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

                                    FORM 10-K

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

                   For the fiscal year ended December 31, 1997
                         Commission File Number 0-18649

                        The National Security Group, Inc.
             (Exact name of registrant as specified in its charter)

     Delaware       63-1020300    661 East Davis Street, Elba, Alabama  36323
(State or other    (IRS Employer          (Address of principal       (Zip code)
 jurisdiction of   identification            executive offices) 
 incorporation or   number)
 organization)
                   
        Registrant's telephone number, including area code (334) 897-2273

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

                                      None

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

                     Common stock par value $1.00 per share
                               Title of Each Class

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( )

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

Aggregate  market  value  of the  voting  stock  held  by  nonaffiliates  of the
Registrant  as of February 27, 1998 (based upon the bid price of these shares on
NASDAQ on such date) - 15,122,840
                
Number of Shares of Common Stock outstanding as of February 27, 1998 - 2,312,820

Portions of the Annual Proxy Statement incorporated  by reference into Part III.

                 Total Number of Sequentially Numbered Pages: 45




                                        1




<PAGE>






                        THE NATIONAL SECURITY GROUP, INC.
                     INDEX TO THE ANNUAL REPORT ON FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1997


Part I                                                                     Page

Item 1.    Business                                                           3
Item 2.    Properties                                                         9
Item 3.    Legal Proceedings                                                  9
Item 4.    Submission of Matters to a Vote of Security Holders                9

Part II

Item 5.    Market for Registrant's Common Equity and Related 
              Stockholder Matters                                             10
Item 6.    Selected Financial Data                                            11
Item 7.    Management's Discussion and Analysis of Financial Condition and
              Results of Operations                                           12
Item 8.    Consolidated Financial Statements and Supplementary Data           17
Item 9.    Changes in and Disagreements with Accountants and 
              Financial Disclosure                                            42

Part III

Item 10.   Directors and Executive Officers of the Registrant                 43
Item 11.   Executive Compensation                                             43
Item 12.   Security Ownership of Certain Beneficial Owners and Management     43
Item 13.   Certain Relationships and Related Transactions                     43

Part IV

Item 14.   Exhibits, Financial Statement Schedules and Reports of Form 8-K    44

Signature Page                                                                45




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<PAGE>



                                     PART I

Item 1.  Business

Summary Description of The National Security Group, Inc.

The National Security Group,  Inc. (the Company),  an insurance holding company,
was  incorporated  in  Delaware  on March 20,  1990.  The  Company,  through its
property and casualty subsidiaries, writes primarily low value dwelling fire and
windstorm,  homeowners, and personal non-standard automobile lines of insurance.
The Company's property and casualty  subsidiaries also write commercial lines of
insurance  for  small  businesses.  The  Company,  through  its  life  insurance
subsidiary,  offers a basic  line of life,  and health  and  accident  insurance
products.   Property-casualty   insurance  is  the  most  significant   segment,
accounting for 87.2% of total premium revenues.

Industry Segment and Geographical Area Information


Property and Casualty Insurance Segment

The  Company's  property and casualty  insurance  business is conducted  through
National  Security  Fire &  Casualty  Company  (Fire  Company),  a wholly  owned
subsidiary of the Company  organized in 1959,  and Omega One  Insurance  Company
(Omega),  a wholly owned subsidiary of National Security Fire & Casualty Company
organized  in 1993.  NSFC is licensed to write  insurance in eight  states,  and
operates on a surplus lines basis in four additional  states.  Omega is licensed
to write insurance in two states. During 1997, over 96% of the property-casualty
subsidiaries' premium revenues were written in the states of Alabama,  Arkansas,
Georgia, Louisiana, Mississippi, South Carolina, and Texas.

In general,  the  property-casualty  insurance business involves the transfer by
the insured,  to an insurance  company of all or a portion of certain  risks for
the payment, by the insured, of a premium to the insurance company. A portion of
such risks is often retained by the insured in the form of deductibles which may
vary greatly from policy to policy.

The  premiums or  payments to be made by the insured for direct  products of the
property-casualty  subsidiaries  are  based  upon  expected  cost  of  providing
benefits, writing, and administering the policies. In determining the premium to
be charged,  the  property-casualty  subsidiaries  utilize data from past claims
experience and anticipated  claims  estimates along with commissions and general
expenses.   Historically,   there  has  been  more   price   competition   among
property-casualty insurers than other types of insurers.

The operating results of the property-casualty insurance industry are subject to
significant  fluctuations  from  quarter to quarter and from year to year due to
the effect of  competition  on pricing,  the  frequency  and  severity of losses
incurred in  connection  with  weather-related  and other  catastrophic  events,
general economic  conditions,  and other factors such as changes in tax laws and
the regulatory environment.

The following table sets forth the premiums earned and income during the periods
reported:

                                                  Year Ended December 31
                                                  (Amounts in Thousands)
                                                  1997      1996      1995
Net premiums earned:
      Fire, Allied lines, and Homeowners ...   $14,647   $13,835   $13,316
      Automobile ...........................    11,082     6,181     4,114
      Other ................................     1,436     2,205     2,039
                                               $27,165   $22,221   $19,469

Income before income taxes ..................  $ 1,572   $ 1,192   $   651

                                        3


<PAGE>



Life Insurance Segment

The  Company's  life  insurance  business  is  conducted  by  National  Security
Insurance Company (Life Company),  a wholly owned subsidiary  organized in 1947.
NSIC is  licensed  to  write  insurance  in five  states.  The  following  table
indicates  those  states  which  accounted  for 5% or more of the  total  direct
premiums collected by the Life Company in 1997:

                                                        Percentage of Total
        State                                             Direct Premiums

      Alabama                                                     87
      Mississippi                                                  7
      Georgia                                                      5

The Life Company  primarily writes home service life insurance  products,  which
means its agents collect premiums and sell new products  directly at the home or
other premises of the insured.  The products primarily consist of term and whole
life insurance and accident and health insurance. The Life Company does not sell
annuities.

Term life  insurance  policies  provide death  benefits if the  insured's  death
occurs  during the specific  premium  paying term of the policy and generally do
not include a savings or investment  element in the policy  premium.  Whole-life
insurance  policies  demand a higher  premium than term life,  but provide death
benefits which are payable under  effective  policies  regardless of the time of
the insured's  death and have a savings and investment  element which may result
in the accumulation of a cash surrender value.

Accident  and health  business is primarily  home service  products and accident
policies sold through schools.  Accident and health insurance  provides coverage
for losses  sustained  through  sickness or  accident  and  includes  individual
hospitalization and accident policies,  group supplementary  health policies and
specialty products, such as cancer policies.  These policies generally provide a
stated benefit and have not experienced  the escalating  health care costs which
many health and accident insurance policies have experienced in recent years.

The following table sets forth certain information respecting the development of
the Life Company's business:

                                                    Year Ended December 31
                                                    (Amounts in Thousands)
                                                   1997       1996       1995
Life insurance in force at end of period:
 Ordinary-whole life ............................ $ 70,000   $ 67,000   $ 71,900
          term life .............................   33,900     42,000     40,000
 Industrial .....................................   34,000     36,000     38,000
 Other ..........................................      100        100        100
                                                   -------    -------    -------
                                                   138,000    145,100    150,000
                                                   =======    =======    =======
New life insurance issued:
 Ordinary-whole life ............................ $ 39,000   $ 26,000   $ 31,000
          term life .............................      200     12,000     18,000
 Industrial .....................................        0          0      1,000
 Other ..........................................      100        100      1,000
                                                    ------     ------     ------
                                                    39,300     38,100     51,000
                                                    ======     ======     ======
Net premiums earned:
 Life insurance ................................. $  2,979   $  3,194   $  3,331
 Accident and health insurance ..................    1,012      1,239      1,572
                                                     -----      -----      -----
                                                     3,991      4,433      4,903
                                                     =====      =====      =====
                                        4


<PAGE>



Investments

The insurance  subsidiaries  are regulated as to the types of investments  which
they may make and the  amount  of  funds  they may  maintain  in any one type of
investment.  Through its  investment  policy,  the Company seeks to conserve its
capital resources and assets,  meet the investment  requirements of its reserves
and provide a reasonable return on investments.

The following  table sets forth  certain  information  respecting  the Company's
investments at the date shown:

                                                          Year Ended December 31
                                                                1997      1996
Investment Securities held-to-maturity,  at amortized cost
 (estimated fair value: 1997 - $30,807, 1996 - $36,038) .....  $29,995   $35,413
Investment Securities available-for-sale,  at market
 (cost: 1997 - $35,257, 1996 - $21,419) .....................  $52,819    32,716
Receivable for securities sold ..............................      400         0
Mortgage loans on real estate, at cost ......................      320       405
Investment real estate, at cost .............................    1,645     1,659
Policy loans ................................................      648       622
Short-term investments ......................................    3,524     4,575
                                                                ------    ------
                                                                89,351    75,390
                                                                ======    ======

The results with respect to the foregoing investments are as follows:

                                                          Year Ended December 31
                                                        1997      1996      1995
Net investment income ................................  $4,204   $3,935   $4,311
Average yield on investments .........................    5.1%     5.4%     6.0%
Economic yield on investments (includes realized and
 unrealized investment gains) ..........................  16.0%    9.7%   13.0%
Net realized gains on investments
 (before income taxes)..................................   2,720  1,839    1,650
Changes in net unrealized gains on investments
 (before income taxes) .................................  6,266   1,340    3,356


As of December 31, 1997,  the maturity  schedule for all bonds and notes held by
the Company, stated at amortized cost, was as follows:

Maturity Schedule (Amounts in thousands)

                                 Available Held to            Percentage
Maturity                         for sale  Maturity    Total   of Total

Maturity in less than 1 year ..$     0   $ 1,976   $ 1,976       3.9%
Maturity in 1-5 years .........  5,586     7,718    13,304      26.0
Maturity in 5-10 years ........  7,668    10,485    18,153      35.5
Maturity after 10 years .......  7,877     9,816    17,693      34.6

Totals ........................$21,131   $29,995   $51,126     100.0%

                                        5


<PAGE>



Certain Information Regarding Insurance Activities

Marketing and Distribution

The Life  Company's  products are  marketed  through a field force of agents and
service  representatives who are employees of the Life Company. The Life Company
began in 1997 to add  independent  agents to its  method of  distribution.  This
method of  distribution  is expected to be more cost effective and will become a
primary method of  distribution in the future.  The Fire Company's  products are
marketed  through  a  network  of  independent  agents  and  brokers,   who  are
independent  contractors and who generally  maintain  relationships  with one or
more competing insurance companies.

Agents  receive  compensation  for  their  sales  efforts.  In the  case of life
insurance  agents,  compensation is paid in the form of sales commissions plus a
servicing commission.  Commissions incurred by the Life Company in 1997 averaged
approximately  25.2% of  premiums.  Commissions  incurred by the Fire Company in
1997  averaged  approximately  17.8% of premiums  and ranged from 12.5% to 22.5%
depending  on the type  and  amount  of  insurance  sold.  During  1997,  no one
independent agent accounted for more than 10% of total net earned premium of the
property-casualty insurance subsidiaries.

The Life Company began in 1997 the process of implementing changes in collection
of premium payments, and the method of marketing. If the policyholder so elects,
he or she may begin making  payments by mail to the home office rather than have
a home service agent come to their house every month and collect premiums.  This
change is being  implemented  in  response  to the change in  lifestyles  of our
policyholders. It is increasingly difficult to reach policyholders at home until
early evening,  and they are usually to busy to be bothered.  Those who elect to
pay by mail will still be provided  service by an area  representative  for help
with claims and policy related questions.  With this method of payment there has
been  reductions  in the  number of Life  Company  agents.  Also,  because it is
becoming  increasingly  difficult to employ high  quality  people to contact our
policy owners at home, Life Company management is beginning to implement changes
in the  method of  marketing  of life  insurance  products.  This new  method of
marketing utilizes independent agents to distribute products, and is just in the
preliminary stages of implementation.

Reinsurance

Both insurance  subsidiaries  customarily  reinsure with other insurers  certain
portions  of the  insurance  risk.  The  primary  purpose  of  such  reinsurance
arrangements is to enable the Company to limit its risk on individual  policies,
and in the  case  of  property  insurance,  limit  its  risk in the  event  of a
catastrophe  in various  geographic  areas. A reinsurance  arrangement  does not
discharge  the issuing  company from primary  liability to the insured,  and the
issuing  company is required to discharge  its  liability to the insured even if
the  reinsurer  is  unable  to  meet  its  obligations   under  the  reinsurance
arrangements.  Reinsurance,  however,  does  make the  reinsurer  liable  to the
issuing  company  to the extent of any  reinsurance  in force at the time of the
loss.  Reinsurance  arrangements  also decrease premiums retained by the issuing
company  since  that  company  pays the  reinsuring  company a portion  of total
premiums based upon the amount of liability reinsured.

The Life Company generally reinsures all risks in excess of $50,000 with respect
to any one policy.  The Fire Company generally  reinsures with third parties any
liability in excess of $100,000 on any one policy. In addition, the Fire Company
has  catastrophe  excess  reinsurance  which protects it in part with respect to
aggregate  property  losses  arising  out of a  single  catastrophe,  such  as a
hurricane.  In 1995, 1996, and 1997, the Fire Company had catastrophe protection
up to a $26 million loss. On a $26 million  catastrophe  loss,  the Fire Company
would pay about $7 million and reinsurers would pay $19 million.

In addition to catastrophe reinsurance, the Fire Company also had three quota 
share reinsurance agreements as follows:
1.  81% quota share on commercial and other property exposure written by Anchor
        General Agency.
2.  90% quota share on casualty exposure written by Anchor General Agency.
3.  50% quota share on ocean marine exposure with additional excess of loss  
        coverage.

The Anchor programs have been discontinued and had no policies in force at 
December 31, 1997.

                                        6


<PAGE>



Reserve liabilities

The Life Company  maintains  reserves for future policy  benefits to meet future
obligations  under  outstanding  policies.  These  reserves are calculated to be
sufficient to meet policy and contract  obligations  as they arise.  Liabilities
for future  policy  benefits are  calculated  using  assumptions  for  interest,
mortality,  morbidity,  expense,  and  withdrawals  determined  at the  time the
policies were issued.  As of December 31, 1997,  the total  reserves of the Life
Company  (including  the  reserves  for  accident  and  health  insurance)  were
approximately  $18.6 million.  The Life Company  believes that such reserves for
future policy  benefits were  calculated in accordance  with generally  accepted
actuarial  methods  and that such  reserves  are  adequate to provide for future
policy benefits. Wakely & Associates,  consulting actuaries,  provided actuarial
services in calculating reserves.

The  property-casualty  subsidiaries are also required to maintain loss reserves
(claim  liabilities)  for all lines of insurance.  Such reserves are intended to
cover the  probable  ultimate  cost of  settling  all  claims,  including  those
incurred  but  not  yet   reported.   The  reserves  of  the   property-casualty
subsidiaries  reflect estimates of the liability with respect to incurred claims
and are  determined  by  evaluating  reported  claims on an ongoing basis and by
estimating  liabilities  for  incurred but not reported  claims.  Such  reserves
include  adjustment  expenses  to cover  the cost of  investigating  losses  and
defending lawsuits. The establishment of accurate reserves is complicated by the
fact that claims in some lines of  insurance  are  settled  many years after the
policies have been issued,  thus raising the possibility that inflation may have
a significant  effect on the amount of ultimate loss  payment,  especially  when
compared  to initial  loss  estimates.  The  subsidiaries,  however,  attempt to
restrict their writing to risks that settle within one to four years of issuance
of the policy. As of December 31, 1997, the  property-casualty  subsidiaries had
reserves  for unpaid  claims of  approximately  $22 million  before  subtracting
unpaid  claims which will be due from  reinsurers  of $7.3  million  leaving net
unpaid claims of $14.7  million.  The reserves are not  discounted  for the time
value of money. No changes were made in the  assumptions  used in estimating the
reserves  during the years ending  December 31, 1997,  1996 or 1995. The Company
believes  such reserves are adequate to provide for  settlement  of claims.  The
Fire  Company's  loss  reserves  are  calculated  by  employees  of the Company.
Milliman & Robertson,  an independent  actuarial  consulting firm, certified the
reserves.

Underwriting Activities

The  insurance  subsidiaries  maintain  underwriting  departments  which seek to
evaluate the risks associated with the issuance of an insurance policy. The Life
Company accepts standard risks and, to an extent,  substandard risks and engages
medical doctors who review certain applications for insurance.

In the  case  of the  property-casualty  subsidiaries,  the  underwriting  staff
attempts to assess,  in light of the type of insurance  sought by an  applicant,
the  risks  associated  with  a  prospective  insured  or  insurance  situation.
Depending  upon the type of insurance  involved,  the process by which the risks
are assessed  will vary.  In the case of  automobile  liability  insurance,  the
underwriting  staff assesses the risks involved in insuring a particular driver,
and in the case of fire  insurance,  the  underwriting  staff assesses the risks
involved in insuring a particular  dwelling.  Where possible,  the  underwriting
staff of the property-casualty insurance subsidiary utilizes standard procedures
as guides  that  quantify  the hazards  associated  with a  particular  business
activity. In general, the property-casualty  subsidiaries  specialize in writing
nonstandard risks.

The  nonstandard  market in which  the  property-casualty  subsidiaries  operate
reacts  to  general  economic  conditions  in much the same way as the  standard
market.  When insurers' profits and equity are strong,  companies  generally cut
rates or not seek increases.  Also, underwriting rules are less restrictive.  As
profit and/or capital fall,  companies tighten underwriting rules, and seek rate
increases.  Premiums  in the  nonstandard  market are higher  than the  standard
market because of the increased risk of the insured,  which generally  comprises
more frequent  claims.  Drivers of autos who have prior traffic  convictions are
one such increased risk which warrants higher premiums. Low valued dwellings and
mobile homes also warrant higher premiums because of the nature of the risk. The
costs of placing such nonstandard  policies and making risk  determinations  are
similar to those of the standard  market.  The added costs due to more  frequent
claims servicing is reflected in the higher premiums which are charged.

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<PAGE>



Regulation

The  insurance  subsidiaries  are each subject to  regulation  by the  insurance
departments  of those  states in which they are  licensed  to conduct  business.
Although the extent of regulation varies from state to state, the insurance laws
of the various states generally establish  supervisory  departments having broad
administrative  powers with  respect to, among other  matters,  the granting and
revocation  of licenses to  transact  business;  the  licensing  of agents;  the
establishment  of  standards  of financial  solvency,  including  reserves to be
maintained,  the nature of  investments  and, in most cases premium  rates;  the
approval  of  forms  and  policies;  and  the  form  and  content  of  financial
statements.  These  regulations  have as their primary purpose the protection of
policyholders and do not necessarily confer a benefit upon stockholders.

Many states in which the insurance subsidiaries operate, including Alabama, have
laws which require that insurers become members of guaranty associations.  These
associations  guarantee that benefits due  policyholders of insurance  companies
will  continue  to be provided  even if the  insurance  company  which wrote the
business is  financially  unable to fulfill its  obligations.  To provide  there
benefits,  the associations  assess the insurance  companies licensed in a state
that write the line of insurance for which coverage is guaranteed. The amount of
an insurer's  assessment  is generally  based on the  relationship  between that
company's  premium  volume in the state and the premium  volume of all companies
writing the particular line of insurance in the state. The Company paid $77,000,
$18,700, and $142,721 in various association assessments in 1997, 1996, and 1995
respectively.  These  payments  are  principally  related to  association  costs
incurred  due  to  the  insolvency  of  various  insurance   companies.   Future
assessments depend on the number and magnitude of insurance company insolvencies
and such assessments are therefore difficult to predict.

Most  states  have  enacted  legislation  or  adopted  administrative  rules and
regulations  covering  such matters as the  acquisition  of control of insurance
companies,  transactions between insurance companies and the persons controlling
them. The National Association of Insurance  Commissioners has recommended model
legislation  on these  subjects and all states where the Company's  subsidiaries
transact business have adopted, with some modifications, that model legislation.
Among the matters  regulated by such  statutes  are the  payments of  dividends.
These  regulations  have a direct  impact on the Company  since its cash flow is
substantially derived from dividends from its subsidiaries. However, the Company
has not had nor does it  foresee  a problem  obtaining  the  necessary  funds to
operate because of the regulation.

Competition

The  insurance  subsidiaries  are engaged in a highly  competitive  business and
compete  with  many  insurance  companies  of  substantially  greater  financial
resources,  including stock and mutual  insurance  companies.  Mutual  insurance
companies  return profits,  if any, to policyholders  rather than  stockholders;
therefore,  mutual insurance  companies may be able to charge lower net premiums
than those charged by stock insurers.  Accordingly,  stock insurers must attempt
to achieve  competitive  premium rates  through  greater  volume,  efficiency of
operations and control of expenses.

The Life  Company  primarily  markets  its life and  health  insurance  products
through  the home  service  system.  Direct  competition  comes  from other home
service  companies,  of which there are many. The Life Company's life and health
products  also compete to a lesser  extent with  products  sold by ordinary life
companies.  The Life Company writes  policies  primarily in Alabama.  The market
share of the total life and  health  premiums  written  is small  because of the
number of insurers  in this highly  competitive  field.  The primary  methods of
competition  in the field are service and price.  The Life  Company  attempts to
price its products with other home service  companies.  Because of the increased
costs associated with a home service company, premium rates are generally higher
than ordinary products,  so competition from these ordinary insurers must be met
through service and home collection of premium.

The  property-casualty  subsidiaries  market their products through  independent
agents and brokers,  concentrating  on low value dwellings and nonstandard  auto
coverage.  The Fire  Company,  though  one of the larger  writers  of  low-value
dwelling fire insurance in Alabama,  nevertheless  faces a number of competitors
in this niche. Moreover, larger general line insurers also compete with the Fire
Company. The market share in states other than Alabama is small. Price is the


                                        8



<PAGE>



primary  method  of  competition.   Due  to  the  method  of  marketing  through
independent agents, commission rates and service to the agent are also important
factors in whether  the  independent  agent  agrees to offer the Fire  Company's
products over its competitors.

Inflation

The Company has not determined the effects of inflation on its  operations,  but
it shares the same risks from  inflation as other  companies.  Inflation  causes
operating  expenses to increase and erodes the purchasing power of the Company's
assets.  A large portion of the Company's  assets are invested in fixed maturity
investments.  The purchasing power of these investments will be less at maturity
because of inflation. This is generally offset by the reserves which are a fixed
liability  and will be paid  with  cheaper  dollars.  Also,  inflation  tends to
increase  investment  yields,  which may  reduce  the  impact  of the  increased
operating expenses caused by inflation.

Item 2.  Properties

The Company owns no property.  The Life insurance  subsidiary owns its principal
executive offices located at 661 East Davis Street, Elba, Alabama. The executive
offices are shared by the insurance  subsidiaries.  The building was constructed
in 1977 and consists of  approximately  26,000 square feet. The Company believes
this space to be  adequate  for its  foreseeable  future  needs.  The  Company's
subsidiaries own certain real estate properties,  including  approximately 2,700
acres of timberland in Alabama.

Item 3.  Legal Proceedings

The Company and its  subsidiaries  continue to be named as parties to litigation
related  to the  conduct  of their  insurance  operations.  Further  information
regarding  details of pending suits can be found in note 11 to the  consolidated
financial statements.

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

There were no matters  submitted to a vote of security  holders during the three
months ended December 31, 1997.





                                        9


<PAGE>



                                     PART II

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

The capital stock of the Company is traded in the Over-the-Counter (OTC) market.
Quotations  are  furnished  by the  National  Association  of  Security  Dealers
Automated Quotations System (NASDAQ). The trade symbol is NSEC.

The number of  shareholders  of the  Company's  capital  stock as of January 31,
1998, was approximately 1,100.

                                        Stock Bid Price             Dividends
                                      High            Low         Per Share
1997
      First Quarter ..............   $13 3/4     $12 3/4           $ .17
      Second Quarter .............    15          13 1/4             .17
      Third Quarter ..............    16 1/2      13 15/16           .17
      Fourth Quarter .............    24          15 1/2             .19

1996
      First Quarter ..............   $14         $12               $ .16
      Second Quarter .............    14          11 5/8             .16
      Third Quarter ..............    14 1/4      12                 .16
      Fourth Quarter ..............   14 1/4      12 1/2             .17






                                       10




<PAGE>



Item 6.  Selected Financial Data
             (Amounts in thousands, except per share)

Operating results                  1997    1996    1995     1994       1993
                                   ====    ====    ====     ====       ====
     Net premiums earned ....... 31,156  $26,654  $24,372  $26,289   $29,240
     Net investment income .....  4,294    3,935    4,311    4,001     3,894
     Net realized investment
          gains ................  2,716    1,839    1,650    1,720       661
     Other income ..............    695      582      505      400       602
Total revenues .................$38,775  $33,010  $30,838  $32,410   $34,397

Income before extraordinary
     Items .....................$ 2,998  $ 1,356  $   214  $ 3,674   $ 3,438
Extraordinary gain .............      0        0        0        0       263
                                $ 2,998  $ 1,356  $   214  $ 3,674   $ 3,701

Net income per share before
     extraordinary items .......$  1.28  $  0.58  $  0.09  $  1.57   $  1.47
Extraordinary gain .............   0.00     0.00     0.00     0.00      0.11
                                $  1.28  $  0.58  $  0.09  $  1.57   $  1.58




Other Selected Financial Data

Total shareholders' equity .....$ 46,352 $ 40,519 $ 39,774  $ 38,482  $ 39,140

Book value per share ...........$  20.04 $  17.43 $  17.11  $  16.44  $  16.73

Dividends per share ............$   0.70 $   0.65 $   0.61  $   0.57  $   0.52

Net change in unrealized
 capital gains (net of tax) ....$  4,556 $    968 $  2,726  ($ 3,030) $    850

Total assets ...................$106,958 $ 98,219 $ 97,266  $ 89,986  $ 86,875





                                       11


<PAGE>



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

The following  analysis of the consolidated  results of operations and financial
condition  of the  Company  should  be read in  conjunction  with  the  Selected
Financial Data and Consolidated  Financial Statements and related notes included
elsewhere herein.

Results of Operations

Consolidated  Results of Operations:  Consolidated  net income from The National
Security Group was $2.998 million in 1997,  more than double the 1996 results of
$1.356  million.  Net income  from 1996 was up over $1.1  million  from the 1995
total of  $215,000.  Earnings  per share were $1.28 in 1997  compared to $.58 in
1996,  and $.09 in 1995.  The  increase  in net  income  is  primarily  due to a
reduction in litigation  expenses and an increase in realized capital gains from
the sale of common stock  investments  which have flourished in the current Bull
Market.  Consolidated  revenues  grew 17% to  $38.8  million  compared  to $33.0
million in 1996.  Revenues in 1996  increased $2.2 million from $30.8 million in
1995.  Revenue  increases are  primarily due to growth in the  property/casualty
subsidiaries private passenger automobile programs in Louisiana and Georgia.

Industry Segment Data

Certain  financial  information for The National Security Group's three segments
(life and accident and health insurance,  property and casualty  insurance,  and
other) is summarized as follows:

Premium revenues:                     1997   %       1996    %       1995    %
 Life and accident and health 
                  insurance ......$  3,991  12.8  $  4,433 16.6  $  4,903   20.1
 Property and casualty insurance .  27,165  87.2    22,221 83.4    19,469   79.9
                                    ------ -----   ------- -----   ------   ----
                                  $ 31,156 100.0  $ 26,654 100.0 $ 24,372  100.0

Income before taxes and cumulative effect adjustment:
                                     1997    %       1996    %        1995    %
 Life and accident and 
         health insurance .....   $  2,171   64.6  $ 1,141   70.4  $(178) (64.5)
 Property and casualty insurance .   1,572   46.8    1,192   73.4    651   235.9
 Other ...........................    (383) (11.4)    (710) (43.8)  (197) (71.4)
                                    ------  ------  ------  -----   -----  -----
                                  $  3,360  100.0  $ 1,621  100.0  $ 276   100.0

Life and Accident and Health  Insurance  Operations:  Pretax earnings in 1997 of
$2.2 million were significantly better than 1996 earnings of $1.1 million. There
was a pretax loss in 1995 of $178,000.  The primary factor  contributing  to the
improvement  in  earnings  was a  reduction  in  litigation  expenses.  In  1997
litigation  expenses were only $80,000 compared to $760,000 in 1996.  Litigation
expenses  in 1995  were $2.3  million.  Also  contributing  to the  increase  in
earnings  was  realized  capital  gains which  increased  over  $400,000 in 1997
compared to 1996.

Premium income,  which totaled $4.0 million in 1997, has declined gradually over
the last five  years and has  decreased  by 27% over  this  period of time.  The
reduction in premium income is due to a reduction in the number of sales agents.
The number of sales  agents has  declined by 69% over the last five years to the
current total of 31. Premium income  decreased  $400,000 to $4.0 million in 1997
compared to 1996 premium income of $4.4 million. Premium income in 1996 was down
$500,000 from the total in 1995 of $4.9  million.  A new agents  contract  which
became effective  January 1, 1998 is expected to improve  retention of premiums.
Also, new products and distribution  methods will be introduced in 1998 which is
expected to improve prospects for future premium growth.

The  decrease in the agency  force has  reduced  sales  commissions  and general
expenses for field operations which has reduced expenses as a percent of premium
income. Administrative and tax expenses have also decreased from last year.

                                       12


<PAGE>


Property & Casualty  Operations:  Pretax earnings were $1.572 million in 1997, a
32% increase over 1996 pretax  earnings of $1.191  million.  Pretax  earnings in
1996 were up 45% compared to $651,000 in 1995. The low valued  dwelling fire and
extended  coverage  program  (LVD) was much  improved  in 1997.  The LVD program
incurred a greater than normal amount of fire and windstorm  losses in 1996, and
was  hit by  Hurricane  Opal in  1995  which  reduced  earnings  by $2  million.
Unfortunately  the  improved  results in the LVD program  were offset by adverse
loss  development  in the  automobile  programs  in Georgia and  Louisiana.  The
property/casualty subsidiary attempted to obtain rate increases in Louisiana due
to the adverse loss  development,  but the rate filings were denied by the State
Insurance  Rating  Bureau.  Due to the  failed  attempts  to adjust  rates,  the
Louisiana  automobile  program will be discontinued in 1998. A rate increase was
granted in the State of Georgia, and more stringent underwriting guidelines have
been  implemented so this program will continue,  but will be monitored  closely
for signs of improvement. The primary reason for the improvement in earnings was
the capital gains realized from the sale of common stock investments.

A measure used to analyze a property/casualty insurer's underwriting performance
is the statutory combined ratio. It is the sum of two ratios:

         a.   The loss and loss expense ratio,  which  measures  losses and loss
              adjustment expenses incurred as a percentage of premiums earned.

         b.      The  underwriting  expense ratio,  which measures  underwriting
                 expenses incurred (e.g.,  agents'  commissions,  premium taxes,
                 and other administrative underwriting expenses) as a percentage
                 of premiums written during the year.

         The results of these ratios for the past three years were:
                                       1997           1996             1995
                                       ----           ----             ----
         Loss and LAE Ratio            79.3%          79.8%            82.8%
         Underwriting Expense Ratio    31.0%          30.9%            31.4%
                                      -----          ------           ------
         Combined Ratio               110.3%         110.7%           114.2%
                                      =====          =====            ======

The  combined  ratio for 1997 did not improve  compared to 1996 due to increased
losses in the private  passenger  automobile  programs.  The low value  dwelling
program  loss ratio  improved  greatly in 1997 but was offset by the increase in
automobile  losses.  The combined ratio for 1996,  though improved over 1995 was
still higher than historical  averages for the  property-casualty  subsidiaries.
The primary reason for the high combined  ratio was higher than normal  incurred
losses in the low value  dwelling  program in the first  quarter of 1996.  These
losses were attributable to the colder than normal winter which led to more fire
losses and several tornado  producing storms which hit the  Southeastern  United
States.  The combined ratio for 1995 was abnormally high due to losses sustained
in Hurricane Opal.

Maintaining a combined  ratio below 100%,  which  indicates  that the company is
making an underwriting  profit,  depends upon many factors  including  hurricane
activity in the Gulf of Mexico,  strict  underwriting of risks, and adequate and
timely  premium  rates. A major  hurricane,  such as Opal,  hitting the coast of
Alabama, Georgia, South Carolina,  Mississippi,  Louisiana, or Texas could cause
the combined ratio to fluctuate materially from prior years. The fire & casualty
subsidiary maintains  catastrophe  reinsurance to minimize the effect of a major
catastrophe.

Premium income  increased 22% to $27.165  million verses $22.222 million in 1996
which  increased  14% from  $19.469  million in 1995.  The  premium  growth came
primarily from automobile programs in Louisiana and Georgia. As mentioned above,
a Louisiana  automobile  program was  discontinued  in February  1998 because of
unfavorable  underwriting  experience and a proposed rate increase being denied.
To help offset this loss of premium, a Florida automobile and a Louisiana mobile
homeowners program began in 1997.



                                       13


<PAGE>





Asset Portfolio Review:  The life insurance and  property/casualty  subsidiaries
primarily invest in highly liquid  investment grade debt and equity  securities.
At December 31, 1997, the company's holdings in debt securities  amounted to 57%
of total  investments  and 48% of total assets.  The following is a breakdown of
the bond  portfolio  quality  according  to National  Association  of  Insurance
Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the
nationally  recognized rating  organization  equivalents of Moody's and Standard
and Poor's:

                  SVO Equivalents                          % of Total
SVO Class   Moody's             Standard and Poor's       Bond Portfolio
---------  ----------           -------------------       --------------
1          Aaa to A3               AAA to A-                   90.4
2          Baa to Baa3             BBB+ to BBB-                 7.3
3          Ba1 to Ba3              BB+ to BB-                   0.6
4          B1 to B3                B+ to B-                     0.9
5          Caa to Ca               CCC+ to C                    0.8
6          C                       Ci to D                      0.0

As of January 1, 1994, the Company adopted Financial  Accounting Standards Board
Statement  115 and  reclassified  a  portion  of its fixed  maturity  securities
portfolio  as  "available-for-sale,"  with the  remainder  being  classified  as
"held-to-maturity."  With that  reclassification,  the fixed maturity securities
classified as "available-for-sale" are carried at fair value and changes in fair
values,  net of related income taxes,  are charged or credited to  shareholders'
equity (see Note 3 to the consolidated financial statements).

The insurance  subsidiaries' fixed maturity  securities include  mortgage-backed
bonds, primarily  collateralized  mortgage obligations (CMO's), of $14.1 million
and  $11.2   million  at   December   31,  1997  and  1996   respectively.   The
mortgage-backed  bonds are subject to risks associated with variable prepayments
of the underlying  mortgage loans.  Prepayments  cause those  securities to have
different  actual  maturities  than  that  expected  at the  time  of  purchase.
Securities  that are  purchased at a premium to par value and prepay faster than
expected will incur a reduction in yield or loss.  Securities that are purchased
at a discount to par value and prepay  faster  than  expected  will  generate an
increase  in yield or gain.  The degree to which a security  is  susceptible  to
either gains or losses is influenced by the  difference  between  amortized cost
and par value, the relative  sensitivity of the underlying mortgages backing the
assets to prepayments in a changing  interest rate environment and the repayment
priority of the securities in the overall securitization structure.

The Company limits the extent of its credit risk by purchasing  securities  that
are backed by stable  collateral,  the majority of the assets are  guaranteed by
U.S.  government   sponsored  entities.   Also,  the  majority  of  all  of  the
subsidiaries'  CMO's are Planned  Amortization  Class (PAC) bonds. PAC bonds are
typically the lowest risk CMO's,  and provide greater cash flow  predictability.
Such  securities  with reduced  risk  typically  have a lower yield,  but higher
liquidity,  than higher- risk mortgage  backed bonds. To reduce the risk of loss
of  principal  should  prepayments  exceed  expectations,  the Company  does not
purchase mortgage backed securities at significant premiums over par value.

The Company's  investment approach in the equity markets is based primarily on a
fundamental  analysis of value. This approach requires the investment  committee
to invest in well managed, primarily dividend paying companies, which have a low
debt to capital ratio,  above average return on net worth for a sustained period
of time, and low price to book value or low volatility rating (beta) relative to
the market.  The dividends  provide a steady cash flow to help pay current claim
liabilities,  and it has been the Company's  experience  that by following  this
investment  strategy,  investment results have been superior to those offered by
bonds, while keeping the risk of loss of capital to a minimum.

Liquidity and Capital Resources: Due to regulatory restrictions, the majority of
the Company's cash is required to be invested in investment-grade  securities to
provide ample  protection for  policyholders.  The  liabilities of the insurance
subsidiaries are of various terms and,  therefore,  those subsidiaries invest in
securities with various  maturities spread over periods usually not exceeding 10
years.



                                       14


<PAGE>







The liquidity  requirements for the Company are primarily met by funds generated
from   operations  of  the  life  insurance  and   property/casualty   insurance
subsidiaries.  Premium and investment  income as well as maturities and sales of
invested  assets  provide  the  primary  sources  of cash  for both the life and
property/casualty  businesses,  while  applications  of cash are applied by both
businesses to the payment of policy benefits, the cost of acquiring new business
(principally commissions),  operating expenses, purchases of new investment, and
in the case of life insurance, policy loans.

The National Security Group's consolidated statement of cash flows indicate that
operating  activities  provided  (used) cash of $7.48  million,  $1.45  million,
$(3.6)  million in 1997,  1996, and 1995  respectively.  Those  statements  also
classify  the  other  sources  and  uses of cash by  investing  activities,  and
financing activities and disclose the amount of cash available at the end of the
year to meet the Company's obligations.  An increase in profits of $1.6 million,
and a large  decrease  in  reinsurance  recoveries  of $4 million  are the major
causes of a $6 million increase in cash provided from operations in 1997.

The primary reason for the increase in cash provided by operating activities for
1996 was the increased cash flow from the new automobile  programs.  The primary
reason for the large increase in cash used for operating  activities in 1995 was
Hurricane  Opal which hit Alabama in early  October.  The cash provided from the
sale  of  available-for-sale  securities  helped  offset  the  increase  in cash
required to pay hurricane claims.

The Company has standby  letters of credit of less than  $25,000.  These letters
are used to guarantee  obligations  of the  property/casualty  subsidiary  under
assumed  reinsurance  contracts.  The  letters of credit are  secured by certain
invested assets of the Company.  The Company also routinely incurs liability for
declared  but  unpaid  dividends.  Long  term  liquidity  needs  of the  Company
constitute only those items which are directly related to the principal business
operations  of the  Company.  The  Company  has long  term debt of  $133,000  at
December 31, 1997.

The ability of the Company to meet its  commitments for timely payment of claims
and other expenses  depends,  in addition to current cash flow, on the liquidity
of its investments.  On December 31, 1997, the Company had no known  impairments
of assets or changes in  operation  which would have a material  adverse  effect
upon liquidity.  Approximately 81% of the Company's assets are invested in cash,
investment  grade fixed income  securities,  short-term  investments and broadly
traded  equity  securities  which  are  highly  liquid.   The  values  of  these
investments  are  subject  to the  conditions  of the  markets in which they are
traded.  Past  fluctuations  in these  markets  have had  little  effect  on the
liquidity of the Company.  The Company has relatively  little  exposure to lower
grade fixed income  investments  which might be especially  subject to liquidity
problems due to thinly traded markets.

Except as discussed in Note 11 to the  consolidated  financial  statements,  the
Company is aware of no known trends, events, or uncertainties  reasonably likely
to have a material effect in its liquidity,  capital  resources,  or operations.
Additionally,  the  Company  has not been made aware of any  recommendations  of
regulatory authorities, which if implemented, would have such an effect.

As disclosed in note 8 to the consolidated  financial  statements,  in 1998, the
amount that The National Security Group's insurance subsidiaries can transfer in
the form of dividends  to the parent  company is limited to $842,000 in the life
insurance  subsidiary  and  $2.7  million  in  the  property/casualty  insurance
subsidiary.  However,  that condition poses no short-term or long-term liquidity
concerns for the parent company.





                                       15




<PAGE>




Statutory  Risk-Based  Capital of Insurance  Subsidiaries:  The NAIC has adopted
Risk-Based  Capital (RBC)  requirements  for life/health  and  property/casualty
insurance companies to evaluate the adequacy of statutory capital and surplus in
relation to investment and insurance risks such as asset quality,  mortality and
morbidity,  asset and liability matching, benefit and loss reserve adequacy, and
other  business  factors.  The RBC  formula  will be  used  by  state  insurance
regulators as an early  warning tool to identify,  for the purpose of initiating
regulatory  action,   insurance  companies  that  potentially  are  inadequately
capitalized. In addition, the formula defines new minimum capital standards that
will  supplement  the current  system of low fixed  minimum  capital and surplus
requirements on a state-by-state basis. Regulatory compliance is determined by a
ratio of the company's  regulatory  total  adjusted  capital,  as defined by the
NAIC, to its  authorized  control  level RBC, as defined by the NAIC.  Companies
below specific  trigger points or ratios are classified  within levels,  each of
which requires corrective action. The levels and ratios are as follows:

                                         Ratio of Total Adjusted Capital to
                                           Authorized Control Level RBC
 Regulatory Event                             (Less Than or Equal to)
 Company action level                                   2
 Regulatory action level                                1.5
 Authorized control level                               1
 Mandatory control level                                0.7

The ratios of Total  Adjusted  Capital to  Authorized  Control Level RBC for The
National   Security   Group's   life/health  and   property/casualty   insurance
subsidiaries are all in excess of five to one at December 31, 1997.

National  Security  Insurance  Company (life  insurer) has  regulatory  adjusted
capital of $13.4  million  and $10.1  million  at  December  31,  1997 and 1996,
respectively,  and a ratio of regulatory  total  adjusted  capital to authorized
control  level RBC of 8.5 and 8.3 at December  31,  1997 and 1996  respectively.
Accordingly,   National  Security   Insurance  Company  meets  the  minimum  RBC
requirements.

National  Security  Fire &  Casualty  Company  (property/casualty  insurer)  has
regulatory  adjusted  capital of $27.2 million and $24.1 million at December 31,
1997 and 1996, respectively, and a ratio of regulatory total adjusted capital to
authorized  control  level  RBC of 8.4 and 8.3 at  December  31,  1997  and 1996
respectively.  Accordingly,  National Security Fire & Casualty Company meets the
minimum RBC requirements.

Omega One Insurance  Company  (property/casualty  insurer),  which began writing
business in late 1995, has regulatory  adjusted capital of $4.4 million and $5.2
million at December 31, 1997 and 1996,  respectively,  and a ratio of regulatory
total  adjusted  capital  to  authorized  control  level  RBC of 5.2 and 10.6 at
December 31, 1997 and 1996 respectively.
Accordingly, Omega One Insurance Company meets the minimum RBC requirements.

Year 2000 Issue

The year 2000 issue relates to computer  system  programs which may not properly
recognize  the change in date years from 1999 to 2000.  As a result of this time
sensitivity of existing  software,  any business  entity is at risk for possible
system failure or miscalculations causing disruptions of operations,  including,
among  other  things,  a  temporary  inability  to  process  transactions,  send
billings, or engage in similar normal business activities.

The Company is currently modifying significant portions of its computer programs
so that its computer  systems will  function  properly  with respect to the year
2000 date recognition. The Company presently believes that with modifications to
existing software,  the year 2000 issue will not pose a significant  operational
problem.  However,  if such modifications are not made, or not completed timely,
the year 2000  issue  could  have a  material  impact on the  operations  of the
Company.

The Company is utilizing  internal  resources to reprogram and test software for
year  2000  modifications.  The  Company  anticipates  completing  the year 2000
project no later than June 30, 1999.  The total cost of the year 2000 project is
not material to the financial results of the Company.
                                       16


<PAGE>




Item 8.  Consolidated Financial Statements and Supplementary Data

Index to Financial Statements

Consolidated Financial Statements:

 Report of Independent Certified Public Accountants ....................      18

 Consolidated Statements of Income - 
   Years Ended December 31, 1997, 1996, and 1995.........................     19

 Consolidated Balance Sheets - December 31, 1997 and 1996................     20

 Consolidated Statements of Shareholders' Equity - 
   Years Ended December 31, 1997, 1996, and 1995.........................     21

 Consolidated Statements of Cash Flows - 
   Years Ended December 31, 1997, 1996, and 1995.........................     22

 Notes to Consolidated Financial Statements - December 31, 1997..........     23

Financial Statement Schedules:

 Report of Independent Certified Public Accountants on 
   Financial Statement Schedules.........................................     34

 Schedule I.  Summary of Investments - December 31, 1997 and 1996........     35

 Schedule III.  Condensed Financial Information of Registrant - 
   December 31, 1997 and 1996.............................................    36

 Schedule V.  Supplementary Insurance Information - 
   December 31, 1997, 1996, and 1995......................................    40

 Schedule VI.  Reinsurance - 
   Years Ended December 31, 1997, 1996, and 1995...........................   41

 All other  Schedules  are not required  under related  instructions  or are
 inapplicable and therefore have been omitted.





                                       17
<PAGE>

                        The National Security Group, Inc.

               Report of Independent Certified Public Accountants



To the Board of Directors
and Shareholders of
The National Security Group, Inc.


We have audited the  accompanying  consolidated  balance  sheets of The National
Security Group,  Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated  statements of income,  shareholders' equity and cash flows
for each of the  three  years in the  period  ended  December  31,  1997.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the consolidated  financial  position of The
National  Security Group,  Inc. and  subsidiaries at December 31, 1997 and 1996,
and the results of their  operations  and their cash flows for each of the three
years in the period ended  December  31,  1997,  in  conformity  with  generally
accepted accounting principles.



Birmingham, Alabama               Dudley, Hopton-Jones, Sims & Freeman PLLP
February 20, 1998

                                       18

<PAGE>





                        THE NATIONAL SECURITY GROUP, INC.

                        CONSOLIDATED STATEMENTS OF INCOME


                                                     (Dollars in thousands
                                                    except per share amounts)
                                                    Years Ended December 31,
                                                    1997       1996      1995

REVENUES
   Net premiums earned ......................   $ 31,156    $ 26,654    $ 24,372
   Net investment income ....................      4,204       3,935       4,311
   Net realized investment gains ............      2,720       1,839       1,650
   Other income .............................        695         582         505
                                                --------    --------    --------
                                                  38,775      33,010      30,838
                                                --------    --------    --------
BENEFITS AND EXPENSES
   Policyholder benefits paid or provided ...     22,995      19,677      17,721
   Amortization of deferred policy
    acquisition costs .......................      1,488         995       1,142
   Commissions ..............................      4,334       3,726       3,539
   General insurance expenses ...............      5,229       5,515       6,709
   Insurance taxes, licenses and fees .......      1,258       1,367       1,339
   Interest expense .........................        111         109         112
                                                --------    --------    --------
                                                  35,415      31,389      30,562
                                                --------    --------    --------
              Income Before Income Taxes ....      3,360       1,621         276
                                                --------    --------    --------
INCOME TAX EXPENSE
   Current ..................................        848         421          45
   Deferred .................................       (486)       (156)         17
                                                --------    --------    --------
                                                     362         265          62
                                                --------    --------    --------
             Net Income .....................   $  2,998    $  1,356    $    214
                                                --------    --------    --------

EARNINGS PER COMMON SHARE

              Net Income ....................   $   1.28    $    .58    $    .09
                                                --------    --------    --------


See accompanying notes to consolidated financial statements.


                                       19


<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                                                    (Dollars in thousands)
                                                                                                         December 31,
<S>                                                                                                       1997         1996
ASSETS                                                                                                ------       ------
                                                                                                    <C>          <C>
Investments
   Securities held-to-maturity at amortized cost (estimated fair value: 1997 - $30,807
     1996 - $36,038)............................................................................... $  29,995    $  35,413
   Securities available-for-sale, at estimated fair value (cost: 1997 - $35,257, 1996 - $21,419)...    52,819       32,716
   Receivable for securities                                                                              400           -
   Mortgage loans on real estate, at cost..........................................................       320          405
   Investment real estate, at cost (accumulated depreciation: 1997 - $36, 1996 - $35)..............     1,645        1,659
   Policy loans....................................................................................       648          622
   Short-term investments..........................................................................     3,524        4,575
                                                                                                       ------       ------
                                                                                 Total Investments     89,351       75,390

Cash...............................................................................................       364          147
Accrued investment income..........................................................................       833          803
Reinsurance recoverable............................................................................     8,489       12,488
Deferred policy acquisition costs..................................................................     4,216        4,013
Prepaid reinsurance premiums.......................................................................       341        1,908
Current income tax recoverable.....................................................................        -           258
Other assets.......................................................................................     3,364        3,212
                                                                                                       -------     --------

                                                                                      Total Assets  $ 106,958    $  98,219
                                                                                                      ========    ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and claims
   Policy liabilities.............................................................................. $  18,677    $  18,558
   Unearned premiums...............................................................................     8,853       10,398
   Claim liabilities...............................................................................    22,246       19,447
                                                                                                       ------       ------
                                                                                                       49,776       48,403

Checks outstanding in excess of bank balance.......................................................     1,190        1,516
Other policyholder funds...........................................................................     1,729        1,842
Accrued income taxes..............................................................................        147          -
Other liabilities..................................................................................     3,686        3,087
Deferred income tax................................................................................     4,078        2,852
                                                                                                       ------       ------
                                                                                 Total Liabilities     60,606       57,700
                                                                                                       ------       ------
Contingencies

Preferred stock, $1 par value, 500,000 shares authorized, none issued or outstanding...............
Class A common stock, $1 par value, 2,000,000 shares authorized, none issued or outstanding........
Common stock, $1 par value, 2,500,000 shares authorized and 2,339,848 shares issued................     2,340        2,340
Additional paid-in capital.........................................................................        17           17
Net unrealized appreciation on securities available-for-sale, net of deferred income taxes.........    12,497        7,941
Retained earnings..................................................................................    31,888       30,513
Treasury stock, at cost (Shares: 1997 - 27,028, 1996 - 20,085).....................................      (390)        (292)
                                                                                                      --------      -------
                                                                         Total Shareholders' Equity    46,352       40,519
                                                                                                      --------     -------
                                                         Total Liabilities and Shareholders' Equity $ 106,958    $  98,219
                                                                                                      =======      =======

</TABLE>


See accompanying notes to consolidated financial statements.


                                      -20-

<PAGE>

                       THE NATIONAL SECURITY GROUP, INC.

                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY


                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                                Net
                                                                           Unrealized
<S>                                                                          Appreciation
                                                             Additional   on Securities                              Total
                                                  Common      Paid-in     Available-     Retained    Treasury    Shareholders'
                                                  Stock       Capital       for-Sale     Earnings      Stock         Equity
                                                 <C>           <C>         <C>            <C>          <C>          <C>

Balance at December 31, 1995.....................    2,340        17          6,973         30,666      ( 222)        39,774

   Net income for 1996...........................    -           -             -             1,356        -            1,356
   Cash dividends ($.65 per share)...............    -           -             -            (1,509)       -           (1,509)
   Net increase in unrealized appreciation of
     securities available-for-sale...............    -           -              968          -            -              968
   Treasury stock purchased......................    -           -             -             -          (  70)        (   70)
                                                   ------       ----         ------        -------       ----        -------

Balance at December 31, 1996.....................$   2,340     $  17        $ 7,941       $ 30,513     $( 292)      $ 40,519
                                                   =======      ====         ======        =======       ====        =======
   Net income for 1997...........................    -           -             -             2,998        -            2,998
   Cash dividends ($.70 per share)...............    -           -             -            (1,623)       -           (1,623)
   Net increase in unrealized appreciation of
     securities available-for-sale...............    -           -            4,556          -            -            4,556
   Treasury stock purchased......................    -           -             -             -          (  98)        (   98)
                                                   ------       ----         ------        -------       ----        -------

Balance at December 31, 1997.....................$   2,340     $  17        $12,497       $ 31,888     $( 390)      $ 46,352
                                                   =======      ====         ======        =======       ====        =======


</TABLE>

See accompanying notes to consolidated financial statements.


                                      -21-

<PAGE>



                        THE NATIONAL SECURITY GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
<S>
                                                                                                    (Dollars in thousands)
                                                                                                     Year ended December 31,
                                                                                                  1997           1996           1995
                                                                                                  ----           ----           ----
Cash flows from operating activities:
                                                                                              <C>           <C>          <C>
Net Income ...............................................................................     $  2,998      $  1,356      $    214

Adjustments   to  reconcile  net  income  to  net  cash  provided  by  operating
activities:
     (Increase) decrease in accrued investment income ....................................          (30)           77           (34)
     (Increase) decrease in reinsurance recoverable ......................................        3,999          (596)       (5,499)
     Amortization of deferred policy acquisition costs ...................................        1,488           995         1,142
     Net realized gains on investments ...................................................       (2,720)       (1,839)       (1,648)
     Policy acquisition costs deferred ...................................................       (1,691)       (1,608)       (1,019)
     (Increase) decrease in current income taxes receivable ..............................          258           571          (829)
     Decrease (increase) in prepaid reinsurance premiums .................................        1,567         3,345          (263)
     Depreciation and amortization expense ...............................................          118           116            68
     Increase in policy liabilities and claims ...........................................        1,373         1,108         4,653
     (Increase) decrease in income tax payable ...........................................          147          --            (226)
     (Decrease)increase in deferred income taxes .........................................         (484)         (156)           17
     Increase (decrease) in other liabilities ............................................          599        (1,952)          420
     Other, net ..........................................................................         (144)          (37)         (609)
                                                                                               --------      --------      --------
                              Net cash provided by (used for) operating activities .......        7,478         1,454        (3,613)
                                                                                               --------      --------      --------
Cash flows from investing activities:
   Purchases of held-to-maturity securities ..............................................         --          (2,741)       (3,486)
   Purchases of available-for-sale securities ............................................      (17,239)       (6,370)       (1,411)
   Purchase of real estate held for investment ...........................................         --             (36)           (5)
   Proceeds from maturities of held-to-maturity securities ...............................        4,859         5,774         2,238
   Proceeds from sales of available-for-sale securities ..................................        6,333         4,474         3,623
   Proceeds from real estate held for investment .........................................           13            81         1,666
   Proceeds from sales and maturities of short-term investments ..........................        1,051          --           2,319
   Receipts from repayment of loans ......................................................           59            79            54
   Purchase of property and equipment ....................................................         (210)          (66)         (344)
   Proceeds from sale of property and equipment ..........................................           33          --              65
   Purchases of short-term investments ...................................................         --          (1,959)         --
                                                                                               --------      --------      --------
                              Net cash provided by (used for) investing activities .......       (5,101)         (764)        4,719
                                                                                               --------      --------      --------
Cash flows from financing activities:
   (Decrease) increase in other policyholder funds .......................................         (113)          (85)         (230)
   Dividends paid ........................................................................       (1,623)       (1,509)       (1,427)
   Purchase of treasury stock ............................................................          (98)          (70)         (222)
   Increase (decrease) in checks outstanding in excess of bank balances ..................         (326)          921           595
                                                                                               --------      --------      --------
                                            Net cash used for financing activities .......       (2,160)         (743)       (1,284)
                                                                                               --------      --------      --------
                                                   Net increase (decrease) in cash .......          217           (53)         (178)

Cash at beginning of year ................................................................          147           201           379
                                                                                               --------      --------      --------
Cash at end of year ......................................................................     $    364      $    147      $    201
                                                                                               ========      ========      ========
Cash paid during the year for:
   Interest ..............................................................................     $     14      $    111      $    119
                                                                                               ========      ========      ========
   Income taxes ..........................................................................     $    440      $    531      $  1,100
                                                                                               ========      ========      ========



</TABLE>



See accompanying notes to consolidated financial statements.


                                      -22-

<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES:

Principles of Consolidation
The accompanying  consolidated  financial statements include the accounts of The
National Security Group,  Inc. (the Company) and its wholly-owned  subsidiaries:
National Security Insurance Company (NSIC),  National Security Fire and Casualty
Company  (NSFC)  and  NATSCO,   Inc.  (NATSCO).   During  1993,  NSFC  formed  a
wholly-owned  subsidiary - Omega One Insurance Company (OMEGA).  All significant
intercompany transactions and accounts have been eliminated.

Description of Major Products
NSIC is  licensed  in the states of  Alabama,  Georgia,  Mississippi,  Texas and
Florida and was organized in 1947 to provide life and burial insurance  policies
to the home  service  market.  Premiums  sold and  serviced  by  company  agents
primarily include  industrial life,  larger ordinary life,  accident and health,
limited hospital, cancer and low valued life insurance. NSFC operates in various
property  and  casualty  lines,  the most  significant  of which are low  valued
dwelling property, home service fire, nonstandard automobile physical damage and
liability,  nonstandard  commercial,  ocean  marine  and  inland  marine.  Omega
operates  in property  and  casualty  lines,  the most  significant  of which is
commercial auto liability.

Basis of Presentation
The significant  accounting  policies  followed by The National  Security Group,
Inc. and subsidiaries that materially affect financial  reporting are summarized
below. The accompanying  consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) which, as to the
subsidiary  insurance  companies,  differ from  statutory  accounting  practices
permitted by regulatory authorities.

Investments
The Company's  securities  are classified in two categories and accounted for as
follows:

o Securities  Held-to-Maturity.  Bonds, notes and redeemable preferred stock for
which the Company has the  positive  intent and ability to hold to maturity  are
reported at cost,  adjusted  for  amortization  of  premiums  and  accretion  of
discounts   which  are  recognized  in  interest   income  using  methods  which
approximate level yields over the period to maturity.

o Securities  Available-for-Sale.  Bonds, notes, common stock and non-redeemable
preferred  stock not  classified  as either  held-to-maturity,  or  trading  are
reported  at fair  value,  adjusted  for  other-than-temporary  declines in fair
value.

The Company and its subsidiaries have no trading securities.

Unrealized   holding   gains   and   losses,   net   of   tax,   on   securities
available-for-sale  are  reported  as a net  amount in a separate  component  of
shareholders' equity until realized.

Realized  gains and  losses  on the sale of  securities  available-for-sale  are
determined using the specific-identification method.

Mortgage  loans and policy loans are stated at the unpaid  principal  balance of
such loans.  Investment  real estate is reported at cost,  less  allowances  for
depreciation  computed on the straight-line  basis.  Short-term  investments are
carried at cost, which  approximates  market value.  Investments with other than
temporary impairment in value are written down to estimated realizable values.


                                       23
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 CONTINUED

Disclosures About Fair Value of Financial Instruments
In 1995, the Company  adopted  Statement of Financial  Accounting  Standards No.
107,  Disclosures  about Fair Value of  Financial  Instruments  (SFAS 107) which
requires  companies to disclose fair value  information  about certain financial
instruments.  SFAS No. 107 defines  fair value as the quoted  market  prices for
those instruments that are actively traded in financial markets.  In cases where
quoted market prices are not available,  fair values are estimated using present
value or other  valuation  techniques.  The fair value  estimates  are made at a
specific  point in time,  based on available  market  information  and judgments
about the  financial  instrument,  such as  estimates  of timing  and  amount of
expected  future  cash  flows.  Such  estimates  do not  reflect  any premium or
discount  that could  result from  offering  for sale at one time the  Company's
entire holdings of a particular financial  instrument,  nor do they consider the
tax impact of the realization of unrealized gains or losses.  In many cases, the
fair value  estimates  cannot be  substantiated  by  comparison  to  independent
markets,  nor can the disclosed value be realized in immediate settlement of the
instrument.

SFAS No. 107 excludes  certain  financial  instruments,  particularly  insurance
liabilities other than financial guarantees and investment  contracts,  from its
disclosure requirements. In evaluating the Company's management of interest rate
and  liquidity  risk,  the fair values of all assets and  liabilities  should be
taken into consideration.

The fair values of cash, cash equivalents,  short-term  investments and balances
due on account from agents,  reinsurers  and other  approximate  their  carrying
amounts as reflected in the consolidated  balance sheets due to their short-term
availability or maturity.

The fair values of debt and equity  securities have been determined using values
supplied  by  independent  pricing  services  and are  disclosed  together  with
carrying amounts in Note 3.

The fair value of the mortgage  loan  portfolio was  approximately  equal to the
carrying  amount of $320,000 on December  31, 1997 and  $405,000 on December 31,
1996.

As of December 31, 1997 and 1996,  the fair value of policy  loans  approximated
their carrying amount of $648,000 and $622,000, respectively.

The  fair  value  of  other  policyholder  funds  on  deposit  is  estimated  to
approximate carrying amount of $1,729,000 on December 31, 1997 and $1,842,000 on
December 31, 1996.

Statement of Cash Flows
For purposes of reporting  cash flows,  cash  includes  cash-on-hand  and demand
deposits with banks.

Premium Revenues
Life  insurance  premiums  are  recognized  as revenues  when due.  Property and
casualty insurance premiums, less amounts ceded to reinsurers, are recognized on
a pro rata basis over the terms of the policies.  Reinsurance  premiums  assumed
are recognized as reported by the ceding company.

Deferred Policy Acquisition Costs
The costs of acquiring  new insurance  business are deferred and amortized  over
the lives of the  policies.  Deferred  costs include  commissions,  other agency
compensation and expenses,  and other underwriting  expenses directly related to
the level of new business produced.

Acquisition  costs  relating to life  contracts are  amortized  over the premium
paying period of the contracts, or the first renewal period of term policies, if
earlier. Assumptions utilized in amortization are consistent with those utilized
in computing policy liabilities.

The method of computing the deferred policy  acquisition  costs for property and
casualty policies limits the amount deferred to a percentage of related unearned
premiums.



                                       24


<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 1 CONTINUED

Policy Liabilities
The liability for future life insurance  policy benefits is computed using a net
level premium method including the following assumptions:
      Years of Issue                          Interest Rate
        1947 - 1968                                4%
        1969 - 1978                          6% graded to 5%
        1979 - 1997                          7% graded to 6%

Mortality  assumptions  include  various  percentages of the 1955-60 and 1965-70
Select and Ultimate Basic Male Mortality Table. Withdrawal assumptions are based
on the Company's experience.

Claim Liabilities
The liability for unpaid claims  represents  the estimated  liability for claims
reported to the Company and its  subsidiaries  plus claims  incurred but not yet
reported and the related  adjustment  expenses.  The  liabilities for claims and
related  adjustment  expenses are determined  using  case-basis  evaluations and
statistical  analyses  and  represent  estimates of the ultimate net cost of all
losses  incurred  through  December  31  of  each  year.  Although  considerable
variability  is  inherent  in  such  estimates,  management  believes  that  the
liabilities for unpaid claims and related adjustment expenses are adequate.  The
estimates are continually  reviewed and adjusted as necessary;  such adjustments
are included in current operations.

Earnings Per Share
Earnings per share of common stock is based on the  weighted  average  number of
shares  outstanding  during each year.  The  adjusted  weighted  average  shares
outstanding was 2,339,848 in 1997 and 2,339,848 in 1996 and 2,337,090 in 1995.

Reinsurance
In the normal  course of business,  NSFC seeks to reduce the loss that may arise
from catastrophes or other events that cause unfavorable underwriting results by
reinsuring  certain  levels of risk in  various  areas of  exposure  with  other
insurance  enterprises or reinsurers.  Amounts  recoverable  from reinsurers are
estimated in a manner  consistent with the claim  liability  associated with the
reinsured  policy.  Amounts  paid  for  prospective  reinsurance  contracts  are
reported  as prepaid  reinsurance  premiums  and  amortized  over the  remaining
contract period.

In the normal  course of  business,  NSIC seeks to limit its exposure to loss on
any  single  insured  and to  recover  a  portion  of  benefits  paid by  ceding
reinsurance to other insurance  enterprises or reinsurers  under excess coverage
contracts.  NSIC retains a maximum of $30,000 of coverage per  individual  life.
The  cost  of  reinsurance  is  amortized  over  the  contract   period  of  the
reinsurance.

Reclassifications
Certain  reclassifications  have been made in the previously  reported financial
statements  to make the prior year  amounts  comparable  to those of the current
year. Such reclassifications had no effect on the previously reported net income
or shareholders' equity.

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


                                       25

<PAGE>
                        THE NATIONAL SECURITY GROUP, INC.

              NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 2 - STATUTORY ACCOUNTING PRACTICES:

The  accompanying  consolidated  financial  statements  have  been  prepared  in
conformity with generally  accepted  accounting  principles (GAAP) which vary in
certain respects from reporting  practices  prescribed or permitted by insurance
regulatory  authorities.  The significant  differences  for statutory  reporting
include:  (a)  acquisition  costs of  acquiring  new  business  are  charged  to
operations as incurred,  (b) life policy  liabilities are established  utilizing
interest and  mortality  factors  specified by regulatory  authorities,  (c) the
Asset  Valuation  Reserve (AVR) and the Interest  Maintenance  Reserve (IMR) are
recorded as  liabilities,  (d) deferred  income taxes are not provided,  and (e)
non-admitted assets (furniture and equipment, agents' debit balances and prepaid
expenses) are charged directly to surplus.

Statutory  net  gains  from  operations  and  capital  and  surplus,   excluding
intercompany transactions, are summarized as follows:
<TABLE>
<S>                                                                                         <C>            <C>            <C>    
                                                                                                        (Dollars in thousands)
                                                                                                       Year ended December 31,

                                                                                                 1997           1996           1995


Net gain from operations:
     NSIC - including realized capital gains of $651, $333 and $121,
         respectively .................................................................      $  1,755       $    802       $    (73)
     NSFC - including realized capital gains of $1,988, $1,506 and $1,528,
         respectively .................................................................      $  2,258       $    613       $    156
     OMEGA ............................................................................      $ (1,529)      $   (352)      $    164
Statutory capital and surplus:
     NSIC - including AVR of $2,539, $2,141 and $1,772, respectively ..................      $ 10,526       $ 10,079       $ 12,083
     NSFC .............................................................................      $ 26,359       $ 22,384       $ 22,148
     OMEGA ............................................................................      $  4,367       $  5,180       $  5,240
</TABLE>

The above amounts  exclude  allocation of overhead from the Company.  NSIC, NSFC
and OMEGA are in compliance with statutory  restrictions  with regard to minimum
amounts of surplus and capital.

NOTE 3 - INVESTMENT SECURITIES:
The amortized cost and aggregate fair values of investments in securities are as
follows:
<TABLE>
<S>                                                   <C>             <C>              <C>             <C>    
                                                                         (Dollars in thousands)
                                                                            December 31, 1997
                                                                         Gross           Gross
                                                         Amortized       Unrealized     Unrealized       Fair
                                                         Cost            Gains           Losses          Value
Available-for-sale securities:
Corporate debt securities ...........................   $ 5,620         $   140         $  (281)         $ 5,479
U.S. treasury securities and obligations of U.S
    government corporations and agencies ............    15,511             115              (2)          15,624
Equity securities ...................................    14,126          17,784            (195)          31,715
                                                        -------          ------            -----          ------
                                           Total ....   $35,257         $18,039         $  (478)         $52,818
</TABLE>

                                       26


<PAGE>
                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 3 CONTINUED
<TABLE>
<S>                                                      <C>      <C>       <C>            <C>    
                                                                      (Dollars in thousands)
                                                                      December 31, 1997
                                                                    Gross       Gross
                                                         Amortized   Unrealized  Unrealized   Fair
                                                           Cost        Gains       Losses    Value

Held-to-maturity securities:
 Corporate debt securities ............................. $11,255   $   162   $   (20)        $11,397
 Obligations of states and political subdivisions ......   8,801       488         0           9,289

 U.S. treasury securities and obligations of U.S
  government corporations and agencies .................   9,939       185        (3)         10,121
                                                          -----       ----      -----         ------
                                   Total ............... $29,995   $   835   $   (23)        $30,807


                                                                         (Dollars in thousands)
                                                                            December 31, 1996
                                                                      Gross       Gross
                                                         Amortized   Unrealized  Unrealized   Fair
                                                         Cost         Gains        Losses     Value
Available-for-sale securities:
Corporate debt securities ...........................   $ 5,412      $    52     $  (305)     $ 5,159
U.S. treasury securities and obligations of U.S
    government corporations and agencies ............     4,333           40          (0)       4,373
Equity securities ...................................    11,674       11,814        (304)      23,184
                                                        -------      -------      -------     -------
                                           Total ....   $21,419      $11,906     $  (609)     $32,716

Held-to-maturity securities:
 Corporate debt securities ............................. $16,037   $   236    $  (20)        $16,121
 Obligations of states and political subdivisions ......   5,005       496         0           5,500

 U.S. treasury securities and obligations of U.S
  government corporations and agencies .................  14,371        70        (3)         14,417
                                                         -------    ------    -------        -------
                                   Total ............... $35,413   $   802   $   (23)        $36,038

</TABLE>

The amortized cost and aggregate  fair value of debt  securities at December 31,
1997, by contractual maturity,  are as follows.  Expected maturities will differ
from  contractual  maturities  because  borrowers  may have the right to call or
prepay obligations with or without call prepayment penalties.

                                                 Amortized             Fair
                                                   Cost               Value

Available-for-sale securities:
     Due in one year or less                $         0      $         0
     Due after one year through five years       5,586,418        5,634,726
     Due after five years through ten years      7,667,898        7,790,173
     Due after ten years                         7,876,498        7,679,283

                                  Total     $    21,130,81    $  21,104,182

Held-to-maturity securities:
     Due in one year or less                $    1,976,325    $    1,989,228
     Due after one year through five years       7,717,801         7,987,579
     Due after five years through ten year      10,484,881        10,881,124
     Due after ten years                         9,815,890         9,949,631

                                   Total     $  29,994,897     $   30,807,562


Proceeds from the maturity or call of  held-to-maturity  securities  during 1997
and 1996 were  $5,258,588 and $5,773,992,  respectively.  Gross gains of $50,619
and $29,565 and gross  losses of $531 and $342 for 1997 and 1996,  respectively,
were realized on those maturities or calls.


                                       27

<PAGE>
                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 3 CONTINUED

Proceeds  from  the  sale of  available-for-sale  securities  during  1997  were
$6,001,536.  Gross gains of $2,392,684 and gross losses of $53,157 for 1997 were
realized on those sales.

NOTE 4 - NET INVESTMENT INCOME:
Major categories of investment income are summarized as follows:

                                                  (Dollars in thousands)
                                                  Year ended December 31,
                                                   1997       1996       1995

Fixed maturities ............................   $ 3,334    $ 3,112    $ 3,336
Equity securities ...........................       654        559        663
Mortgage loans on real estate ...............        29         39         45
Investment real estate ......................        18         13         17
Policy loans ................................        37         37         34
Other, principally short-term investments ...       222        230        234
                                                 -------    -------    -------
                                                  4,294      3,990      4,329
Less:  Investment expenses ..................       (90)       (55)       (18)
                                                 -------    -------    -------
Net investment income .......................   $ 4,204    $ 3,935    $ 4,311


An analysis of investment gains follows:
                                                     Year ended December 31,
                                                  1997       1996       1995

Net realized investment gains:
  Fixed maturities ...........................  $    66   $    12   $     56
  Other, principally equity securities            2,654     1,827      1,594
                                                -------    -------    -------
                                                $ 2,720   $ 1,839   $  1,650

An  analysis  of the net  increase  (decrease)  in  unrealized  appreciation  on
available-for-sale securities follows:

                                                    Year ended December 31,
                                                  1997       1996       1995

Net increase (decrease) in unrealized
   appreciation on available-for-sale
   securities before deferred income tax ....   $ 6,266    $ 1,340    $ 3,356
Deferred income tax .........................    (1,711)      (372)      (630)
                                                 -------    -------    -------
Net increase (decrease) in unrealized
   appreciation on available-for-sale
   securities ...............................   $ 4,555    $   968    $ 2,726
                                                 -------    -------    -------

Investment  real  estate  with a  carrying  value  of  approximately  $2,000,000
produced  insignificant  income  during the year ended  December 31, 1995.  This
property was sold during the year ended December 31, 1995.

                                       28

<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 5 - INCOME TAXES:  Total income tax expense varies from amounts computed by
applying  current  federal  income tax rates to income before income taxes.  The
reasons for these differences and the approximate tax effects are as follows:

                                                    Year ended December 31,
                                                  1997       1996       1995

Federal income tax rate applied to
   pre-tax income ..........................    $ 1,142     $   551     $    94
Dividends received deduction and
   tax-exempt interest .....................       (239)       (256)       (261)
Other, net .................................       (134)        (30)        229
Small life insurance company deduction .....       (407)       --          --
                                                -------     -------     -------
Federal income tax expense .................    $   362     $   265     $    62
                                                -------     -------     -------

Net deferred tax  liabilities are determined  based on the estimated  future tax
effects of differences  between the financial  statement and tax bases of assets
and liabilities given the provisions of the enacted tax laws.

The tax effect of significant  temporary  differences  representing deferred tax
assets and liabilities are as follows:
(Dollars in Thousands)
                                                    December 31,     December 31
                                                        1997            1996
                                                        -----          ------

Deferred policy acquisition costs ....................     $(1,434)     $(1,364)
Policy liabilities ...................................         519          516
Unearned premiums ....................................         442          440
Claim liabilities ....................................         530          329
General insurance expenses ...........................         931          582
Unrealized gains on securities available-for-sale ....      (5,066)      (3,355)
                                                           -------      -------
Net deferred tax liabilities .........................     $(4,078)     $(2,852)
                                                           -------      -------

The  approximate  income tax effects of changes in temporary  differences are as
follows:
                                                    Year ended December 31,
                                                  1997       1996       1995

Deferred policy acquisition costs ..........      $  70       $ 226       $ (59)
Policy liabilities .........................         (3)        (17)        (76)
Unearned premiums ..........................         (2)        (87)        (21)
General insurance expenses .................       (349)       (268)         (3)
Claim liabilities ..........................       (201)        (38)       --
Other ......................................       --            28         176
                                                  -----       -----       -----
                                                  $(485)      $(156)      $  17
                                                  -----       -----       -----

Under  pre-1984 life  insurance  company tax laws, a portion of NSIC's gain from
operations was not subject to current income  taxation,  but was accumulated for
tax purposes in a memorandum account designated  "policyholders'  surplus".  The
aggregate  balance in this account,  $3,720,000  at December 31, 1997,  would be
taxed at current rates only if  distributed  to  shareholders  or if the account
exceeded a prescribed  minimum.  The Deficit  Reduction  Act of 1984  eliminated
additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have
not been provided on amounts designated as policyholders'  surplus. The deferred
tax liability not recognized is approximately $1,270,000 at December 31, 1997.

                                       29

<PAGE>
                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 6 - REINSURANCE:
NSFC is involved as a reinsurer in which it assumes some of the risk  originally
undertaken  by another  insurance  company.  Conversely,  NSFC and NSIC also are
involved in transactions in which another  insurance company assumes some of the
risk  originally  undertaken  by NSFC and  NSIC.  Reinsurance  contracts  do not
relieve  NSIC and NSFC from  their  obligations  to  policyholders.  Failure  of
reinsurers to honor their  obligations  could result in losses to NSIC and NSFC.
NSIC and NSFC evaluate the financial  condition of their  reinsurers and monitor
concentrations  of  credit  risk  arising  from  similar   geographic   regions,
activities,  or economic  characteristics  of the  reinsurers to minimize  their
exposure to significant  losses from  reinsurance  insolvences.  At December 31,
1997,  reinsurance  receivables  with a carrying  value of $406,000  and prepaid
reinsurance premiums of $341,000 were associated with a single reinsurer.

The effect of reinsurance on premiums written and earned is as follows:
                                          (Dollars in Thousands)
                                                 1997
                                   ----------------------------------
                                    NSIC                        NSFC
                            ----------------             ----------------
                         Written        Earned         Written          Earned
                         -------        ------         -------          --------
Direct .........       $  4,118        $  4,039        $ 29,270        $ 30,815
Assumed ........           --              --              --              --
Ceded ..........            (48)            (48)         (2,086)           (520)
                        --------        --------        --------        --------
Net ............       $  4,070        $  3,991        $ 27,185        $ 30,295
                        --------        --------        --------        --------

                                          (Dollars in Thousands)
                                                 1996
                                   ----------------------------------
                                    NSIC                        NSFC
                            ----------------             ----------------
                         Written        Earned         Written          Earned
                         -------        ------         -------          --------
Direct .........       $  4,451        $  4,483        $ 31,920        $ 27,299
Assumed ........           --              --                 1            --
Ceded ..........            (51)            (51)         (8,422)         (5,077)
                        --------        --------        --------        --------
Net ............       $  4,400        $  4,432        $ 23,499        $ 22,222
                        --------        --------        --------        --------

NSFC also  reinsures  certain  portions of insurance  risk which exceed  various
retention  limits.  Claim  liabilities for NSFC are stated after a deduction for
reinsurance ceded to other companies  totaling  $7,146,000 at December 31, 1997.
Reinsurance  recoveries for claims and claim settlement  expense were $1,343,000
during 1997.

NOTE 7 - EMPLOYEE BENEFIT PLAN:
In 1989, the Company and its subsidiaries  established a retirement savings plan
and  transferred  the assets from the defined  contribution  profit sharing plan
into the new  plan.  All  full-time  employees  who have  completed  one year of
service at January 1 or July 1 are  eligible  to  participate  and all  employee
contributions  are fully vested for employees who have completed  1,000 hours of
service  in the year of  contribution.  Contributions  for  1997,  1996 and 1995
amounted to $170,000,  $90,708 and $-0-, respectively.  Contributions are at the
Board of Directors' discretion subject to governmental limitations.

In 1987, the Company  established a deferred  compensation plan for its Board of
Directors.  The Board  members have an option of deferring  their fees to a cash
account or to a stock  account and all share  deferrals are recorded at the fair
market value on the date of the award.  Costs of the deferred  compensation plan
for 1997, 1996 and 1995 amounted to approximately $228,525, $61,813 and $13,000,
respectively.

                                       30

<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 8 - REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS:
The  amount  of  dividends  paid from  NSIC to the  Company  in any year may not
exceed, without prior approval of regulatory authorities,  the greater of 10% of
statutory surplus as of the end of the preceding year, or the statutory net gain
from  operations for the preceding  year. At December 31, 1997,  NSIC's retained
earnings unrestricted for the payment of dividends in 1998 amounted to $842,377.
NSFC is similarly  restricted in the amount of dividends payable to the Company;
dividends  may not exceed the greater of 10% of statutory  surplus as of the end
of the  preceding  year,  or net income  for the  preceding  year.  As a result,
dividends from NSFC to the Company are limited to $2,722,430 in 1998.

Securities with market values of $3,306,062 and $3,314,044, at December 31, 1997
and 1996, respectively, were deposited with various states pursuant to statutory
requirements.

Under applicable  Alabama  insurance laws and  regulations,  NSFC is required to
maintain a minimum  total surplus (to include both paid-in and  contributed  and
unassigned surplus) of $100,000.

Under applicable  Alabama  insurance laws and  regulations,  NSIC is required to
maintain a minimum  total surplus (to include both paid-in and  contributed  and
unassigned surplus) of $200,000.

NOTE 9 - SHAREHOLDERS' EQUITY:
Preferred Stock
The  Preferred  Stock may be issued in one or more  series as shall from time to
time be determined and  authorized by the Board of Directors.  The directors may
make specific  provisions  regarding (a) the voting  rights,  if any (b) whether
such  dividends  are  to be  cumulative  or  noncumulative  (c)  the  redemption
provisions,  if any (d)  participating  rights,  if any (e) any sinking  fund or
other retirement  provisions (f) dividend rates (g) the number of shares of such
series and (h) liquidation preference.

Common Stock
The holders of the Class A Common Stock will have  one-twentieth of one vote per
share, and the holders of the common stock will have one vote per share.

In the event of any  liquidation,  dissolution or  distribution of the assets of
the Company  remaining  after the payments to the holders of the Preferred Stock
of the full  preferential  amounts to which they may be  entitled as provided in
the resolution or resolutions  creating any series thereof, the remaining assets
of the  Company  shall be  divided  and  distributed  among the  holders of both
classes  of  common  stock,  except as may  otherwise  be  provided  in any such
resolution or resolutions.

NOTE 10 - INDUSTRY SEGMENTS:
The Company and its subsidiaries  operate  primarily in the insurance  industry.
Premium  revenues and operating  income by industry  segment for the years ended
December 31, 1997, 1996 and 1995 are summarized below:

                                                     (Dollars in thousands)
                                                     Year ended December 31,
                                                   1997       1996       1995

Premium revenues:
   Individual life and accident and health
     insurance ................................    $ 3,991    $ 4,432    $ 4,903
   Property and casualty insurance ............     27,165     22,222     19,469
                                                   -------    -------    -------
                                                   $31,156    $26,654    $24,372
                                                   -------    -------    -------
Income (loss) before income taxes and cumulative effect adjustment:
   Individual life and accident and health
     insurance ................................   $ 2,171    $ 1,140    $  (178)
   Property and casualty insurance ............     1,572      1,191        651
   Other ......................................      (272)      (601)       (85)
                                                  -------    -------    -------
                                                    3,471      1,730        388
         Interest expense .....................      (111)      (109)      (112)
                                                  -------    -------    -------
                                                  $ 3,360    $ 1,621    $   276
                                                  -------    -------    -------

                                       31
<PAGE>

                                                    (Dollars in thousands)
                                                     Year ended December 31,
                                                   1997       1996       1995
Assets:
   Individual life and accident and health
     insurance ................................  $ 39,569   $ 35,590   $ 35,870
   Property and casualty insurance ............    67,286     62,538     61,192
   Other ......................................       103         91        204
                                                  -------    -------    -------
                                                 $106,958   $ 98,219   $ 97,266
                                                  -------    -------    -------

Amortization of deferred policy acquisition costs and depreciation expense:
   Individual life and accident and health
     insurance ................................  $    319   $    232   $    271
   Property and casualty insurance ............     1,339        879        939
                                                  -------    -------    -------
                                                 $  1,658   $  1,111   $  1,210
                                                  -------    -------    -------

Capital expenditures are not material, and consequently, are not reported.

NOTE 11 - CONTINGENCIES:
The Company and its  subsidiaries  continue to be named as parties to litigation
related to the  conduct  of their  insurance  operations.  These  suits  involve
alleged breaches of contracts, torts, including bad faith and fraud claims based
on alleged wrongful or fraudulent acts of agents of the Company's  subsidiaries,
and miscellaneous  other causes of action. Most of these lawsuits include claims
for punitive  damages in addition to other  specified  relief.  The frequency of
these  lawsuits has increased  significantly  in recent years,  particularly  in
Alabama  where the Company  conducts  the majority of its  business.  Certain of
these  actions are filed in  jurisdictions  in Alabama  where local  juries have
returned  large  punitive  damage  verdicts  against  insurance   companies  and
financial  institutions  with, in many cases,  the punitive damage award bearing
little or no relation to the actual  damages.  It is not  feasible to predict or
determine the ultimate outcome of these matters.

On October 4, 1996, a jury in the Circuit  Court of Palm Beach  County,  Florida
returned  a  verdict  against  National  Security  Fire &  Casualty  Company,  a
subsidiary of the Company,  in the amount of $995,252.  The  plaintiff,  Leon B.
King, had alleged that the Company's subsidiary had acted in bad faith in, among
other actions, failing to timely deliver a settlement check in connection with a
1986 automobile  accident.  This same case was previously tried in 1993 with the
jury  returning  a verdict in favor of the  Company's  subsidiary  on all counts
alleged.  This verdict was subsequently reversed on appeal which resulted in the
subject trial.  Various  post-trial  motions  including a motion for a new trial
were denied and this  verdict is being  appealed.  The amount of this verdict is
reflected in the accompanying financial statements. It should be noted, however,
that in the event that this  verdict is  ultimately  upheld,  there  could be an
award of additional amounts including interest and attorneys' fees.

A resolution of these matters may significantly impact consolidated earnings and
may significantly impact the Company's consolidated financial position, although
it remains  management's  opinion,  based upon information  presently available,
that the ultimate resolution of these matters will not have a material impact on
the Company's consolidated financial position. It should be noted, however, that
management  is unable to  assess  with any  degree  of  accuracy  the  potential
liability  to the Company  arising  from these  matters.  The civil tort system,
particularly  in  Alabama,  must be  presently  regarded  as, for the most part,
hostile to insurance companies.

                                       32

<PAGE>
                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 12 - CONCENTRATION OF CREDIT RISK:
The Company maintains its cash accounts primarily with banks located in Alabama.
The total cash  balances  are  insured by the FDIC up to  $100,000  per bank.  A
summary of the total insured and uninsured amounts held by all banks at December
31, 1997 follows:
                                                          (Dollars in thousands)

   Cash and cash equivalents per balance sheet                         $    364
   Checks outstanding in excess of bank balance per balance sheet      (  1,190)
                                                                        --------
   Cash on hand                                                        (    826)

   Deposit in transit                                                  (    771)
   Outstanding checks                                                     2,666
                                                                        --------
   Total cash held at banks                                               1,069
   Portion secured by FDIC                                             (    613)
                                                                        --------
   Uninsured cash balances                                             $    456
                                                                        --------

                                       33

<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
                        ON FINANCIAL STATEMENT SCHEDULES



To the Board of Directors
and Shareholders of
The National Security Group, Inc.


We have audited in accordance with generally  accepted auditing  standards,  the
financial  statements of The National  Security  Group,  Inc. as of December 31,
1997 and 1996 and for the years then ended  included in this Form 10-K, and have
issued our report  thereon dated February 20, 1998. Our audits were made for the
purpose  of  forming  an  opinion  on those  statements  taken  as a whole.  The
schedules  listed  in the  accompanying  index  are  the  responsibility  of the
Company's  management  and are  presented  for  purposes of  complying  with the
Securities  and  Exchange  Commission's  rules  and  are not  part of the  basic
financial  statements.  These schedules as of December 31, 1997 and 1996 and for
the years then ended have been subjected to the auditing  procedures  applied in
the audits of the basic financial  statements and, in our opinion,  fairly state
in all material  respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.



Birmingham, Alabama
February 20, 1998                     Dudley, Hopton-Jones, Sims & Freeman PLLP

                                       34

<PAGE>

                       THE NATIONAL SECURITY GROUP, INC.
                SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED)
                             (AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                  December 31, 1997                           December 31, 1996
                                                ---------------------------------------    --------------------------------

                                                                            Amount per                          Amount per
                                                    Original      Market    the Balance    Original   Market   the Balance
                                                      Cost        Value         Sheet       Cost      Value       Sheet
                                                 ------------- ------------ ------------  ---------- --------  -----------
Securities Held to Maturity:
<S>                                                   <C>         <C>         <C>         <C>         <C>         <C>              
United States government ........................      10,388      10,416      10,386      14,413      14,417      14,373
States, municipalities and
                political subdivisions ..........       4,527       5,081       4,592       4,947       5,500       5,005
Public Utilities ................................       3,527       3,592       3,596       3,511       3,550       3,559
Industrial and Miscellaneous ....................      11,341      11,719      11,421      12,382      12,571      12,476
                                                       ------      ------      ------      ------      ------      ------
Total Securities Held to Maturity ...............      29,783      30,808      29,995      35,253      36,038      35,413
                                                       ------      ------      ------      ------      ------      ------

Securities Available for Sale:

          Equity Securities:
Public utilities ................................       2,857       4,788       4,788       2,108       3,428       3,428
Banks and insurance companies ...................       2,456       7,141       7,141       2,361       5,863       5,863
Industrial and all other ........................       8,813      19,786      19,786       7,237      13,893      13,893
                                                       ------      ------      ------      ------      ------      ------
Total equity securities .........................      14,126      31,715      31,715      11,706      23,184      23,184
                                                       ------      ------      ------      ------      ------      ------

            Debt Securities:
            United States government ............      15,511      15,625      15,625       4,332       4,373       4,373
            Public Utilities ....................         694         710         710         687         701         701
            Industrial and Miscellaneous ........       4,926       4,769       4,769       4,694       4,458       4,458
                                                       ------      ------      ------      ------      ------      ------
            Total Debt Securities ...............      21,131      21,104      21,104       9,713       9,532       9,532
                                                       ------      ------      ------      ------      ------      ------

            Total Available for Sale ............      35,257      52,819      52,819      21,419      32,716      32,716
                                                       ------      ------      ------      ------      ------      ------

            Total Securities ....................      65,040      83,627      82,814      56,672      68,754      68,129
Mortgage loans on real estate ...................         320                     320         405                     405
Investment real estate ..........................       1,645                   1,645       1,659                   1,659
Policy loans ....................................         648                     648         622                     622
Short term investments ..........................       3,924                   3,924       4,575                   4,575
                                                       ------                  ------      ------                  ------
                            Total investments ...      71,577                  89,351      63,933                  75,390
                                                       ======                  ======      ======                  ======

</TABLE>





                                       35

<PAGE>


               THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
          SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                                 BALANCE SHEETS
                             (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                December 31,
                                                           ---------------------
                                                              1997        1996
                                                            -------      ------
<S>                                                         <C>         <C>
Assets
Cash .................................................      $   167      $   155
Investment in subsidiaries (equity method)
eliminated upon consolidation ........................       46,721       40,854
Other assets .........................................          380          318
                                                            -------      -------
Total Assets .........................................      $47,268      $41,327
                                                            =======      =======

Liabilities and Shareholders' Equity
Accrued general expenses .............................      $   916      $   808

Total Liabilities ....................................          916          808

Total Shareholders' Equity ...........................      $46,352      $40,519
                                                            -------      -------
Total Liabilities and Shareholders' Equity ...........      $47,268      $41,327
                                                            =======      =======

</TABLE>


The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc." are an integral part this condensed financial information of the 
registrant.

See  accompanying  "Notes to Condensed Financial Information of Registrant"

                                       36


<PAGE>

               THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
          SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                              STATEMENTS OF INCOME
                             (AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                For the Years Ended December 31,
                                                --------------------------------
                                                   1997      1996         1995
                                                --------------------------------
<S>                                              <C>        <C>        <C>
Income
From subsidiaries-eliminated upon consolidation
Dividends .....................................   $ 1,850    $ 1,800    $ 1,680
                                                  -------    -------    -------

Expenses
State taxes ...................................        26         25         25
Other expenses ................................       246        575         60
                                                  -------    -------    -------
                                                      272        600         85
                                                  -------    -------    -------
Income before income taxes and equity in
undistributed earnings of subsidiaries ........     1,578      1,200      1,595
Income tax benefit ............................      (109)      (175)       (43)
                                                  -------    -------    -------

Income before equity in undistributed earnings
of subsidiaries ...............................     1,687      1,375      1,638
Equity in undistributed earnings (losses) 
of subsidiaries ...............................     1,311        (19)    (1,424)
                                                  -------    -------    -------

Net Income ....................................   $ 2,998    $ 1,356    $   214
                                                  =======    =======    =======


</TABLE>


The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc." are an integral part of this condensed financial information of the 
registrant.

See  accompanying  "Notes to Condensed Financial Information of Registrant"

                                       37

<PAGE>


               THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
          SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                            STATEMENTS OF CASH FLOWS
                             (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>

                                                      For the Years Ended December 31,
                                                    ----------------------------------
                                                        1997         1996        1995
                                                    ----------------------------------
<S>                                                    <C>         <C>        <C> 
Cash flows from operating activities:
Net income ..........................................   $ 2,998    $ 1,356    $   214
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed (income) loss of subsidiaries    (1,311)        19      1,424
Provision for amortization ..........................         0         22         12
(Increase)decrease in other assets .................       (62)      (157)        64
Increase (decrease) in other liabilities ............       107        433        (43)
                                                        -------    -------    -------
Net cash provided by
operating activities ................................     1,732      1,673      1,671
                                                        -------    -------    -------

Cash flows from financing activities:
Purchase of treasury stock ..........................       (98)       (70)      (222)
Cash dividends ......................................    (1,622)    (1,509)    (1,427)
                                                        -------    -------    -------
Net cash used in
financing activities ................................    (1,720)    (1,579)    (1,649)
                                                        -------    -------    -------

Net increase (decrease) in cash and cash equivalents         12         94         22

Cash and due from banks at beginning of year ........       155         61         39
                                                        -------    -------    -------

Cash and due from banks at end of year ..............   $   167    $   155    $    61
                                                        =======    =======    =======


</TABLE>



The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc." are an integral part of this condensed financial information of the 
registrant.

See accompanying "Notes to Condensed Financial Information of Registrant"

                                       38

<PAGE>


               THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
             Notes to Condensed Financial Information of Registrant


Note 1-Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the Condensed  Financial  Information of the Registrant  does not include all of
the information and notes normally included with financial  statements  prepared
in accordance with generally accepted accounting  principles.  It is, therefore,
suggested that these Condensed Financial  Statements be read in conjunction with
the  Consolidated  Financial  Statements  and  Notes  thereto  included  in  the
Registrant's Annual Report as referenced in Form 10-K, Part II, Item 8, page 23.

Note 2-Cash Dividends from Subsidiaries
Dividends of $1.85  million in 1997,  $1.80 million in 1996 and $1.68 million in
1995 were paid to the Registrant by its subsidiaries.






                                       39

<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.
         SCHEDULE V. SUPPLEMENTARY INSURANCE INFORMATION (CONSOLIDATED)
                             (Amounts in thousands)
<TABLE>
<CAPTION>

                                                                                                                       Policy Claims
                                                                                   Deferred       Future                   and Other
                                                                                  Acquisition     Policy        Unearned    Benefits
                                                                                     Costs        Benefits      Premiums     Payable
                                                                                  ----------   --------------  ---------- ----------
<S>                                                                                 <C>           <C>          <C>          <C> 
At December 31, 1997:
Life and accident and health insurance .........................................      $ 2,659      $18,667      $     0      $   386
Property and casualty insurance ................................................        1,557            0        8,853       21,860
                                                                                      -------      -------      -------      -------
Total ..........................................................................      $ 4,216      $18,667      $ 8,853      $22,246
                                                                                      =======      =======      =======      =======

At December 31, 1996:
Life and accident and health insurance .........................................      $ 2,700      $18,558      $     0      $   360
Property and casualty insurance ................................................        1,313            0       10,398       19,087
                                                                                      -------      -------      -------      -------
Total ..........................................................................      $ 4,013      $18,558      $10,398      $19,447
                                                                                      =======      =======      =======      =======

At December 31, 1995:
Life and accident and health insurance .........................................      $ 2,544      $18,290      $     0      $   477
Property and casualty insurance ................................................          856            0       12,467       16,061
                                                                                      -------      -------      -------      -------
Total ..........................................................................      $ 3,400      $18,290      $12,467      $16,538
                                                                                      =======      =======      =======      =======

                                                                                                      Commissions,
                                                                                          Benefits,  Amortization  General
                                                                                           Claims,    of Deferred  Expenses,
                                                                       Net               Losses and    Policy     Taxes,
                                                          Premium  Investment    Other  Settlement  Acquisition  Licenses   Premiums
                                                          Revenue     Income     Income    Expenses    Costs     and Fees    Written
                                                        ----------  ---------    --------   --------   ---------- --------  --------
                                                          <C>        <C>        <C>        <C>        <C>        <C>        <C>    
For the year ended December 31, 1997:
Life and accident and health insurance ................    $ 3,991    $ 2,048    $     3    $ 2,106    $ 1,087    $ 2,089    $ 3,991
Property and casualty insurance .......................     27,165      2,156        692     20,889      4,735      4,290     27,185
Other .................................................          0          0          0          0          0        219         0
                                                           -------    -------    -------    -------    -------    -------    -------
Total .................................................    $31,156    $ 4,204    $   695    $22,995    $ 5,822    $ 6,598    $31,176
                                                           =======    =======    =======    =======    =======    =======    =======

For the year ended December 31, 1996:
Life and accident and health insurance.................    $ 4,432    $ 1,861    $     8    $ 2,484    $ 1,234    $ 2,804    $ 4,400
Property and casualty insurance .......................     22,222      2,074        574     17,193      3,487      3,825     23,498
Other .................................................          0          0          0          0          0        362         0 
                                                           -------    -------    -------    -------    -------    -------    -------
Total .................................................    $26,654    $ 3,935    $   582    $19,677    $ 4,721    $ 6,991    $27,898
                                                           =======    =======    =======    =======    =======    =======    =======

For the year ended December 31, 1995:
Life and accident and health insurance.................    $ 4,903    $ 2,074    $     3    $ 2,166    $ 1,275    $ 4,587    $ 4,947
Property and casualty insurance .......................     19,469      2,237        502     15,555      3,406      3,488     20,119
Other .................................................          0          0          0          0          0         85          0
                                                           -------    -------    -------    -------    -------    -------    -------
Total .................................................    $24,372    $ 4,311    $   505    $17,721    $ 4,681    $ 8,160    $25,066
                                                           =======    =======    =======    =======    =======    =======    =======


</TABLE>


Note:  Investment income and other operating expenses are reported separately by
       segment and not allocated.


                                       40


<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.
                     SCHEDULE VI. REINSURANCE (CONSOLIDATED)
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                                                                      Percentage
                                                                                 Ceded       Assumed                  of Amount
                                                                     Gross      to Other    from Other       Net        Assumed
                                                                     Amount     Companies    Companies      Amount       to Net
                                                                   -----------  ----------  ------------  ----------- -------------

<S>                                                               <C>            <C>           <C>            <C>           <C>
For the year ended December 31, 1997:
Life insurance in force ...................................       $138,059       $  6,332       $      0       $131,727         0.0%
                                                                  ========       ========       ========       ========       ===

Premiums:
Life insurance and accident and health insurance ..........       $  4,039       $     48       $      0       $  3,991         0.0%
Property and casualty insurance ...........................         30,815          3,652              0         27,163         0.0%
                                                                  --------       --------       --------       --------       ---

Total premiums ............................................       $ 34,854       $  3,700       $      0       $ 31,154         0.0%
                                                                  ========       ========       ========       ========       ===

For the year ended December 31, 1996:
Life insurance in force . . . . . . . . . . ...............       $145,054       $  6,764       $      0       $138,290         0.0%
                                                                    ========       ========       ========       ========       ===

Premiums:
Life insurance and accident and health insurance ..........       $  4,484       $     51       $      0       $  4,433         0.0%
Property and casualty insurance ...........................         33,987         11,768              0         22,219         0.0%
                                                                  --------       --------       --------       --------       ---

Total premiums ............................................       $ 38,471       $ 11,819       $      0       $ 26,652         0.0%
                                                                  ========       ========       ========       ========       ===



For the year ended December 31, 1995:
Life insurance in force ...................................       $149,855       $  7,886       $      0       $141,969         0.0%
                                                                  ========       ========       ========       ========       ===

Premiums:
Life insurance and accident and health insurance ..........       $  4,961       $     58       $      0       $  4,903         0.0%
Property and casualty insurance ...........................         32,702         13,234              1         19,469         0.0%
                                                                  --------       --------       --------       --------       ---

Total premiums ............................................       $ 37,663       $ 13,292       $      1       $ 24,372         0.0%
                                                                  ========       ========       ========       ========       ===


</TABLE>


Note:   Net reinsurance assumed premiums were, $0, $0, and $(2) for 1997, 1996,
        and 1995, respectively.



                                       41

<PAGE>








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

               None.





                                       42



<PAGE>




                                    PART III

Item 10.  Directors and Officers of the Registrant

         The information contained on pages 2-4 of The National Security Group's
         Proxy  Statement  dated April 14, 1998,  with respect to directors  and
         executive officers of the Company,  is incorporated herein by reference
         in response to this item.

Item 11.  Executive Compensation

         The  information  contained on pages 7 and 8 of The  National  Security
         Group's Proxy Statement dated April 14, 1998, with respect to executive
         compensation and transactions,  is incorporated  herein by reference in
         response to this item.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

         The information  contained on page 9 of The National  Security  Group's
         Proxy  Statement  dated  April 14,  1998,  with  respect  to  security
         ownership of certain beneficial owners and management,  is incorporated
         herein by reference to this item.

Item 13.  Certain Relationships and Related Transactions

         The  information  contained on pages 6 and 7 of The  National  Security
         Group's Proxy  Statement  dated April 14, 1998, with respect to certain
         relationships  and  related  transactions,  is  incorporated  herein by
         reference in response to this item.





                                       43



<PAGE>


                                     PART IV




Item 14.    Exhibits, financial statement schedules, and reports on Form 8-K

a.  The following documents are filed as part of this report:             Page #

    Report of Independent Certified Public Accountants                        18

    Consolidated Statements of Income--
       Years Ended December 31, 1997, 1996, and 1995                          19

    Consolidated Balance Sheets--December 31, 1997 and 1996                   20

    Consolidated Statements of Shareholders' Equity--
       Years Ended December 31, 1997, 1996, and 1995                          21

    Consolidated Statements of Cash Flows--
       Years Ended December 31, 1997, 1996, and 1995                          22

    Notes To Consolidated Financial Statements--December 31, 1997             23

    Schedule I. Summary Of Investments--December 31, 1997 and 1996            35

    Schedule III. Condensed Financial Information of Registrant--
       December 31, 1997 and 1996                                             36

    Schedule V. Supplementary Insurance Information--
       December 31, 1997, 1996, and 1995                                      40

    Schedule VI. Reinsurance--
       Years Ended December 31, 1997, 1996, and 1995                          41


All other  Schedules  are not  required  under the related  instructions  or are
inapplicable and therefore have been omitted.

b.    Reports on Form 8-K

The Company did not file any Form 8-K during the fourth quarter of 1997.



                                       44




<PAGE>


                                    SIGNATURE

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

                        THE NATIONAL SECURITY GROUP, INC.

/s/ M.L. Murdock                                      /s/ J.R. Brunson
---------------------------                          --------------------------
M.L. Murdock                                          J.R. Brunson
Senior Vice President, Chief Financial Officer,       President, Chief Executive
Treasurer and Director                                Officer and Director


Date: March 30, 1998

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in their capacity as a Director of The National Security Group, Inc. On February
21, 1998.

                                    SIGNATURE

/s/ Lewis Avinger                                       /s/ D.M. English

/s/ Winfield Baird                                      /s/ M.L. Murdock

/s/ Carolyn Brunson                                     /s/ Craig S. Pittman

/s/ J.R. Brunson                                        /s/ James B. Saxon

/s/ Jerry B. Brunson                                    /s/ Walter P. Wilkerson

/s/ Fred D. Clark Jr.




                                       45




<PAGE>