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, 1998
                         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 26, 1999 (based upon the bid price of these shares on
NASDAQ on such date) -  8,953,406

Number of Shares of Common Stock outstanding as of February 26, 1999 - 2,051,311

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

                 Total Number of Sequentially Numbered Pages: 46




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<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           18
Item 9.    Changes in and Disagreements with Accountants and
              Financial Disclosure                                            43

Part III

Item 10.   Directors and Executive Officers of the Registrant                 44
Item 11.   Executive Compensation                                             44
Item 12.   Security Ownership of Certain Beneficial Owners and Management     44
Item 13.   Certain Relationships and Related Transactions                     44

Part IV

Item 14.   Exhibits, Financial Statement Schedules and Reports of Form 8-K    45

Signature Page                                                                46




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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 86.5% 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 (NSFC), 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 the states of Alabama, Arkansas, Florida,
Georgia, Mississippi, Oklahoma, South Carolina, and Tennessee, and operates on a
surplus lines basis in the states of Kentucky,  Louisiana,  Missouri, and Texas.
Omega is licensed to write  insurance in Alabama and  Louisiana.  The  following
table  indicates  those  states  which  accounted  for more than five percent of
direct written premium during 1998:

             State                         Percent of direct written premium
            ------                         ---------------------------------
           Alabama                                           31.90%
           Arkansas                                           9.69%
           Florida                                           11.04%
           Georgia                                           10.97%
           Louisiana                                         19.53%
           Mississippi                                        5.34%

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.


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

                                                     Year Ended December 31
                                                     (Amounts in Thousands)
                                                   1998       1997       1996
                                                   ----       ----       ----
Net premiums earned:
      Fire, Allied lines, and Homeowners .....   $ 15,817    $ 14,647   $ 13,835
      Automobile .............................      7,715      11,082      6,181
      Other ..................................      1,082       1,436      2,205
                                                 --------    --------   --------
                                                 $ 24,614    $ 27,165   $ 22,221
                                                 ========    ========   ========

Income before income taxes ...................   $ (1,000)   $  1,572   $  1,192
                                                 ========    ========   ========

Life Insurance Segment

The  Company's  life  insurance  business  is  conducted  by  National  Security
Insurance  Company (NSIC), 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 4% or more of the total direct premiums  collected by
the Life Company in 1998:

              State                       Percentage of Total Direct Premiums

             Alabama                                    91
             Mississippi                                 4
             Georgia                                     4

NSIC  primarily  writes home service life  insurance  products,  which means its
agents 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. NSIC 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)
                                           1998          1997             1996
                                         --------       --------        --------
Life insurance in force at end of period:
Ordinary-whole life ............        $ 71,800        $ 70,000        $ 67,000
         term life .............          33,500          33,900          42,000
Industrial .....................          32,300          34,000          36,000
Other ..........................             100             100             100
                                        --------        --------        --------
                                         137,700         138,000         145,100
                                        ========        ========        ========

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                                                   Year Ended December 31
                                                   (Amounts in Thousands)
                                                1998        1997          1996
                                                ----        ----          ----

New life insurance issued:
  Ordinary-whole life ...................      $41,300      $39,000      $26,000
           term life ....................        5,300          200       12,000
  Industrial ............................            0            0            0
  Other .................................          100          100          100
                                               -------      -------      -------
                                                46,700       39,300       38,100
                                               =======      =======      =======

Net premiums earned:
  Life insurance ........................      $ 2,914      $ 2,979      $ 3,194
  Accident and health insurance .........          923        1,012        1,239
                                               -------      -------      -------
                                                 3,837        3,991        4,433
                                               =======      =======      =======

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
                                                                1998      1997
                                                                -----     -----
Investment Securities held-to-maturity,  at amortized cost
      (estimated fair value: 1998 - $31,835, 1997 - $30,807)   $30,807   $29,995
Investment Securities available-for-sale,  at market
      (cost: 1998 - $34,175, 1997 - $35,257) ...............    51,235    52,819
Receivable for securities sold .............................       315       400
Mortgage loans on real estate, at cost .....................       135       320
Investment real estate, at cost ............................     1,629     1,645
Policy loans ...............................................       645       648
Short-term investments .....................................     3,290     3,524
                                                               -------   -------
                                                               $88,056   $89,351
                                                               =======   =======

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

                                                      Year Ended December 31
                                                   1998        1997       1996
                                                   -----       -----     -----
Net investment income ........................   $ 4,351     $ 4,204    $ 3,935
Average yield on investments .................       4.9%        5.1%       5.4%
Economic yield on investments (includes
  realized and unrealized investment gains) ..       9.0%       16.0%       9.7%
Net realized gains on investments
  (before income taxes) ......................     4,117       2,720      1,839
Changes in net unrealized gains on investments
               (before income taxes) .........      (503)      6,266      1,340





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As of December 31, 1998,  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 ......    $ 1,000    $ 2,312    $ 3,312        6.5%
Maturity in 1-5 years .............      5,240     10,265     15,505       30.3
Maturity in 5-10 years ............      7,325      7,900     15,225       29.8
Maturity after 10 years ...........      6,750     10,329     17,079       33.4
                                         -------    -------    -------    -----

Totals ...........................     $20,315    $30,807    $51,122      100.0%
                                         =======    =======    =======    =====


Certain Information Regarding Insurance Activities

Marketing and Distribution

The NSIC's  products  are  marketed  through a field force of agents and service
representatives who are employees of the Life Company. NSIC 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 an  important  method of
distribution in the future.  NSFC'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  NSIC  in  1998   averaged
approximately  25.1%  of  premiums.  Commissions  incurred  by the  NSFC in 1998
averaged  approximately  17.7%  of  premiums  and  ranged  from  12.5%  to 27.5%
depending  on the type  and  amount  of  insurance  sold.  During  1998,  no one
independent agent accounted for more than 10% of total net earned premium of the
property-casualty insurance subsidiaries.

NSIC is continuing 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 too 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 people to contact our policy owners at
home,  NSIC  management  is  continuing  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 still in the early 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.
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NSIC generally  reinsures all risks in excess of $50,000 with respect to any one
policy.  NSFC and Omega  generally  reinsure with third parties any liability in
excess of $100,000 on any single  policy.  In  addition,  the  property-casualty
subsidiaries have 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 1996, 1997, and 1998, the property-casualty  subsidiaries had
catastrophe  protection up to a $26 million  loss. On a $26 million  catastrophe
loss,  the  property-casualty  subsidiaries  would  pay  about  $7  million  and
reinsurers would pay $19 million.

In  addition  to  catastrophe  reinsurance,  NSFC  also  had a 50%  quota  share
reinsurance  agreement on ocean marine exposure with  additional  excess of loss
coverage.

Reserve liabilities

NSIC maintains life insurance 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,  1998,  the total  reserves of NSIC
(including the reserves for accident and health  insurance)  were  approximately
$18.8 million.  NSIC 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, 1998, the  property-casualty  subsidiaries had
reserves  for unpaid  claims of  approximately  $22 million  before  subtracting
unpaid  claims which will be due from  reinsurers  of $5.9  million  leaving net
unpaid claims of $16.1  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, 1998,  1997 or 1996. 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.  NSIC
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.


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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.

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 $0,
$77,000, and $18,700 in various association  assessments in 1998, 1997, and 1996
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.

NSIC 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.  NSIC's life and health  products also compete to a lesser
extent with  products  sold by ordinary  life  companies.  NSIC 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.
NSIC attempts to price its products with

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<PAGE>



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.

The  property-casualty  subsidiaries  market their products through  independent
agents and brokers,  concentrating  on low value dwellings and nonstandard  auto
coverage.  NSFC,  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 NSFC. The market share
in  states  other  than  Alabama  is  small.  Price  is the  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, 1998.



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<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,
1999, was approximately 1,100.

                                       Stock Bid Prices     Dividends
                                       High      Low        Per Share

1998
  First Quarter ...............        $21 1/4    $17         $.19
  Second Quarter ..............         21         18          .19
  Third Quarter ...............         18 1/2     14          .19
  Fourth Quarter ..............         14         10 1/2      .20

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



                                       10





<PAGE>



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

Operating results                 1998     1997      1996      1995       1994
-----------------                -----     -----     ----      ----       -----

Net premiums earned ..........   $28,451   $31,156   $26,654   $24,372   $26,289
Net investment income ........     4,351     4,204     3,935     4,311     4,001
Net realized investment
  gains ......................     4,117     2,720     1,839     1,650     1,720
Other income .................       385       695       582       505       400
                                 -------   -------   -------   -------   -------
Total revenues ...............   $37,304   $38,775   $33,010   $30,838   $32,410
                                 =======   =======   =======   =======   =======

Net Income ...................   $   930   $ 2,998   $ 1,356   $   214   $ 3,674
                                 =======   =======   =======   =======   =======

Net income per share .........   $  0.42   $  1.28   $  0.58   $  0.09   $  1.57
                                 =======   =======   =======   =======   =======


Other Selected Financial Data

Total shareholders' equity ....  $ 41,968  $ 46,352  $ 40,519  $ 39,774  $38,482

Book value per share ..........  $  20.46  $  20.04  $  17.43  $  17.11  $ 16.44

Dividends per share ...........  $   0.77  $   0.70  $   0.65  $   0.61  $  0.57

Net change in unrealized
     capital gains (net of tax) ($   351)  $  4,556  $    968  $  2,726 ($3,030)

Total assets ..................  $103,973  $106,958  $ 98,219  $ 97,266  $89,986




                                       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:

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997:

Consolidated  net income for The  National  Security  Group  (The  Company)  was
$930,000  in 1998  compared  to $2.998  million  in 1997.  On a per share  basis
earnings  were $0.42 in 1998  compared  to $1.28 in 1997.  The  decrease  in net
income  was due to poor  operating  results in The  Company's  property/casualty
subsidiaries operations. The operating results of the subsidiaries are discussed
in further  detail in the sections that follow.  Realized  capital gains in 1998
were $4.1 million compared to $2.7 million in 1997.  Consolidated  revenues were
$37.3  million in 1998  compared to 38.8 million in 1997.  Revenues were down 4%
for the year due to a decrease in property and casualty insurance premiums.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996:

Consolidated  net income for The  National  Security  Group was $3.0 million for
1997 compared to $1.4 million in 1996. On a per share basis  earnings were $1.28
in 1997  compared to $0.58 in 1996.  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.  Consolidated  revenues  grew 17% to
$38.8 million in 1997 compared to $33.0 million in 1996.  Revenue increases were
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:       1998    %      1997    %      1996    %
                      -------  -----  ------  -----   -----  ----
Life and accident 
  and health insurance $ 3,837  13.5  $ 3,991  12.8 $ 4,433  16.6
Property and casualty 
 insurance              24,614  86.5   27,165  87.2  22,221  83.4
                       -------  -----  ------  ---- -------  -----
                       $28,451 100.0  $31,156 100.0 $26,654 100.0

Income before taxes and cumulative effect adjustment:
                        1998       %    1997     %      1996     % 
                        ----       -   -----     --     -----   ---
Life and accident
 and health insurance  $ 2,489  225.0  $ 2,171   64.6  $ 1,141   70.4
Property and casualty
 insurance ......       (1,000) (90.4)   1,572   46.8    1,192   73.4
Other ..............      (383) (34.6)    (383) (11.4)    (710) (43.8)
                        -------  -----  ------  -----   -------  -----
                       $ 1,106  100.0  $ 3,360  100.0  $ 1,621   100.0
                       =======  =====   ======  =====   =======  =====




                                       12



<PAGE>



Life and Accident and Health Insurance Operations:

The Company's life,  accident and health insurance business is conducted through
National  Security  Insurance  Company (NSIC),  a wholly owned subsidiary of the
Company organized in 1947.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997:

Pretax earnings in 1998 were $2.5 million  compared to $2.2 million in 1997. The
increase  in  pretax  earnings  was  primarily  due  to  a  decrease  in  agents
commissions  and  litigation  expenses.  Premium income was $3.8 million in 1998
compared to $4.0 million in 1997. Premium income appears to be stabilizing after
a rapid decline over the past five years.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996:

Pretax  earnings in 1997 of $2.2  million  were  significantly  better than 1996
earnings of $1.1 million.  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.  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, is
down from $4.4  million in 1996.  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.

Property & Casualty Operations:

The  Company's  property and casualty  insurance  business is conducted  through
National  Security Fire & Casualty  Company (NSFC), 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.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997:

Pretax  losses  were $1.0  million  in 1998  compared  to pretax  income of $1.6
million in 1997. Several  catastrophe losses and a litigation  settlement during
1998 had a major  impact on the  results  of  property  and  casualty  insurance
operations.

One of the property and casualty subsidiaries, NSFC, was hit by natural disaster
losses in the first and last half of the year.  During  the first six  months of
1998, NSFC incurred over $1.0 million in tornado losses. The most severe tornado
loss was in  Jefferson  County,  Alabama  in the  Spring  of 1998.  This  single
tornado,  which was  reported to be a category F5 tornado with winds of over 200
miles per hour,  caused over  $550,000 in damage to NSFC  policyholders.  In the
last half of 1998 NSFC was hit by Hurricane  Georges which hit the Gulf Coast of
Alabama and  Mississippi  and caused over $1.1  million in incurred  losses.  In
total,  hurricane  losses accounted for 10% of all property and casualty losses.
However,  even though  catastrophe  losses were substantial in 1998,  NSFC's low
value  dwelling  line of  business,  which  was hit  with a  majority  of  these
catastrophe losses, ended the year with a combined ratio of less than 100%. NSFC
had no significant catastrophic losses in 1997.

NSFC  also  settled a long  standing  lawsuit  in 1998  which  decreased  pretax
earnings by over $2.0 million. This settlement is discussed in further detail in
Note 11 of the financial statements.

The most significant  operating result in the property and casualty subsidiaries
was the continued poor  performance of the  subsidiaries  private  passenger and
commercial  automobile  programs.  The combined ratio of these  programs,  which
produced over $7.7 million in earned premium,  was over 150%. Pretax losses from
these automobile programs totaled over $4.1 million.  Two of the programs,  both
in Louisiana,  have been  discontinued.  The remaining  in-force policies from a
private  passenger  auto  program  expired in late 1998,  and in early  1999,  a
commercial taxi program in Louisiana was  discontinued.  The remaining  in-force
policies  from this program will not expire  until  mid-1999.  Based on previous
loss  experience,  the taxi  program is  expected  to incur  losses in excess of
earned premium until the remaining policies expire. These two programs accounted
for 1998 pretax losses of $2.7 million.

                                       13


<PAGE>



Year Ended December 31, 1997 Compared to Year Ended December 31, 1996:

Pretax  earnings  were $1.572  million in 1997, a 32% increase  over 1996 pretax
earnings of $1.191 million.  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.  Unfortunately  the improved
results in the LVD  program  were  offset by  adverse  loss  development  in the
automobile  programs in Georgia and  Louisiana.  Omega  attempted to obtain rate
increases for a private  passenger  auto program 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 was discontinued in 1998. NSFC was granted a rate increase for a private
passenger auto program in the State of Georgia, and more stringent  underwriting
guidelines  were  implemented,  so this program has continued,  but at a greatly
reduced  premium  volume.  The primary reason for the improvement in earnings in
1997 compared to 1996 was an increase in capital gains realized from the sale of
common stock investments.

Property & Casualty Combined Ratio:

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:
                                                 1998          1997        1996
                                                -----         -----        ----
Loss and LAE Ratio ......................          87.0%        79.3%      79.8%
Underwriting Expense Ratio ..............          31.6%        31.0%      30.9%
                                                  -----        -----       -----
Combined Ratio ..........................         118.6%       110.3%     110.7%

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  hitting the coast of Alabama,  Georgia,
South Carolina, Mississippi,  Louisiana, or Texas could cause the combined ratio
to fluctuate materially from prior years. The property and casualty subsidiaries
maintain catastrophe reinsurance to minimize the effect of a major catastrophe.

The  combined  ratio  for  1998  was  substantially  higher  than  1997  due  to
catastrophe  losses  and  very  unfavorable   underwriting  results  in  private
passenger and commercial  automobile lines of business.  Catastrophe losses from
Hurricane  Georges  and  tornadoes  increased  the  combined  ratio  by over 9%.
However,  the  most  significant  impact  on the  combined  ratio  was the  poor
underwriting results from the automobile lines of business, which had a combined
ratio of over 150%. Losses,  adjustment expenses,  and underwriting  expenses in
excess of earned premium on the automobile  programs increase the combined ratio
for all lines of business by over 16.5 percentage points.

The  combined  ratio for 1997  compared to 1996 did not improve 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 primary reason for the high combined ratio for 1996 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.

Asset Portfolio Review: The life insurance and property/casualty subsidiaries
primarily invest in highly liquid investment grade debt and equity securities.
At December 31, 1998, the company's holdings in debt securities amounted to 58%
of total investments and 49% of total assets. The following is a breakdown of
the bond portfolio quality according to National Association of Insurance

                                       14


<PAGE>



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-             93.2
 2            Baa to Baa3        BBB+ to BBB-           5.9
 3            Ba1 to Ba3         BB+ to BB-             0.0
 4            B1 to B3           B+ to B-               0.5
 5            Caa to Ca          CCC+ to C              0.4
 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 $15.5 million
and  $14.1   million  at   December   31,  1998  and  1997   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.

Market Risk Disclosures:  Since the Company's assets and liabilities are largely
monetary in nature, the Company's financial position and earnings are subject to
risks resulting from changes in interest rates at varying maturities, changes in
spreads over U.S.  Treasuries on new  investment  opportunities,  changes in the
yield curve and equity pricing risks.

The  Company  is exposed to equity  price  risk on its  equity  securities.  The
Company  holds  common stock with a fair value of $30.9  million.  If the market
value of the S & P 500 Index decreased 10% from its December 31, 1998 value, the
fair value of the Company's common stock would decrease by $3.9 million.

Certain fixed interest rate market risk sensitive  instruments may not give rise
to incremental  income or loss during the period  illustrated but may be subject
to changes in fair values.  Note 1 presents  additional  disclosures  concerning
fair values of Financial Assets and Financial  Liabilities,  and is incorporated
by reference herein.

The Company limits the extent of its market 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.

                                       15


<PAGE>



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.

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  (used) provided cash of $(1.90  million),  $7.48 million,
$1.45  million in 1998,  1997,  and 1996  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 claim  payments  was a
primary  use of cash in  operating  activities  for 1998.  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 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 notes  payable of $3.0  million at December 31, 1998. A $700,000
note is payable in quarterly  installments  over five years,  and a $2.3 million
note matures in April of 1999.  The Company  expects to  refinance  this note at
maturity with an extended repayment term of no less than five years.

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, 1998, the Company had no known  impairments
of assets or changes in  operation  which would have a material  adverse  effect
upon liquidity.  Approximately 84% 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 on 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 1999, the
amount that The National Security Group's insurance subsidiaries can transfer in
the form of  dividends  to the parent  company is limited to $1.7 million in the
life insurance  subsidiary and $2.5 million in the  property/casualty  insurance
subsidiary.  However,  that condition poses no short-term or long-term liquidity
concerns for the parent company.

                                       16







<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 four to one at December 31, 1998.

National  Security  Insurance  Company (life  insurer) has  regulatory  adjusted
capital of $14.5  million  and $13.4  million  at  December  31,  1998 and 1997,
respectively,  and a ratio of regulatory  total  adjusted  capital to authorized
control  level RBC of 9.5 and 8.5 at December  31,  1998 and 1997  respectively.
Accordingly,   National  Security   Insurance  Company  meets  the  minimum  RBC
requirements.

National  Security  Fire &  Casualty  Company  (property/casualty  insurer)  has
regulatory  adjusted  capital of $25.0 million and $27.2 million at December 31,
1998 and 1997, respectively, and a ratio of regulatory total adjusted capital to
authorized  control  level  RBC of 9.1 and 8.4 at  December  31,  1998  and 1997
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 $3.2 million and $4.4
million at December 31, 1998 and 1997,  respectively,  and a ratio of regulatory
total  adjusted  capital  to  authorized  control  level  RBC of 4.0  and 5.2 at
December 31, 1998 and 1997 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.

                                       17


<PAGE>



Item 8.  Consolidated Financial Statements and Supplementary Data

Index to Financial Statements

Consolidated Financial Statements:

Report of Independent Certified Public Accountants .....................     19

Consolidated Statements of Income - 
  Years Ended December 31, 1998, 1997, and 1996.........................     20

Consolidated Balance Sheets - December 31, 1998 and 1997................     21

Consolidated Statements of Shareholders' Equity -
  Years Ended December 31, 1998, 1997, and 1996.........................     22

Consolidated Statements of Cash Flows -
  Years Ended December 31, 1998, 1997, and 1996.........................     23

Notes to Consolidated Financial Statements - December 31, 1998..........     24

Financial Statement Schedules:

Report of Independent Certified Public Accountants 
  on Financial Statement Schedules......................................     35

Schedule I.  Summary of Investments - December 31, 1998 and 1997........     36

Schedule III.  Condensed Financial Information of Registrant -
  December 31, 1998 and 1997............................................     37

Schedule V.  Supplementary Insurance Information - 
  December 31, 1998, 1997, and 1996.....................................     41

Schedule VI.  Reinsurance - 
  Years Ended December 31, 1998, 1997, and 1996.........................     42

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


                                       18



<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, 1998 and 1997, and the
related consolidated  statements of income,  shareholders' equity and cash flows
for each of the  three  years in the  period  ended  December  31,  1998.  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, 1998 and 1997,
and the results of their  operations  and their cash flows for each of the three
years in the period ended  December  31,  1998,  in  conformity  with  generally
accepted accounting principles.



Birmingham, Alabama               Dudley, Hopton-Jones, Sims & Freeman PLLP
February 19, 1999


                                       19

<PAGE>



                        THE NATIONAL SECURITY GROUP, INC.

                        CONSOLIDATED STATEMENTS OF INCOME

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

                                                   1998       1997        1996
                                                 --------   --------    --------

REVENUES
   Net premiums earned ........................  $ 28,451   $ 31,156    $ 26,654
   Net investment income ......................     4,351      4,204       3,935
   Net realized investment gains ..............     4,117      2,720       1,839
   Other income ...............................       385        695         582
                                                 --------   --------    --------
                                                   37,304     38,775      33,010
                                                 ========   ========    ========

BENEFITS AND EXPENSES
   Policyholder benefits paid or provided ......   22,880     22,995      19,677
   Amortization of deferred policy
      acquisition costs ........................    1,856      1,488         995
   Commissions .................................    3,764      4,334       3,726
   General insurance expenses ..................    6,261      5,229       5,515
   Insurance taxes, licenses and fees ..........    1,194      1,258       1,367
   Interest expense ............................      243        111         109
                                                 --------   --------    --------
                                                   36,198     35,415      31,389
                                                 ========   ========    ========

           Income Before Income Taxes ..........    1,106      3,360       1,621
                                                 --------   --------    --------
INCOME TAX EXPENSE
   Current .....................................      93        848         421
   Deferred ....................................      83       (486)       (156)
                                                 --------   --------    --------
                                                      176        362         265
                                                 --------   --------    --------
                             Net Income ........ $    930   $  2,998    $  1,356
                                                 ========   ========    ========
EARNINGS PER COMMON SHARE

                             Net Income ........ $    .42   $   1.28    $    .58
                                                 ========   ========    ========


See accompanying notes to consolidated financial statements.
  
                                       20
<PAGE>




                        THE NATIONAL SECURITY GROUP, INC.

                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<S>                                                          <C>          <C>   
                                                             (Dollars in thousands)
                                                                  December 31,        
                                                            -----------------------
                                                                 1998        1997
                                                                  ----        ----
ASSETS
Investments
   Securities held-to-maturity at amortized cost
    (estimated fair value: 1998 - $31,835; 1997 - $30,807)    $  30,807    $  29,995
   Securities available-for-sale, at estimated fair value
    (cost: 1998 - $34,175; 1997 - $35,257) ................      51,235       52,819
   Receivable for securities ..............................         315          400
   Mortgage loans on real estate, at cost .................         135          320
   Investment real estate, at book value
    (accumulated depr.: 1998 - $37; 1997 - $36) ...........       1,629        1,645
   Policy loans ...........................................         645          648
   Short-term investments .................................       3,290        3,524
                                                              ---------    ---------
          Total Investments ...............................      88,056       89,351

Cash ......................................................         783          364
Accrued investment income .................................         764          833
Reinsurance recoverable ...................................       6,833        8,489
Deferred policy acquisition costs .........................       4,154        4,216
Prepaid reinsurance premiums ..............................         266          341
Current income tax recoverable ............................          75         --
Other assets ..............................................       3,042        3,364
                                                              ---------    ---------
          Total Assets ....................................   $ 103,973    $ 106,958
                                                              =========    =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and claims
   Policy liabilities .....................................   $  18,833    $  18,677
   Unearned premiums ......................................       8,745        8,853
   Claim liabilities ......................................      21,875       22,246
                                                              ---------    ---------
                                                                 49,453       49,776

Checks outstanding in excess of bank balance ..............         776        1,190
Other policyholder funds ..................................       1,635        1,729
Notes payable .............................................       3,004         --
Accrued income taxes ......................................        --            147
Other liabilities .........................................       2,992        3,686
Deferred income tax .......................................       4,145        4,078
                                                              ---------    ---------
          Total Liabilities ...............................      62,005       60,606
                                                              ---------    ---------
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
Accumulated other comprehensive income ....................      12,146       12,497
Retained earnings .........................................      31,106       31,888
Treasury stock, at cost (shares: 1998-288,537; 1997-27,028)      (3,641)        (390)
                                                              ---------    ---------
          Total Shareholders' Equity ......................      41,968       46,352
                                                              ---------    ---------
          Total Liabilities and Shareholders' Equity ......   $ 103,973    $ 106,958
                                                              =========    =========
</TABLE>

 See accompanying notes to consolidated financial statements.

                                      21

<PAGE>

                       THE NATIONAL SECURITY GROUP, INC.

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<S>                                       <C>       <C>            <C>          <C>             <C>         <C>          <C>

                                                                              (Dollars in thousands)
                                            ---------------------------------------------------------------------------------------
                                                                                   Accumulated
                                                                                     Other
                                                     Comprehensive    Retained    Comprehensive   Common      Paid-in      Treasury
                                             Total       Income       Earnings       Income        Stock      Capital       Stock
                                            -------  -------------    --------    -------------   -------     --------     --------
Balance at January 1, 1997                 $ 40,519  $                $ 30,513     $ 7,941        $ 2,340     $    17      $  (292)
Comprehensive Income
  Net Income for 1997                         2,998         2,998        2,998
  Other comprehensive income (net of tax)
    Unrealized gain on securities, net
    of reclassification adjustment            4,556         4,556                    4,556 
                                                     ------------- 
Comprehensive Income                                        7,554                     
                                                     =============
  Cash dividends ($.70) per share            (1,623)                    (1,623)
  Treasury stock purchased                      (98)                                                                           (98) 
                                            -------                   --------    -------------   -------     --------     --------
Balance at December 31, 1997               $ 46,352                     31,888      12,497          2,340           17        (390)
Comprehensive Income
  Net Income for 1998                           930           930          930
  Other comprehensive income (net of tax)
    Unrealized loss on securities, net
    of reclassification adjustment             (351)         (351)                   (351) 
                                                     ------------- 
Comprehensive Income                                 $        579
                                                     =============
  Cash dividends ($.77) per share            (1,712)                    (1,712)
  Treasury stock purchased                   (3,251)                                                                        (3,251)
                                            -------                   --------    -------------   -------     --------     --------
Balance at December 31, 1998               $ 41,968                   $ 31,106    $ 12,146        $ 2,340     $     17     $(3,641) 
                                            =======                   ========    =============   =======     ========     ========



</TABLE>


See accompanying notes to consolidated financial statements.

                                      22

<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S>                                                           <C>         <C>        <C>  

                                                                     (Dollars in thousands)
                                                                     Year ended December 31,             
                                                                    ------------------------
                                                                    1998      1997      1996
                                                                   -----     -----     ----- 
Cash flows from operating activities:
Net Income                                                      $    930   $  2,998   $ 1,356

Adjustments to reconcile net income to net cash provided by
   operating activities:
     (Increase) decrease in accrued investment income                 69       (30)        77
     (Increase) decrease in reinsurance recoverable                1,656      3,999      (596)
     Amortization of deferred policy  acquisition  costs           1,856      1,488       995
     Net realized  gains  on  investments                         (4,117)    (2,720)   (1,839)
     Policy acquisition  costs  deferred                          (1,794)    (1,691)   (1,608)
     (Increase) decrease  in current  income  taxes  receivable      (75)       258       571
     Decrease in prepaid reinsurance  premiums                        75      1,567     3,345
     Depreciation and amortization expense                           142        118       116
     Increase (decrease) in policy liabilities and claims           (323)     1,373     1,108
     Increase (decrease) in income tax  payable                     (147)       147       -
     (Decrease) increase in deferred income taxes                    219       (484)     (156) 
     Increase (decrease) in other liabilities                       (694)       599    (1,952)
     Other, net                                                      306       (144)       36
                                                                  ------      ------   -------
        Net cash provided by (used for) operating activities      (1,897)     7,478     1,453
                                                                  ------      ------   -------
Cash flows from investing activities:
   Purchases of held-to-maturity securities                       (4,881)       -      (2,741)   
   Purchases of available-for-sale securities                     (5,731)   (17,239)   (6,370)
   Purchase of real estate held for investment                        -         -         (36)
   Proceeds from maturities of held-to-maturity securities         4,501      4,859     5,774
   Proceeds from sales of available-for-sale securities           10,549      6,333     4,474
   Proceeds from real estate held for investment                      15         13        81
   Proceeds from sales and maturities of short-term investments      234      1,051       -
   Receipts from repayment of loans                                  188         59        79
   Purchase of property and equipment                               (110)      (210)      (66)
   Proceeds from sale of property and equipment                       18         33       -
   Purchases of short-term investments                                -         -      (1,959)
                                                                  ------      ------   -------
       Net cash provided by (used for) investing activities        4,783      (5,101)    (764) 
                                                                  ------      ------   -------
Cash flows from financing activities:
   Proceeds from short-term notes payable                          3,100        -          -
   Payments on short-term notes payable                             (96)        -          -
   Decrease  in other policyholder funds                           (414)       (113)      (85)
   Dividends paid                                                (1,712)     (1,623)   (1,509)
   Purchase of treasury stock                                    (3,251)        (98)      (70)
   Increase (decrease) in checks outstanding
     in excess of bank balances                                     (94)       (326)      921
                                                                  ------      ------   -------           
        Net cash used for financing activities                   (2,467)     (2,160)     (743)
                                                                  ------      ------   -------        
        Net increase (decrease) in cash                             419         217       (54) 
                                                                  ------      ------   -------
Cash at beginning of year                                           364         147       201
                                                                  ------      ------   -------
Cash at end of year                                             $   783    $    364   $   147
                                                                  ======      ======   =======
Cash paid during the year for:
   Interest                                                     $    91    $     14   $   111
                                                                  ======      ======   =======
   Income taxes                                                 $    97    $    440   $   531
                                                                  ======      ======   =======
</TABLE>

See accompanying notes to consolidated financial statements.

                                       23
                                                          
<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).   NSFC  includes  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.


                                       24
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - CONTINUED
Disclosures About Fair Value of 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 $135,000 on December  31, 1998 and  $320,000 on December 31,
1997.

As of December 31, 1998 and 1997,  the fair value of policy  loans  approximated
their carrying amount of $645,000 and $648,000, respectively.

The  fair  value  of  other  policyholder  funds  on  deposit  is  estimated  to
approximate carrying amount of $1,635,000 on December 31, 1998 and $1,729,000 on
December 31, 1997.

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.


                                       25
<PAGE>
                       THE NATIONAL SECURITY GROUP, INC.

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - 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 - 1998                                 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 2,228,940 in 1998, 2,316,953 in 1997 and 2,337,931 in 1996.

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.

Recently Issued Accounting Standards
Effective January 1, 1998 the Company and its subsidiaries  adopted Statement of
Financial Accounting Standards No. 130, Reporting  Comprehensive  Income, ("SFAS
No. 130").  SFAS No. 130 establishes  reporting and  presentation  standards for
comprehensive  income and its components in a set of  general-purpose  financial
statements.  Comprehensive  income  is  defined  as the  change  in  equity of a
business  enterprise  during a period  from  transactions  and other  events and
circumstances  arising from nonowner sources. SFAS No. 130 is effective for both
interim  and annual  financial  statements  issued for periods  beginning  after
December  15,  1997.  Restatement  of prior  periods for  comparative  financial
statements is required.

                                       26

<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

              NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - CONTINUED
Recently Issued Accounting Standards - Continued

The  adoption  of SFAS No. 130 did not have a material  impact on the  financial
statements of the Company

Effective January 1, 1998 the Company and its subsidiaries  adopted Statement of
Financial  Accounting  Standards  No.  131,  Disclosures  about  Segments  of an
Enterprise and Related Information, ("SFAS No. 131"). SFAS No. 131 requires that
financial and descriptive information be disclosed for each reportable operating
segment based on the management  approach.  The management  approach  focuses on
financial information that a business enterprise's decision makers use to assess
performance  and make decisions about resource  allocations.  The statement also
prescribes the enterprise-wide disclosures to be made about products,  services,
geographic  areas and major  customers.  SFAS No.  131 is  effective  for annual
financial  statements  issued for periods beginning after December 15, 1997, and
for interim financial statements in the second year of application. The adoption
of SFAS No. 131 did not have a material  impact on the  financial  statements of
the Company.

Effective January 1, 1998 the Company and its subsidiaries  adopted Statement of
Financial Accounting Standards No 132, Employers' Disclosures about Pensions and
Other Postretirement  Benefits,  ("SFAS No. 132"). SFAS No. 132 standardizes the
disclosure   requirements  for  pensions  and  other  postretirement   benefits,
eliminates certain disclosures and requires additional information on changes in
benefit  obligations  and fair values of plan assets.  SFAS No. 132 is effective
for annual financial  statements for periods  beginning after December 15, 1997.
Restatement of disclosures for previous  periods is also required.  The adoption
of SFAS No 132 did not have a material impact on the financial statements of the
Company.

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,              
                                                                             --------------------------
                                                                               1998        1997        1996
                                                                           --------    --------    --------
Net gain from operations:
   NSIC - including realized capital gains of $668, $651 and $333,
     respectively ......................................................   $  2,103    $  1,755    $    802
                                                                           ========    ========    ========
   NSFC - including realized capital gains of $3,143, $1,988 and $1,506,
     respectively ......................................................   $    657    $  2,258    $    613
                                                                           ========    ========    ========
   OMEGA - including realized capital gains of $306 for 1998 ...........   $ (1,420)   $ (1,529)   $   (352)
                                                                           ========    ========    ========
Statutory capital and surplus:
   NSIC - including AVR of $2,458, $2,539 and $2,141, respectively .....   $ 14,505    $ 10,526    $ 10,079
                                                                           ========    ========    ========
   NSFC ................................................................   $ 25,072    $ 26,359    $ 22,384
                                                                           ========    ========    ========
   OMEGA ...............................................................   $  3,210    $  4,367    $  5,180
                                                                           ========    ========    ========
</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.

                                       27

<PAGE>



                        THE NATIONAL SECURITY GROUP, INC.

              NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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, 1998                         
                                               ----------------------------------------
                                                           Gross       Gross
                                              Amortized   Unrealized Unrealized   Fair
                                                Cost        Gains      Losses     Value     
                                               ------      ------      -------   -------            
Available-for-sale securities:
 Corporate debt securities .................   $ 5,288   $   155   $  (316)   $ 5,127
 U.S. treasury securities and obligations of
   U.S. government corporations and agencies    15,027       186        (3)    15,210
 Equity securities .........................    13,860    17,490      (452)    30,898
                                                -------   -------    -------   -------
                                       Total    $34,175   $17,831   $  (771)   $51,235
                                                =======   =======    =======   =======  

                                                            Gross       Gross
                                              Amortized   Unrealized Unrealized   Fair
                                                Cost        Gains      Losses     Value     
                                               ------      ------      -------   -------  
Held-to-maturity securities:
 Corporate debt securities .................   $13,213   $   517     $  0     $13,730
 Obligations of states and political
   subdivisions ............................     3,583       463        0       4,046
 U.S. treasury securities and obligations of
   U.S. government corporations and agencies    14,011        48        0      14,059
                                               -------   -------      ------   -------
                                   Total ...   $30,807   $ 1,028     $  0     $31,835
                                               =======   =======      ======   =======

                                                    (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
                                                =======   =======   =======    =======

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
                                                =======   =======   =======    =======

</TABLE>

                                       28
<PAGE>

                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 3 - INVESTMENT SECURITIES: - CONTINUED
The amortized cost and aggregate  fair value of debt  securities at December 31,
1998, 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.

                                           (Dollars in Thousands)
                                          Amortized     Fair
                                           Cost         Value 

Available-for-sale securities:
   Due in one year or less ..............   $ 1,000   $ 1,030
   Due after one year through five years      5,240     5,339
   Due after five years through ten years     7,325     7,480
   Due after ten years ..................     6,750     6,488
                                            -------   -------
                          Total .........   $20,315   $20,337
                                            =======   =======
Held-to-maturity securities:
   Due in one year or less ..............   $ 2,312   $ 2,326
   Due after one year through five years     10,266    10,781
   Due after five years through ten years     7,900     8,311
   Due after ten years ..................    10,329    10,417
                                            -------   -------
                          Total .........   $30,807   $31,835
                                            =======   =======

Gross gains of $4,009,429  and $2,392,684 and gross losses of $5,884 and $53,157
for 1998 and 1997,  respectively,  were  realized on sales of  available - for -
sale securities.

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

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

Fixed maturities ........................   $ 3,503    $ 3,334    $ 3,112
Equity securities .......................       682        654        559
Mortgage loans on real estate ...........        17         29         39
Investment real estate ..................        18         18         13
Policy loans ............................        38         37         37
Other, principally short-term investments       136        222        230
                                            -------    -------    -------
                                              4,394      4,294      3,990
Less:  Investment expenses ..............       (43)       (90)       (55)
                                            -------    -------    -------
Net investment income ...................   $ 4,351    $ 4,204    $ 3,935
                                            =======    =======    =======


An analysis of investment gains follows:
                                        Year ended December 31, 
                                       --------------------------
                                       1998      1997       1996
                                       ----      ----       ----
Net realized investment gains:
Fixed maturities ...................   $   53   $   66   $   12
Other, principally equity securities    4,064    2,654    1,827
                                       ------   ------   ------
                                       $4,117   $2,720   $1,839
                                       ======   ======   ======

                                       29
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 4 - NET INVESTMENT INCOME: - CONTINUED
An  analysis  of the net  increase  (decrease)  in  unrealized  appreciation  on
available-for-sale securities follows:


                                                    Year ended December 31,
                                                  1998       1997       1996
                                                 -------    -------    ------- 
Net increase (decrease) in unrealized
   appreciation on available-for-sale
   securities before deferred income tax ....   $  (472)   $ 6,266    $ 1,340
Deferred income tax .........................       121     (1,711)      (372)
                                                 -------    -------    -------
Net increase (decrease) in unrealized
   appreciation on available-for-sale
   securities ...............................   $  (351)   $ 4,555    $   968
                                                 =======    =======    =======
 
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,
                                                  1998       1997       1996

Federal income tax rate applied to
   pre-tax income ..........................    $   376     $ 1,142     $  551 
Dividends received deduction and
   tax-exempt interest .....................       (174)       (239)      (256) 
Other, net .................................        (54)       (134)       (30)
Small life insurance company deduction .....       (440)       (407)         0
Alternative minimum tax effect .............        468           0          0
                                                -------     -------     -------
Federal income tax expense .................    $   176     $   362     $  265
                                                =======     =======     =======

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
                                                          1998          1997
                                                          -----        ------

Deferred policy acquisition costs ....................     $(1,412)     $(1,434)
Policy liabilities ...................................         463          519
Unearned premiums ....................................         440          442
Claim liabilities ....................................         569          530
General insurance expenses ...........................         710          931
Unrealized gains on securities available-for-sale ....      (4,915)      (5,066)
                                                           -------      -------
Net deferred tax liabilities .........................     $(4,145)     $(4,078)
                                                           -------      -------

                                       30
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 5 - INCOME TAXES: - CONTINUED
The  approximate  income tax effects of changes in temporary  differences are as
follows:
  
                                                    Year ended December 31,
                                                  1998       1997       1996

Deferred policy acquisition costs ..........      $ (22)      $  70      $ 226  
Policy liabilities .........................         56         ( 3)       (17)
Unearned premiums ..........................          2         ( 2)       (87)
General insurance expenses .................        222        (349)      (268)
Claim liabilities ..........................        (39)       (202)       (38)
Other ......................................       (136)          0         28 
                                                  -----       -----       -----
                                                  $ (83)      $(486)     $(156)
                                                  =====       =====       =====

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, 1998,  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, 1998.

NOTE 6 - REINSURANCE:
NSFC and NSIC 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  insolvencies.  At December 31,
1998,  reinsurance  receivables  with a carrying  value of $906,000  and prepaid
reinsurance premiums of $266,000 were associated with a single reinsurer.

The effect of reinsurance on premiums written and earned is as follows:


                                          (Dollars in Thousands)
                                                 1998
                                   ----------------------------------
                                    NSIC                        NSFC
                            ----------------             ----------------
                         Written        Earned         Written          Earned
                         -------        ------         -------          --------
Direct .........       $  3,886        $  3,892        $ 26,085        $ 26,194
Assumed ........              0               0               0               0
Ceded ..........            (55)            (55)         (1,503)         (1,580)
                        --------        --------        --------        --------
Net ............       $  3,831        $  3,837        $ 24,582        $ 24,614
                        ========        ========        ========        ========

                                          (Dollars in Thousands)
                                                 1997
                                   ----------------------------------
                                    NSIC                        NSFC
                            ----------------             ----------------
                         Written        Earned         Written          Earned
                         -------        ------         -------          --------
Direct .........       $  4,118        $  4,039        $ 29,271        $ 30,815
Assumed ........           --              --              --              --
Ceded ..........            (48)            (48)         (2,086)         (3,650)
                        --------        --------        --------        --------
Net ............       $  4,070        $  3,991        $ 27,185        $ 27,165
                        --------        --------        --------        --------
                                                                                
                                       31
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.


             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 6 - REINSURANCE: - CONTINUED
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  $5,889,000 at December 31, 1998.
Reinsurance  recoveries  for claims and claim  settlement  expense were $844,000
during 1998.

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  1998,  1997 and 1996
amounted to $61,000, $170,000, and $90,708,  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  1998,  1997 and 1996  amounted  to  approximately  $90,300,  $228,525,  and
$61,813, respectively.

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, 1998,  NSIC's retained
earnings  unrestricted  for  the  payment  of  dividends  in  1999  amounted  to
$1,656,796.  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 $2,507,154 in 1999.

Securities with market values of $3,296,573 and $3,306,062, at December 31, 1998
and 1997, 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.

Under applicable  Alabama  insurance laws and regulations,  Omega is required to
maintain a minimum  total surplus (to include both paid-in and  contributed  and
unassigned surplus) of $600,000.

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.

                                       32
<PAGE>


                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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, 1998, 1997 and 1996 are summarized below:

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

Premium revenues:
   Individual life and accident and health
     insurance ................................    $ 3,837    $ 3,991    $ 4,432
   Property and casualty insurance ............     24,614     27,165     22,222
                                                   -------    -------    -------
                                                   $28,451    $31,156    $26,654
                                                   =======    =======    =======
Income (loss) before income taxes:
   Individual life and accident and health
     insurance ................................   $ 2,489    $ 2,171    $ 1,140 
   Property and casualty insurance ............    (1,000)     1,572      1,191
   Other ......................................      (140)      (272)      (601)
                                                  -------    -------    -------
                                                    1,349      3,471      1,730
         Interest expense .....................      (243)      (111)      (109)
                                                  -------    -------    -------
                                                  $ 1,106    $ 3,360    $ 1,621
                                                  =======    =======    =======


                                                    (Dollars in thousands)
                                                     Year ended December 31,
                                                   1998       1997       1996
Assets:
   Individual life and accident and health
     insurance ................................  $ 41,935   $ 39,569   $ 35,590
   Property and casualty insurance ............    61,842     67,286     62,538
   Other ......................................       196        103         91
                                                  -------    -------    -------
                                                 $103,973   $106,958   $ 98,219
                                                  =======    =======    =======

Amortization of deferred policy acquisition costs and depreciation expense:
   Individual life and accident and health
     insurance ................................  $    450   $    319   $    232
   Property and casualty insurance ............     1,599      1,339        879
                                                  -------    -------    -------
                                                 $  2,049   $  1,658   $  1,111
                                                  =======    =======    =======
                                                                            
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.  It is not feasible
to predict or determine the ultimate  outcome of these matters.  A resolution of
these  matters 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.

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 the verdict was appealed.  The Florida  District Court of Appeal
for the Fourth  District  subsequently  affirmed  the verdict  and  concurrently
granted the motion for attorney's  fees and costs filed by the attorneys for the
plaintiff,  remanding  the case to the trial  court for a  determination  of the
amount.  The  Company's  subsidiary  subsequently  reached a  settlement  of the
attorney's  fee issue and the  judgement,  including  all  related  issues,  was
satisfied on July 8, 1998.

                                       33
<PAGE>



                        THE NATIONAL SECURITY GROUP, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


NOTE 11 - CONTINGENCIES: - CONTINUED

This  judgement and the  settlement of the  attorney's  fee award  resulted in a
combined  charge to the  Company's  1998  earnings of $2 million.  The Company's
subsidiary  is now  pursuing  recovery  of the  amount  it has  expended  in the
resolution of this litigation from the independent  adjusting firm whose actions
it believes  caused or contributed to the basis for the subject  litigation.  No
provision has been established for any potential recovery.

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.  The
company had cash  balances on deposit  with  Alabama  banks at December 31, 1998
that exceeded the balance insured by the F.D.I.C. in the amount of $322,000.

NOTE 13 - NOTES PAYABLE:
At December 31, 1998, notes payable totaling  $3,004,402  consisted of unsecured
notes payable, bearing interest rates from 7% to 8%, due 1999.

                                       34
<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,
1998 and 1997 and for the years then ended  included in this Form 10-K, and have
issued our report  thereon dated February 19, 1999. 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, 1998 and 1997 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 19, 1999                      Dudley, Hopton-Jones, Sims & Freeman PLLP


                                       35
<PAGE>



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

<TABLE>
<CAPTION>
<S>                                      <C>      <C>      <C>        <C>      <C>     <C>

                                              December 31, 1998           December 31, 1997
                                         ----------------------------  --------------------------

                                                           Amount per                  Amount per
                                         Original  Fair    Balance    Original  Fair    Balance
                                          Cost     Value     Sheet     Cost     Value    Sheet
                                         --------  ------  --------   -------  ------  --------
Securities Held to Maturity:

  United States government .............   14,008   14,059   14,011   10,388   10,416   10,386
  States, municipalities and
                  political subdivisions    3,509    4,046    3,583    4,527    5,081    4,592
  Public Utilities .....................    2,457    2,520    2,484    3,527    3,592    3,596
  Industrial and Miscellaneous .........   10,617   11,210   10,729   11,341   11,719   11,421
                                           ------   ------   ------   ------   ------   ------
  Total Securities Held to Maturity ....   30,591   31,835   30,807   29,783   30,808   29,995
                                           ------   ------   ------   ------   ------   ------

Securities Available for Sale:

Equity Securities:
  Public utilities .....................    2,405    4,563    4,563    2,857    4,788    4,788
  Banks and insurance companies ........    1,742    5,580    5,580    2,456    7,141    7,141
  Industrial and all other .............    9,713   20,755   20,755    8,813   19,786   19,786
                                           ------   ------   ------   ------   ------   ------
  Total equity securities ..............   13,860   30,898   30,898   14,126   31,715   31,715
                                           ------   ------   ------   ------   ------   ------

Debt Securities:
  United States government .............   13,827   13,983   13,983   15,511   15,625   15,625
  States, municipalities and
                  political subdivisions    1,200    1,227    1,227        0        0        0
  Public Utilities .....................      396      408      408      694      710      710
  Industrial and Miscellaneous .........    4,892    4,719    4,719    4,926    4,769    4,769
                                           ------   ------   ------   ------   ------   ------
  Total Debt Securities ................   20,315   20,337   20,337   21,131   21,104   21,104
                                           ------   ------   ------   ------   ------   ------

  Total Available for Sale .............   34,175   51,235   51,235   35,257   52,819   52,819
                                           ------   ------   ------   ------   ------   ------

  Total Securities .....................   64,766   83,070   82,042   65,040   83,627   82,814
Mortgage loans on real estate ..........      135               135      320               320
Investment real estate .................    1,629             1,629    1,645             1,645
Policy loans ...........................      645               645      648               648
Short term investments .................    3,605             3,605    3,924             3,924
                                           ------            ------   ------            ------
           Total investments ...........   70,780            88,056   71,577            89,351
                                           ======            ======   ======            ======

</TABLE>






                                       36
<PAGE>



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

                                                            December 31,
                                                        ------------------
                                                          1998      1997
                                                        --------   -------
Assets
     Cash ............................................   $   119   $   167
     Investment in subsidiaries (equity method)
         eliminated upon consolidation ...............    45,367    46,721
     Other assets ....................................       357       380
                                                         -------   -------

            Total Assets .............................   $45,843   $47,268
                                                         =======   =======

Liabilities and Shareholders' Equity
     Accrued general expenses ........................   $   871   $   916
     Notes Payable ...................................     3,004         0
                                                         -------   -------

            Total Liabilities ........................     3,875       916
                                                         -------   -------

            Total Shareholders' Equity ...............   $41,968   $46,352
                                                         -------   -------

            Total Liabilities and Shareholders' Equity   $45,843   $47,268
                                                         =======   =======



The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc."  are an  integral  part of this  condensed  financial  information  of the
registrants.  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 INCOME
                             (AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
<S>                                                       <C>        <C>         <C>
                                                           For the Years Ended December 31,
                                                           -------------------------------
                                                              1998       1997       1996
                                                           -------------------------------
Income
    From subsidiaries-eliminated upon consolidation
        Dividends .......................................   $ 2,000    $ 1,850    $ 1,800
                                                            -------    -------    -------

Expenses
    State taxes .........................................        26         26         25
    Other expenses ......................................       113        246        575
                                                            -------    -------    -------
                                                                139        272        600
                                                            -------    -------    -------
Income before income taxes and equity in
    undistributed earnings of subsidiaries ..............     1,861      1,578      1,200
Income tax benefit ......................................       (73)      (109)      (175)
                                                            -------    -------    -------

Income before equity in undistributed earnings
    of subsidiaries .....................................     1,934      1,687      1,375
Equity in undistributed (losses) earnings of subsidiaries    (1,004)     1,311        (19)
                                                            -------    -------    -------

    Net Income ..........................................   $   930    $ 2,998    $ 1,356
                                                            =======    =======    =======

</TABLE>


The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc."  are an  integral  part of this  condensed  financial  information  of the
registrants.  See  accompanying  "Notes to Condensed  Financial  Information  of
Registrant"

                                       38
<PAGE>



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

                                                              For the Years Ended December 31,
                                                              --------------------------------
                                                                 1998        1997       1996
                                                              --------------------------------
Cash flows from operating activities:
Net income ..................................................   $   930    $ 2,998    $ 1,356
Adjustments to reconcile net income to net
    cash provided by operating activities:
        Equity in undistributed loss (income) of subsidiaries     1,004     (1,311)        19
        Provision for amortization ..........................         0          0         22
       Decrease (Increase) in other assets ..................        23        (62)      (157)
        (Decrease) Increase in other liabilities ............       (45)       107        433
                                                                -------    -------    -------
                   Net cash provided by
                       operating activities .................     1,912      1,732      1,673
                                                                -------    -------    -------

Cash flows from financing activities:
Proceeds from notes payable .................................     3,100          0          0
Payments on notes payable ...................................       (96)         0          0
Purchase of treasury stock ..................................    (3,251)       (98)       (70)
Cash dividends ..............................................    (1,713)    (1,622)    (1,509)
                                                                -------    -------    -------
                   Net cash used in
                       financing activities .................    (1,960)    (1,720)    (1,579)
                                                                -------    -------    -------

Net increase in cash and cash equivalents ...................       (48)        12         94

Cash and due from banks at beginning of year ................       167        155         61
                                                                -------    -------    -------

Cash and due from banks at end of year ......................   $   119    $   167    $   155
                                                                =======    =======    =======



</TABLE>



The "Notes to Consolidated  Financial Statements of The National Security Group,
Inc."  are an  integral  part of this  condensed  financial  information  of the
registrants.  See  accompanying  "Notes to Condensed  Financial  Information  of
Registrant"
]
                                       39
<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 this  Condensed  Financial
     Information  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 18.

Note 2-Cash Dividends from Subsidiaries
     Dividends of $2 million in 1998, $1.85 million in 1997 and $1.80 million in
     1996 were paid to the Registrant by its subsidiaries.



                                       40
<PAGE>



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

                                                                         Policy
                                                                         Claims
                                         Deferred   Future             and Other
                                        Acquisition Policy    Unearned  Benefits
                                           Costs    Benefits  Premiums   Payable
                                         ---------  --------  --------  --------
At December 31, 1998:
  Life and accident and health insurance   $ 2,588   $18,833   $     0   $   347
  Property and casualty insurance ......     1,566         0     8,745    21,528
                                           -------   -------   -------   -------
      Total ............................   $ 4,154   $18,833   $ 8,745   $21,875
                                           =======   =======   =======   =======

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
                                           =======   =======   =======   =======



<TABLE>
<CAPTION>
                                                                                                      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
                                                         --------    --------    -------   --------   ---------    -------  --------
<S>                                                      <C>         <C>        <C>        <C>       <C>         <C>        <C>
For the year ended December 31, 1998:
    Life and accident and health insurance ............    $ 3,837    $ 2,018    $     4    $ 2,130    $ 1,104    $ 1,736    $ 3,831
    Property and casualty insurance ...................     24,614      2,333        381     20,750      4,516      5,816     24,582
    Other .............................................          0          0          0          0          0        146          0
                                                           -------    -------    -------    -------    -------    -------    -------
        Total .........................................    $28,451    $ 4,351    $   385    $22,880    $ 5,620    $ 7,698    $28,413
                                                           =======    =======    =======    =======    =======    =======    =======

For the year ended December 31, 1997:
    Life and accident and health insurance ............    $ 3,991    $ 2,048    $     3    $ 2,106    $ 1,087    $ 2,089    $ 4,070
    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    $31,255
                                                           =======    =======    =======    =======    =======    =======    =======

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
                                                           =======    =======    =======    =======    =======    =======    =======


</TABLE>


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

                                       41

<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, 1998:
Life insurance in force .........................   $137,785   $  5,782   $      0   $132,003     0.0%
                                                    ========   ========   ========   ========   ===

Premiums:
 Life insurance and accident and health insurance   $  3,892   $     55   $      0   $  3,837     0.0%
 Property and casualty insurance ................     26,194      1,580          0     24,614     0.0%
                                                    --------   --------   --------   --------   ---

     Total premiums .............................   $ 30,086   $  1,635   $      0   $ 28,451     0.0%
                                                    ========   ========   ========   ========   ===

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      3,650          0     27,165     0.0%
                                                    --------   --------   --------   --------   ---

     Total premiums .............................   $ 34,854   $  3,698   $      0   $ 31,156     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   $  4,483   $     51   $      0   $  4,432     0.0%
 Property and casualty insurance ................     33,987     11,765          0     22,222     0.0%
                                                    --------   --------   --------   --------   ---

     Total premiums .............................   $ 38,470   $ 11,816   $      0   $ 26,654     0.0%
                                                    ========   ========   ========   ========   ===

</TABLE>


                                       42
<PAGE>





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

               None.



                                       43




<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 13, 1999,  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 13, 1999, 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  13,  1999,  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 13, 1999, with respect to certain
         relationships  and  related  transactions,  is  incorporated  herein by
         reference in response to this item.



                                       44




<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                    19

   Consolidated Statements of Income--
     Years Ended December 31, 1998, 1997, and 1996                       20

   Consolidated Balance Sheets--
     December 31, 1998 and 1997                                          21

   Consolidated Statements of Shareholders' Equity--
     Years Ended December 31, 1998, 1997, and 1996                       22

   Consolidated Statements of Cash Flows--
     Years Ended December 31, 1998, 1997, and 1996                       23

   Notes To Consolidated Financial Statements--December 31, 1998         24

   Schedule I. Summary Of Investments--December 31, 1998 and 1997        36

   Schedule III. Condensed Financial Information of Registrant--
     December 31, 1998 and 1997                                          37

   Schedule V. Supplementary Insurance Information--
     December 31, 1998, 1997, and 1996                                   41

   Schedule VI. Reinsurance--
     Years Ended December 31, 1998, 1997, and 1996                       42


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

b. Reports on Form 8-K

Incorporated by reference to the  Registrant's Current Report on Form 8-K, filed
on October 12, 1998.



                                       45





<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 29, 1999

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
19, 1999.

                                    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/ Walter P. Wilkerson                               /s/ Fred D. Clark Jr.



                                       46


<PAGE>