<PAGE>   1                                     
             UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                           WASHINGTON, DC 20549
--------------------------------------------------------------------------
                                 FORM 10-Q

/X/   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

              For the Quarterly Period Ended September 30, 1998    
                                     
                                     OR

/ /   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
      For the transition period from                  to
                    -------------------------------------
                     Commission File Number   33-94670-01
                    -------------------------------------
                              FARMERS GROUP, INC.
           (Exact name of registrant as specified in its charter)
                                     
                                   NEVADA
                       (State or other jurisdiction of
                       incorporation or organization)

                                  95-0725935
                      (IRS Employer Identification No.)

           4680 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90010
             (Address of principal executive offices)(Zip Code)

                                (323) 932-3200
             (Registrants telephone number, including area code)
                                     
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for 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  / /

Registrant's Common Stock outstanding on September 30, 1998 was 1,000 shares.

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                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES

                           TABLE OF CONTENTS FORM 10-Q

                      FOR THE PERIOD ENDED SEPTEMBER 30, 1998


PART I.   FINANCIAL INFORMATION                                             PAGE
                                                                            ----
  ITEM 1. Financial Statements

          Consolidated Balance Sheets - Assets
             September 30, 1998 and December 31, 1997                         4

          Consolidated Balance Sheets - Liabilities and Stockholders' 
             Equity
             September 30, 1998 and December 31, 1997                         5

          Consolidated Statements of Income 
             Nine Month Periods ended September 30, 1998 and     
             September 30, 1997                                               6

          Consolidated Statements of Comprehensive Income 
             Nine Month Periods ended September 30, 1998 and     
             September 30, 1997                                               7

          Consolidated Statements of Income 
             Three Month Periods ended September 30, 1998 and     
             September 30, 1997                                               8

          Consolidated Statements of Comprehensive Income 
             Three Month Periods ended September 30, 1998 and     
             September 30, 1997                                               9

          Consolidated Statement of Stockholders' Equity
             Nine Month Period ended September 30, 1998                      10

          Consolidated Statement of Stockholder's Equity
             Nine Month Period ended September 30, 1997                      11

          Consolidated Statements of Cash Flows
             Nine Month Periods ended September 30, 1998 and   
             September 30, 1997                                              12

          Notes to Interim Financial Statements                              13

  ITEM 2. Management's Discussion and Analysis of Financial Condition
          and Results of Operations                                          19

PART II.  OTHER INFORMATION                                                  28

SIGNATURES                                                                   30

<PAGE>   4








PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
                                 FARMERS GROUP, INC.
                                  AND SUBSIDIARIES
                             CONSOLIDATED BALANCE SHEETS
                               (Amounts in thousands)
                                     (Unaudited)
                                       ASSETS
<TABLE>
<CAPTION>
                                                                September 30, December 31,
                                                                     1998         1997
                                                                ------------- ------------
<S>                                                             <C>           <C>  
Current assets, excluding insurance subsidiaries:
 Cash and cash equivalents                                      $     155,593 $    506,273
 Marketable securities, at market value                                47,777       78,147
 Accrued interest                                                      16,911       43,849
 Accounts receivable, principally from the P&C Group                   59,349       34,804
 Notes receivable - affiliate                                               0      137,000
 Deferred taxes                                                        26,599       28,925
 Prepaid expenses and other                                            20,019       13,725
                                                                ------------- ------------
  Total current assets                                                326,248      842,723
                                                                ------------- ------------
Investments, excluding insurance subsidiaries:
 Fixed maturities available-for-sale, at market value
  (cost: $638,826 and $482,355)                                       649,666      488,245
 Mortgage loans on real estate                                            207          240
 Common stocks available-for-sale, at market value
  (cost: $329,188 and $322,741)                                       385,110      388,966
 Certificates in surplus of the P&C Group                              34,380      684,380
 Real estate, at cost (net of accumulated depreciation:
  $32,630 and $29,212)                                                 63,295       63,512
 Joint ventures, at equity                                                864        4,825
                                                                ------------- ------------
                                                                    1,133,522    1,630,168
                                                                ------------- ------------
Other assets, excluding insurance subsidiaries:
 Notes receivable - affiliate                                       1,057,000      270,000
 Goodwill (net of accumulated amortization: 
  $585,429 and $540,396)                                            1,816,326    1,861,359
 Attorney-in-fact contracts (net of accumulated amortization:
  $416,578 and $384,534)                                            1,292,465    1,324,509
 Securities lending collateral                                         26,325       49,908
 Other assets                                                         249,221      297,602
                                                                ------------- ------------
                                                                    4,441,337    3,803,378
                                                                ------------- ------------
Properties, plant and equipment, at cost:  (net of accumulated
 depreciation: $283,870 and $242,392)                                 412,167     450,880
                                                                ------------- ------------
Investments of insurance subsidiaries:
 Fixed maturities available-for-sale, at market value
  (cost: $3,932,615 and $3,408,426)                                 4,115,963    3,555,148
 Mortgage loans on real estate                                         65,105       89,903
 Non-redeemable preferred stocks available-for-sale, at market
  value (cost: $1,153 and $1,153)                                       1,286        1,227
 Common stocks available-for-sale, at market value
  (cost: $41 and $0)                                                        7          120
 Certificates in surplus of the P&C Group                             119,000            0
 Policy loans                                                         180,742      165,894
 Real estate, at cost (net of accumulated depreciation:
  $21,253 and $19,306)                                                 65,547       69,265
 Joint ventures, at equity                                              8,243        9,515
 Other investments, at market value (cost: $9,870 and $3,450)           9,033        3,299
                                                                ------------- ------------
                                                                    4,564,926    3,894,371
                                                                ------------- ------------
Other assets of insurance subsidiaries:
 Cash and cash equivalents                                            183,107        9,980
 Marketable securities, at market value                                 8,133       50,069
 Reinsurance premiums receivable - P&C Group                          107,067            0  
 Accrued investment income                                             58,909       52,017
 Deferred policy acquisition costs and value of life business
  acquired                                                            795,250      798,725
 Securities lending collateral                                        482,132      544,580
 Other assets                                                          30,159       40,542
                                                                ------------- ------------
                                                                    1,664,757    1,495,913
                                                                ------------- ------------
   Total assets                                                  $ 12,542,957 $ 12,117,433
                                                                ============= ============
The accompanying notes are an integral part of these interim financial statements.

</TABLE>

<PAGE>   5
                                  FARMERS GROUP, INC.
                                   AND SUBSIDIARIES
                              CONSOLIDATED BALANCE SHEETS
                                (Amounts in thousands)
                                      (Unaudited)
                         LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                 September 30, December 31,
                                                                     1998         1997
                                                                ------------- ------------
<S>                                                             <C>           <C>
Current liabilities, excluding insurance subsidiaries:
 Notes and accounts payable:
  P&C Group                                                      $      3,823 $      2,478
  Other                                                                25,896       28,204
 Accrued liabilities:
  Profit sharing                                                       38,306       51,067
  Income taxes                                                         46,323       82,279
  Other                                                                24,397       12,245
                                                                 ------------ ------------
   Total current liabilities                                          138,745      176,273
                                                                 ------------ ------------
Other liabilities, excluding insurance subsidiaries:
 Real estate mortgages payable                                             26           92
 Non-current deferred taxes                                           600,952      643,910
 Securities lending liability                                          26,325       49,908
 Other                                                                134,803      131,056
                                                                 ------------ ------------
                                                                      762,106      824,966
                                                                 ------------ ------------
Liabilities of insurance subsidiaries:
 Policy liabilities:
  Future policy benefits                                            3,122,215    3,010,162
  Claims                                                               28,921       22,156
  Other policyholder funds                                             57,606       60,072
 Provision for non-life losses and loss adjustment expenses           105,251            0
 Income taxes (including deferred taxes: $164,705 and $153,006)       176,508      148,868
 Unearned investment income                                             1,019        1,016
 Reinsurance payable - P&C Group                                      157,989            0
 Securities lending liability                                         482,132      544,580
 Other liabilities                                                     63,245       47,766
                                                                 ------------ ------------
                                                                    4,194,886    3,834,620
                                                                 ------------ ------------
   Total liabilities                                                5,095,737    4,835,859
                                                                 ------------ ------------

Commitments and contingencies

Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures                                               500,000      500,000
                                                                 ------------ ------------
Stockholders' Equity:
 Common stock, $1 par value per share; authorized, issued                   0            1
  and outstanding:  as of December 31, 1997 - 1,000 shares                                
 Class A common stock, $1 par value per share; authorized, issued         0.5            0
  and outstanding:  as of September 30, 1998 - 500 shares
 Class B common stock, $1 par value per share; authorized, issued         0.5            0
  and outstanding:  as of September 30, 1998 - 500 shares
 Additional capital                                                 5,212,618    5,212,618
 Accumulated other comprehensive income (net of deferred 
  taxes: $69,749 and $61,193)                                         129,501      113,549
 Retained earnings                                                  1,605,100    1,455,406
                                                                 ------------ ------------
   Total stockholders' equity                                       6,947,220    6,781,573
                                                                 ------------ ------------
     Total liabilities and stockholders' equity                  $ 12,542,957 $ 12,117,432
                                                                 ============ ============
The accompanying notes are an integral part of these interim financial statements.

</TABLE>

<PAGE>   6
                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                             (Amounts in thousands)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                      Nine month period
                                                                      ended September 30,
                                                                  ------------------------
                                                                      1998        1997
                                                                  -----------  -----------
<S>                                                               <C>          <C> 
Consolidated operating revenues                                   $ 2,286,713  $ 1,504,332
                                                                  ===========  ===========
Management services to property and casualty
 insurance companies; and other:
  Operating revenues                                              $ 1,015,816  $   981,107
                                                                  -----------  -----------
  Operating expenses                                                  598,528      550,118
  Merger related expenses                                              20,532            0
                                                                  -----------  -----------
    Total expenses                                                    619,060      550,118
                                                                  -----------   ----------
    Operating income                                                  396,756      430,989
  Net investment income                                               104,039      110,018
  Net realized gains                                                   17,977       56,609
  Gain on sale of subsidiaries                                              0       16,536
  Dividends on preferred securities of subsidiary trusts              (31,553)     (31,553)
                                                                  -----------   ----------
    Income before provision for taxes                                 487,219      582,599
  Provision for income taxes                                          198,455      252,835
                                                                  -----------   ----------
    Management services income                                        288,764      329,764
                                                                  -----------   ----------
Insurance subsidiaries:
  Life premiums                                                       129,225      122,270
  Non-life reinsurance premiums                                       750,104            0
  Life policy charges                                                 154,643      166,026
  Investment income, net of expenses                                  226,918      222,064
  Net realized gains                                                   10,007       12,865
                                                                  -----------  -----------
    Total revenues                                                  1,270,897      523,225
                                                                  -----------  -----------
  Non-life losses and loss adjustment expenses                        491,271            0
  Life policyholders' benefits and charges                            228,298      223,628
  Non-life reinsurance commissions                                    239,974            0
  General operating expenses                                          113,822      132,019
                                                                  -----------  -----------
    Total operating expenses                                        1,073,365      355,647
                                                                  -----------  -----------
    Income before provision for taxes                                 197,532      167,578
  Provision for income taxes                                           70,202       58,086
                                                                  -----------  -----------
    Insurance subsidiaries income                                     127,330      111,492
                                                                  -----------  -----------

Consolidated net income                                           $   416,094  $   441,256
                                                                  ===========  ===========
The accompanying notes are an integral part of these interim financial statements.
</TABLE>

<PAGE>   7
                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                           CONSOLIDATED STATEMENTS OF 
                              COMPREHENSIVE INCOME
                             (Amounts in thousands)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                      Nine month period
                                                                     ended September 30,
                                                                  ------------------------
                                                                      1998        1997
                                                                  -----------  -----------
<S>                                                               <C>          <C> 
Consolidated net income                                           $   416,094  $   441,256
                                                                  ===========  ===========
Other comprehensive income, net of tax:
  Unrealized holding gains/(losses) on securities:
    Unrealized holding gains arising during the period,
      net of tax of $15,896                                       $    29,582  $  
    Less:  reclassification adjustment for gains
      included in net income, net of tax of ($4,728)                   (8,780)
                                                                  -----------  -----------
  Net unrealized holding gains on securities,        
      net of tax of $11,168 and $12,216                                20,802       22,918
  Change in effect of unrealized losses on other 
      insurance accounts, net of tax of ($2,612) and 
      ($4,024)                                                         (4,850)      (7,473)
                                                                  -----------  -----------
  Other comprehensive income                                           15,952       15,445
                                                                  -----------  -----------
Comprehensive income                                              $   432,046  $   456,701
                                                                  ===========  ===========

The accompanying notes are an integral part of these interim financial statements.
</TABLE>

<PAGE>   8
                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                             (Amounts in thousands)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                     Three month period
                                                                     ended September 30,
                                                                  ------------------------
                                                                      1998        1997
                                                                  -----------  -----------
<S>                                                               <C>          <C> 
Consolidated operating revenues                                   $   774,354 $   494,022
                                                                  ===========  ===========
Management services to property and casualty
 insurance companies; and other:
  Operating revenues                                              $   343,904  $   331,569
                                                                   ----------   ----------
  Operating expenses                                                  229,108      186,514
  Merger related expenses                                              20,532            0
                                                                   ----------   ----------
    Total expenses                                                    249,640      186,514
                                                                   ----------   ----------
    Operating income                                                   94,264      145,055
  Net investment income                                                27,065       39,615
  Net realized gains/(losses)                                            (552)      15,906
  Dividends on preferred securities of subsidiary trusts              (10,518)     (10,518)
                                                                  -----------   ----------
    Income before provision for taxes                                 110,259      190,058
  Provision for income taxes                                           47,329       76,861
                                                                  -----------   ----------
    Management services income                                         62,930      113,197
                                                                  -----------   ----------
Insurance subsidiaries:
  Life premiums                                                        44,993       38,389
  Non-life reinsurance premiums                                       250,104            0
  Life policy charges                                                  51,588       50,505
  Investment income, net of expenses                                   80,369       69,299
  Net realized gains                                                    3,396        4,260
                                                                  -----------  -----------
    Total revenues                                                    430,450      162,453
                                                                  -----------  -----------
  Non-life losses and loss adjustment expenses                        160,525            0
  Life policyholders' benefits and charges                             79,195       66,870
  Non-life reinsurance commissions                                     83,220            0
  General operating expenses                                           38,893       38,199
                                                                  -----------  -----------
    Total operating expenses                                          361,833      105,069
                                                                  -----------  -----------
    Income before provision for taxes                                  68,617       57,384
  Provision for income taxes                                           23,965       19,475
                                                                  -----------  -----------
    Insurance subsidiaries income                                      44,652       37,909
                                                                  -----------  -----------

Consolidated net income                                           $   107,582  $   151,106
                                                                  ===========  ===========
The accompanying notes are an integral part of these interim financial statements.
</TABLE>

<PAGE>   9
                                 FARMERS GROUP, INC.
                                  AND SUBSIDIARIES
                             CONSOLIDATED STATEMENTS OF 
                                COMPREHENSIVE INCOME
                               (Amounts in thousands)
                                     (Unaudited)
<TABLE>
<CAPTION>
                                                                     Three month period
                                                                     ended September 30,
                                                                  ------------------------
                                                                      1998         1997
                                                                  -----------  -----------
<S>                                                               <C>          <C> 
Consolidated net income                                           $   107,582  $  151,106
                                                                  ===========  ===========
Other comprehensive income, net of tax:
  Unrealized holding gains/(losses) on securities:
    Unrealized holding gains arising during the period,
      net of tax of $3,190                                         $    5,935  $  
    Less:  reclassification adjustment for gains
      included in net income, net of tax of ($2,969)                   (5,514)
                                                                  -----------  -----------
  Net unrealized holding gains on securities,        
      net of tax of $221 and $26,720                                      421      45,173
  Change in effect of unrealized losses on other 
      insurance accounts, net of tax of ($2,470) and 
      ($6,072)                                                         (4,587)    (11,276)
                                                                  -----------  -----------
  Other comprehensive income                                           (4,166)     33,897
                                                                  -----------  -----------
Comprehensive income                                              $   103,416  $  185,003
                                                                  ===========  ===========

The accompanying notes are an integral part of these interim financial statements.
</TABLE>

<PAGE>   10

                                    FARMERS GROUP, INC.
                                     AND SUBSIDIARIES
                      CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                    For the nine month period ended September 30, 1998
                                  (Amounts in thousands)
                                        (Unaudited)
<TABLE>
<CAPTION>
                                                     Accumulated Other                     Total
                                Common    Additional  Comprehensive        Retained    Stockholders'
                                Stock      Capital        Income           Earnings       Equity
                               --------  -----------  ----------------   ------------  ------------ 
<S>                            <C>       <C>          <C>                <C>           <C>
Balance, December 31, 1997     $      1  $ 5,212,618  $        113,549   $  1,455,406  $  6,781,574

Net income                                                                    416,094       416,094

Unrealized holding gains   
  arising during the period,  
  net of tax of $15,896                                         29,582                       29,582
  
Reclassification adjustment 
  for gains included in net
  income, net of tax of ($4,728)                                (8,780)                      (8,780)

Change in effect of unrealized 
  losses on other insurance 
  accounts, net of tax of ($2,612)                              (4,850)                      (4,850)
  
Cash dividends paid                                                          (266,400)     (266,400)
                               --------  -----------  ----------------   ------------  ------------ 
Balance, September 30, 1998    $      1  $ 5,212,618  $        129,501   $  1,605,100  $  6,947,220 
                               ========  ===========  ================   ============  ============ 

The accompanying notes are an integral part of these interim financial statements.

</TABLE>

<PAGE>   11

                                     FARMERS GROUP, INC.
                                      AND SUBSIDIARIES
                       CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
                     For the nine month period ended September 30, 1997
                                   (Amounts in thousands)
                                         (Unaudited)
<TABLE>
<CAPTION>
                                                    Accumulated Other                     Total
                              Common    Additional    Comprehensive       Retained     Stockholder's
                              Stock      Capital         Income           Earnings        Equity
                             --------  ------------ -----------------   ------------   ------------
<S>                          <C>       <C>          <C>                 <C>            <C>
Balance, December 31, 1996   $      1  $  5,212,618 $          92,104   $  1,199,108   $  6,503,831

Net income                                                                   441,256        441,256

Change in other comprehensive
  income, net of tax of 
  $8,192                                                       15,445                        15,445

Cash dividends paid                                                         (252,900)      (252,900)
                             --------  ------------ -----------------   ------------   ------------
Balance, September 30, 1997  $      1  $  5,212,618 $         107,549   $  1,387,464   $  6,707,632
                             ========  ============ =================   ============   ============

The accompanying notes are an integral part of these interim financial statements.

</TABLE>

<PAGE>   12

                                 FARMERS GROUP, INC.
                                  AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                               (Amounts in thousands)
                                     (Unaudited)
<TABLE>
<CAPTION>
                                                                     Nine month period 
                                                                     ended September 30,
                                                                  -----------------------
                                                                     1998         1997
                                                                  ----------   ---------- 
<S>                                                               <C>          <C> 
Cash Flows from Operating Activities:
 Consolidated net income                                          $  416,094   $  441,256
 Non-cash and operating activities adjustments:
  Depreciation and amortization                                      141,205      130,322
  Amortization of deferred policy acquisition costs and
    value of life business acquired                                   67,759       80,759
  Policy acquisition costs deferred                                  (71,746)     (74,472)
  Life insurance policy liabilities                                   21,311       13,500
  Provision for non-life losses and loss adjustment expenses         105,251            0
  Universal life type contracts:
     Deposits received                                               223,394      221,181
     Withdrawals                                                    (180,274)    (174,062)
     Interest credited                                                50,285       46,113
  Equity in earnings of joint ventures                                (1,039)      (2,824)
  Gain on sales of assets                                            (28,197)     (70,505)
  Gain on sale of subsidiaries                                             0      (16,536)
 Changes in assets and liabilities:
  Current assets and liabilities                                      34,533       25,420
  Non-current assets and liabilities                                  62,598     (112,874)
 Other, net                                                          (32,095)          77
                                                                  ----------  ----------- 
 Net cash provided by operating activities                           809,079      507,355 
                                                                  ----------  ----------- 
Cash Flows from Investing Activities:
 Purchases of investments available-for-sale                      (1,257,063)  (1,288,241)
 Purchases of properties                                             (34,963)     (55,823)
 Purchase of notes receivable - affiliate                         (1,057,000)           0 
 Purchase of surplus certificates of the P&C Group                  (119,000)           0 
 Proceeds from sales and maturities of investments
  available-for-sale                                                 656,622      815,164
 Proceeds from sales of properties                                    20,143       12,243
 Proceeds from redemption of surplus certificates of the P&C Group   650,000            0
 Proceeds from redemption of notes receivable - affiliate            407,000            0
 Proceeds from sale of subsidiaries                                        0      335,408
 Mortgage loan collections                                            24,058       21,465
 Increase in policy loans                                            (14,848)     (12,785)
 Other, net                                                            3,250       (4,290)
                                                                  ----------  -----------
 Net cash used in investing activities                              (721,801)    (176,859)
                                                                  ----------  -----------
Cash Flows from Financing Activities:
 Dividends paid to stockholders                                     (266,400)    (252,900)
 Annuity contracts:                                                                     
    Deposits received                                                107,341       94,463
    Withdrawals                                                     (164,283)    (120,841)
    Interest credited                                                 58,577       60,041
 Payment of long-term notes payable                                      (66)         (60)
                                                                  ----------  -----------
 Net cash used in financing activities                              (264,831)    (219,297)
                                                                  ----------  -----------

Increase/(decrease) in cash and cash equivalents                    (177,553)     111,199
Cash and cash equivalents - at beginning of year                     516,253      499,328
                                                                  ----------  -----------
Cash and cash equivalents - at end of period                      $  338,700   $  610,527
                                                                  ==========  ===========

The accompanying notes are an integral part of these interim financial statements.

</TABLE>

<PAGE>   13
                                    FARMERS GROUP, INC.
                                     AND SUBSIDIARIES
                          NOTES TO INTERIM FINANCIAL STATEMENTS
                                        (Unaudited)


A.   Basis of presentation and summary of significant accounting policies

     The accompanying consolidated balance sheet of Farmers Group, Inc. ("FGI")
and its subsidiaries (together, the "Company") as of September 30, 1998, the
related consolidated statements of income, comprehensive income, stockholders'
equity and cash flows for the nine month periods ended September 30, 1998 and
September 30, 1997, and the consolidated statements of income and
comprehensive income for the three month periods ended September 30, 1998 and
September 30, 1997, have been prepared in accordance with generally accepted
accounting principles ("GAAP") for interim periods and are unaudited.
However, in management's opinion, the consolidated financial statements include
all adjustments (consisting of only normal recurring adjustments) necessary for
a fair presentation of results for such interim periods.  These statements do
not include all of the information and footnotes required by GAAP for complete
financial statements and should be read in conjunction with the consolidated
balance sheets of the Company as of December 31, 1997 and 1996, and the
related consolidated statements of income, stockholder's equity, and cash flows
for each of the three years in the period ended December 31, 1997.  

     Interim results are not necessarily indicative of results for the full 
year.  All material inter-company transactions have been eliminated.  Certain
amounts applicable to prior years have been reclassified to conform with the
1998 presentation.

     The preparation of the Company's financial statements in conformity with
GAAP 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 as well as the reported
amounts of revenues and expenses during the reporting periods.  Actual results
could differ from those estimates.

     The Company is attorney-in-fact ("AIF") for three inter-insurance
exchanges: Farmers Insurance Exchange, Fire Insurance Exchange and Truck
Insurance Exchange (collectively, the "Exchanges"), which operate in the
property and casualty insurance industry.  As AIF, FGI, or its subsidiaries, as
applicable, provides management services to the Exchanges, their respective
subsidiaries and Farmers Texas County Mutual Insurance Company (collectively,
the "P&C Group") and receives compensation based on a percentage of earned
premiums.

     Prior to April 15, 1997, the Company's life insurance operations were
conducted by three wholly owned life insurance subsidiaries:  Farmers New World
Life Insurance Company ("Farmers Life"), The Ohio State Life Insurance Company
("OSL") and Investors Guaranty Life Insurance Company ("IGL").  On April 15,
1997, FGI sold OSL and IGL to Great Southern Life Insurance Company, a
subsidiary of Americo Life, Inc..  The contribution to net income of these
subsidiaries in 1997 was $5,507,000, and the combined net assets of these
subsidiaries as of April 15, 1997 was $317,625,000.

     In December 1997, Farmers Reinsurance Company ("Farmers Re"), a property
and casualty insurance subsidiary of FGI, was formed and licensed to conduct
business.  In January 1998,

<PAGE>   14

Farmers Re entered into a quota share reinsurance treaty with Farmers 
Insurance Exchange under which it reinsures a percentage of the auto physical 
damage business written by the P&C Group. 

     As a result of the foregoing, references to the "Insurance Subsidiaries"
within the 1998 consolidated financial statements are to Farmers Life and
Farmers Re, whereas, references to the  "Insurance Subsidiaries" within the
1997 consolidated statements of income and comprehensive income and
consolidated statement of cash flows are to Farmers Life, OSL and IGL. 

     In December 1988, BATUS Inc. ("BATUS"), a subsidiary of B.A.T Industries
p.l.c. ("B.A.T"), acquired 100% ownership of the Company for $5,212,619,000 in
cash, including related expenses, through its wholly owned subsidiary BATUS
Financial Services. Immediately thereafter, BATUS Financial Services was merged
into Farmers Group, Inc..  The acquisition was accounted for as a purchase
and, accordingly, the acquired assets and liabilities were recorded in the
Company's consolidated balance sheets based on their estimated fair values at
December 31, 1988.  In January 1990, ownership of the Company was transferred
to South Western Nominees Limited, a subsidiary of B.A.T.

     On December 22, 1997, a definitive agreement was reached to merge B.A.T
Industries' Financial Services Businesses, which includes the Company, with
Zurich Insurance Company ("Zurich").  In June 1998, the merger was approved by
the shareholders of B.A.T and Zurich.  In September 1998, this merger was
completed and the businesses of Zurich and B.A.T Industries' Financial Services
Businesses were transferred to Zurich Financial Services ("ZFS"), a new Swiss
company with headquarters in Zurich.  As a result, each two shares of the
Company's prior outstanding stock were recapitalized into one share of Class A
Common Stock, par value $1.00 per share ("Ordinary Shares") and one share of
Class B Common Stock, par value $1.00 per share ("Income Shares").  Under the
merger agreement, all Ordinary Shares became wholly owned by ZFS and all Income
Shares became wholly owned by Allied Zurich Holdings, an affiliated company
created during the restructuring of B.A.T.

     In February 1997, the Financial Accounting Standards Board ("FASB")
released Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share".  This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established standards for
computing and presenting earnings per share and applies to entities with
publicly held common stock or potential common stock.  The Company does not
have any publicly held common stock and, therefore, is not subject to the
requirements of this Statement.

     In 1998, the Company adopted SFAS No. 129, "Disclosure of Information
About Capital Structure".  This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established standards for
disclosing information about an entity's capital structure.  The adoption of
this Statement did not have a material impact on the Company's consolidated
financial statements.

     In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income".  This Statement, effective for fiscal periods beginning after
December 15, 1997, established standards for reporting and displaying
comprehensive income and its components.  This Statement mandated that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement
with the same prominence as other financial statements.  As a result of
adopting this Statement, the components of comprehensive income are now stated
in the consolidated statements of comprehensive income.  The adoption of this 
Statement did not have a material impact on the Company's consolidated 
financial statements.

<PAGE>   15

     In June 1997, the FASB released SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information".  This Statement, effective for
financial statements of public enterprises issued for periods beginning after
December 15, 1997, established standards for reporting information about
operating segments in annual financial statements and required the reporting
of selected information about operating segments in interim financial reports
issued to shareholders.  It also established standards for related disclosures
about products and services, geographic areas, and major customers.  This
Statement superseded SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise", and amended SFAS No. 94, "Consolidation of All Majority
Owned Subsidiaries".  As this Statement need not be applied to the interim
financial statements in the initial year of its application, the Company will
adopt SFAS No. 131 beginning with its December 31, 1998 annual financial
statements.  The Company does not expect the adoption of this Statement to have
a material impact on its consolidated financial statements.

     In February 1998, the FASB released SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits".  This Statement, effective
for financial statements of public and nonpublic enterprises issued for fiscal
years beginning after December 15, 1997, standardized the disclosure
requirements relating to pension and other postretirement benefit plans.
It addressed disclosure only and, as such, did not change the requirements for
measurement or recognition of such plans.  This Statement superceded the
disclosure requirements set forth in SFAS No. 87, "Employers' Accounting for
Pensions", SFAS No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits", and SFAS No.
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions".
The Company does not expect the adoption of this Statement to have a material
impact on its consolidated financial statements.

     In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use".  This SOP, effective
for financial statements issued for periods beginning after December 15, 1998,
applies to all nongovernmental entities and establishes the rules for
capitalizing or expensing internally used software.  The Company does not
expect the adoption of this Statement to have a material impact on its
consolidated financial statements.  

     In June 1998, the FASB released SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities".  This Statement, effective for financial
statements of public and nonpublic entities issued for fiscal years beginning
after June 15, 1999, established accounting and reporting standards for
derivative instruments (including certain derivative instruments embedded in
other contracts) and for hedging activities.  SFAS No. 133 required that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
This Statement amended SFAS No. 52, "Foreign Currency Translation", and SFAS
No. 107, "Disclosures about Fair Value of Financial Instruments".  It
superseded SFAS No. 80, "Accounting for Futures Contracts", SFAS No. 105,
"Disclosure of Information about Financial Instruments with Off-Balance-Sheet
Risk and Financial Instruments with Concentrations of Credit Risk", and SFAS
No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments".  The Company does not expect the adoption of this
Statement to have a material impact on its consolidated financial statements.

<PAGE>   16

B.   Material contingencies

     The Company is a party to numerous lawsuits arising from its normal
business activities. These actions are in various stages of discovery and
development, and some seek punitive as well as compensatory damages.  In the
opinion of management, the Company has not engaged in any conduct which should
warrant the award of any material punitive or compensatory damages.  The
Company intends to vigorously defend its position in each case, and management
believes that, while it is not possible to predict the outcome of such matters
with absolute certainty, ultimate disposition of these proceedings should not
have a material adverse effect on the Company's consolidated results of
operations or financial position.

C.   Company Obligated Mandatorily Redeemable Preferred Securities of 
     Subsidiary Trusts Holding Solely Junior Subordinated Debentures

     In 1995, Farmers Group Capital and Farmers Group Capital II
(the "Subsidiary Trusts"), consolidated wholly owned subsidiaries of Farmers
Group, Inc., issued $410 million of 8.45% Cumulative Quarterly Income Preferred
Securities ("QUIPS"), Series A and $90 million of 8.25% QUIPS, Series B,
respectively.  In connection with the Subsidiary Trusts' issuance of the QUIPS
and the related purchase by Farmers Group, Inc. of all of the Subsidiary
Trusts' Common Securities ("Common Securities"), Farmers Group, Inc. issued to
Farmers Group Capital $422,680,399 principal amount of its 8.45% Junior
Subordinated Debentures, Series A due on December 31, 2025, (the "Junior
Subordinated Debentures, Series A") and issued to Farmers Group Capital II
$92,783,505 principal amount of its 8.25% Junior Subordinated Debentures,
Series B due on December 31, 2025 (the "Junior Subordinated Debentures, Series
B" and, together with the Junior Subordinated Debentures, Series A, the "Junior
Subordinated Debentures").  The sole assets of Farmers Group Capital are the
Junior Subordinated Debentures, Series A.  The sole assets of Farmers Group
Capital II are the Junior Subordinated Debentures, Series B.  In addition,
these arrangements are governed by various agreements between Farmers Group,
Inc. and the Subsidiary Trusts (the Guarantee Agreements, the Trust Agreements,
the Expense Agreements, the Indentures and the Junior Subordinated Debentures)
which considered together constitute a full and unconditional guarantee by
Farmers Group, Inc. of the Subsidiary Trusts' obligations under the Preferred
Securities.

     Under certain circumstances, the Junior Subordinated Debentures may be
distributed to holders of the QUIPS and holders of the Common Securities in
liquidation of the Subsidiary Trusts.  The QUIPS are subject to mandatory
redemption upon repayment of the Junior Subordinated Debentures at maturity,
or upon their earlier redemption, at a redemption price of $25 per Preferred
Security, plus accrued and unpaid distributions thereon to the date fixed for
redemption.  Farmers Group, Inc. will have the option at any time on or after
September 27, 2000 to redeem, in whole or part, the Junior Subordinated
Debentures.

     As of September 30, 1998 and 1997, a total of 20,000,000 shares of QUIPS
were outstanding.

D.   Management fees

     As AIF, the Company, or its subsidiaries, as applicable, provides
management services to the P&C Group and receives management fees for the
services rendered.  As a result, the Company received management fees from the
P&C Group of $950,787,000 and $918,587,000 for the nine month periods ended
September 30, 1998 and September 30, 1997, respectively.

<PAGE>   17

E.   Related parties

     On September 3, 1998, the Company received $423,734,000 from B.A.T Capital
Corporation, a subsidiary of B.A.T, in settlement of $407,000,000 of notes
receivable and $16,734,000 of accrued interest.  These notes were fixed rate
medium-term notes with maturity dates as follows: $137,000,000 in October 1998,
$135,000,000 in October 1999, and $135,000,000 in October 2000.  Interest on
these notes was paid semi-annually at coupon rates of 5.35%, 6.68%, and 6.33%,
respectively.  On October 7, 1997, a four year $135,000,000 note with an
interest rate of 5.10% matured and the $135,000,000 note that would have
matured in October 2000 was subsequently issued at an interest rate of 6.33%.
Income earned on the notes outstanding for the nine month periods ended
September 30, 1998 and September 30, 1997 was $16,734,000 and $17,424,000,
respectively.

     In addition, on September 3, 1998, the Company, using the proceeds from
the $407,000,000 B.A.T note redemption and $650,000,000 from the redemption of
P&C Group Certificates in Surplus (see note G), issued $1,057,000,000 of notes
receivable to British American Financial Services (UK and International) Ltd.
("BAFS"), a subsidiary of the Zurich Financial Services Group.  These notes are
fixed rate medium-term notes with maturity dates as follows: $200,000,000 in
September 2000, $207,000,000 in September 2001, $200,000,000 in September 2002,
$200,000,000 in September 2003 and $250,000,000 in September 2004.  Interest on
these notes is paid semi-annually at coupon rates of 5.44%, 5.48%, 5.67%, 5.71%
and 5.78%, respectively.  Income earned on these notes through September 30,
1998 was $4,761,000.

F.   Supplemental cash flow information

     For financial statement purposes, the Company considers all investments
with original maturities of 90 days or less as cash equivalents.  Following is
a reconciliation of the individual balance sheet cash and cash equivalent
totals to the consolidated cash flow total: 

<TABLE>
<CAPTION>
                                                    Excluding          
                                                    Insurance      Insurance
                                                  Subsidiaries   Subsidiaries  Consolidated
                                                  ------------   ------------  ------------
                                                          (Amounts in thousands)
<S>                                               <C>            <C>           <C>
Cash and cash equivalents  -- December 31, 1996   $    412,018   $     87,310  $    499,328
                              Activity through September 1997                       111,199
                                                                               ------------
Cash and cash equivalents  -- September 30, 1997       585,803         24,724  $    610,527
                                                                               ============

Cash and cash equivalents  -- December 31, 1997        506,273          9,980  $    516,253
                              Activity through September 1998                      (177,553)
                                                                               ------------
Cash and cash equivalents  -- September 30, 1998       155,593        183,107  $    338,700
                                                                               ============
</TABLE>

     Cash payments for interest were $1,601,000 and $2,138,000 for the nine 
month periods ended September 30, 1998 and September 30, 1997, respectively, 
while the cash payment for dividends to the holders of the Company's QUIPS was 
$31,553,000 for each of the nine month periods ended September 30, 1998 and 
September 30, 1997.  Cash payments for income taxes were $315,977,000 and 
$314,475,000 for the nine month periods ended September 30, 1998 and September 
30, 1997, respectively.

<PAGE>   18

     For the nine month period ended September 30, 1997, net cash proceeds 
from the sale of OSL and IGL amounted to $335,408,000 and were primarily in
consideration for the following:

     Investments                                             $     808,208,000
     Deferred policy acquisition costs and value of life           182,472,000
            business acquired
     Life insurance policy liabilities                            (690,426,000)

G.   Certificates of Surplus of the P&C Group

     On September 8, 1998, Farmers Life made a $119,000,000 surplus 
contribution to the P&C Group and, in return, received a $119,000,000 
certificate of contribution, bearing interest at 6.10% annually.  In addition, 
as of September 30, 1998, the Company held miscellaneous other certificates of 
contribution from the P&C Group totaling $34,380,000 which bear interest 
at various rates.

     Conditions governing repayment of these amounts are outlined in the
certificates.  Generally, repayment may be made only when the surplus balance
of the issuer reaches a certain specified level, and then only after approval 
is granted by issuer's governing Board and the appropriate Department of 
Insurance.

On July 10, 1998, the Company received $675,647,000 from the P&C Group as 
follows:

     Redemption of a $100,000,000 certificate of contribution, issued on 
     December 20, 1996, bearing interest at 8.95% annually.

     Redemption of a $135,000,000 certificate of contribution, issued on 
     September 30, 1996, bearing interest at 8.95% annually.

     Redemption of a $165,000,000 certificate of contribution, issued on 
     June 27, 1996, bearing interest at 8.95% annually.

     Redemption of a $250,000,000 certificate of contribution, issued in 
     1995, bearing interest at 8.95% annually.

     A $25,647,000 repayment of accrued interest.
  
H.   Merger Related Expenses

     As a result of the merger between B.A.T Industries' Financial Service
Businesses and Zurich, the Company has recorded various merger related expenses
totaling $20,532,000, of which $16,545,000 relates to losses the Company will
incur in connection with taking over the management of Zurich's US personal 
lines business.  In addition, $2,728,000 relates to a write-off of 
redundant capitalized software and $1,259,000 relates to miscellaneous audit, 
legal and travel expenses incurred by the Company in connection with the 
merger.

<PAGE>   19

ITEM 2.  Management's Discussion and Analysis of Financial Condition and 
Results of Operations

General

     The Company's principal activities are providing management services to
the property and casualty insurance companies, underwriting life insurance and
annuity products, and providing reinsurance coverage to the P&C Group.
Revenues and expenses relating to these principal business activities are
reflected in the Company's Consolidated Financial Statements prepared in
accordance with GAAP, which differs from statutory accounting practices
("SAP"), which Farmers Life and Farmers Re are required to use for regulatory
reporting purposes.

     The Company underwrites life insurance and annuity products through 
Farmers Life.  Revenues attributable to traditional life insurance products, 
such as whole life or term life contracts, are classified as premiums as they 
become due.  Future benefits are associated with such premiums (through 
increases in liabilities for future policy benefits), and prior period 
capitalized costs are amortized (through amortization of Deferred Policy 
Acquisition Costs ("DAC")) so that profits are generally recognized over the 
same period as revenue income.  Revenues attributable to Universal Life 
("UL") products consist of policy charges for the cost of insurance, policy 
administration charges, surrender charges, and investment income on assets 
allocated to support policyholder account balances on deposit.  Revenues for 
deferred annuity products consist of surrender charges and investment income 
on assets allocated to support policyholder account balances.  Expenses on UL 
and annuity policies include interest credited to policyholders on policy 
balances as well as benefit claims incurred in excess of policy account 
balances.

Three Months Ended September 30, 1998 Compared to Three Months Ended 
September 30, 1997

  Management Services to Property and Casualty Insurance Companies; and Other

     Operating Revenues.  Operating revenues increased from $331.6 million 
for the three months ended September 30, 1997 to $343.9 million for the three 
months ended September 30, 1998, an increase of $12.3 million, or 3.7%.  
Operating revenues primarily consist of management fees paid to the Company 
as a percentage of gross premiums earned by the P&C Group.  Such premiums 
increased from $2,537.8 million in the third quarter of 1997 to $2,609.1 
million in the third quarter of 1998 due primarily to higher premiums earned 
in the Auto and Fire lines of business.

     Operating Expenses.  Operating expenses as a percentage of operating 
revenues increased from 56.3% in the third quarter of 1997 to 72.6% in the 
third quarter of 1998, an increase of 16.3% due to $20.5 million of merger 
related expenses and a $45.8 million write-off of impaired assets.  Excluding 
these two items, operating expenses decreased 1.7% between years.

          Salaries and Employee Benefits.  Salaries and employee benefits
     decreased from $83.9 million for the three months ended September 30,
     1997 to $79.3 million for the three months ended September 30, 1998, a
     decrease of $4.6 million, or 5.5%, due primarily to a reduction in 
     employee complement.

          Buildings and Equipment Expenses.  Buildings and equipment expenses
     increased from $25.4 million for the three months ended September 30,
     1997 to $70.2 million for the three months ended September 30, 1998, an 
     increase of $44.8 million.  In September 1998, a review of capitalized 
     software was conducted and $43.4 million of capitalized costs that were 
     no longer expected to be recoverable were written-off.

<PAGE>   20

          Amortization of Attorney-In-Fact Contracts and Goodwill.  Purchase
     accounting entries related to the acquisition of the Company by B.A.T in 
     December 1988 include goodwill (capitalized at $2.4 billion) and the 
     value of the AIF contracts of the P&C Group (capitalized at $1.7 billion).
     Amortization of these two items, which is being taken on a straight-line 
     basis over forty years, reduced pretax income by approximately $25.7 
     million in each of the three month periods ended September 30, 1998 
     and September 30, 1997.

          General and Administrative Expenses.  General and administrative
     expenses increased from $51.5 million for the three months ended 
     September 30, 1997 to $53.9 million for the three months ended September 
     30, 1998, an increase of $2.4 million, or 4.7%, due primarily to higher 
     business levels.

          Merger Related Expenses.  Expenses incurred by the Company as a 
     result of the merger between B.A.T Industries' Financial Services 
     Businesses and Zurich amounted to $20.5 million in the three month period 
     ended September 30, 1998 (see Footnote H).

     Net Investment Income.  Net investment income decreased from $39.6
million for the three months ended September 30, 1997 to $27.1 million for the
three months ended September 30, 1998 due primarily to a decrease in investment
yields.

     Net Realized Gains/(Losses).  Net realized gains decreased from a $15.9
million gain for the three months ended September 30, 1997 to a ($0.5) million
loss for the three months ended September 30, 1998. This is a result of the
fact that significant gains were realized in 1997 in connection with
restructuring the equities portfolio coupled with the negative movements in 
the stock market in 1998.

     Dividends on Preferred Securities of Subsidiary Trusts.  Dividend expense
related to the $500.0 million of QUIPS issued in 1995 was $10.5 million for 
the three months ended September 30, 1998 and September 30, 1997.

     Provision for Income Taxes.  Provision for income taxes decreased from
$76.9 million for the three months ended September 30, 1997 to $47.3 million
for the three months ended September 30, 1998, a decrease of $29.6 million, or
38.5%.  This decrease was due to a decrease in pretax income.

     Management Services Income.  As a result of the foregoing, management
services income decreased from $113.2 million for the three months ended
September 30, 1997 to $62.9 million for the three months ended September 30,
1998, a decrease of $50.3 million, or 44.4%.

Insurance Subsidiaries

     In December 1997, Farmers Re, a property and casualty insurance 
subsidiary of FGI, was formed and licensed to conduct business.  In January 
1998, Farmers Re entered into a quota share reinsurance treaty with Farmers 
Insurance Exchange under which it reinsures a percentage of the auto physical 
damage business written by the P&C Group.  As a result, for the three month 
period ended September 30, 1998, Farmers Re assumed $250.1 million of 
premiums, incurred $160.5 million of non-life losses and loss adjustment 
expenses and incurred $83.3 million of non-life reinsurance commissions.  
For the three months ended September 30, 1998, Farmers Re contributed $9.5 
million to income before taxes and $6.2 million to net income.

<PAGE>   21

     On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance
Company, a subsidiary of Americo Life, Inc..  As a result, there was no
contribution to net income from OSL or IGL for the three months ended September
30, 1998 and 1997.

     The following commentary addresses the results of the Company's remaining
life insurance subsidiary, Farmers Life.

     Total Revenues. Total revenues increased from $162.5 million for the 
three months ended September 30, 1997 to $177.2 million for the three months 
ended September 30, 1998, an increase of $14.7 million, or 9.0%.

          Life Premiums.  Premiums increased $6.6 million for the three months 
     ended September 30, 1998, or 17.2%, over the three months ended September 
     30, 1997.  This increase was due to growth in the average volume of 
     insurance in-force which was driven by sales of the Premier Whole Life 
     ("PWL"), Farmers Premier 20 Year Term  ("FP20"), and Single Premium 
     Immediate Annuities ("SPIA") products.

          Life Policy Charges.  Policy charges increased $1.1 million for the
     three months ended September 30, 1998, or 2.1%, over the three months
     ended September 30, 1997, reflecting growth in the average volume of
     universal life-type insurance in-force.

          Investment Income.  Net investment income increased $7.9 million in
     the three months ended September 30, 1998, or 11.4%, over the three
     months ended September 30, 1997 due to higher bond interest income
     earned on a higher invested asset base.

          Net Realized Gains.  Net realized gains decreased $0.9 million, from 
     $4.3 million in the three months ended September 30, 1997 to $3.4 million 
     in the three months ended September 30, 1998 due to lower gains realized 
     on bond sales in 1998.

     Total Operating Expenses.  Total operating expenses increased from $105.1 
million for the three months ended September 30, 1997 to $118.1 million for 
the three months ended September 30, 1998, an increase of $13.0 million, or 
12.4%.

          Life Policyholders' Benefits and Charges.  Life policyholders'
     benefits expense and charges increased from $66.9 million for the three 
     months ended September 30, 1997 to $79.2 million for the three months 
     ended September 30, 1998, an increase of $12.3 million, or 18.4%.

               Policy benefits.  Policy benefits, which consist primarily of
          death and surrender benefits on life products, increased $9.4 
          million over September 30, 1997 to $35.0 million, due to growth in
          the volume of life insurance in-force and an increase in mortality
          experience between periods.

               Increase in liability for future benefits.  Increase in
          liability for future benefits expense increased from $4.2 million
          for the three months ended September 30, 1997 to $6.4 million for
          the three months ended September 30, 1998. This increase was
          primarily attributable to additional sales of the PWL, SPIA and the 
          Farmers Premier product series, especially the FP20 product 
          introduced in October 1997.

<PAGE>   22

               Interest credited to policyholders.  Interest credited to
          policyholders, which represents the amount credited to policyholder 
          funds on deposit under universal life-type contracts and deferred 
          annuities, increased from $37.1 million for the three months ended 
          September 30, 1997 to $37.8 million for the three months ended 
          September 30, 1998, or 1.9%, reflecting growth in the universal life 
          fund balance.

          General Operating Expenses.  General operating expenses increased
     from $38.2 million for the three months ended September 30, 1997 to $38.9 
     million for the three months ended September 30, 1998, an increase of 
     $0.7 million, or 1.8%.

               Amortization of DAC and Value of Life Business Acquired.
          Amortization expense decreased from $25.3 million for the three 
          months ended September 30, 1997 to $23.9 million for the three
          months ended September 30, 1998 due to higher universal life death
          claims experience in 1998.

               Commissions. Commissions increased from $3.5 million for the
          three months ended September 30, 1997 to $4.7 million for the three
          months ended September 30, 1998, or $1.2 million. 

               General and Administrative Expenses. General and administrative
          expenses increased from $9.4 million for the three months ended
          September 30, 1997 to $10.3 million for the three months ended
          September 30, 1998, or 9.6%.  This increase resulted mainly from
          increased premium taxes.

     Provision for Income Taxes.  Provision for income taxes increased from
$19.5 million for the three months ended September 30, 1997 to $20.6 million
for the three months ended September 30, 1998, an increase of $1.1 million, 
due to an increase in pretax operating income.

     Farmers Life Income.  As a result of the foregoing, Farmers Life income 
increased from $37.9 million for the three months ended September 30, 1997 to 
$38.5 million for the three months ended September 30, 1998, an increase of 
$0.6 million, or 1.6%.

Consolidated Net Income

     Consolidated net income of the Company decreased from $151.1 million for 
the three months ended September 30, 1997 to $107.6 million for the three 
months ended September 30, 1998, a decrease of $43.5 million, or 28.8%, due 
primarily to the merger related expenses and the write-off of impaired assets.

Nine Months Ended September 30, 1998 Compared to Nine Months Ended 
September 30, 1997

  Management Services to Property and Casualty Insurance Companies; and Other

     Operating Revenues.  Operating revenues increased from $981.1 million 
for the nine months ended September 30, 1997 to $1,015.8 million for the 
nine months ended September 30, 1998, an increase of $34.7 million, or 3.5%.  
This growth reflects higher gross premiums earned by the P&C Group, which 
increased from $7,520.9 million in the first nine months of 1997 to $7,718.5 
million in the first nine month of 1998 primarily as a result of policy growth 
experienced within the Auto and Fire lines of business which was achieved 
despite increasingly competitive market conditions. 

<PAGE>   23

     Operating Expenses.  Operating expenses as a percentage of operating 
revenues increased from 56.1% for the nine months ended September 30, 1997 to 
60.9% for the nine months ended September 30, 1998 due to $20.5 million of 
merger related expenses and a $45.8 million write-off of impaired assets.  
Excluding these two items, operating expenses increased less than 1.0% between 
years.

          Salaries and Employee Benefits.  Salaries and employee benefits 
     decreased from $250.9 million for the nine months ended September 30, 
     1997 to $247.3 million for the nine months ended September 30, 1998, a 
     decrease of $3.6 million, or 1.4%, primarily due to a reduction in 
     employee complement.

          Buildings and Equipment Expenses.  Buildings and equipment expenses 
     increased from $70.8 million for the nine months ended September 30, 1997 
     to $122.9 million for the nine months ended September 30, 1998, an 
     increase of $52.1 million, or 73.6%.  This increase was primarily due to 
     the $43.4 million write-off of capitalized software coupled with higher 
     amortization expense associated with information technology systems.

          Amortization of Attorney-In-Fact Contracts and Goodwill.  
     Amortization expense was $77.1 million in each of the nine month periods 
     ended September 30, 1998 and September 30, 1997.

          General and Administrative Expenses.  General and administrative 
     expenses were $151.3 million in each of the nine months ended September 
     30, 1998 and September 30, 1997.

          Merger Related Expenses.  Expenses incurred by the Company as a 
     result of the merger between B.A.T Industries' Financial Services 
     Businesses and Zurich amounted to $20.5 million in the nine month 
     period ended September 30, 1998 (see Footnote H).

     Net Investment Income.  Net investment income decreased from $110.0 
million for the nine months ended September 30, 1997 to $104.0 million for 
the nine months ended September 30, 1998 due substantially to lower yield 
rates.  

     Net Realized Gains.  Net realized gains decreased from $56.6 million 
for the nine months ended September 30, 1997 to $18.0 million for the nine 
months ended September 30, 1998 due to the fact that significant gains were 
realized in 1997 in connection with restructuring the equities portfolio.

     Gain on Sale of Subsidiaries.  A $16.5 million gain related to the sale 
of OSL and IGL was recognized through September 30, 1997.

     Dividends on Preferred Securities of Subsidiary Trusts.  Dividend expense 
was $31.5 million in each of the nine month periods ended September 30, 1998 
and September 30, 1997.

     Provision for Income Taxes.  Provision for income taxes decreased from 
$252.8 million for the nine months ended September 30, 1997 to $198.4 million 
for the nine months ended September 30, 1998, a decrease of $54.4 million, or 
21.5%.  This decrease was due to the decrease in pretax income and the fact 
that $27.3 million of taxes were recorded in 1997 related to the sale of OSL 
and IGL.

<PAGE>   24

     Management Services Income.  As a result of the foregoing, management 
services income decreased from $329.8 million for the nine months ended 
September 30, 1997 to $288.8 million for the nine months ended September 30, 
1998.  Exclusive of the merger related expenses and the write-off of impaired 
assets, management services income increased slightly between years.

Insurance Subsidiaries

     Through September 30, 1998, Farmers Re assumed $750.1 million of premiums,
incurred $491.3 million of non-life losses and loss adjustment expenses and 
incurred $240.1 million of non-life reinsurance commissions.  For the first 
nine months of 1998, Farmers Re contributed $25.7 million to income before 
taxes and $16.7 million to net income.

     As OSL and IGL were sold to Great Southern Life Insurance Company on 
April 15, 1997, there was no contribution to net income from OSL or IGL for 
the nine months ended September 30, 1998, compared to a $5.5 million 
contribution to net income for the nine months ended September 30, 1997.  

     The following commentary addresses the results of the Company's remaining 
life insurance subsidiary, Farmers Life.

     Total Revenues. Total revenues increased from $477.7 million for the 
nine months ended September 30, 1997 to $513.8 million for the nine months 
ended September 30, 1998, an increase of $36.1 million, or 7.6%.  

          Life Premiums.  Premiums increased $16.2 million for the nine months 
     ended September 30, 1998, or 14.2%, over the nine months ended September 
     30, 1997.  This increase was due to a 15.1% growth in the average volume 
     of insurance in-force driven by sales of the PWL and FP20 products.  Also 
     contributing to the increase in premiums was an increase in the number of 
     annuities entering the payment phase.
 
          Life Policy Charges.  Policy charges increased $4.4 million for the 
     nine months ended September 30, 1998, or 2.9%, over the nine months ended 
     September 30, 1997, reflecting a 3.5% growth in the average volume of 
     universal life-type insurance in-force.  

          Investment Income.  Net investment income increased $15.3 million 
     in the nine months ended September 30, 1998, or 7.5%, over the nine 
     months ended September 30, 1997.  The increase was due to higher bond 
     interest income earned on a higher invested asset base.

          Net Realized Gains.  Net realized gains increased $0.2 million, 
     from $9.7 million in the nine months ended September 30, 1997 to $9.9 
     million in the nine months ended September 30, 1998.  This increase was 
     due to higher gains realized on bond sales.

     Total Operating Expenses.  Total operating expenses increased from $318.2 
million for the nine months ended September 30, 1997 to $342.0 million for 
the nine months ended September 30, 1998, an increase of $23.8 million, 
or 7.5%.

<PAGE>   25

          Life Policyholders' Benefits and Charges.  Life policyholders' 
     benefits expense and charges increased from $203.6 million for the nine 
     months ended September 30, 1997 to $228.3 million for the nine months 
     ended September 30, 1998, an increase of $24.7 million, or 12.1%.  

               Policy benefits.  Policy benefits increased $15.8 million over 
          September 30, 1997 to $99.2 million, due to a 7.7% growth in the 
          volume of life insurance in-force and an increase in mortality 
          experience between periods.  

               Increase in liability for future benefits. Increase in 
          liability for future benefits expense increased from $11.2 million 
          for the nine months ended September 30, 1997 to $16.7 million for 
          the nine months ended September 30, 1998.  This increase was 
          primarily attributable to additional sales of the PWL, AIP and the 
          Farmers Premier product series, especially the FP20 product 
          introduced in October 1997.

               Interest credited to policyholders. Interest credited to 
          policyholders increased from $109.0 million for the nine months 
          ended September 30, 1997 to $112.4 million for the nine months ended 
          September 30, 1998, or 3.1%, reflecting growth in the universal 
          life fund balance.

          General Operating Expenses.  General operating expenses decreased 
     from $114.6 million for the nine months ended September 30, 1997 to 
     $113.7 million for the nine months ended September 30, 1998, a decrease 
     of $0.9 million, or 0.8%.

               Amortization of DAC and Value of Life Business Acquired. 
          Amortization expense decreased from $71.4 million for the nine 
          months ended September 30, 1997 to $67.8 million for the nine 
          months ended September 30, 1998 due to higher universal life death 
          claims experience in 1998.

               Commissions.  Commissions increased from $12.9 million for the 
          nine months ended September 30, 1997 to $14.1 million for the nine 
          months ended September 30, 1998, as a result of growth in business 
          in force. 

               General and Administrative Expenses.  General and administrative
          expenses increased from $30.3 million for the nine months ended 
          September 30, 1997 to $31.8 million for the nine months ended 
          September 30, 1998, or 5.0%.  This increase resulted mainly from 
          increased premium taxes.

     Provision for Income Taxes.  Provision for income taxes increased from 
$53.5 million for the nine months ended September 30, 1997 to $61.2 million 
for the nine months ended September 30, 1998, an increase of $7.7 million, 
due to an increase in pretax operating income.

     Farmers Life Income.  As a result of the foregoing, Farmers Life income 
increased from $106.0 million for the nine months ended September 30, 1997 to 
$110.6 million for the nine months ended September 30, 1998.

<PAGE>   26

Consolidated Net Income

     Consolidated net income of the Company decreased from $441.3 million for 
the nine months ended September 30, 1997 to $416.1 million for the nine months 
ended September 30, 1998 due to the merger related expenses and the write-off 
of impaired assets. Exclusive of these two items, consolidated net income 
increased 3.7% between periods.

Year 2000 Issue

     Many computer systems in use today were designed and developed using two 
digits, rather than four, to specify the year.  As a result, such systems will 
recognize "00" as the year 1900 rather than the year 2000.  This could cause 
many computer applications to fail completely or to create erroneous results 
unless corrective measures are taken.  As early as 1995, the Company's 
management recognized that its information systems were at risk to produce 
erroneous results due to the effect of the century rollover.  Significant 
efforts have been expended to gain a complete understanding of Year 2000 
implications and to develop a strategy to make the Company's and P&C Group's 
systems Year 2000 compliant.  The costs associated with the Year 2000 Project 
are being expensed as incurred and, through the period ended September 30, 
1998, such costs totaled $13.9 million, of which $3.2 million was allocated 
to the P&C Group.  Total costs of the project are expected to be approximately 
$20.5 million, of which approximately $5.1 million is expected to be allocated 
to the P&C Group.  

     To remedy the Year 2000 problem, management has devised a three-phase 
     plan:

     Phase I -"Awareness and Initial Impact Assessment" - This phase was 
completed in May 1996.  During this phase, Year 2000 "Impact Assessment" was 
performed using a mainframe analysis tool to determine which areas were at 
risk.

     Phase II -"Year 2000 Workpackage and Development Blueprint Project" - 
This phase was completed in November 1996 and consisted of creating a 
comprehensive master plan which included establishing and prioritizing 
clusters (groups of similar computer programs) and agreeing upon a definition 
of what would be acceptable Year 2000 compliance.  In addition, a timeframe 
was established for the conversion, compliance testing and the implementation 
of Year 2000 compliant programs into production.

     Phase III -"Year 2000 Conversion and Implementation" - The Company is 
currently in the process of converting, implementing and testing these Year 
2000 conversion programs.  Management expects this phase to be completed by 
July 1999.

     In addition, the Company has evaluated its relationships with third 
parties with which the Company has a direct and material relationship to 
determine whether they are Year 2000 compliant.  The Company has sent out 
questionnaires and warranty requests to all third party vendors and is 
currently in the process of performing compliance testing with all vendors to 
validate the vendors' claims regarding Year 2000 compliance.  Management 
anticipates that by July 1999, compliance testing related to third party 
relationships will be completed.  However, it is not possible to state with 
certainty that the operations of third parties will not be materially impacted 
in turn by other parties with whom they themselves have a relationship.

<PAGE>   27

     The Year 2000 issue may not only affect the Company's information 
technology systems (IT) but also its non-IT systems.  The Company has assessed 
the readiness of its non-IT systems and believes that in the event of an 
interruption of these systems, contingency plans have been established such 
that no major disruptions will occur.

     The Company has completed its first drafts of Year 2000 contingency 
plans.  These plans will be reviewed and updated as more information becomes 
available.  In the event that the Company's vendors do not expect to be Year 
2000 compliant, the Company's contingency plans may include replacing such 
vendors.  The operations of the Company and the P&C Group are such that in 
the event all electronic communications are down, the Company and the P&C 
Group could continue to operate until an alternative communication source 
was acquired.

Liquidity and Capital Resources

     As of September 30, 1998 and September 30, 1997 the Company held cash 
and cash equivalents of $338.7 million and $610.5 million, respectively.  
In addition, as of September 30, 1998, the Company had available revolving 
credit facilities enabling it to borrow up to $500.0 million in the event 
such a need should arise.

     Net cash provided by operating activities increased from $507.4 million 
for the nine months ended September 30, 1997 to $809.1 million for the nine 
months ended September 30, 1998, an increase of $301.7 million, or 59.5%.  
This increase in cash was primarily due to a $105.3 million increase in the 
provision for non-life losses and loss adjustment expenses by Farmers Re, as 
well as a $97.9 million decrease in non-current liabilities in 1997.

     Net cash used in investing activities increased from $176.9 million for 
the nine months ended September 30, 1997 to $721.8 million for the nine months 
ended September 30, 1998, a decrease in cash of $544.9 million.  This decrease 
in cash was due to the $1,057.0 million of notes receivable issued to BAFS in 
1998, the $119.0 million surplus contribution made to the P&C Group by Farmers 
Life in 1998 and $335.0 million of proceeds received from the sale of OSL and 
IGL in 1997.  Partially offsetting these decreases in cash were $650.0 million 
of proceeds received from the redemption of certificates of contribution by the 
P&C Group in 1998 and $407.0 million of proceeds received from the settlement 
of the B.A.T Capital Corporation notes receivable in 1998.

     Net cash used in financing activities increased from $219.3 million for 
the nine months ended September 30, 1997 to $264.8 million for the nine months 
ended September 30, 1998, an increase of $45.5 million, or 20.7%.  This 
decrease in cash was due to a $13.5 million increase in dividends paid to 
the Company's stockholders in 1998 and a $43.4 million increase in annuity 
contract withdrawals by policyholders between years.

<PAGE>   28


                      PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings.

          The Company is a party to numerous lawsuits arising from its normal 
     business activities.  These actions are in various stages of discovery 
     and development, and some seek punitive as well as compensatory damages.  
     In the opinion of management, the Company has not engaged in any conduct 
     which should warrant the award of any material punitive or compensatory 
     damages.  The Company intends to vigorously defend its position in each 
     case, and management believes that, while it is not possible to predict 
     the outcome of such matters with absolute certainty, ultimate 
     disposition of these proceedings should not have a material adverse 
     effect on the Company's consolidated results of operations or financial 
     position.  In addition, the Company is, from time to time, involved as a 
     party to various governmental and administrative proceedings.


Item 2.  Changes in Securities. 

     After approval by the Company's shareholder, each two shares of the 
     Company's outstanding stock were recapitalized into the following:

       -One share Class A Common Stock (Ordinary Share), par value $1.00 per 
       share.  

          Holders of Ordinary Shares are entitled to one vote per share 
          upon election of directors and all other matters upon which 
          stockholders generally are entitled to vote.  In addition, holders 
          of Ordinary Shares are entitled to receive dividends and in the 
          event of a liquidation are entitled to any and all distributions of 
          money or other property of the Company.

       -One share Class B Common Stock (Income Share), par value $1.00 per 
       share. 

          Holders of Income Shares are entitled to one-ninth vote per share 
          upon election of directors and all other matters upon which 
          stockholders generally are entitled to vote.  In addition, holders 
          of Income Shares are entitled to receive dividends, but have no 
          right to capital in the event of a liquidation.  

     Dividends may be paid to holders of Ordinary Shares and Income Shares in 
     equal amounts, at the exclusion of one class of stock or in any ratio 
     determined solely at the discretion of the Board of Directors of the 
     Company.


Item 3.  Defaults upon Senior Securities.  None.


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

          On September 4, 1998, at a special meeting of the Stockholder, the 
     Company's sole Stockholder approved an amendment to Article Fourth of the 
     Restated Articles of Incorporation which restructured the capital 
     structure of the Company.  For additional information, refer to the Form 
     8-K filed by the Company dated September 6, 1998.

<PAGE>   29

Item 5.  Other Information.   None.


Item 6.  Exhibits and Reports on Form 8-K.  

          (a) Exhibits.

           3.1 Restated Articles of Incorporation of FGI, as amended May 23,
               1977, as further amended September 24, 1984, as further amended
               May 19, 1986, as further amended February 3, 1989, as further
               amended September 4, 1998.

          (b) Reports on Form 8-K.  

               On July 17, 1998, FGI filed a report on Form 8-K announcing 
          the private placement of $650,000,000 of Exchange Trust Surplus 
          Note Securities. 

                FGI filed a report on Form 8-K dated September 6, 1998, 
          announcing the completion of the merger between the financial 
          services businesses of B.A.T Industries p.l.c. (which includes the 
          Company) and Zurich Insurance Company to form a new company known 
          as Zurich Financial Services, a company organized under the laws of 
          Switzerland.


<PAGE>   30


                             FARMERS GROUP, INC. 
                              AND SUBSIDIARIES

                                 SIGNATURES
                                   



      Pursuant to the requirements of the Securities Exchange Act of 1934, the 
registrant has duly caused this report to be signed on it behalf by the 
undersigned thereunto duly authorized.


                                                           Farmers Group, Inc.
                                                                  (Registrant)

                                  November 9, 1998   /s/   Martin D. Feinstein
                                  --------------------------------------------
                                  Date                     Martin D. Feinstein
                                                        Chairman of the Board,
                                         President and Chief Executive Officer


                                  November 9, 1998   /s/    Gerald E. Faulwell
                                  --------------------------------------------
                                  Date                      Gerald E. Faulwell
                                                         Senior Vice President
                                                   and Chief Financial Officer