's  aggregate  investment  portfolio at
December 31, 1997:

<TABLE>
<CAPTION>
                                                                   Gross        Gross
                                               Amortized        Unrealized   Unrealized         Estimated
                                                  Cost             Gains        Losses          Fair Value
                                              ------------------------------------------------------------
                                                                (Dollars in Thousands)
<S>                                           <C>              <C>           <C>                <C>       
  Fixed maturity securities available-for-sale:
       U.S. Treasury securities and
         obligations of U.S. government
         agencies                             $   85,977       $   4,089     $    (13)          $   90,053
       Obligations of states and
         political subdivisions                  453,326          34,370            -              487,696
       Corporate securities                      112,595           2,759         (142)             115,212
       Mortgage-backed securities                152,720           2,758          (35)             155,443
       Asset-backed                               64,050           1,477           (9)              65,518
       Emerging markets                           18,537             160         (196)              18,501
                                              ------------------------------------------------------------
  Total available-for-sale                       887,205          45,613         (395)             932,423
  Short-term investments
                                              ------------------------------------------------------------
  Total investments                               75,500               -            -               75,500
                                              ------------------------------------------------------------
                                              $  962,705       $  45,613     $   (395)          $1,007,923
                                              ============================================================
</TABLE>


8.   Investments in Securities (continued)

The  amortized  cost and  estimated  fair  value of  fixed  maturity  securities
available-for-sale  at December  31,  1998,  by  contractual  maturity are shown
below.  Expected  maturities  will differ from  contractual  maturities  because
borrowers may have the right to call or prepay  obligations with or without call
or prepayment penalties.

                                       Amortized Cost       Fair Value
                                       -------------------------------
                                             (Dollars in Thousands)
Maturity:
   Due in 1999-2003                     $  138,517          $  139,476
   Due in 2004-2008                        131,149             135,588
   Due after 2008                          576,912             618,207
   Mortgage-backed securities              190,284             193,620
                                       ===============================
Total                                   $1,036,862          $1,086,891
                                       ===============================


In 1998,  the  Corporation  realized  gross gains and losses of $8.8 million and
($10.3)  million,  respectively.  Included in realized losses was a $7.5 million
write-down in the  Corporation's  investment  in common and preferred  shares of
CGA,  based on  management's  belief that its  investment  in CGA had suffered a
permanent  impairment.  After  the  write-down,  the  carrying  value of the CGA
investment was $3.4 million.  In 1997, the Corporation  realized gross gains and
losses  of  $12.4  million  and  ($4.4)  million,  respectively.  In  1996,  the
Corporation  realized gross gains and losses of $8.5 million and ($7.0) million,
respectively.

Approximately  16.4% of the  Corporation's  total  investment  portfolio of $1.2
billion at December 31, 1998 is comprised of mortgage-backed securities ("MBS"),
including  collateralized  mortgage  obligations.  Of the  securities in the MBS
portfolio,  approximately  86.5% are backed by agencies or entities sponsored by
the U.S.  government.  As of December 31,  1998,  the  weighted  average  credit
quality of the Corporation's entire investment portfolio was AA+.

Net investment income is derived from the following sources:

                                                     Year ended December 31,
                                                  1998        1997        1996
                                               --------------------------------
                                                     (Dollars in Thousands)

Income from fixed maturity securities          $ 61,678    $ 51,187    $ 46,207
Income from short-term investments                4,699       6,834       6,351
                                               --------------------------------
Total investment income                          66,377      58,139      52,558
Less investment expenses                         (1,523)     (1,523)     (1,000)
                                               --------------------------------
Net investment income                          $ 64,854    $ 56,498    $ 51,558
                                               ================================

Under agreements with its cedants and in accordance with statutory requirements,
certain of the Corporation's  subsidiaries maintain fixed maturity securities in
trust accounts for the benefit of


                                       74
<PAGE>

8.   Investments in Securities (continued)

reinsured  companies and for the protection of  policyholders in states in which
they are not licensed.  The carrying amount of such restricted balances amounted
to approximately $109.2 million and $87.3 million at December 31, 1998 and 1997,
respectively. Additionally, at December 31, 1998 and 1997, $4.5 million and $4.1
million,  respectively,  was on deposit  with  state  insurance  departments  to
satisfy regulatory requirements.

9.   Reserves for Unpaid Losses and Loss Adjustment Expenses

The  following  table  provides a  reconciliation  of the  beginning  and ending
reserve balances for unpaid losses and loss adjustment expenses ("LAE").

<TABLE>
<CAPTION>
                                                                       Year ended December 31,
                                                                   1998          1997           1996
                                                                -------------------------------------
                                                                        (Dollars in Thousands)
<S>                                                             <C>           <C>            <C>     
Reserve for losses and LAE, net of related
   reinsurance recoverables, at beginning of year               $ 22,555      $ 17,759       $ 10,245
Add:
   Provision for unpaid losses and LAE for claims
     occurring in the current year, net of                        68,350        13,784          8,370
     reinsurance
   Increase in estimated losses and LAE for claims
     occurring in prior years, net of reinsurance                  6,832         1,849          1,113
                                                                -------------------------------------
   Incurred losses during the current year, net of
     reinsurance                                                  75,182        15,633          9,483
                                                                -------------------------------------
Deduct:
   Losses and LAE payments (net of recoverables) for
     claims occurring in the current year                          2,507           985             10
   Losses and LAE payments (net of recoverables) for
     claims occurring in the prior year                           10,676         9,852          1,959
                                                                -------------------------------------
Total                                                             13,183        10,837          1,969
                                                                -------------------------------------
Reserve for unpaid losses and LAE, net of related
   reinsurance recoverables, at end of year                       84,554        22,555         17,759
Unrealized foreign exchange loss (gain) on reserve
   revaluation                                                       114           (96)           310
Reinsurance recoverables on unpaid losses and LAE,
   at end of year                                                  3,292         5,527          1,833
                                                                -------------------------------------
Reserve for unpaid losses and LAE, gross of
   reinsurance recoverables on unpaid losses at end
   of year                                                      $ 87,960      $ 27,986       $ 19,902
                                                                =====================================
</TABLE>


The  increase in incurred  losses in 1998 were  principally  from two  financial
guaranty  losses in the amounts of $10.0 million and $44.1  million,  as well as
expected losses in the mortgage guaranty,  trade credit and financial  solutions
reinsurance  lines of business.  The financial  guaranty losses incurred in 1998
related to two discrete  reinsured bond issuances.  The $10 million loss was for
bonds issued by a now bankrupt  hospital  system while the $44.1 million was for
losses expected on securities  backed by charged off credit cards.  During 1997,
incurred losses were principally



                                       75
<PAGE>

9.   Reserves for Unpaid Losses and Loss Adjustment Expenses (continued)

from the  mortgage  guaranty  and trade  credit  reinsurance  lines of business.
Incurred losses in 1996 were caused primarily by increases in reserves estimated
for mortgage  guaranty  losses.  The increases for 1997 and 1996 are  consistent
with  the  expected  loss  development  patterns  for the  respective  lines  of
business.

10.  Segment Reporting

The Corporation  provides  reinsurance to primary insurers in various  specialty
insurance markets. For segment reporting purposes, the Corporation's reinsurance
lines of business are organized into four discrete segments municipal  financial
guaranty,  nonmunicipal financial guaranty, each of which include credit default
swap  transactions,  mortgage  guaranty and trade credit.  Two additional lines,
financial  solutions and title reinsurance are combined into "Other" for segment
reporting purposes. Operating procedures and corporate resources are tailored to
the  business  and  regulatory  needs of each line of  business  or  segment  as
necessary. In cases where practical, the same procedures and or resources may be
utilized for more than one line of business.

Financial guaranty insurance of municipal and nonmunicipal debt obligations,  is
a form of credit enhancement  which, as a specialized class of surety,  provides
for the  unconditional  and  irrevocable  guarantee of the  obligor's  scheduled
payment  of  principal   and  interest  on   investment   grade   municipal  and
non-municipal   debt  obligations.   The  premiums  related  to  municipal  bond
reinsurance are generally paid in full at the time of policy issuance,  credited
to a deferred  premium  account and then recognized as revenues over the life of
the reinsured  obligation.  As a result,  only a small portion of annual premium
revenue is derived from  premiums  written in any one year.  Given the zero loss
underwriting  standard,  this multi-year  revenue  translates into an annuity of
earned premiums,  which is itself  supplemented by the investment income derived
from the deferred premiums account.  Non-municipal  financial  guaranty premiums
are generally paid in installments  over the life of the underlying  obligation,
also providing an annuity of earned premiums.

Mortgage  guaranty  insurance  is  a  specialized  class  of  credit  insurance,
providing  protection to mortgage  lenders  against  default by borrowers on low
down-payment  residential  mortgage loans.  For the  Corporation's  proportional
mortgage guaranty business, reinsurance premiums are paid on a monthly basis and
fully  recognized  when  written.  A certain level of losses is expected in this
business.  For the  non-proportional  mortgage guaranty  business,  premiums are
generally paid in full at contract  inception and earned over the life,  usually
ten years. Generally,  losses are not expected in this non-proportional mortgage
guaranty business.

Credit  insurance  protects  suppliers  of goods and  services  from the risk of
non-payment by their  customers.  Some level of losses are also expected in this
business.  This business is centered on blending participation in excess of loss
reinsurance programs with traditional


                                       76
<PAGE>

10.  Segment Reporting (continued)

proportional  treaty lines. These contracts are generally of a one year duration
and premiums are  typically  received in  installments  throughout  the coverage
period.

For  purposes  of  financial  planning,   resource  allocation  and  performance
evaluation,  segments are measured based on net  underwriting  profits and other
income directly  attributable to the segments.  For segment reporting  purposes,
investment  income,  net  realized   gains/losses,   operating  expenses  (i.e.,
salaries,  rent,  etc.),  interest expense and income taxes are allocated to the
segments.  The mortgage  segment  includes equity income from an investment in a
subsidiary  engaged in mortgage related  products.  Management does not allocate
assets  to  the  Corporation's  segments.   Rather,  assets  are  managed  as  a
consolidated pool.

For marketing  purposes,  the Corporation  aggregates its  reinsurance  lines of
business  into two  divisions,  Financial  Guaranty  and  Financial  Risks.  The
municipal and  non-municipal  lines including credit default swaps, are combined
to represent  Financial  Guaranty while the Financial  Risks  division  includes
mortgage, credit, title and financial solutions.

The  following  tables  summarize  the  operating  results of the  Corporation's
segments:

<TABLE>
<CAPTION>
                                                                           Year Ended December 31, 1998
                                                                                Reportable Segments
                                                    -------------------------------------------------------------------------------
                                                                        Non
                                                     Municipal     Municipal     Mortgage        Credit        Other   Consolidated
                                                    -------------------------------------------------------------------------------
<S>                                                 <C>           <C>           <C>           <C>           <C>           <C>      
Gross Written Premiums                              $  55,280     $  39,872     $  66,802     $  35,298     $  16,689     $ 213,941
Ceded Premiums                                         (3,015)         (100)          (76)         (156)            0        (3,347)
                                                    -------------------------------------------------------------------------------
Written Premiums                                       52,265        39,772        66,726        35,142        16,689       210,594
Increase in Deferred Premium Revenue                   (9,310)      (19,067)       (7,378)       (6,454)            0       (42,209)
                                                    -------------------------------------------------------------------------------
Premiums                                               42,955        20,705        59,348        28,688        16,689       168,385
                                                    -------------------------------------------------------------------------------
Income                                                      0           258          (154)            0         2,967         3,071
                                                    -------------------------------------------------------------------------------
Underwriting Revenue and Other
Segment Related Income                                 42,955        20,963        59,194        28,688        19,656       171,456
Losses Incurred                                         9,966        45,249         3,187        16,780        11,382        86,564
Commissions (Net of DAC)                               13,333         3,950        14,131         7,804          (232)       38,986
Profit Commissions                                        800           (99)       17,101           153         1,270        19,225
                                                    -------------------------------------------------------------------------------
Net Underwriting Expense                               24,099        49,100        34,419        24,737        12,420       144,775
Net Underwriting Profit (Loss) and
Segment Related Income                              $  18,856     $ (28,137)    $  24,774     $   3,951     $   7,236     $  26,681
</TABLE>


                                       77
<PAGE>

10.  Segment Reporting (continued)

<TABLE>
<CAPTION>
                                                                           Year Ended December 31, 1997
                                                                                Reportable Segments
                                                    -------------------------------------------------------------------------------
                                                                        Non
                                                     Municipal     Municipal     Mortgage        Credit        Other   Consolidated
                                                    -------------------------------------------------------------------------------
<S>                                                 <C>           <C>           <C>           <C>           <C>           <C>      

Gross Written Premiums                              $  52,778     $  16,674     $  70,752     $  23,025      $   6,714    $ 169,943
Ceded Premiums                                         (2,621)          (75)         (272)          (71)        (2,629)      (5,668)
                                                    -------------------------------------------------------------------------------
Net Written Premiums                                   50,157        16,599        70,480        22,954          4,085      164,275
   Increase in Deferred Premium Revenue               (20,409)       (5,197)      (17,234)       (5,747)          (397)     (48,984)
                                                    -------------------------------------------------------------------------------
Earned Premiums                                        29,748        11,402        53,246        17,207          3,688      115,291
                                                    -------------------------------------------------------------------------------
Other Income                                              115            83           260             0          1,078        1,536
                                                    -------------------------------------------------------------------------------
 Total Underwriting Revenue and Other
          Segment Related Income                       29,863        11,485        53,506        17,207          4,766      116,827

Losses Incurred                                           (33)            0         7,540         8,126              0       15,633
Commissions (Net of DAC)                                9,562         3,112        13,399         3,967             86       30,126
Profit Commissions                                        210          (119)        4,115          (115)         1,020        5,111
                                                    -------------------------------------------------------------------------------
   Net Underwriting Expense                             9,739         2,993        25,054        11,978          1,106       50,870

Net Underwriting Profit and Other
       Segment Related Income                       $  20,124     $   8,492     $  28,452     $   5,229      $   3,660    $  65,957
</TABLE>


                                       78
<PAGE>

10.  Segment Reporting (continued)

<TABLE>
<CAPTION>
                                                                           Year Ended December 31, 1996
                                                                                Reportable Segments
                                                    -------------------------------------------------------------------------------
                                                                        Non
                                                     Municipal     Municipal     Mortgage        Credit        Other   Consolidated
Reportable Segments                                 -------------------------------------------------------------------------------
<S>                                                 <C>           <C>           <C>           <C>           <C>           <C>      
Gross Written Pemiums                               $  48,411     $  10,903     $  53,682     $  15,070     $   1,752     $ 129,818
Ceded Premiums                                        (11,704)            0       (12,746)         (180)            0       (24,630)
                                                    -------------------------------------------------------------------------------
Net Written Premiums                                   36,707        10,903        40,936        14,890         1,752       105,188
(Increase) Decrease in Deferred Premium
Revenue                                                (9,167)       (3,704)        2,947                        (176)      (12,752)
                                                    -------------------------------------------------------------------------------
Earned Premiums                                        27,540         7,199        43,883        12,238         1,576        92,436
                                                    -------------------------------------------------------------------------------
Other Income                                                0             0           523             0             0           523
                                                    -------------------------------------------------------------------------------
    Total Underwriting Revenue and Other
          Segment Related Income                       27,540         7,199        44,406        12,238         1,576        92,959

Losses Incurred                                            (9)            0         3,396         6,096             0         9,483
Commissions (Net of DAC)                                6,538         1,266        11,405         3,339             0        22,548
Profit Commissions                                       (146)         (135)        5,439           310           540         6,008
                                                    -------------------------------------------------------------------------------
   Net Underwriting Expense                             6,383         1,131        20,240         9,745           540        38,039

Net Underwriting Profit and Other
       Segment Related Income                       $  21,157     $   6,068     $  24,166     $   2,493     $   1,036     $  54,920
</TABLE>


                                       79
<PAGE>

10.  Segment Reporting (continued)


                                                     Year Ended December 31,
Reconciliation to Consolidated Results            1998        1997        1996
                                               --------------------------------
                                                     (Dollars in Thousands)
Net Segment Income                             $ 26,681    $ 65,957    $ 54,920
Investment Income and Net Realized
    Gains                                        63,348      64,535      53,029
Other Income                                        142          98         290
Operating Expense, net                          (22,167)    (20,002)    (17,709)

Interest Expense & Minority Int in Subs         (13,150)    (13,137)    (12,603)
                                               --------------------------------

Consolidated Income Before Taxes               $ 54,854    $ 97,451    $ 77,927
                                               --------------------------------

The  majority of the  Corporation's  gross  premiums are for  reinsurance  risks
located in the United  States.  Remaining  gross written  premiums are for other
worldwide  risks with a  concentration  in western  Europe.  The following table
summarizes the Corporation's gross written premiums on a geographic basis:



Geographic Information

                                       Gross Written Premium
                                       Year Ended December 31,
                          1998                 1997                     1996
                  ------------------------------------------------------------
                                    (Dollars in Thousands)
United States     $169,699    79.3%    $130,842     77.0%    $104,727     80.7%
Non U.S.            44,242    20.7%      39,101     23.0%      25,091     19.3%
                  ------------------------------------------------------------
                  $213,941   100.0%    $169,943    100.0%    $129,818    100.0%


                                       80
<PAGE>

10.      Segment Reporting (continued)

The Corporation  derives the majority of its gross written premiums from a small
number of primary insurers. The primary insurers which accounted for 10% or more
of gross written premiums are as follows:

                                      Year Ended   December 31,
                                  1998          1997         1996
                                  -------------------------------
Primary insurer

MBIA                              15.7          12.4         14.9%
CMAC                              14.6          15.8         15.9
FSA                               12.0          11.5          *
PMI                                *             *           10.7
FGIC                               *             *           11.9

         *Less than 10%

Customer  concentration  occurs as a result of the fact that a large  portion of
the Corporation's total gross written premiums comes from the financial guaranty
and mortgage  guaranty  reinsurance  lines of  business.  These  industries  are
composed  of a small  number of  primary  insurance  companies  writing  primary
financial guaranty and mortgage guaranty insurance.

11.  Debt and Liquidity Facility

Debt consists of:

                                                           December 31,
                                                         1998         1997
                                                       --------------------
                                                      (Dollars in Thousands)
   7.75% debentures due 2002, net of unamortized
   discount of $0.2 million in 1998 and 1997
   ("Debentures")                                      $74,856      $74,819
   Bank note payable                                    25,000       25,000
                                                       --------------------
   Total                                               $99,856      $99,819
                                                       ====================

The Debentures include certain covenants,  none of which significantly  restrict
the Corporation's  operating activities or dividend paying ability. During 1996,
the Corporation  entered into a $25 million credit facility with Chase Manhattan
Bank,  expiring  August 20, 1999.  The  facility is  renewable  each year at the
option of the Corporation.  Interest on the facility is payable semi-annually at
a rate equal to the then London Interbank offered rate plus 40 basis points.


                                       81
<PAGE>

11.  Debt and Liquidity Facility (continued)

Capital Reinsurance is party to a credit facility with Deutsche Bank AG pursuant
to which Deutsche Bank AG provides up to $100 million  specifically  designed to
provide rating agency qualified capital to further support Capital Reinsurance's
claims-paying resources. This agreement expires January 27, 2006.

During 1998, 1997 and 1996, the Corporation paid total interest of approximately
$7.4 million, $7.4 million and $6.9 million, respectively.

12.  Income Taxes

The  Corporation  and its  subsidiaries  file a consolidated  federal income tax
return.  The  Corporation's  effective federal corporate tax rate for 1998, 1997
and 1996 was 19.4%, 27.3% and 26.7%, respectively.

A reconciliation from the tax provision calculated at the federal statutory rate
of 35% in 1998, 1997 and 1996, to the total tax is as follows:


                                                    Year ended December 31,
                                                1998         1997         1996
                                             ----------------------------------
                                                    (Dollars in Thousands)

Tax provision at statutory rate              $ 19,199     $ 34,107     $ 27,274
Tax-exempt interest                            (8,436)      (7,751)      (6,710)
Other                                             (96)         277          349
                                             ----------------------------------
Total federal income tax provision           $ 10,667     $ 26,633     $ 20,913
                                             ==================================


The liability for deferred  federal  income taxes reflects the tax effect of the
following temporary differences:

                                                                December 31,
                                                            1998          1997
                                                        -----------------------
                                                         (Dollars in Thousands)

Deferral of acquisition costs                           $  47,260     $  44,673
Contingency reserve                                        33,437        33,437
Deferred premium revenue                                    4,834         1,517
Unrealized gain on fixed maturity securities
   available-for-sale                                      17,511        15,826
Investment writedown                                       (2,663)
Deferred compensation                                           0        (1,397)
Other                                                        (107)       (1,223)
                                                        -----------------------
Effects of temporary differences                          100,272        92,833
Credit for alternative minimum tax carryforwards           (2,298)       (1,217)
Tax and loss bonds                                        (18,737)      (18,737)
                                                        -----------------------
Liability for deferred federal income taxes             $  79,237     $  72,879
                                                        =======================


                                       82
<PAGE>

12.  Income Taxes (continued)

Income taxes paid during 1998, 1997 and 1996 were  approximately  $16.1 million,
$18.9 million and $7.9 million, respectively.

13.  Reinsurance Ceded

To limit its  exposure on assumed  risks,  the  Corporation  enters into certain
proportional and nonproportional  retrocessional  agreements that cede a portion
of risks underwritten to other insurance companies. In the event that any or all
of the reinsurers were unable to meet their  obligations,  the Corporation would
be liable for such defaulted amounts.

For the years ended December 31, 1998, 1997 and 1996, ceded earned premiums were
$13.7 million, $17.8 million and $14.7 million,  respectively.  Ceded losses for
the same periods were $4.8 million, $6.6 million and $6.5 million, respectively.

During 1993,  Capital  Reinsurance  entered  into a  multi-year  nonproportional
reinsurance  contract  which  provides for  aggregate  loss  protection of $80.0
million in exchange for $19.5 million of premium. Additional premiums may become
payable dependent upon the level of losses incurred. During 1993, Capital Credit
entered  into  similar  multi-year   reinsurance  contracts  which  provide  for
aggregate  loss  protection  of $34.0  million in exchange for $4.25  million in
premiums.  Additional  premiums may also become payable dependent upon the level
of losses incurred.

During  1994,  Capital  Reinsurance  entered  into a  portfolio  excess  of loss
reinsurance  contract which provides $100.0 million aggregate loss protection on
specified  municipal  obligations in excess of $82.0 million of losses.  Capital
Mortgage entered into a similar  portfolio  excess of loss reinsurance  contract
which provides $30.0 million  aggregate loss protection in excess of a specified
loss ratio  covering all reinsured  obligations.  Premiums due on both contracts
are not dependent upon the level of losses incurred.

During 1995,  Capital Mortgage entered into an assumption  agreement  whereby it
provides  excess of loss  reinsurance on an existing  portfolio of mortgage pool
insurance.  In connection  with this assumed  transaction,  Capital  Mortgage is
required  to cede a  portion  of the  risks,  thereby  reducing  its  total  net
retention.  Total ceded  premiums  under the contract were  approximately  $21.0
million.  Total expected  assumed premiums of $56.0 million are payable in seven
annual  installments  of $8.0 million.  As of December 31, 1998, the Corporation
has received  four of the seven  installments.  Contingent  commissions  will be
payable on the assumed  reinsurance  and  receivable  on the ceded  reinsurance,
dependent upon the level of losses incurred under the contract.

14.  Fair Values of Financial Instruments

The following methods and assumptions were used by the Corporation in estimating
its fair value disclosure for financial  instruments.  These determinations were
made  based  on  available   market   information  and   appropriate   valuation
methodologies.  Considerable  judgment is required to  interpret  market data to
develop the estimates and therefore,  they may not  necessarily be indicative of
the amount the Corporation could realize in a current market exchange.


                                       83
<PAGE>

14.  Fair Values of Financial Instruments (continued)

Cash and Short-term Investments

The  carrying  amount  reported  in the  balance  sheet  for  these  instruments
approximates fair value.

Fixed Maturity Securities

The fair value for fixed maturity  securities shown in Note 8 is based on quoted
market prices.

Deferred Premium Revenue

The  fair  value  of the  Corporation's  deferred  premium  revenue  is based on
entering  into a cession of the entire  portfolio  with third  party  reinsurers
under market conditions. This figure was determined by using the statutory basis
unearned  premium  reserve,  net of  commissions,  and the present  value of the
estimated  future cash flow stream from  installment  premiums.  At December 31,
1998,  the fair value of the  Corporation's  net  deferred  premium  revenue was
estimated to be $361.5 million.

Reserve for Losses and Loss Adjustment Expenses, Net of Reinsurance
   Recoverable on Ceded Losses

For financial  guaranty  losses,  the carrying amount is composed of the present
value of the expected cash flows for case basis claims and therefore  represents
the best  estimate  of fair  value.  The  short-term  nature of losses  from the
remaining lines of business indicate that the carrying value represents the best
estimate of fair  value.  Accordingly,  for all lines,  the  carrying  amount is
deemed the best estimate of fair value as of December 31, 1998.

Debt

The fair value of the Corporation's  $75.0 million of outstanding  Debentures is
determined  based  on the  projected  cash  flows  discounted  by the sum of the
seven-year U.S.  treasury yield at December 31, 1998 and the appropriate  credit
spread for similar debt instruments. At December 31, 1998, the fair value of the
Corporation's  Debentures was estimated to be $80.2 million. The carrying amount
of the  Corporation's  bank note payable of $25 million  approximates fair value
due to its floating interest rate provision.

Preferred Securities of Capital Re LLC

The fair value of the Corporation's $75.0 million Company obligated  mandatorily
redeemable preferred securities of Capital Re LLC at December 31, 1998 was $74.6
million based on the closing  price per share on the New York Stock  Exchange at
that date.

15.  Dividends

Under Maryland's insurance law, the amount of surplus available for distribution
as  dividends  is subject  to  certain  statutory  provisions,  which  generally
prohibit the payment of dividends in any


                                       84
<PAGE>

15.  Dividends (continued)

twelve-month  period  without  prior  approval of the Maryland  Commissioner  of
Insurance in an amount exceeding 10% of policyholder's  surplus at the preceding
December 31. The amount  available  for  distribution  from Capital  Reinsurance
during  1998 with  notice to,  but  without  prior  approval  of,  the  Maryland
Commissioner  of Insurance  under the Maryland  insurance  law is  approximately
$32.3 million.  During 1998, Capital Reinsurance paid dividends in the amount of
$8.0 million to the Corporation.

Capital Credit's and KRE's dividend  distributions  are governed by Bermuda law.
Under  Bermuda law and the By-Laws of Capital  Credit and KRE,  dividends may be
paid out of the  profits  of  Capital  Credit and KRE  (defined  as  accumulated
realized   profits  less   accumulated   realized   losses).   Distributions  to
shareholders  may also be paid out of Capital Credit's and KRE's surplus limited
by  requirements  that Capital Credit and KRE must at all times (i) maintain the
minimum share capital  required under Bermuda law and (ii) have relevant  assets
in an  amount  equal to or  greater  than 75% of  relevant  liabilities,  all as
defined under Bermuda law. Since its organization,  KRE has not declared or paid
any dividends. During 1998 Capital Credit paid $4.0 million to the Corporation.

Under New York  Insurance  Law, as a mortgage  guaranty  insurance  corporation,
Capital  Mortgage may not pay dividends except from earned surplus as defined by
New York  Insurance  Law.  Capital  Mortgage is further  restricted  from paying
dividends to the extent that any dividend paid to shareholders  which,  together
with all dividends  declared or  distributed  by it during the preceding  twelve
months,  exceeds the lesser of 10% of its surplus to  policyholders  as shown by
its last  statement  on file with the  superintendent,  or 100% of adjusted  net
investment  income  during  such  period  unless  specifically  allowed  by  the
superintendent.  To  date,  Capital  Mortgage  has  not  declared  or  paid  any
dividends.  The maximum  dividend  payable by Capital Mortgage during 1998 is $0
since its earned surplus was ($9.2) million as of December 31, 1998.

Capital  Title is subject  to the New York  Insurance  Law laws and  regulations
governing  title  insurers.  Accordingly,  dividends  may only be  declared  and
distributed  out of earned  surplus as defined under New York  Insurance Law and
only if such  dividends do not reduce the company's  surplus to less than 50% of
its  outstanding  capital  shares,  i.e.,  the value of its  outstanding  common
equity.  Additionally,  no dividend may be declared or  distributed in an amount
which, together with all dividends declared or distributed by the company during
the preceding twelve months,  exceeds 10% of the company's  outstanding  capital
shares, unless, after deducting such dividends,  it has a surplus at least equal
to 50% of its  statutory  reinsurance  reserve  or a surplus  at least  equal to
$250,000, whichever is greater. As of December 31, 1998, Capital Title's maximum
amount payable as a dividend during 1998 is approximately $3.6 million.



                                       85
<PAGE>

16.  Commitments

At December 31, 1998,  future  minimum  rental  payments  under the terms of the
Corporation's  noncancellable operating leases for office space are $1.2 million
for the year 1999,  $1.4  million for each of the years 2000,  2001,  2002,  and
2003, and $8.0 million in the aggregate thereafter.  These future minimum rental
payments  total $14.8  million.  These  payments are subject to  escalations  in
building  operating costs and real estate taxes.  Total rent expense amounted to
approximately $1.0 million in 1998 and 1997 and $0.9 million in 1996.

As part of the  Corporation's  agreement to invest in CGA, it has also committed
to invest an  additional  $7.5  million  in the form of the  purchase  of common
shares in the event that  maintenance of Commercial  Guaranty  Assurance  Ltd.'s
triple A rating from Duff & Phelps make such action necessary.

The Corporation  participates in the Lloyd's of London  insurance market through
its corporate name, CRC Capital Ltd. At the Corporation's direction, a letter of
credit has been provided to Lloyd's in  satisfaction  of CRC  Capital's  capital
requirement.  All  corporate  capital  providers are required by Lloyd's to post
funds  at  Lloyd's  equal  to a fixed  percentage  of the  amount  of  committed
insurance  capacity.  For the year ended  December 31, 1998, the total amount of
insurance  capacity  committed by CRC Capital was British  Pound  Sterling  88.2
million,  and CRC Capital's Funds at Lloyd's  requirement was 50% of that amount
and was supported by a letter of credit for British Pound Sterling 44.1 million.
For the 1999 year, the Corporation  increased its insurance capacity  commitment
to British Pound  Sterling 95.0 million which is supported by a letter of credit
of British Pound Sterling 47.5 million.

17.  Capital Re LLC

In  January  1994,  the  Corporation  formed and  capitalized  Capital Re LLC, a
limited  liability  company  organized  under the laws of the  Turks and  Caicos
Islands. Additionally, in January 1994, Capital Re LLC issued $75,000,000, 7.65%
of cumulative monthly income preferred shares, the proceeds of which were loaned
to the Corporation.  The preferred shares were issued at $25 par value per share
and are  shown  on the  balance  sheet  under  the  caption  "Company  obligated
mandatorily  redeemable preferred securities of Capital Re LLC." The Corporation
guarantees  the  payment of the monthly  dividend  as well as any  amounts  upon
liquidation  or redemption  which cannot occur prior to January 31, 1999, at the
Corporation's  discretion.   The  Corporation  has  no  plans  to  exercise  its
redemption  option in the near or midterm.  Capital Re LLC exists solely for the
purpose of issuing  preferred  and common shares and lending the proceeds to the
Corporation to fund its business operations.  The total amount paid to preferred
shareholders  for each of the years ended 1998, 1997 and 1996 was  approximately
$5.7 million and is shown on the income  statement  under the caption  "Minority
interest in Capital Re LLC."

18.  Compensation Plans

Prior to its initial public offering, the Corporation had a stock incentive plan
wherein  eligible  employees  were granted  shares of  restricted  common stock.
Shares  awarded  under the Plan  amounted to 696,000 at December 31,  1991.  For
these  awards,  the  difference  between the price paid by the employees and the
market value of the award at the date of grant, if any, was recorded 


                                       86
<PAGE>

18.  Compensation Plans (continued)

as deferred  compensation and was amortized  ratably over the four-year  vesting
period.  Upon  completion of the initial public  offering in 1992,  these shares
became vested and all restrictions lapsed.

To enable  recipients  of awards  under  the  stock  incentive  plan to meet tax
obligations which may have resulted from such awards,  the Corporation agreed to
make loans to recipients,  payable upon ultimate  disposition of their shares or
three years after their  termination of employment.  As of December 31, 1998 and
1997, total loans outstanding under all officer loan programs were approximately
$0.9 million and $1.64 million, respectively, and are included under the caption
"Other assets."

On April 15, 1992, the Corporation adopted the 1992 Stock Option Plan (the "1992
Option  Plan").  The 1992 Option  Plan  enables key  employees  to benefit  from
appreciation  in the  price of the  common  stock of the  Corporation.  The 1992
Option Plan provides for grants of incentive  stock options  ("ISO"),  which are
intended  to qualify  under  Section  422 of the  Internal  Revenue  Code and of
options  which are  intended not to so qualify  ("NQSO").  Under the 1992 Option
Plan,  options  may be granted at a price not less than 100% of the fair  market
value as determined on the date granted.  ISO's and NQSO's awarded, vest in four
equal  yearly  installments  commencing  one year after the date of grant.  Once
vested,  options may be exercised at any time and expire ten years from the date
of grant.  According to the terms of the 1992 Option Plan, the aggregate  number
of shares  subject to option awards may not exceed  1,450,000.  During 1997, the
Corporation  adopted the 1997 Stock Option Plan ("1997 Plan").  The terms of the
1997 Plan are similar to those of the 1992 Option Plan,  however,  the number of
shares subject to option award shall not exceed 1,000,000.

In 1993,  the  Corporation  also  adopted a stock  option plan (the  "Director's
Plan")  for the  benefit  of its  outside  directors.  The terms of the plan are
similar to those of the employee plan except that options become fully vested at
the time of grant.  According to the terms of the Director's Plan, the aggregate
number of shares subject to option award shall not exceed 30,000.

The Corporation 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  because,  as discussed  below, the
alternative  fair value  accounting  provided for under FASB  Statement 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  Corporation's  employee stock options
equals  the  market  price of the  underlying  stock on the  date of  grant,  no
compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been  determined as if the  Corporation 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 for 1998, 1997 and 1996,  respectively:  risk-free interest rates of
5.5%, 6.3% and 5.4%;  dividend yields of .53%,.67% and .80%;  volatility factors
of the expected market price of 


                                       87
<PAGE>

18.  Compensation Plans (continued)

the Corporation's  common stock of 21.35,  23.37 and 19.10; and an expected life
of the options of 7 years.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded  options which have no vesting  restrictions  and are fully
transferable.  In addition,  option valuation models require the input of highly
subjective  assumptions  including the expected stock price volatility.  Because
the  Corporation's  employee  stock options have  characteristics  significantly
different from those of traded  options,  and because  changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of the fair value of its employee stock options.

For purposes of pro forma  disclosures,  the estimated fair value of the options
is amortized to expense over the options'  expected lives. The Corporation's pro
forma information follows (in thousands, except for per share information):

                                                 Year Ended   December 31,
                                              ------------------------------
                                                 1998       1997       1996
                                              ------------------------------

Pro forma net income                          $ 40,080   $ 69,052   $ 56,030
Pro forma basic earnings per common share     $   1.26   $   2.18   $   1.79
Pro forma diluted earnings per common share   $   1.23   $   2.12   $   1.76

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

<TABLE>
<CAPTION>
                                                         1998                    1997                   1996
                                               ----------------------  -----------------------  ---------------------
                                                            Weighted-                Weighted-               Weighted-
                                                             Average                  Average                 Average
                                                             Exercise                 Exercise                Exercise
                                                 Options      Price       Options      Price       Options      Price
                                               ----------------------------------------------------------------------
<S>                                            <C>           <C>        <C>           <C>        <C>           <C>   
Outstanding, beginning of year                 2,363,150     $14.54     1,937,200     $12.00     1,816,000     $10.39
Granted                                          457,800      30.05       605,000      21.70       555,000      15.75
Exercised                                       (102,245)     16.54      (161,950)     10.99      (411,174)      9.85
Forfeited                                       (171,250)     20.67       (17,100)     14.52       (22,626)     13.25
                                               ----------------------------------------------------------------------
Outstanding, end of year                       2,547,455     $16.83     2,363,150     $14.54     1,937,200     $12.01
                                               ======================================================================
Exercisable, end of year                       1,436,676     $12.19     1,041,950     $10.98       844,894     $10.13
                                               ======================================================================
</TABLE>


                                               1998       1997       1996 
                                             -----------------------------
Weighted-average fair value of options
   granted during the year                    $10.89     $8.50      $5.21
--------------------------------------------------------------------------


                                       88
<PAGE>

18.  Compensation Plans (continued)

Exercise  prices for options  outstanding  as of  December  31, 1998 ranged from
$9.75  to  $37.81.  The  weighted-average  remaining  contractual  life of those
options is approximately 6.0 years.

In 1996,  the  Corporation  adopted a performance  share plan for the benefit of
senior  executives  of the  Corporation.  The plan is intended  to align  senior
management with the interest of the shareholders. To achieve this objective, the
plan ties awards  granted  under the plan with earning per share growth and with
total shareholder  return and share price.  Awards under the plan are payable on
December 31, 1999 and December 31, 2001. The Corporation recognized $3.0 million
and $1.0 million in deferred  compensation  expense for the years ended December
31, 1997 and 1996. As of December 31, 1998, because the relevant targets had not
been met, no accrued expense was recognized and expenses  recognized in 1997 and
1996 were reversed.  The Corporation maintains a savings incentive plan which is
qualified under Section 401 of the Internal Revenue Code. The savings  incentive
plan is available  to all  full-time  employees  with a minimum of six months of
service. Eligible participants may contribute 9% of their base salary subject to
a maximum of $10,000 for 1998. Contributions are matched by the Corporation at a
rate of 100%,  up to 7% of the  participants'  contribution  subject  to certain
limitations  and vest at a rate of 25% per year starting with the second year of
service. The Corporation contributed approximately $0.4 million in 1998 and $0.3
million in 1997 and 1996.

The  Corporation  also maintains a profit sharing plan which is available to all
full-time   employees   with  a  minimum  of  six  months  of  service.   Annual
contributions  to the plan are at the discretion of the Board of Directors.  The
plan  contains a qualified  portion and a  nonqualified  portion.  Total expense
incurred under the plan amounted to approximately $0.3 million in 1998, 1997 and
1996.

The  Corporation  does not  provide  health care or life  insurance  benefits to
retirees.


                                       89
<PAGE>

19.  Quarterly Financial Summary (Unaudited)*

<TABLE>
<CAPTION>
                                                                      1st           2nd           3rd           4th
                                                                    Quarter       Quarter       Quarter       Quarter          Year
                                                                   -----------------------------------------------------------------
                                                                             (Dollars in Thousands Except Per Share Amounts)
<S>                                                                <C>           <C>           <C>           <C>            <C>     
1998
Gross written premiums                                             $ 62,127      $ 55,804      $ 41,435      $ 54,575       $213,941
Net written premiums                                                 61,046        55,365        40,625        53,558        210,594
Earned premiums                                                      43,731        39,225        46,215        39,214        168,385
Net investment income and net realized gains                         17,045        17,468        18,261        10,574         63,348
Income (loss) before provision for federal
income tax                                                           27,828        27,536        18,583       (19,092)        54,855
Net income (loss) from continuing operations                         20,274        19,681        14,335       (10,102)        44,187
Net income (loss)                                                    19,795        20,184        14,470       (12,906)        41,542
------------------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) from continuing
operations per common share                                           $0.64         $0.62         $0.45        ($0.32)         $1.39
Diluted net income (loss) from continuing                                                                                      
operations per share                                                  $0.53         $0.49         $0.44        ($0.31)         $1.35
------------------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share                              $0.62         $0.63         $0.45        ($0.40)         $1.30
Diluted net income (loss) per share                                   $0.61         $0.62         $0.44        ($0.40)         $1.27
------------------------------------------------------------------------------------------------------------------------------------
1997
Gross written premiums                                             $ 44,110      $ 45,586      $ 42,843      $ 37,404       $169,943
Net written premiums                                                 41,783        45,172        40,035        37,285        164,275
Earned premiums                                                      28,806        27,922        31,513        27,050        115,291
Net investment income and net realized gains                         16,586        13,773        16,880        17,296         64,535
Income before provision for federal income tax                       24,320        22,472        25,153        25,503         97,451
Net income from continuing operations                                17,320        15,849        18,463        19,185         70,818
Net income                                                           17,136        16,109        18,256        18,550         70,052
------------------------------------------------------------------------------------------------------------------------------------
Basic net income from continuing operations
per common share                                                      $0.55         $0.50         $0.58         $0.60          $2.23
Diluted net income from continuing operations                                                                                  
per share                                                             $0.53         $0.49         $0.57         $0.59          $2.18
------------------------------------------------------------------------------------------------------------------------------------
Basic net income per common share                                     $0.54         $0.51         $0.58         $0.58          $2.21
Diluted net income per share                                          $0.53         $0.50         $0.56         $0.57          $2.16

1996
Gross written premiums                                             $ 34,255      $ 30,957      $ 43,220      $ 21,386       $129,818
Net written premiums                                                 18,060        26,902        40,500        19,726        105,188
Earned premiums                                                      20,104        22,322        22,005        28,005         92,436
Net investment income and net realized gains                         12,191        11,781        12,781        16,276         53,029
Income before provision for federal income tax                       17,193        18,207        18,808        23,778         77,927
Net income from continuing operations                                12,767        13,285        13,955        17,008         57,014
Net income                                                           12,767        13,285        13,955        16,517         56,524
------------------------------------------------------------------------------------------------------------------------------------
Basic net income from continuing operations per
common share                                                          $0.42         $0.43         $0.44         $0.53          $1.82
Diluted net income from continuing operations                                                                                  
per common share                                                      $0.42         $0.42         $0.44         $0.53          $1.79
------------------------------------------------------------------------------------------------------------------------------------
Basic net income per common share                                     $0.42         $0.43         $0.44         $0.52          $1.81
Diluted net income per share                                          $0.42         $0.42         $0.44         $0.51          $1.77
</TABLE>

* Numbers may not add due to rounding.


                                       90
<PAGE>

20.  Subsequent Event

In February  1999,  ACE Bermuda  Insurance  Ltd., a  subsidiary  of ACE Limited,
agreed to invest $75  million in the  Corporation  through a purchase  of common
stock.  The  proceeds  will be used to augment the surplus of the  Corporation's
operating  subsidiaries.  Under the stock purchase  agreement,  as amended,  the
purchase  price is  determined as the lower of (i) fully diluted GAAP book value
per share at December 31, 1998 (or $18.87 per share) and (ii) the average of the
highest five consecutive market closing prices of the Corporation's common stock
from March 12, 1999 through  April 15, 1999.  Closing is contingent on customary
conditions  and the  affirmation  of S&P's  financial  strength  ratings  of the
Corporation's major subsidiaries.















                                       91
<PAGE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure.

None.

                                    PART III

Item 10. Directors and Executive Officers of the Registrant.

The information  concerning directors set forth under "Election of Directors" in
the Company's 1999 Proxy Statement is incorporated herein by reference.

Information  concerning  executive  officers  is set forth  under PART I, Item 1
"BUSINESS OF CAPITAL RE: Executive Officers" in this report.

Item 11. Executive Compensation.

The information concerning  compensation of the Company's executive officers set
forth in the Company's 1999 Proxy Statement is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

The information  concerning  security ownership of certain beneficial owners and
management  set forth in the  Company's  1999 Proxy  Statement  is  incorporated
herein by reference.

Item 13. Certain Relationships and Related Transactions.

The information  concerning certain  relationships and related  transactions set
forth in the Company's 1999 Proxy Statement is incorporated herein by reference.




                                       92
<PAGE>

                                     PART IV

Item 14.

          (a)  Financial Statements, Financial Statement Schedules and Exhibits.

          1.   Financial Statements

          The  following  consolidated  financial  statements of the Company are
          filed as part of this Report in Item 8:

          CAPITAL RE CORPORATION AND SUBSIDIARIES

          Report of Independent Auditors

          Consolidated Balance Sheets at December 31, 1998 and 1997

          Consolidated  Statements of Income For the Years Ended  December 31,
               1998, 1997 and 1996

          Consolidated  Statements of Comprehensive Income for the Years Ended
               December 31, 1998, 1997 and 1996

          Consolidated  Statements of Stockholders' Equity for the Years Ended
               December 31, 1998, 1997 and 1996

          Consolidated  Statements of Cash Flows for the Years Ended  December
               31, 1998, 1997 and 1996

          Notes to Consolidated Financial Statements

          2.   Financial Statement Schedules

          The following  Financial Statement Schedules are filed as part of this
          Report:

          Schedule            Title
          --------            -----
          II                  Condensed Financial Information of Registrant
          IV                  Reinsurance

         The report of the Registrant's independent auditors with respect to the
         above  listed  financial  statement  schedules  is set forth in Exhibit
         23.01 of this Report.

         All other schedules are omitted because they are either inapplicable or
         the required  information  is presented in the  consolidated  financial
         statements of the Company or the notes thereto.

          3.   Exhibits

          The following are annexed as exhibits to this Report:

          Exhibit No.                Exhibit
          -----------                -------

          3.01      Certificate of Incorporation of the Company,  dated December
                    3,  1991,  1992  (Filed  as  exhibit  3.01 to the  Company's
                    Registration  Statement on Form S-1 (Reg. No.  33-45286) and
                    incorporated herein by reference)

          3.02      By-laws  of  the  Company  (Filed  as  exhibit  3.02  to the
                    Company's  Registration  Statement  on Form  S-1  (Reg.  No.
                    33-45286) and incorporated herein by reference)


                                       93
<PAGE>

          3.03      Certificate  of Ownership  and Merger of Capital Re Delaware
                    Corporation  and  Capital Re  Corporation  (Filed as exhibit
                    3.03 to the  Company's  Registration  Statement  on Form S-1
                    (Reg. No. 33-45286) and incorporated herein by reference)

          4.01      Specimen  Stock  Certificate  representing  shares of Common
                    Stock (Filed as exhibit 4.01 to the  Company's  Registration
                    Statement on Form S-1 (Reg. No.  33-45286) and  incorporated
                    herein by reference)

          4.02      Form of  Indenture  between the Company and Morgan  Guaranty
                    Trust  Company  of New York,  as Trustee  including  form of
                    specimen  Debenture  (Filed as exhibit 4.01 to the Company's
                    Registration  Statement on Form S-1 (Reg. No.  33-53618) and
                    incorporated herein by reference)

          4.03      Form of  Subordinated  Promissory  Notes  (Filed as Exhibits
                    10.01 - 10.03 to the Company's Quarterly Report on Form 10-Q
                    for the quarter  ended  September  30, 1993 (Comm.  File No.
                    1-10995) and incorporated herein by reference)

          4.04      Form of Payment and Guarantee  Agreement  between Capital Re
                    LLC and the Company  (Filed as exhibit 4.1 to the  Company's
                    Registration  Statement on Form S-3 (Reg. No.  33-72090) and
                    incorporated herein by reference)

          4.05      Form of the  Declaration  of Terms of  Capital  Re LLC 7.65%
                    Cumulative Monthly Income Preferred Shares,  Series A (Filed
                    as exhibit 4.2 to the  Company's  Registration  Statement on
                    Form S-3 (Reg.  No.  33-72090)  and  incorporated  herein by
                    reference)

          4.06      Form of Liability  Assumption  Agreement  between Capital Re
                    LLC and Capital Re Corporation (Filed as exhibit 99.2 to the
                    Company's  Registration  Statement  on Form  S-3  (Reg.  No.
                    33-72090) and incorporated herein by reference)

          4.07      Form of Loan Agreement between Capital Re LLC and Capital Re
                    Corporation   (Filed  as  exhibit  99.1  to  the   Company's
                    Registration  Statement on Form S-3 (Reg. No.  33-72090) and
                    incorporated herein by reference)

          4.08      $25 Million  Credit  Facility  between the Company,  Various
                    Banks and Deutsche  Bank AG, as Agent (Filed as Exhibit 4.08
                    to the  Company's  Annual Report on Form 10-K for the fiscal
                    year ended  December 31, 1994 (Comm.  File No.  1-10995) and
                    incorporated herein by reference)

          4.09      $75 Million Credit  Facility  between  Capital  Reinsurance,
                    Various  Banks  and  Deutsche  Bank AG,  as Agent  (Filed as
                    Exhibit 4.09 to the Company's Annual Report on Form 10-K for
                    the fiscal year ended  December  31,  1994  (Comm.  File No.
                    1-10995) and incorporated herein by reference)

          4.10      $25 Million  Credit  Facility  between the Company,  Various
                    Banks and The Chase Manhattan  Bank, as Agent,  dated August
                    20,  1996  (Filed as Exhibit  4.10 to the  Company's  Annual
                    Report on Form 10-K for the fiscal year ended  December  31,
                    1996 (Comm.  File No.  1-10995) and  incorporated  herein by
                    reference).


                                       94
<PAGE>

          4.11      Amendment  dated as of March 22, 1999 to $100 Million Credit
                    Facility  between  Capital  Reinsurance,  Various  Banks and
                    Deutsche Bank AG, as Agent.

          9.01      Stockholders'  Agreement dated as of January 17, 1992 by and
                    among  the  Company,  its  institutional   stockholders  and
                    certain  of its  management  stockholders  (Filed as exhibit
                    9.01 to the  Company's  Registration  Statement  on Form S-1
                    (Reg. No. 33-53618) and incorporated herein by reference)

          9.02      First Amendment to Capital Re Corporation 1992  Stockholders
                    Agreement  dated December 28, 1992 (Filed as exhibit 9.03 to
                    the Company's Annual Report on From 10-K for the fiscal year
                    ended   December  31,  1992  and   incorporated   herein  by
                    reference)

          9.03      Modification of Credit Re Corporation Stockholders Agreement
                    dated  August  20,  1993  (Filed  as  Exhibit  10.31  to the
                    Company's  Annual  Report on Form 10-K for the  fiscal  year
                    ended  December  31,  1993  (Comm.  File  No.  1-10995)  and
                    incorporated herein by reference) *

          10.01     Capital Re Corporation 1988 Stock Incentive Plan, as amended
                    (the "1988 Plan")  (Filed as exhibit  10.04 to the Company's
                    Registration  Statement on Form S-1 (Reg. No.  33-45286) and
                    incorporated herein by reference)

          10.02     Form  of 1988  Stock  Incentive  Plan  Agreement  (Filed  as
                    exhibit  10.05 to the  Company's  Registration  Statement on
                    Form S-1 (Reg.  No.  33-45286)  and  incorporated  herein by
                    reference)

          10.03     Forms of Tax  Equalization  Loan Agreements  related to 1988
                    Plan (Filed as exhibit 10.06 to the  Company's  Registration
                    Statement on Form S-1 (Reg. No.  33-45286) and  incorporated
                    herein by reference)

          10.04     Form of Indemnity  Agreement  related to 1988 Plan (Filed as
                    exhibit  10.07 to the  Company's  Registration  Statement on
                    Form S-1 (Reg.  No.  33-45286)  and  incorporated  herein by
                    reference)

          10.05     1992 Stock  Option  Plan and related  form of  Non-Qualified
                    Stock  Option  Agreement  (Filed  as  exhibit  10.11  to the
                    Company's  Registration  Statement  on Form  S-1  (Reg.  No.
                    33-45286) and incorporated herein by reference)

          10.06     Lease Agreement for the Company's  principal  office between
                    Capital  Reinsurance  Company and 1325  Limited  Partnership
                    (Filed as Exhibit  10.29 to the  Company's  Annual Report on
                    Form 10-K for the fiscal year ended December 31, 1992 (Comm.
                    File No. 1-10995) and incorporated herein by reference) *

          10.07     Capital Re Corporation  Directors'  Stock Option Plan (Filed
                    as Exhibit 10.26 to the Company's Annual Report on Form 10-K
                    for the fiscal year ended December 31, 1993 (Comm.  File No.
                    1-10995) and incorporated herein by reference) *




                                       95
<PAGE>

          10.08     Capital Re Corporation Deferred Compensation Plan. (Filed as
                    Exhibit  10.37 to the  Company's  Annual Report on Form 10-K
                    for the fiscal year ended December 31, 1995 (Comm.  File No.
                    1-10995) and incorporated herein by reference)

          10.09     Capital Re  Corporation  Non-Qualified  Profit Sharing Plan.
                    (Filed as Exhibit  10.38 to the  Company's  Annual Report on
                    Form 10-K for the fiscal year ended December 31, 1995 (Comm.
                    File No. 1-10995) and incorporated herein by reference)

          10.10     Capital Re  Corporation  Performance  Share  Plan  (Filed as
                    Exhibit  10.39 to the  Company's  Annual Report on Form 10-K
                    for the fiscal year ended December 31, 1996 (Comm.  File No.
                    1-10995) and incorporated herein by reference).

          10.11     1997 Employee  Stock Option Plan (Filed as Appendix A to the
                    Company's  definitive  proxy  statement  for the 1997 annual
                    meeting  of  the  Company's  shareholders  and  incorporated
                    herein by reference)

          10.12     Annual Incentive Plan for Covered Executive  Officers (Filed
                    as Appendix C to the Company's  definitive  proxy  statement
                    for the 1997 annual  meeting of the  Company's  shareholders
                    and incorporated herein by reference)

          10.13     Employment  Agreement  between  the  Company  and  Jerome F.
                    Jurschak dated February 2, 1999.

          10.14     Employment Agreement between the Company and Joseph W. Swain
                    III dated February 2, 1999.

          10.15     Employment  Agreement between the Company and David A. Buzen
                    dated February 2, 1999.

          10.16     Employment  Agreement  between the Company and Laurence C.D.
                    Donnelly dated February 2, 1999.

          10.17     Employment Agreement between the Company and Alan S. Roseman
                    dated February 2, 1999.

          10.18     Amendment Number 1 to 1997 Employee Stock Option Plan

          10.19     Stock  Purchase  Agreement  dated as of February 19, 1999 by
                    and between the Company and Ace Bermuda Insurance, Ltd.

          10.20     First  Amendment,  dated as of March 16, 1999,  to the Stock
                    Purchase  Agreement  dated as of  February  19,  1999 by and
                    between the Company and Ace Bermuda Insurance, Ltd.

          11.01     Statement Re: Computation of Per Share Earnings

          21.01     Subsidiaries of Registrant

          23.01     Consent of Ernst & Young LLP, Independent Auditors



                                       96
<PAGE>

          24.01     Power of Attorney of the Board of Directors

          27.01     Financial Data Schedule as of December 31, 1998

         ----------

         *     Confidential  treatment was afforded, or has been requested,  for
               certain portions of these agreements

         (b) Reports on Form 8-K

         None.





                                       97
<PAGE>

                                   SIGNATURES

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

Dated: March 30, 1999                       CAPITAL RE CORPORATION
                                            (Registrant)

                                            By: /s/ Alan S. Roseman
                                                --------------------------------
                                            Name:  Alan S. Roseman
                                            Title: Executive Vice President,
                                                   General Counsel and Secretary

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.

Name                       Title                                  Date
----                       -----                                  ----
Jerome F. Jurschak*        Chairman of the Board and              March 30, 1999
                           Chief Executive Officer
                           (Principal Executive
                           Officer)

David A. Buzen*            Executive Vice President and           March 30, 1999
                           Chief Financial Officer
                           (Principal Financial and
                           Accounting Officer)

Harrison Conrad*           Director                               March 30, 1999
Richard L. Huber*          Director                               March 30, 1999
Jerome F. Jurschak*        Director                               March 30, 1999
Steven D. Kesler*          Director                               March 30, 1999
Philip Robinson*           Director                               March 30, 1999
Edwin Russell*             Director                               March 30, 1999
Dan R. Skowronski*         Director                               March 30, 1999
Barbara Stewart*           Director                               March 30, 1999
Jeffrey F. Stuermer*       Director                               March 30, 1999
Joseph W. Swain III*       Director                               March 30, 1999

----------
*Alan S.  Roseman,  by signing  his name  hereto,  does  hereby sign this Annual
Report  on Form  10-K on behalf of each of the  Directors  and  Officers  of the
Company  named  above  pursuant  to powers of  attorney  duly  executed  by such
Directors and Officers and filed with the Securities and Exchange  Commission as
an exhibit to this report.

                                           By: /s/ Alan S. Roseman
                                               ---------------------------------
                                               Alan S. Roseman, Attorney-in-fact


                                       98
<PAGE>

Schedule II - Condensed Financial Information of Registrant
Capital Re Corporation
December 31, 1998
(Dollars in thousands)

Condensed Balance Sheets

                                                           As of           As of
                                                    December 31,    December 31,
                                                            1998            1997
                                                    ------------    ------------
Assets

Investment in affiliates                                $794,494        $748,465
Net Assets of Discontinued Operations                     11,695          17,046
                                                        --------        --------
    Total Assets                                        $806,189        $765,511
                                                        ========        ========

Liabilities and Stockholders' Equity

Long-term debt                                           $74,856         $74,819
Bank note payable                                         25,000          25,000
Intercompany balance with affiliates                      95,315          94,946
Other Liabilities                                            192           1,803
Stockholders' Equity                                     610,826         568,943
                                                        --------        --------
    Total Liabilities and Stockholders' Equity          $806,189        $765,511
                                                        ========        ========


<TABLE>
<CAPTION>
                                                      Year Ended      Year Ended       Year Ended
                                                    December 31,    December 31,     December 31,
                                                            1998            1997             1996
                                                    ------------    ------------     ------------
<S>                                                      <C>             <C>              <C>
Condensed Statements of Income

Revenues                                                    $315            $241             $183
Expenses                                                  15,462          16,376           13,564
                                                        --------        --------         --------
    Total Operating (Loss)                               (15,147)        (16,135)         (13,381)
Equity in net income of affiliates                        54,376          81,578           66,062
                                                        --------        --------         --------
    Income before income tax (benefit)                    39,229          65,443           52,681
Income tax (benefit)                                      (4,958)         (5,375)          (4,333)
                                                        --------        --------         --------
Net Income from Continuing Operations                    $44,187         $70,818          $57,014
                                                        ========        ========         ========
Income from Discontinued Operations                      ($2,645)          ($766)           ($490)
                                                        --------        --------         --------
Net Income                                               $41,542         $70,052          $56,524
                                                        ========        ========         ========
</TABLE>

See accompanying notes to Condensed Financial Statements


<PAGE>


<TABLE>
<CAPTION>
                                                                    Year Ended         Year Ended         Year Ended
                                                                  December 31,       December 31,       December 31,
                                                                          1998               1997               1996
                                                                  ------------       ------------       ------------
<S>                                                                    <C>                <C>                <C>
Condensed Statements of Cash Flows

Operating Activities

Net Income                                                             $41,542            $70,052            $56,524
Adjustments to reconcile net income to net cash
  provided by (used in) operating activities:
Equity in net income of affiliates                                     (54,376)           (81,578)           (66,062)
Dividends received from subsidiary                                      12,000              8,000             17,500
Other                                                                    1,940              6,925                645
Discontinued operations, net                                            12,846              6,730             (2,162)
                                                                      --------           --------           --------
    Net cash provided by/(used in) operating activities                 13,952             10,129              6,445

Investing Activities

Investment in affiliates                                                     0                  0            (25,402)
Maturities (purchases) of short-term investments, net                        0                  0                  0
Discontinued operations, net                                            (7,320)            (5,553)           (24,354)
                                                                      --------           --------           --------
     Net cash used in investing activities                              (7,320)            (5,553)           (49,756)

Financing Activities

Proceeds from issuance of stock                                          2,283              2,636             30,881
Net proceeds from issuance of bank note payable                              0                  0              9,000
Dividends paid to stockholders'                                         (5,102)            (4,606)            (3,945)
Purchase of treasury stock, at cost                                          0             (1,021)              (232)
Discontinued operations, net                                              (190)               (23)             8,395
                                                                      --------           --------           --------
    Net cash provided by/(used in) financing activities                 (3,009)            (3,014)            44,009

(Decrease)/Increase in cash                                              3,623              1,562                787
Cash at beginning of year                                                2,512                950                162
                                                                      --------           --------           --------
Cash at end year                                                        $6,135             $2,512               $950
                                                                      ========           ========           ========
</TABLE>


See accompanying notes to Condensed Financial Statements


<PAGE>


Schedule II - Condensed Financial Information of Registrant - continued
Capital Re Corporation
December 31, 1998


Notes to Condensed Financial Statements


The accompanying  condensed  financial  statements should be read in conjunction
with the  consolidated  financial  statements  and notes  thereto  of Capital Re
Corporation and Subsidiaries.

The long-term debt of $74.9 million is senior unsecured debentures.  See Note 11
to  the  consolidated   financial  statements  of  Capital  Re  Corporation  and
Subsidiaries for a description of Capital Re Corporation's debt.

Of the $95.3 million  intercompany  balance with subsidiary,  $94.9 million is a
loan between the Corporation and its subsidiary,  Capital Re LLC, a limited life
company organized under the laws of Turks and Caicos Islands.  The $94.9 million
loan consists of $75.0 million of proceeds received from the issuance of Company
obligated mandatorily  redeemable preferred securities of Capital Re LLC as well
as the  Corporation's  $19.9 million common stock  investment in Capital Re LLC.
See Note 17 to the consolidated  financial  statements of Capital Re Corporation
and Subsidiaries for an explanation of the loan.

The  Corporation  reflects  its  investment  in  its  Lloyd's  operations  as  a
discontinued  operation,  since in 1998 it  commenced  a plan  divestiture.  For
comparative purposes, all prior periods have been restated.


<PAGE>


                             CAPITAL RE CORPORATION
                             Schedule IV - Reinsurance
                             (dollars in thousands)


<TABLE>
<CAPTION>

        Premiums                                                                       Percentage
        Property                      Ceded to          Assumed                         of Amount
             and       Gross             Other       from Other            Net         Assumed to
       Liability      Amount         Companies        Companies         Amount                Net
       ---------      ------         ---------        ---------         ------                ---
<S>         <C>           <C>           <C>            <C>            <C>                  <C>
            1998          $0            $3,347         $213,941       $210,594             101.6%
            1997          $0            $5,668         $169,943       $164,275             103.5%
            1996          $0           $24,630         $129,818       $105,188             123.5%
</TABLE>
<PAGE>