# SECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549

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# FORM 10-K

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# ANNUAL REPORT PURSUANT
TO SECTION 13 or 15(D) OFTHE SECURITIES EXCHANGE ACT OF 1934

# 

|For Fiscal Year Ended December 31, 2004 | Commission File Number 0-18649
|--------------------------------------- | ------------------------------
|                                        |                               

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

# 

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|                                                                           |                                           
|-------------------------------------------------------------------------- | ------------------------------------------
|Delaware(State or Other Jurisdiction of Incorporation or Organization)     | 63-1020300(IRS EmployerIdentification No.)
|661 East Davis StreetElba, Alabama(Address of principal executive offices) | 36323(Zip-Code)                           

# Registrant's Telephone
Number including Area Code (334) 897-2273

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# 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

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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      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 amendment to this Form 10-K.

Indicate by check mark whether the
registrant is an accelerated filer (as defined in rule 12b-2 of the
Act).    Yes      No

The aggregate market value of the
voting stock held by nonaffiliates of the Registrant as of February 28, 2004, (based upon
the bid price of these shares on NASDAQ on such date) was $22,741,844.

Indicate the number of shares
outstanding of each of the issuers classes of Common Stock, as of the close of the
period covered by this report.

|Class | Outstanding December 31, 2004
|----- | -----------------------------
|
|      |                              

1

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# Table of Contents

|Part I   | Page                                                                                           |   
|-------- | ---------------------------------------------------------------------------------------------- | --
|Item 1   | Business                                                                                       | 4 
|Item 2   | Properties                                                                                     | 13
|Item 3   | Legal Proceedings                                                                              | 13
|Item 4   | Submission of Matters to a Vote of Security Holders                                            | 13
|Part II 
|Item 5   | Market for Registrant's Common Equity and Related Stockholder Matters                          | 14
|Item 6   | Selected Financial Data                                                                        | 15
|Item 7   | Management's Discussion and Analysis of Financial Condition and Results of Operations          | 16
|Item 7A  | Quantitative and Qualitative Disclosures About Market Risk                                     | 27
|Item 8   | Consolidated Financial Statements and Supplementary Data                                       | 28
|Item 9   | Changes in and Disagreements with Accountants on Financial Disclosure                          | 61
|Item 9A  | Controls and Procedures                                                                        | 61
|Item 9B  | Other Information                                                                              | 61
|Part III
|Item 10  | Directors and Executive Officers of the Registrant                                             | 62
|Item 11  | Executive Compensation                                                                         | 62
|Item 12  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 62
|Item 13  | Certain Relationships and Related Transactions                                                 | 62
|Item 14  | Principal Accountant Fees and Services                                                         | 62
|Part IV 
|Item 15  | Exhibits, Financial Statement Schedules and Reports of Form 8-K                                | 63
|         | Signature Page                                                                                 | 65
|         | Certifications                                                                                 | 66
|         | Exhibit 3.                                                                                     |   
|        

2

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|                                          |                                  
|----------------------------------------- | ---------------------------------
|Note Regarding Forward-Looking Statements | The National Security Group, Inc.

# Note Regarding
Forward-Looking Statements

Any statement contained in this
report which is not a historical fact, or which might otherwise be considered an opinion
or projection concerning the Company or its business, whether expressed or implied, is
meant as and should be considered a forward-looking statement as that term is defined in
the Private Securities Litigation Reform Act of 1995. The following report contains
forward-looking statements that are not strictly historical and that involve risks and
uncertainties. Such statements include any statements containing the words
expect, plan, estimate, anticipate or
other words of a similar nature. Management cautions investors about forward-looking
statements. Forward-looking statements involve certain evaluation criteria, such as risks,
uncertainties, estimates, and/or assumptions made by individuals informed of the Company
and industries in which we operate. Any variation in the preceding evaluation criteria
could cause actual results to differ materially from those expressed or implied by such
forward-looking statements. These risks and uncertainties include, without limitation, the
following:

| |  | The insurance industry is highly competitive and the Company encounters significant
competition in all lines of business from other insurance companies. Many of the competing
companies have more abundant financial resources than the Company.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Insurance is a regulated industry. It is possible that legislation may be enacted which
would have an adverse effect on the Companys business.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Company is subject to regulation by state governments for each of the states in which it
conducts business. The Company cannot predict the subject of any future regulatory
initiative(s) or its(their) impact on the Companys business.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Company is rated by various insurance rating agencies. If a rating is downgraded from
its current level by one of these agencies, sales of the Companys products and stock
could be adversely impacted.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys financial results are adversely affected by increases in policy claims
received by the Company. While a manageable risk, this fluctuation is unpredictable.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys investments are subject to a variety of risks. Investments are subject
to defaults and changes in market value. Market value can be affected by changes in
interest rates, market performance and the economy.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Company mitigates risk associated with life policies through implementing effective
underwriting and reinsurance strategies. These factors mitigate, not control, risk related
to mortality and morbidity exposure. The Company has established reserves for claims and
future policy benefits based on amounts determined by independent actuaries. There is no
assurance that these estimated reserves will prove to be sufficient or that the Company
will not incur claims exceeding reserves, which could result in operating losses.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Company mitigates risk associated with property and casualty policies through
implementing effective underwriting and reinsurance strategies. The Company obtains
reinsurance, which increases underwriting capacity and limits the risk associated with
policy claims. The Company is subject to credit risk with regard to reinsurers as
reinsurance does not alleviate the Companys liability to its insureds for the ceded
risks. The Company utilizes a third party to develop a reinsurance treaty with reinsurers
who are reliable and financially stable. However, there is no guarantee that booked
reinsurance recoverables will actually be recovered. A reinsurers insolvency or
inability to make payments due could have a material adverse impact on the financial
condition of the Company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

3

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The National Security Group, Inc.

# 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
dwelling fire and windstorm, homeowners, mobile homeowners, and personal non-standard
automobile lines of insurance in eleven states. The Company, through its life insurance
subsidiary, offers a basic line of life, and health and accident insurance products in six
states. Property-casualty insurance is the most significant segment, accounting for 88% of
total premium revenues.

The Companys common stock is
traded on the NASDAQ National Market under the symbol NSEC.

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 1992. This segment will be referred to throughout this
report as NSFC, Omega, property and casualty segment or P&C segment. 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 Louisiana, Missouri, and Texas. Omega is licensed to write insurance in Alabama
and Louisiana. The following table indicates allocation percentages of direct written
premium by state for the three years ended December 31, 2004, 2003 and 2002:

|               | 2004    | 2003    | 2002   
|-------------- | ------- | ------- | -------
|Alabama        | 39.62%  | 44.88%  | 52.18% 
|Arkansas       | 8.25%   | 7.69%   | 7.71%  
|Georgia        | 6.42%   | 5.36%   | 6.66%  
|Louisiana      | 7.48%   | 7.87%   | 5.72%  
|Mississippi    | 20.23%  | 19.11%  | 12.99% 
|South Carolina | 7.88%   | 6.72%   | 6.91%  
|Florida        | 0.43%   | 0.46%   | 0.48%  
|Missouri       | 1.64%   | 1.88%   | 2.61%  
|Oklahoma       | 2.77%   | 1.98%   | 1.73%  
|Tennessee      | 3.71%   | 1.96%   | 0.92%  
|Texas          | 1.57%   | 2.09%   | 2.09%  
|               |         |         |        
|               | 100.00% | 100.00% | 100.00%

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 vary from policy to policy, but are typically in the range of $250 to
$500 on NSFC and Omegas primary dwelling and automobile lines of business.

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.

4

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|       |                                  
|------ | ---------------------------------
|Part I | The National Security Group, Inc.

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

The following table sets forth the
premiums earned and income during the periods reported for the property and casualty
insurance segment:

|                                   | Year Ended December 31
(Amounts In Thousands)
|---------------------------------- | ---------------------------------------------
|
|Net premiums earned:               |                                              
|Fire, Allied lines, and Homeowners |                                              
|Automobile                         |                                              
|Other                              |                                              
|                                   |                                              
|                                   |                                              
|                                   |                                              
|Income before taxes                |                                              
|                                   |                                              

Property and Casualty Loss Reserves

The following Loss Reserve
Re-estimates table illustrates the change over time of the net reserves established for
property-liability insurance claims and claims expense at the end of the last 10 calendar
years. The first section shows the reserves as originally reported at the end of the
stated year. The second section, reading down, shows retroactive re-estimates of the
original recorded reserve as of the end of each successive year which is the result of the
Companys expanded awareness of additional facts and circumstances that pertain to
the unsettled claims. The third section, reading down, shows the cumulative amounts paid
as of the end of successive years with respect to that years reserve liability. The
last section compares the latest re-estimated reserve to the reserve originally
established, and indicates whether the original reserve was adequate to cover the
estimated costs of unsettled claims. The Loss Reserve Re-estimates table is cumulative
and, therefore, ending balances should not be added since the amount at the end of each
calendar year includes activity for both the current and prior years.

While the information in the table
provides a historical perspective on the adequacy of unpaid losses and loss adjustment
expenses established in previous years, it should not be assumed to be predictive of
redundancies or deficiencies on current year unpaid losses in future periods. Company
management believes that the reserves established at the end of 2004 are adequate.
However, due to inherent uncertainties in the loss reserve estimation process, management
cannot assert that current year reserve balances will prove to be adequate. Due to the
short tail nature of the property and casualty subsidiaries claim liabilities, the Company
does not discount loss reserves for the time value of money. Dollar amounts are in
thousands.

5

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|       |                            
|------ | ---------------------------
|Part I | The National Security Group

|                           | 1994 | 1995 | 1996 | 1997   | 1998 | 1999 | 2000   | 2001 | 2002 | 2003   | 2004
|-------------------------- | ---- | ---- | ---- | ------ | ---- | ---- | ------ | ---- | ---- | ------ | ----
|Gross unpaid losses per    |      |     
|Consolidated Balance Sheet |      |      | $    | 12,294 |      | $    | 16,037 |      | $    | 19,088 |     
|Ceded reserves             |      |      |      | (5,172 | )    |      | (8,737 | )    |      | (9,967 | )   
|                           |      |      |      |        |      |      |        |      |      |        |     
|Net unpaid losses          |      |      | $    | 7,122  |      | $    | 7,300  |      | $    | 9,121  |     
|                           |      |      |      |        |      |      |        |      |      |        |     
|Liability re-estimated:    |      |     
|1 year later               |      |      |      | 8,111  |      |      | 9,161  |      |      | 11,091 |     
|2 years later              |      |      |      | 8,294  |      |      | 9,833  |      |      | 10,691 |     
|3 years later              |      |      |      | 8,332  |      |      | 9,657  |      |      | 10,940 |     
|4 years later              |      |      |      | 8,255  |      |      | 9,706  |      |      | 10,295 |     
|5 years later              |      |      |      | 8,324  |      |      | 9,613  |      |      | 10,310 |     
|6 years later              |      |      |      | 8,384  |      |      | 9,733  |      |      | 10,862 |     
|7 years later              |      |      |      | 8,424  |      |      | 10,373 |      |      | 10,724 |     
|8 years later              |      |      |      | 8,967  |      |      | 10,285 |      |      | 10,785 |     
|9 years later              |      |      |      | 8,932  |      |      | 10,356 |     
|10 years later             |      |      |      | 9,049  |     
|                           |      |      |      |        |      |      |        |      |      |        |     

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|Cumulative deficiency (redundancy) | $1,927 | $3,056 | $1,664 | ($1,617) | ($4,552) | ($6,142) | ($5,081) | ($3,237) | ($2,793) | ($925) | 
|---------------------------------- | ------ | ------ | ------ | -------- | -------- | -------- | -------- | -------- | -------- | ------ | 
|Cumulative payments:               |        |       
|1 year later                       |        |        |        | 4,236    |          |          | 5,449    |          |          | 5,227  | 
|2 years later                      |        |        |        | 6,310    |          |          | 7,298    |          |          | 7,660  | 
|3 years later                      |        |        |        | 7,247    |          |          | 8,215    |          |          | 8,848  | 
|4 years later                      |        |        |        | 7,593    |          |          | 8,818    |          |          | 9,117  | 
|5 years later                      |        |        |        | 7,939    |          |          | 8,988    |          |          | 9,479  | 
|6 years later                      |        |        |        | 8,035    |          |          | 9,213    |          |          | 10,367 | 
|7 years later                      |        |        |        | 8,089    |          |          | 10,069   |          |          | 10,473 | 
|8 years later                      |        |        |        | 8,772    |          |          | 10,104   |          |          | 10,631 | 
|9 years later                      |        |        |        | 8,800    |          |          | 10,262   |         
|10 years later                     |        |        |        | 8,958    |         
|                                   |        |        |        |          |          |          |          |          |          |        | 
|                                   |        |        |        |          |          |          |          |          |          |        | 
|Net deficiency (redundancy) above  |        |        | $      | 1,927    |          | $        | 3,056    |          | $        | 1,664  | 
|                                   |        |        |        |          |          |          |          |          |          |        | 

6

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|       |                                  
|------ | ---------------------------------
|Part I | The National Security Group, Inc.

# Life Insurance Segment

National Security Insurance Company
(NSIC), a wholly owned subsidiary organized in 1947, conducts the Companys life
insurance business. This segment will be referred to throughout this report as NSIC, Life
Company, or Life segment. NSIC is licensed to write insurance in six states: Alabama,
Florida, Georgia, Mississippi, South Carolina, and Texas. The following table indicates
NSICs percentage of direct premiums collected by state for the three years ended
December 31, 2004, 2003 and 2002.

|State          | Percentage of Total Direct Premiums
|-------------- | -----------------------------------
|
|Alabama        | 65.23%                             
|Georgia        | 18.80%                             
|Mississpi      | 8.76%                              
|South Carolina | 3.18%                              
|Florida        | 2.17%                              
|Texas          | 1.86%                              
|               |                                    
|               | 100.00%                            

NSIC has two primary methods of
distribution of insurance products, home service agents and independent agents. The home
service distribution method of life insurance products accounts for 50% of total premium
revenues in the life insurance segment. Home service life products consist of products
marketed directly at the home or other premises of the insured by an employee agent. The
Company employed 17 home service agents at December 31, 2004. The independent agent
distribution method accounts for 41% of total premium revenue in the life insurance
segment. Since NSIC began marketing life, accident and health products through independent
agents in 1999 the distribution channel has become the fastest growing method of
distribution. The Company had approximately 624 agents that had new business production
during 2004. The remaining 9% of premium revenue consists of the following: an acquired
book of premium from a state guaranty association in 2000 (4%), premium generated through
direct sales of school accident insurance (3%), and other miscellaneous business serviced
directly through the home office.

The products offered by NSIC
primarily consist of term and whole life insurance and supplemental accident and health
insurance. NSIC does not sell annuities, interest sensitive whole life or universal life
insurance products. 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 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 specified fixed benefit and therefore have
not experienced the escalating health care costs, which many health and accident insurance
policies have experienced in recent years.

The following table displays a break
down of 2004 life segment premium produced by product and distribution method (dollars in
thousands):

|Line of Business                     | Home Service
Agent | Independent
Agent | Other
|------------------------------------ | ------------------ | ----------------- | -----
|Industrial                           |                    |                   | $    
|Ordinary                             |                    |                   |      
|Group Life                           |                    |                   |      
|A&H Group                            |                    |                   |      
|A&H Other                            |                    |                   |      
|                                     |                    |                   |      
|Total Premium by Distribution Method |                    |                   | $    
|                                     |                    |                   |      

7

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|       |                                  
|------ | ---------------------------------
|Part I | The National Security Group, Inc.

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

|                                          | Year Ended December 31
(Amounts In Thousands)
|----------------------------------------- | ---------------------------------------------
|
|Life insurance in force at end of period: |                                              
|Ordinary-whole Life                       |                                              
|Term Life                                 |                                              
|Industrial life                           |                                              
|Other                                     |                                              
|                                          |                                              
|                                          |                                              
|                                          |                                              
|Life insurance issued:                    |                                              
|Ordinary-whole life                       |                                              
|Term Life                                 |                                              
|Industrial                                |                                              
|Other                                     |                                              
|                                          |                                              
|                                          |                                              
|                                          |                                              
|Net premiums earned:                      |                                              
|Life insurance                            |                                              
|Accident and health insurance             |                                              
|                                          |                                              
|                                          |                                              
|                                          |                                              

# Investments

Investment income is a significant
portion of the Companys total income. Assets that will eventually be used to pay
reserve liabilities and other policyholder obligations along with Company capital are
invested to generate investment income while held by the Company. Investment income is
comprised primarily of interest and dividend income on debt and equity securities and
realized capital gains and losses generated by debt and equity securities. For 2004,
investments comprise 76% of total assets and investment income (including realized gains)
comprises 11% of total revenues evidencing the significant impact investments can have on
financial results. As the Companys insurance subsidiaries are regulated as to the
types of investments that they may make and the amount of funds they may maintain in any
one type of investment, the Company has developed a conservative value oriented investment
philosophy, which meets regulatory requirements. The central theme of the Companys
investment philosophy is to conserve capital resources and assets while meeting the
investment requirements of its reserves and providing a reasonable return on investments.
This return is generated through current yield from invested assets as well as capital
appreciation of investments.

The single most significant
investment for the Company is The Mobile Attic, Inc. (Mobile Attic), a joint venture with
a local manufacturing firm established in the fourth quarter of 2001. Mobile Attic,
through a network of dealers, leases portable storage units in locations across Alabama
and the Florida panhandle. During January of 2004, Mobile Attic established Mobile Attic
Franchising Company (MAFCO), a wholly owned subsidiary. The primary focus of MAFCO will be
to market Mobile Attic portable storage leasing franchises in the continental United
States. The primary customers of Mobile Attic are building contractors, retail
establishments, and residential consumers.

8

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|       |                                  
|------ | ---------------------------------
|Part I | The National Security Group, Inc.

When established in 2001, the
investment in Mobile Attic was accounted for under the equity method of accounting as
management of the Company does not participate in the day-to-day management of Mobile
Attic nor does the Company own a controlling interest in Mobile Attic. As discussed in
note 2 to the Consolidated Financial Statements, due to preexisting guarantees of Mobile
Attic debt, The Financial Accounting Standards Boards adoption of FIN 46R dictated
that the Company consolidates the results of Mobile Attic beginning in the first quarter
of 2004.

The Company guarantees Mobile Attic
debt totaling $13.1 million. Additional details of investments, including further
discussion on the operations of Mobile Attic are discussed in detail in the accompanying
managements discussion and analysis.

# Marketing and
Distribution

NSIC products are marketed through a
field force of agents and service representatives who are employees of the Life Company
and through a network of independent agents. The independent agent method of distribution
is expected to be more cost effective in the long term and has become the fastest growing
method of distribution. In an effort to boost productivity and better educate agents on
the products and services of NSIC, our marketing team routinely holds training meetings
across the various regions we serve. We also offer our best agents opportunities to attend
retreats, usually over a weekend, at least twice a year to network with the home office
staff that helps serve them and our policyholders, gain broader knowledge of the products
we offer, and offer feedback on how we can better serve our agency force and
policyholders.

NSFC and Omega 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. Like
NSIC, NSFC also routinely visits with agents both in their office and at training sessions
throughout the regions we serve with a primary objective of educating agents about our
products and services.

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 paid by NSIC in 2004 averaged
approximately 23% of premiums. Commissions paid by the NSFC in 2004 averaged approximately
18% of premiums. During 2004, no one independent agent accounted for more than 10% of
total net earned premium of the property-casualty insurance subsidiaries. NSFC also offers
a profit sharing bonus plan to independent agents in order to promote better
field underwriting and encourage retention of profitable business. This plan not only
rewards our agents but also enhances profitability by giving the agent a vested interest
in our success and also aids in maintaining price stability for all our customers as
agents have a financial incentive to use good field underwriting practices when completing
an application for insurance.

At December 31, 2004 NSIC employed 17
home service agents and one manager. NSIC also had approximately 624 independent agents
actively producing new business.

At December 31, 2004 NSFC had
contracts with approximately 1,335 independent agents in twelve states.

# Risk Management

Underwriting

Underwriting is the first step in the
Companys risk management process. The insurance subsidiaries maintain underwriting
departments that 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 dwelling 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 occupancy. In general, the property-casualty
subsidiaries specialize in writing nonstandard risks.

9

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|Part I | The National Security Group, Inc.

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 do 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
that warrants higher premiums. Lower 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 generally higher premiums
that are charged.

Reinsurance

Reinsurance is the second step in the
Companys risk management process. 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.

NSIC generally reinsures all risks in
excess of $50,000 with respect to any one insured. NSFC and Omega generally reinsure with
third parties any liability in excess of $150,000 on any single policy. In addition, the
property-casualty subsidiaries have catastrophe excess reinsurance, which provided
protection in part with respect to aggregate property losses arising out of a single
catastrophe, such as a hurricane. In 2004, the property-casualty subsidiaries had
catastrophe protection up to a $35 million loss. Under the property and casualty
subsidiaries reinsurance arrangement in force during 2004, the Company retained the first
$2 million of insured losses from any single catastrophic event. The next $15.5 million in
insured losses from any single event was 95% reinsured with the Companys net
retention being 5%. The final layer of reinsurance protection provided coverage for 100%
of insured losses exceeding $17.5 million and up to $35 million. The amount of catastrophe
reinsurance protection purchased by the Company was based on computer modeling of actual
Company exposure. The Company generally seeks protection for worst case scenarios based on
the computer modeling that mitigates losses up to a 1 in 250 year event, that is a loss
that has less than a 1⁄2 of 1% chance of occurring in any given year. NSFC and Omega had a
provision for one reinstatement (coverage for two catastrophic events) during 2004. In
addition to catastrophe reinsurance, NSFC also had a 60% 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, 2004, the total reserves of NSIC (including the
reserves for accident and health insurance) were approximately $24 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

10

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|Part I | The National Security Group, Inc.

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, 2004, the property-casualty subsidiaries had
reserves for unpaid claims of approximately $13.1 million before subtracting unpaid
claims, which will be due from reinsurers of $2.6 million leaving net unpaid claims of
$10.5 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, 2004, 2003 or 2002. The Company believes such reserves are adequate to
provide for settlement of claims. Employees of the Company calculate NSFC and Omega loss
reserves. Milliman, Inc. an independent actuarial consulting firm, reviews loss
reserve estimates and issues a Statement of Actuarial Opinion regarding the adequacy of
reserves.

# Financial Ratings

The insurance subsidiaries are rated
by AM Best Company, an insurance company-rating agency. NSFC is rated B++ (Very Good),
Omega is rated B+ (Good) and NSIC is rated B (Fair) by AM Best Company.

# 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 these 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 has paid no material amounts to
guaranty associations over the past three years. These payments, when made, 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.
Statutory limitations of dividend payments by subsidiaries are disclosed in Note 12 to the
accompanying Consolidated Financial Statements.

# 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.

11

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|Part I | The National Security Group, Inc.

NSIC primarily markets its life and
health insurance products through the home service system and independent producers.
Direct competition comes from other home service companies and other insurance companies
that utilize independent producers to sell insurance products, of which there are many.
NSICs life and health products also compete with products sold by ordinary life
companies. NSIC writes policies primarily in Alabama, Georgia and Mississippi. 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.

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. Initial
costs of distribution through independent agents are generally more than through home
service distribution methods, but lower commissions are paid in years subsequent to the
first year of the policy so costs decline rapidly as policies renew after the first year.
The primary factor in controlling cost under the independent agents distribution method is
maintaining a high persistency rate. The persistency rate is the rate at which new
business is maintained in renewal periods subsequent to the first year. The higher the
persistency percentage that can be maintained, the lower overall distribution costs become
due to lower commission rate payments on policies in force subsequent to the first year.

The property-casualty subsidiaries
market their products through independent agents and brokers, concentrating primarily on
dwelling fire, homeowners and nonstandard auto coverage. NSFC, though one of the larger
writers of lower 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 NSFC products over its competitors.

# Inflation

The Company 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 is 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 that 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.

# Employees

The Company has no management or
operational employees. Subsidiary National Security Insurance Company employs all
employees. The Company and its property and casualty subsidiary have a Management Service
Agreement (Agreement) with the National Security Insurance Company whereby the
Company and the property and casualty subsidiary reimburse NSIC for salaries and expenses
of employees provided under the Agreement. Involved are employees in the areas of
Underwriting, Customer Service, Policy Services, Accounting, Marketing, Administration,
Imaging, Data Processing, Programming, Personnel, Claims, and Management. The Company,
through NSIC, was represented by 17 employee agents in Alabama. The Companys property
and casualty subsidiaries had over 1300 independent agents at December 31, 2004. The
Company believes its employee relations are good.

# Additional information
with respect to The National Security Groups business

The Company  maintains a website  (www.nationalsecuritygroup.com).  The  National  Security  Group,  Inc.s  annual
reports  on Form 10-K,  quarterly  reports on Form 10-Q,  current  reports on Form 8-K and any  amendments  to such
reports that we file or furnish  pursuant to Section  13(a) of the  Securities  Exchange Act of 1934 are  available
through our Internet  website,  free of charge,  as soon as reasonably  practical  upon having been  electronically
filed or furnished to the  Securities  and  Exchange  Commission.  The  Companys  code of ethical  conduct is also
available on our website and in print to any stockholder  who requests  copies by contacting The National  Security
Group,  Attn:  Investor  Relations,  P. O. Box 703, Elba, AL 36323.  The Companys  periodic reports filed with the
SEC,  which  include  Forms 3, 4 and 5, Form  10-K,  Form 10-Q,  Form 8-K and any  amendments  thereto  may also be
accessed  free of charge from the SECs  website at  www.sec.gov.  Additional  information  about the Companys 50%
owned subsidiary, The Mobile Attic, Inc., can be found on its website www.mobileattic.com.

12

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|Part I | The National Security Group, Inc.

# Item 2. Properties

The Company owns no property. The
Life insurance subsidiary owns the Company's 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 are
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 15 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, 2004.

13

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|Part II | The National Security Group, Inc.

# PART II

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

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

The following table sets forth the
high and low sales prices per share, as reported by NASDAQ during the period indicated:

|               | Stock Closing Prices
|-------------- | --------------------
|
|2004           |                     
|First Quarter  |                     
|Second Quarter |                     
|Third Quarter  |                     
|Fourth Quarter |                     
|2003           |                     
|First Quarter  |                     
|Second Quarter |                     
|Third Quarter  |                     
|Fourth Quarter |                     

# Shareholders

The number of shareholders of the
Companys capital stock as of January 31, 2005, was approximately 1,100.

# Dividends

The following table sets forth
quarterly dividend payment information for the Company for the periods indicated:

|               | Dividends
Per Share
|-------------- | -------------------
|2004           |                    
|First Quarter  | 0.210              
|Second Quarter | 0.210              
|Third Quarter  | 0.210              
|Fourth Quarter | 0.215              
|2003           |                    
|First Quarter  | 0.205              
|Second Quarter | 0.205              
|Third Quarter  | 0.205              
|Fourth Quarter | 0.210              

Discussion regarding dividend
 restrictions may be found on page 23 of the Managements  Discussion and Analysis as
well as in Note 12 of the consolidated financial statements.

14

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|Part II | The National Security Group, Inc.

# Item 6. Selected Financial Data

| | (Amounts
in thousands, except per share)
| | ----------------------------------------

|Operating results                    | 2004 | 2003 | 2002 | 2001   | 2000
|------------------------------------ | ---- | ---- | ---- | ------ | ----
|Net premiums earned                  |      |      | $    | 52,985 |     
|Net investment income                |      |      |      | 4,328  |     
|Net realized investment gains        |      |      |      | 2,162  |     
|Net revenues from leasing operations |      |      |      | 2,459  |     
|Other income                         |      |      |      | 1,312  |     
|                                     |      |      |      |        |     
|Total revenues                       |      |      | $    | 63,246 |     
|                                     |      |      |      |        |     
|Net Income                           |      |      | $    | 3,113  |     
|                                     |      |      |      |        |     
|Net income per share                 |      |      | $    | 1.26   |     
|                                     |      |      |      |        |     

|Other Selected Financial Data | 2004 | 2003 | 2002 | 2001    | 2000
|----------------------------- | ---- | ---- | ---- | ------- | ----
|Total shareholders' equity    |      |      | $    | 46,676  |     
|Book value per share          |      |      |      | 18.92   |     
|Dividends per share           |      |      |      | 0.845   |     
|Net change in unrealized      |      |     
|capital gains (net of tax)    |      |      |      | (225    | )   
|                              |      |      |      |         |     
|Total assets                  |      |      | $    | 128,631 |     
|                              |      |      |      |         |     

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

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

# OVERVIEW

The following discussion highlights
significant factors influencing the consolidated financial position and results of
operations of The National Security Group, Inc. (referred to in this document as we, our,
us, the Company or NSEC) and its subsidiaries for the three years ended December 31, 2004.
This discussion and 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. Please
refer to our note regarding forward-looking statements on page 3 of this report.

The following are two words that will
appear almost chronically throughout this discussion: Hurricane Ivan. Losses resulting
from the impact of Hurricane Ivan significantly influenced the financial results for the
year ended December 31, 2004. While total losses were mitigated through risk management
using catastrophe excess of loss reinsurance; the Companys share of total losses and
catastrophe reinsurance reinstatement premium reduced net income by over $3,600,000.

# RESULTS OF OPERATIONS

The following analysis of the Results
of Operations should be read in conjunction with the Consolidated Financial Statements,
which begin on Page 28 of this Form 10-K. Primary reference is made to the Consolidated
Statements of Income on page 29 and segment information provided in Note 14 to the
Consolidated Financial Statements.

Consolidated Results of
Operations:

# Year Ended December 31,
2004 Compared to Year Ended December 31, 2003

For the third consecutive year, 2004
premium revenue reached a new Company record high. Total premium revenue was $52,985,000,
an increase of 11.5% over 2003 premium revenue of $47,536,000. Life segment revenue
accounted for 11.7% of consolidated premium revenue and increased 6.5% over 2003. Property
and casualty segment revenue accounted for 88.5% of consolidated premium revenue and
increased 12.2% over 2003. Continued strong growth in the dwelling property lines of
business, particularly the homeowners line of business, were the major contributor to
increases in property and casualty premium revenue.

Consolidated income before income
taxes declined 31.5% in 2004 to $3,853,000 compared to $5,628,000 in 2003. Hurricane Ivan,
which struck the Alabama Gulf coast in September of 2004, is the primary factor leading to
the decline in consolidated income before income taxes. Gross incurred losses, before
reinsurance recoveries, from Hurricane Ivan totaled $14,577,000 including paid losses of
$12,806,000, case unpaid losses and adjustment expenses of $1,077,000 and incurred but not
reported reserve (IBNR) estimates of $694,000. After reinsurance recoveries, pre-tax
losses from Hurricane Ivan totaled over $4,100,000 and a catastrophe reinsurance
reinstatement premium of $1,400,000 was also incurred in the third quarter of 2004. As for
the bottom line impact from Hurricane Ivan, consolidated net income declined by over
$3,600,000 due to losses and expenses related to Hurricane Ivan.

Consolidated net income for 2004 was
$3,113,000 compared to $4,090,000 in 2003, a decline of 23.9%. Again, Hurricane Ivan was
the primary factor contributing to the decline in consolidated net income. On a per share
basis earnings were $1.26 in 2004 compared to $1.66 in 2003.

Additional details on the sources of
premium revenue growth and the impact of individual segments on consolidated income will
be discussed in the respective Segment Results of Operations sections that follow.

# Year Ended December 31,
2003 Compared to Year Ended December 31, 2002

Premium revenue reached a record high
(eclipsed in 2004) of $47,536,000 in 2003, an increase of 45.3% over 2002 premium revenue
of $32,631,000, a previous Company record. Continued strong growth in the property and
casualty insurance segment was the primary catalyst contributing to the increase in
premium revenue. Property and casualty premium revenue totaled $41,737,000 in 2003
compared to $27,236,000 in 2002. Strong growth in dwelling property lines of business,
particularly homeowners type products, were the major contributor to the increase in
property and casualty premium revenue. The life, accident and health segment continued to
increase premium revenue at a healthy pace with a 7.5% increase over 2002.

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Consolidated net income for the
Company was $4,090,000 in 2003 compared to $908,000 in 2002. On a per share basis earnings
were $1.66 in 2003 compared to $.37 in 2002. Realized capital gains in 2003 were
$1,420,000 compared to $1,170,000 in 2002. Pre-tax earnings were $5,600,000 in 2003
compared to $1,500,000 in 2002. A much improved property and casualty combined ratio in
the property and casualty subsidiaries was the primary factor contributing to the
significant increase in the segments pre-tax earnings. The improvement in the property and
casualty combined ratio is discussed further in the segment information presented below.
The life, accident and health insurance segment experienced a 50% decline in pre-tax
earnings primarily due to litigation related cost, which is discussed further in Note 15
to the consolidated financial statements.

Additional details on the sources of
premium revenue growth and the impact of individual segments on consolidated income will
be discussed in the respective segment results of operations sections that follow.

Industry Segment Data

Certain financial information for The
National Security Groups three segments (Life segment, property and casualty
segment, and other (non-insurance)) is summarized as follows (amounts in thousands):
Premium revenues:

|                                    | 2004 | % | 2003 | %      | 2002 | %
|----------------------------------- | ---- | - | ---- | ------ | ---- | -
|Life, accident and health insurance |      |   | $    | 6,173  |      |  
|Property and casualty insurance     |      |   |      | 46,812 |      |  
|                                    |      |   |      |        |      |  
|                                    |      |   | $    | 52,985 |      |  
|                                    |      |   |      |        |      |  

Income before taxes and minority
interest:

|                                    | 2004 | % | 2003 | %     | 2002 | %
|----------------------------------- | ---- | - | ---- | ----- | ---- | -
|Life, accident and health insurance |      |   | $    | 216   |      |  
|Property and Casualty insurance     |      |   | $    | 4,224 |      |  
|Other                               |      |   | $    | 140   |      |  
|Interst expense                     |      |   |      | (727  | )    |  
|                                    |      |   |      |       |      |  
|                                    |      |   | $    | 3,853 |      |  
|                                    |      |   |      |       |      |  

In addition to the preceding table,
reference is made to Note 14 of the Consolidated Financial Statements contained in this
report for the segment information that follows.

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,
2004 Compared to Year Ended December 31, 2003:

Income before income taxes in 2004
was $186,000 compared to $529,000 in 2003. A decline in realized capital gains of $680,000
in the Life segment was the primary factor contributing to the decline in income before
income taxes. Also, litigation related expenses continued to be a drain on the bottom
line. Litigation expenses exceeded $250,000 in 2004 compared to $565,000 in 2003.
Litigation expenses for 2004 and 2003 are related to items discussed in Note 15 to the
Consolidated Financial Statements.

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Premium revenue increased to
$6,173,000 in 2004 compared to $5,799,000 in 2003, an increase of 6.5%. Premium revenue
produced by independent agents totaled $2,537,000 in 2004 compared to $2,186,000 in 2003,
a 16% increase. While NSIC is continuing to focus on growth through the independent agent
method of distribution, we will begin to shift to an increased focus on quality. For
the past five years, NSIC has worked to establish a position in the independent agent
market. In the process of establishing this position, NSIC has had very low thresholds for
business production and persistency. NSIC had appointments with over 1,828 independent
agents at the end of 2004 but only 33% of agents appointed actually produced any new
business. Management will begin to place more stringent performance standards on agents
beginning in 2005 including higher production standards and higher expectations of
persistency of business. These changes will no doubt greatly reduce the number of total
agency appointments when fully implemented, but should improve quality and profitability
of business produced. Premium revenue produced by NSIC home service agency force increased
slightly in 2004 to $2,996,000 from $2,970,000 in 2003. Due to changing market conditions,
the home service market is not considered to be a growth market, but the Company intends
to maintain a niche in this market to serve our current policyholders that prefer this
method of service. At December 31, 2004 NSIC had 17 home service agents that serviced this
book of business.

Commission expense, including field
servicing cost from the home service method of distribution, as a percent of premium
revenue declined 3.4 percentage points in 2004 compared to 2003. Commission expense
totaled 37% of revenue in 2004 compared to over 40% in 2003. Life insurance commission
rates for independent agents are typically front loaded meaning that higher commissions
are paid in the early years of a policy and commission rates decline as the policy ages.
Because the independent agent method of distribution is a relatively new method of
distribution, overall commission rates are skewed higher because the majority of in force
policies are still paying the higher commission rates of the early years. Management is
continuing to focus on reducing commissions through improving the rate of retention of new
and existing business.

# Year Ended December 31,
2003 Compared to Year Ended December 31, 2002:

Income before income taxes in 2003
was $529,000 compared to $1,082,000 in 2002. Litigation related expenses decreased pretax
earnings by over $565,000 and was the primary factor contributing to the 50% decline in
pre-tax earnings. Pending litigation against NSIC is discussed further in Note 15 to the
consolidated financial statements.

Premium revenue increased to
$5,799,000 in 2003 compared to $5,395,000 in 2002, an increase of 7.5%. Insurance sales
through independent agent distribution channels increased over 32% in 2003 over prior
year; while sales through NSICs traditional home service distribution channel
declined by 7%.

Commission expense increased 5.7% in
2003 compared to 2002. The continuing increases in new sales through independent agents
and a change in the home service agents commission contract were the primary factors
contributing to the increase in commission. Independent agents typically receive much
higher commission rates in the early years of a policy compared to employee agents in the
home service market, which typically receive a lower and more level commission over a
longer number of years. With premium growth generated exclusively through independent
agents, commission expense will rise at a faster rate than premium growth until a more
significant block of insurance business rolls into subsequent years at lower commission
rates.

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 1992.

# Year Ended December 31,
2004 Compared to Year Ended December 31, 2003:

Property and casualty premium
revenues totaled $46,812,000 in 2004 compared to $41,737,000 in 2003, an increase of
12.2%. The significant growth in premium revenue over the past four years has been
achieved through several different methods including an acquisition in 2000, increased
marketing efforts in states outside of Alabama, and careful monitoring and increasing of
rates in order to achieve underwriting profitability. The homeowners line of business was
the largest contributor to the increase in premium revenue. Gross written premium from the
homeowners market for the P&C subsidiaries totaled $3,067,000 in 2000 and has grown to
$18,872,000 in written premium in 2004, a 57.5% compound growth rate over four years.
Several factors have contributed to this growth including, the development of a new
homeowners product launched in 2001, an upgrade to an existing homeowners product that
made the product more competitive, and favorable market conditions that have allowed
pricing of the product to achieve more attractive margins. Significant premium growth has
also been achieved in NSFCs traditional dwelling fire market. Dwelling fire written
premium totaled $22,183,000 in 2004 compared to $19,890,000 in 2003, an increase of 11.5%.
This line of business has also enjoyed robust growth over the last four years and has
grown at a 19.4% compound growth rate since 2000. This growth is primarily attributable to
favorable market conditions, as many larger carriers do not focus on the dwelling fire
market with insured values typically less than $80,000 per dwelling.

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Income before income tax declined
considerably in 2004 to $4.22 million compared to $ 5.72 million in 2003. As discussed
earlier, results for 2004 were negatively impacted by losses and adverse claims experience
related to hurricane losses in the third quarter of 2004. Claims frequency increased
significantly in 2004 compared to 2003 with claims on dwelling lines of business
(homeowners and dwelling fire) exceeding 12,500 claims compared to 5,100 claims in 2003.
Over 7,500 claims were reported from Hurricane Ivan so without the impact of Ivan, claims
frequency was in line with 2003 total of around 5,000 claims. Average severity on dwelling
claims in 2004 declined to an average of $2,900 compared to $3,600 in 2003. Average
severity declined primarily due to the large volume of Hurricane Ivan claims. Because most
of the losses from Hurricane Ivan were inland and limited primarily to minor wind damage,
claims from Ivan averaged less than $2,000 per occurrence, which skewed 2004 average
severity downward. Hurricanes typically cause higher number of claims (frequency) and a
lower average cost per claim (severity) than tornado related losses. Tornadoes tend to
affect a more isolated area and therefore have a lower frequency but typically cause more
structural damage including a higher proportion of total losses therefore severity is
greater from tornado losses. Non-catastrophe related dwelling losses typically have an
average per loss severity in the $3,500 to $4,000 range for the P&C subsidiaries.

Claim adjustment expenses averaged
6.4% of earned premium in 2004 compared to 5.6% in 2003. The slight increase was primarily
due to the increase in cost associated with settling claims from Hurricane Ivan. The
Company employs claims adjusters, which work approximately 50% of reported dwelling claims
in a typical year with independently contracted adjusters working remaining claims. In
areas with large concentrations of business, it is typically less expensive to use
employee adjusters compared to independent adjusters. Due to the large number of claims
from Hurricane Ivan, the Company utilized more independent adjusters to handle the
increased workload in order to expedite the payment of claims to our policyholders.

P&C segment revenue before income
taxes was $4,224,000 in 2004 compared to $5,720,000 in 2003. The decline in pretax
earnings was due to losses incurred from Hurricane Ivan. Pretax losses from Ivan,
including catastrophe reinstatement premium of $1,400,000 reduced P&C segment income
before taxes by over $5,500,000. As shown in the combined ratio comparison that follows,
the P&C companies still managed to achieve a combined ratio below 100% even after the
impact of Hurricane Ivan.

# Year Ended December 31,
2003 Compared to Year Ended December 31, 2002:

Property and casualty premium
revenues increased $14,905,000 for the year ended December 31, 2003 compared to the same
period in 2002, an increase of over 45.7%. The acquisition of a book of business
contributed nearly $3,000,000 to the total increase in premium revenue. Increased
production in the homeowners line of business added nearly $5,000 000 in increased premium
revenue. NSFCs traditional dwelling fire line of business grew over 32% during the
year and added nearly $5,000,000 in premium revenue.

Net income before income tax was
$5,628,000 in 2003 compared to $1,470,000 in 2002. Pre-tax income increased significantly
over 2002. Results for 2002 were negatively impacted by adverse claims experience from
hurricane losses in the fourth quarter of 2002 and an increased severity of losses on new
business issued. Results for 2003 were much improved due to decreases in both severity and
frequency of losses. Average severity on dwelling property claims declined from nearly
$4,000 per loss in 2002 to $3,600 per loss in 2003. Prior year growth also helped 2003
results as a larger book of renewal business helped significantly reduce NSFC loss ratios.
Typically, insurance business issued within one year has a higher occurrence of losses
than renewal business. Due to the rapid growth the P&C subsidiaries have experienced
over the last three years, larger amounts of new business have led to higher loss ratios
as was demonstrated in 2002. Typically, as renewal books of business grow and the rapid
growth of new business moderates, loss ratios improve.

19

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Property & Casualty Combined Ratio:

A measure used to analyze a
property/casualty insurers underwriting performance is the 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 premium revenue.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------

| | 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 revenue.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The results of these ratios for the
past three years were:

|                           | 2004  | 2003  | 2002  
|-------------------------- | ----- | ----- | ------
|Loss and LAE Ratio         | 68.2% | 60.0% | 75.5% 
|Underwriting Expense Ratio | 31.4% | 30.8% | 31.9% 
|Combined Ratio             | 99.6% | 90.8% | 107.4%

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 and the southern Atlantic
coast, 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 2004 compared
to 2003 increased 8.8 percentage points. This increase was entirely due to losses incurred
from Hurricane Ivan. Hurricane Ivan added 8.9 percentage points to the combined ratio for
2004.

The combined ratio for 2003 compared
to 2002 declined 16.6 percentage points due to much improved underwriting results on the
dwelling lines of business in the P&C subsidiaries. A $400 decline in average severity
discussed in the preceding property and casualty segment information along with a drop in
frequency relative to premium volume were the primary factors contributing to the decline
in the combined ratio in 2003 compared to 2002.

# Leasing operations:

The Companys leasing operations
are conducted through its 50% owned subsidiary, Mobile Attic, Inc. Mobile Attic was
incorporated in August of 2001 and is a joint venture with a manufacturing partner, Cash
Brothers Leasing of Elba, Alabama. As detailed in Note 1 (a) of the consolidated financial
statements on page 34, the Company consolidated its investment in the subsidiary Mobile
Attic, Inc.

Mobile Attic is in the business of
leasing portable storage containers to individual and commercial customers through
franchises and an independent dealer network currently covering Alabama and expanding
throughout the Southeastern United States. At December 31, 2004 there were 14 franchise
locations throughout the Southeast and 13 dealerships. At December 31, 2004 Mobile Attic
had available approximately 3,500 storage containers for lease through franchise and
dealer locations. The portable storage containers are eight feet wide and eight feet tall
and are available in lengths of 8, 16, 20, and 40 feet. Independent dealers market these
portable storage containers primarily to household customers in need of a convenient
alternative to fixed location mini-storage, commercial customers in need of secure storage
facilities at job sites, and retail customers for storage of seasonal inventory.

20

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Mobile Attic began the steps to
franchise its business model during 2004. Expansion through this new avenue will allow
Mobile Attic to venture more rapidly into new areas and expand into larger cities while
significantly reducing future capital requirements. Mobile Attic began selling franchised
locations in the first quarter of 2004.

In 2004 Mobile Attic generated a
$211,000 net loss. The business generated positive cash flow for the year, but a decrease
in revenues from dealership sales fees and utilization fees below expected ultimate levels
generated an operating loss for the year. The Mobile Attic discontinued the sales of
dealerships in 2003 in anticipation of a change in strategy of growing Mobile Attic
through a franchise system, which began in the third quarter of 2004. Mobile Attic
completed the build out of company owned storage units in late 2004 and as the utilization
rates on these units increase, cash flow and profits will improve significantly.

Net income in 2002 was $136,000 and
primarily driven by the addition of several dealers during the year, thus increasing
dealer fee revenue. In 2001, the year in which operations began, gross rental revenues
were $87,000. In 2004, gross revenues from leasing operations were $2,459,000. Mobile
Attic expects to add over 50 franchise locations during 2005.

# Asset Portfolio Review:

The life insurance and
property/casualty subsidiaries primarily invest in highly liquid investment grade debt and
equity securities. At December 31, 2004, the companys holdings in debt securities
amounted to 73.4% of total investments and 55.3% of total assets. The following is a
breakdown of the bond portfolio quality according to National Association of Insurance
Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the
nationally recognized rating organization equivalents of Moodys and Standard and
Poors:

|SVO Equivalents
|---------------
|
|1              
|2              
|3              
|4              
|5              
|6              

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 4 to the consolidated financial
statements).

The insurance subsidiaries
fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage
obligations (CMOs), of $8.7 million and $7.8 million at December 31, 2004 and 2003
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. In order to
minimize risk associated with prepayments on collateralized mortgage obligations, the
Company typically invests primarily in more predictable planned amortization class (PAC)
structures of CMOs and typically avoids investment in CMOs priced at
significant premiums above par value.

21

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

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

|                                                 | Year Ended December 31
|------------------------------------------------ | ----------------------
|
|Net investment income                            | $  4,328              
|Average current yield on investments             | 4.5%                  
|Total return on investments                      | 6.4%                  
|Net realized gains on investments (before taxes) | 2,162                 
|Changes in net unrealized gains on investments  
|(before income taxes)                            | $  (339)              

Maturity Schedule
(Amounts in thousands)

|Maturity                     | Available
for sale | Held to
Maturity | Total | Percentage
of Total
|---------------------------- | ------------------ | ---------------- | ----- | -------------------
|
|Maturity in less than 1 year |                    |                  | $     | 709                
|Maturity in 1-5 years        |                    |                  |       | 18,392             
|Maturity in 5-10 years       |                    |                  |       | 13,419             
|Maturity after 10 years      |                    |                  |       | 17,644             
|                             |                    |                  |       |                    
|                             |                    |                  | $     | 50,164             
|                             |                    |                  |       |                    

Liquidity and Capital
Resources: Due to increased claims from Hurricane Ivan, the Company sold approximately
$2 million of primarily short-term securities to fund the payment of hurricane claims.
Consequently, the amount of securities with maturities of less than one year declined
below normal levels causing a temporary asset/liability mismatch. However, due to the
large percentage of the fixed maturity portfolio with maturities ranging from 1 to 5
years, the mismatch can be corrected in short order with no material impact on earnings,
liquidity or 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 property
and casualty 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 liabilities of the life insurance subsidiaries are typically of a
longer duration and therefore, a higher percentage of securities in the life insurance
subsidiaries is invested for periods 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 and
consolidated statement of cash flows indicate that operating activities provided cash of
$886,000, $11,398,000, $5,189,000 in 2004, 2003, and 2002 respectively. The significant
decline in cash flow from operating activities in 2004 compared to 2003 was primarily due
to the significant increase in claims associated with Hurricane Ivan. Cash flow in 2003
compared to 2002 was significantly improved primarily due to the previously discussed
improvement in the property and casualty subsidiaries combined ratio.

22

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

The Company has standby letters of
credit of $25,000. These letters are used to guarantee obligations of the
property/casualty subsidiary under assumed reinsurance contracts. Certain invested assets
of the Company secure the letters of credit. The Company also routinely incurs a 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.

# Contractual
Obligations and Commitments

|                                     | Payments due by period
|------------------------------------ | ----------------------
|
|
|Long-Term Debt Obiligations          |                       
|                                     |                       
|Property and casualty claim reserves |                       
|                                     |                       

Long-term debt obligations include
$2,731,000 in debt held directly by the Company. It is anticipated that this debt will be
retired in 2007. Long-term debt obligations also include $13,105,000 in debt held by a 50%
owned subsidiary, The Mobile Attic. The current debt obligation of Mobile Attic matures in
2007, but it is currently anticipated that Mobile Attic will seek to refinance
approximately 50% of this debt under a longer term financing prior to maturity.

In estimating the time interval for
payment of property and casualty claim reserves, the Company utilized historical payment
patterns. By the nature of the insurance contracts under which these liabilities exist,
there can be no certainty that actual payments will fall in the periods indicated above.
However, management feels that current liquidity and capital resources are sufficient to
pay these obligations as they come due. Also, due to the relatively short-tail nature of
the majority of the Companys claim liabilities, management can conclude with a
reasonable level of confidence that historical patterns indicate that approximately 70% of
claim liabilities at the end of a given year are settled within the following two year
period.

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, 2004, the Company
had no known impairments of assets or changes in operation, which would have a material
adverse effect upon liquidity. Approximately 85% of the Companys insurance
subsidiary 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 15 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 12 to the
consolidated financial statements, in 2004, the amount that The National Security
Groups insurance subsidiaries can transfer in the form of dividends to the parent
company is limited to $1,029,000 million in the life insurance subsidiary and $2,376,000
million in the property/casualty insurance subsidiary. However, that condition poses no
short-term or long-term liquidity concerns for the parent company.

Off-Balance Sheet Arrangements:With the consolidation of 50% owned subsidiary, The Mobile Attic, Inc. triggered by
preexisting debt guarantees and the adoption of Financial Accounting Standards Board
Interpretation 46 (FIN 46R), the Company has no off balance sheet arrangements.

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

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. State insurance regulators will use the RBC formula
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
|------------------------ | ---------------------------------------------------------------
|
|
|Company action level     | 2.0                                                            
|Regulatory action level  | 1.5                                                            
|Authorized control level | 1.0                                                            
|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 3.6 to 1 at December 31,
2004.

National Security Insurance Company
(life insurer) has regulatory adjusted capital of $11.45 million and $11.37 million at
December 31, 2004 and 2003, respectively, and a ratio of regulatory total adjusted capital
to authorized control level RBC of 14.0 and 16.0 at December 31, 2004 and 2003
respectively. Accordingly, National Security Insurance Company exceeds the minimum RBC
requirements.

National Security Fire & Casualty
Company (property/casualty insurer) has regulatory adjusted capital of $23.7 million and
$23.1 million at December 31, 2004 and 2003, respectively, and a ratio of regulatory total
adjusted capital to authorized control level RBC of 3.6 and 4.0 at December 31, 2004 and
2003 respectively. Accordingly, National Security Fire & Casualty Company exceeds the
minimum RBC requirements.

Omega One Insurance Company
(property/casualty insurer), which began writing business in late 1995, has regulatory
adjusted capital of $7.6 million and $6.7 million at December 31, 2004 and 2003,
respectively, and a ratio of regulatory total adjusted capital to authorized control level
RBC of 12.3 and 9.3 at December 31, 2004 and 2003 respectively. Accordingly, Omega One
Insurance Company exceeds the minimum RBC requirements.

Application of Critical Accounting
Policies:Our consolidated financial statements are based upon the development and
application of accounting policies that require management to make significant estimates
and assumptions. Accounting policies may be based on (including but not limited to) GAAP
authoritative literature, statutory authoritative literature, regulations, and industry
standards. The Companys financial results would be directly impacted by changes in
assumptions and judgments used to select and apply our accounting policies. It is
managements opinion that the following are some of the more critical judgment areas
in regards to the application of our accounting policies and their affect on our financial
condition and results of operations.

| |                                                   | 
| | ------------------------------------------------- | 
| |  Reinsurance Receivables                         | 
| |  Deferred Policy Acquisition Costs               | 
| |  Deferred Taxes                                  | 
| |  Valuation of Investments                        | 
| |  Reserves for losses and loss adjustment expense | 
| |  Recognition of Revenue                          | 
| |  Evaluation of Litigation                        | 

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

Reinsurance

As part our risk management strategy
we routinely cede risks associated with insurance policies we underwrite to reinsurers
pursuant to contractual agreements. Reinsurance provides protection for individual loss
occurrences, including catastrophes, to alleviate fluctuation in the results of our
underwriting activities and to limit our net liability for individual risks. The estimated
reinsurance recoverable on paid losses, including an estimate for losses incurred but not
reported, and amounts paid to reinsurers applicable to unexpired terms of policies in
force are reported as assets.

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.

When a claim is made under a policy
we have reinsured, we initially pay the full amount owed to the policyholder or claimant.
Subsequently, we initiate the process to recover any amounts due from reinsurers in
accordance with the terms of applicable reinsurance treaties. The estimated recoverable is
recorded as an asset on the financial statements.

At December 31, 2004, the estimated
reinsurance recoverable recorded was $3,318,000. The Company does not anticipate any
issues with collection of the recorded amount.

The reinsurance related amounts
recorded have been estimated based upon managements interpretation of the related
reinsurance treaty. Areas in which judgment has been used regarding said estimates
include: assessing the financial viability and credit quality of each reinsurer as well as
the ability of each reinsurer to pay amounts owed.

There is a possibility that the
actual amounts recovered from reinsurers could be materially less than the estimates
recorded. This possibility could result in a material adverse impact on our financial
condition and results of operations. Reinsurers may dispute claims under reinsurance
treaties, such as the calculated amount of reinsurance recoverable.

NSIC generally reinsures all risks in
excess of $50,000 with respect to any one insured. NSFC and Omega generally reinsure with
third parties any liability in excess of $150,000 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 2004, the property-casualty subsidiaries had catastrophe protection up
to a $35 million loss. Based on a evaluation using actual NSFC and Omega exposures and
catastrophe modeling based on a 250 year loss, that is a loss that has a less than
1⁄2 of 1% chance of occurring in any given year, the property and casualty
subsidiaries would pay $2.7 million in losses and reinsurers would pay $36.8 million.

In addition to catastrophe
reinsurance, NSFC also had a 60% quota share reinsurance agreement on ocean marine
exposure with additional excess of loss coverage.

For more information regarding
reinsurance please see Note 10 to our consolidated financial statements.

Deferred Policy Acquisition Costs

Deferred policy acquisition costs
(DAC) are those costs incurred in connection with acquiring new business or renewing
existing business. DAC is primarily comprised of commissions and other costs related to
issuing insurance policies, net of amounts ceded to reinsurers. In accordance with
generally accepted accounting principles, these costs are not expensed in their entirety,
rather they are recorded as an asset and amortized over the lives of the policies.

A reduction in DAC is recognized if
the sum of the expected loss and loss adjustment expenses, unamortized acquisition costs,
and maintenance costs exceeds related unearned premiums and projected investment income.
Management reviews DAC calculations throughout the year to establish and assess their
recoverability. Changes in managements assumptions, estimates or judgment with
respect to calculating DAC could materially impact our financial statements and financial
condition. Changes in loss ratios, projected investment income, premium rates or overall
expense levels could negatively impact the recoverability of DAC.

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | The National Security Group, Inc.

At December 31, 2004, we had recorded
$6,217,000 as an asset for DAC in our financial statements. For more information regarding
deferred policy acquisition costs, please see Note 1 to our financial statements.

Deferred Income Taxes

Deferred income taxes are created
when there are differences between assets and liabilities for tax and financial reporting
purposes, as well as tax credits, net operating losses and other carryforwards. SFAS 109
Accounting for Income Taxes, requires that deferred tax assets be reduced by a
valuation allowance if, based on the available evidence, it is more likely than not that
all of the recorded deferred tax assets will not be realized in future periods. This
standard requires management to exercise judgment in determining whether or not the
deferred tax asset is realizable.

At December 31, 2004 there is no
evidence to suggest to management that the deferred tax asset is unrealizable. For more
information regarding deferred income taxes, please see Note 7 to our financial
statements.

Valuation of Investments

Investments are recorded at fair
value based upon quoted prices when available. Quoted prices are available for every
investment included in the financial statements. Periodically, the carrying values of an
individual investment may become temporarily impaired because of time value, volatility,
credit quality and existing market conditions. Management evaluates investments to
determine whether an impairment is other-than-temporary. Evaluation criteria include
credit quality of security, severity of decrease between cost and market value, length of
time of the impairment and likelihood that the impairment will reverse in the near future.
This evaluation requires significant assumptions, estimates and judgments by management.
If the impairment is determined to be other-than-temporary, the investment is written down
to the current fair value and a realized loss is recorded on the income statement.

At December 31, 2004 there were no
other-than-temporary impairments. For more information regarding valuation of investments,
see Note 1 to our financial statements.

Loss and Loss Adjustment Expense

Property and casualty loss reserves
are maintained to cover the estimated unpaid liability for losses and loss adjustment
expenses with respect to reported and unreported incurred claims. Loss reserves are an
estimation based on actuarial projection techniques common in the insurance industry.
Reserves are managements expectations of what the settlement and administration of
claims will cost. Management estimated reserves are based on historical settlement
patterns, estimated salvage and subrogation, and an appraisal of the related facts and
circumstances. Managements reserve estimates are reviewed by independent actuaries
to determine their adequacy and reasonableness.

At December 31, the recorded
liability for loss and loss and adjustment expense was $13,094,000. For more
information regarding loss and loss adjustment expense, see Note 9 to our financial
statements.

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| | ---------------------------------
| | The National Security Group, Inc.

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

The Companys primary objectives
in managing its investment portfolio are to maximize investment income and total
investment returns while minimizing overall credit risk. Investment strategies are
developed based on many factors including changes in interest rates, overall market
conditions, underwriting results, regulatory requirements, and tax position. Investment
decisions are made by management and reviewed and approved by the Board of Directors.
Market risk represents the potential for loss due to adverse changes in fair value of
securities. The three potential risks related to the Companys fixed maturity
portfolio are interest rate risk, prepayment risk, and default risk. The primary risk
related to the Companys equity portfolio is equity price risk.

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
$20.2 million. If the market value of the S & P 500 Index decreased 10% from its
December 31, 2004 value, the fair value of the Companys common stock would decrease
by approximately $2.1 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 in the
consolidated financial statements 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 issued 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, long term investment results have been superior to those offered
by bonds, while keeping the risk of loss of capital to a minimum relative to the overall
equity market.

As for shifts in investment
allocations, the major shift has been a move away from corporate bonds and into government
agency issues. Corporate spreads have remained extremely tight relative to agency
securities. Due to the tight interest rate spreads, the investment committee has not felt
compelled from a risk/reward standpoint to increase or maintain the allocation to
corporate bonds. Corporate bonds now compose just 15.3% of bond investments compared to
over 26.5% last year. In contrast, government securities, primarily agency issues, compose
67.5% of bond investments compared to 52.8% last year. The allocation to collateralized
mortgage obligations, which primarily consists of planned amortization class structures,
remains virtually unchanged from last year. The Company does not anticipate any further
major shifts in fixed income investment allocations in the near future.

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|Item 8. Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

# Item 8. Consolidated Financial Statements and Supplementary Data

|Index to Financial Statements                                 |   
|------------------------------------------------------------- | --
|Consolidated Financial Statements:                           
|Report of Independent Registered Public Accounting Firm       | 29
|Consolidated Statements of Income -                          
|Years Ended December 31, 2004, 2003, and 2002                 | 30
|Consolidated Balance Sheets -                                
|December 31, 2003 and 2002                                    | 31
|Consolidated Statements of Shareholders' Equity -            
|Years Ended December 31, 2004, 2003, and 2002                 | 32
|Consolidated Statements of Cash Flows -                      
|Years Ended December 31, 2004, 2003, and 2002                 | 33
|Notes to Consolidated Financial Statements -                 
|December 31, 2004                                             | 34
|Financial Statement Schedules:                               
|Schedule I.  Summary of Investments -                        
|December 31, 2004 and 2003                                    | 54
|Schedule II.  Condensed Financial Information of Registrant -
|December 31, 2004 and 2003                                    | 55
|Schedule III.  Supplementary Insurance Information -         
|December 31, 2004, 2003, and 2002                             | 59
|Schedule IV.  Reinsurance -                                  
|Years Ended December 31, 2004, 2003, and 2002                 | 60

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

28

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|Item 8. Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

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, 2004, 2003 and 2002, and the related consolidated statements of income,
shareholders equity and cash flows for each of the years in the three-year period
ended December 31, 2004. Our audits also included the financial statement schedules listed
in the Index at page 28. These consolidated financial statements and financial statement
schedules are the responsibility of the Companys management. Our responsibility is
to express an opinion on these consolidated financial statements and financial statement
schedules based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. An audit includes consideration of internal control over
financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also, includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of The National Security Group, Inc. and subsidiaries as of December
31, 2004 and 2003, and the results of its operations and its cash flows for each of the
years in the three-year period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. Also, in our opinion, the
financial statement schedules listed in the Index at page 28, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.

/S/ Barfield, Murphy, Shank, & SmithBirmingham, AlabamaFebruary
25, 2005

29

---

|                                                                 |                                  
|---------------------------------------------------------------- | ---------------------------------
|Item 8. Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC.

CONSOLIDATED STATEMENTS
OF INCOME

|                                                  | (Dollars in thousands)
except per share amounts
Year Ended December 31,
|------------------------------------------------- | -----------------------------------------------------------------------
|
|REVENUES                                          |                                                                        
|Net premiums earned                               |                                                                        
|Net investment income                             |                                                                        
|Net realized investment gains                     |                                                                        
|Net revenues from leasing operations              |                                                                        
|Other income                                      |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|BENEFITS AND EXPENSES                             |                                                                        
|Policyholder benefits paid or provided            |                                                                        
|Amortization of deferred policy acquisition costs |                                                                        
|Commissions                                       |                                                                        
|General insurance expenses                        |                                                                        
|Expenses from leasing operations                  |                                                                        
|Insurance taxes, licenses and fees                |                                                                        
|Interest expense                                  |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|Income Before Income Taxes and Minority Interest  |                                                                        
|INCOME TAX EXPENSE (BENEFIT)                      |                                                                        
|Current                                           |                                                                        
|Deferred                                          |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|                                                  |                                                                        
|Income Before Minority Interest                   |                                                                        
|                                                  |                                                                        
|Loss (Income) of Minority Interest                |                                                                        
|                                                  |                                                                        
|Net Income                                        |                                                                        
|                                                  |                                                                        
|EARNINGS PER COMMON SHARE                         |                                                                        
|Net Income                                        |                                                                        
|                                                  |                                                                        

See accompanying notes to
consolidated financial statements

30

---

|                                                                 |                                  
|---------------------------------------------------------------- | ---------------------------------
|Item 8. Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

# The National Security
Group, Inc.

CONSOLIDATED BALANCE
SHEETS

|ASSETS                                                                                      | (Dollars in thousands)
December 31,
|------------------------------------------------------------------------------------------- | -----------------------------------
|
|Investments                                                                                 |                                    
|Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2004 - $19,967; |                                    
|2003 - $18,198)                                                                             |                                    
|Fixed maturities available-for-sale, at estimated fair value (cost: 2004 - $50,164;         |                                    
|2003- $53,000)                                                                              |                                    
|Equity securities available-for-sale, at estimated fair value (cost: 2004 - $8,995;         |                                    
|2003 - $10,205)                                                                             |                                    
|Mortgage loans on real estate, at cost                                                      |                                    
|Investment real estate, at book value (accumulated depreciation: 2004 - $17; 2003 - $17)    |                                    
|Policy loans                                                                                |                                    
|Other invested assets                                                                       |                                    
|Short-term investments                                                                      |                                    
|                                                                                            |                                    
|Total Investments                                                                           |                                    
|Cash                                                                                        |                                    
|Accrued investment income                                                                   |                                    
|Receivable from agents, less allowance for credit losses (2004 - $110; 2003 - $140)         |                                    
|Reinsurance recoverable                                                                     |                                    
|Deferred policy acquisition costs                                                           |                                    
|Property and equipment, net                                                                 |                                    
|Other assets                                                                                |                                    
|                                                                                            |                                    
|Total Assets                                                                                |                                    
|                                                                                            |                                    
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                        |                                    
|Note payable                                                                                |                                    
|Policy and claim reserves                                                                   |                                    
|Other policyholder funds                                                                    |                                    
|Long-term debt                                                                              |                                    
|Accrued income taxes                                                                        |                                    
|Other liabilities                                                                           |                                    
|Deferred income tax                                                                         |                                    
|                                                                                            |                                    
|Total Liabilities                                                                           |                                    
|                                                                                            |                                    
|Contingencies                                                                               |                                    
|Minority interest                                                                           |                                    
|Shareholders' Equity                                                                        |                                    
|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, 10,000,000 and 2,500,000 shares authorized, respectively,       |                                    
|2,466,600 shares issued and outstanding                                                     |                                    
|Additional paid-in capital                                                                  |                                    
|Accumulated other comprehensive income                                                      |                                    
|Retained earnings                                                                           |                                    
|                                                                                            |                                    
|Total Shareholders' Equity                                                                  |                                    
|                                                                                            |                                    
|Total Liabilities and Shareholders' Equity                                                  |                                    
|                                                                                            |                                    

See accompanying notes to
consolidated financial statements

31

---

|                                                                 |                                  
|---------------------------------------------------------------- | ---------------------------------
|Item 8. Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC.

CONSOLIDATED STATEMENTS
OF SHAREHOLDERS' EQUITY

|Consolidated Statements of Shareholders' Equity | (Dollars in thousands)
|----------------------------------------------- | ----------------------
|
|Balance at December 31, 2001                    |                       
|Comprehensive loss:                             |                       
|Net income for 2002                             |                       
|Other comprehensive loss, net of tax            |                       
|Unrealized loss on securities, net              |                       
|of reclassification adjustment of $852          |                       
|                                                |                       
|Comprehensive loss                              |                       
|                                                |                       
|Cash dividends                                  |                       
|                                                |                       
|Balance at December 31, 2002                    |                       
|Comprehensive income:                           |                       
|Net income for 2003                             |                       
|Other comprehensive income, net of tax          |                       
|Unrealized gain on securities, net              |                       
|of reclassification adjustment of $1,130        |                       
|                                                |                       
|Comprehensive income                            |                       
|                                                |                       
|Cash dividends                                  |                       
|                                                |                       
|Balance at December 31, 2003                    |                       
|Comprehensive income:                           |                       
|Net income for 2004                             |                       
|Other comprehensive loss, net of tax            |                       
|Unrealized loss on securities, net              |                       
|of reclassification adjustment of $1,483        |                       
|                                                |                       
|Comprehensive income                            |                       
|                                                |                       
|Cash dividends                                  |                       
|                                                |                       
|Balance at December 31, 2004                    |                       
|                                                |                       
|                                                |                       

See accompanying notes to consolidated
financial statements.

32

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|                                                                                                                            |                                  
|--------------------------------------------------------------------------------------------------------------------------- | ---------------------------------
|Item         8.         Consolidated          Financial          Statements         and         Supplementary          Data | The National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC.

CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                             | (Dollars in thousands)
Year ended December 31,
|------------------------------------------------------------ | ----------------------------------------------
|
|Cash flows from operating activities:                        |                                               
|Net income                                                   |                                               
|Adjustments to reconcile net income to net cash provided by  |                                               
|operating activities:                                        |                                               
|Change in accrued investment income                          |                                               
|Change in reinsurance recoverable                            |                                               
|Amortization of deferred policy acquisition costs            |                                               
|Change in receivable for securities                          |                                               
|Net realized gains on investments                            |                                               
|Policy acquisition costs deferred                            |                                               
|Change in prepaid reinsurance premiums                       |                                               
|Depreciation expense and amortization/accretion              |                                               
|Change in policy liabilities and claims                      |                                               
|Change in income tax payable                                 |                                               
|Change in deferred income taxes                              |                                               
|Change in other liabilities                                  |                                               
|Loss of Minority Interest                                    |                                               
|Other, net                                                   |                                               
|                                                             |                                               
|Net cash provided by operating activities                    |                                               
|Cash flows from investing activities:                        |                                               
|Purchases of held-to-maturity securities                     |                                               
|Purchases of available-for-sale securities                   |                                               
|Proceeds from maturities of held-to-maturity securities      |                                               
|Proceeds from sales of available-for-sale securities         |                                               
|Proceeds from sales of real estate held for investment       |                                               
|Purchases of real estate held for investment                 |                                               
|Purchase of other invested assets                            |                                               
|Proceeds from sales of other invested assets                 |                                               
|Net proceeds from sale (purchases of) short-term investments |                                               
|(Advances on) repayment of loans, net                        |                                               
|Purchase of property and equipment                           |                                               
|Proceeds from sale of property and equipment                 |                                               
|                                                             |                                               
|Net cash provided by (used in) investing activities          |                                               
|Cash flows from financing activities:                        |                                               
|Proceeds from debt                                           |                                               
|Payments on debt                                             |                                               
|Change in other policyholder funds                           |                                               
|Dividends paid                                               |                                               
|                                                             |                                               
|Net cash (used in) provided by financing activities          |                                               
|                                                             |                                               
|Net (decrease) increase in cash                              |                                               
|Cash at beginning of year                                    |                                               
|                                                             |                                               
|Cash at end of year                                          |                                               
|                                                             |                                               

See accompanying notes to
consolidated financial statements.

33

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# 1 -  SIGNIFICANT
ACCOUNTING POLICIES

| | (a) | Principles of Consolidation
| | --- | ---------------------------

| | T | he accompanying
consolidated financial statements include the accounts of (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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | T | he accompanying
consolidated financial statements also include an investment in affiliate,
which consists of a fifty percent interest in The Mobile Attic, Inc and its wholly owned
subsidiary established in January of 2004, Mobile Attic Franchising Company (MAFCO). The
Mobile Attic, Inc. is a portable storage leasing company that began operations in 2001.
MAFCO was established in the first quarter of 2004 to conduct the business of selling
Mobile Attic portable storage leasing franchises. Effective in the first quarter of 2004
the Company consolidated the accounts of Mobile Attic, Inc. and subsidiary MAFCO according
to guidance in Financial Accounting Standards Board Interpretation 46 as revised December
2003 (FIN 46R).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C | hanges in financial statement presentation as a result of the adoption of recently issued
accounting standards:
| | - | ---------------------------------------------------------------------------------------------------------------

| | A | s disclosed
in the notes to the audited consolidated financial statements for the year ended December
31, 2003, the Company adopted Financial Accounting Standards Board Interpretation 46 as
revised December 2003 (FIN 46R), in the first quarter of 2004. As a result of the
adoption of FIN 46R, triggered by previously existing and disclosed guarantees of Mobile
Attic debt by the Company, the Company consolidated an investment in a subsidiary Mobile
Attic, Inc. Further details of the debt guarantees are discussed in Note 2 to these
consolidated financial statements.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M | obile Attic
was previously reported using the equity method of accounting. For comparative purposes,
the Company made adjustments to the December 31, 2003 Balance Sheet shown in these
audited financial statements and the Income Statement and Statement of Cash Flows for the
periods ended December 31, 2003 and 2002. These adjustments increased December 31, 2003
assets by $15,109,000 and liabilities by $13,394,000. The adjustment had no effect on
consolidated stockholders equity. Certain accounts in the Income Statement for the
periods ended December 31, 2003 and 2002 were adjusted as a result of the consolidation
of Mobile Attic, but because the results of Mobile Attic were previously reported under
the equity method, the adjustments had no effect on the consolidated results of
operations for the periods ended December 31, 2003 and 2002. Cash flow, for the years
ended December 31, 2003 and 2002, from operating activities increased $79,000 and
$327,000, respectively; from investing activities decreased $7,224,000 and $1,872,000,
respectively; and from financing activities increased $7,862,000 and $362,000,
respectively. Total cash increased $169,000 and $77,000, respectively.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Description of Major Products
| | --- | -----------------------------

| | N | SIC is
licensed in the states of Alabama, Florida, Georgia, Mississippi, South Carolina and
Texas and was organized in 1947 to provide life and burial insurance policies to the home
service market. Business is now produced by both company and independent agents. Primary
products include ordinary life, accident and health, supplemental hospital, and cancer
insurance products.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | N | SFC is
     licensed in Alabama,  Arkansas,  Florida, Georgia,  Mississippi,  Oklahoma,
South  Carolina,  and  Tennessee.  In addition  NSFC operates on a surplus lines
basis in Louisiana,  Missouri,  and Texas. NSFC operates in various property and
casualty lines, the most significant of which are dwelling
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

34

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES  CONTINUED

| |  | property fire and extended coverage, homeowners, mobile homeowners,
ocean marine, nonstandard automobile physical damage and liability and nonstandard
commercial auto liability.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O | mega is
licensed in the states of Alabama and Louisiana. Omega operates in property and casualty
lines, the most significant of which are homeowners and nonstandard automobile physical
damage and liability.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Basis
of Presentation
| | --- | ---------------------

| | T | he significant
accounting policies followed by  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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (d) | Investments
| | --- | -----------

| | T | he 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | U | nrealized 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | M | ortgage
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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O | ther invested
assets consist principally of state sponsored investments with a portion of investment
yield derived from insurance premium tax credits.  These investments are
                 reported at the unpaid principal balance.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (e) | Receivable
from Agents
| | --- | ----------------------

| | A | gent balances
are reported at unpaid balances, less a provision for credit losses.
| | - | ----------------------------------------------------------------------------------

| | (f) | Property
and Equipment
| | --- | ----------------------

| | P | roperty and
equipment is carried at cost less accumulated depreciation and includes expenditures that
substantially increase the useful lives of existing property and equipment. Maintenance,
repairs, and minor renovations are charged to expense as incurred. Upon sale or retirement of property and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

35

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

NOTE 1  SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

| | (f) | Property
and Equipment  Continued
| | --- | ----------------------------------

| |  | equipment, the cost and related accumulated depreciation are eliminated
from the respective account and the resulting gain or loss is included in the results of
operations. The Company provides for depreciation of property and equipment using the
straight-line method designed to amortize costs over estimated useful lives. Estimated
useful lives range up to 40 years for buildings and from 3-20 years for electronic data
processing equipment and furniture and fixtures.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (g) | Fair
Value of Financial Instruments
| | --- | -----------------------------------

| | T | he table
below presents the carrying value and fair value of the Companys financial
instruments, as defined in accordance with applicable requirements. Fair values of the
Companys financial instruments are estimated by reference to quoted prices from
market sources and financial institutions, as well as other valuation techniques. 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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C | ertain financial
instruments, particularly insurance liabilities other than financial guarantees and
investment contracts are excluded from the disclosures. 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | T | he fair
values of cash, cash equivalents, short-term investments and balances due on accounts
from agents, reinsurers and others approximate their carrying amounts as reflected in the
consolidated balance sheet due to their short-term availability or maturity.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | In Thousands of Dollars at December 31,
|----------------------------------- | ---------------------------------------
|
|
|Assets and related instruments      |                                        
|Debt and equity securities          |                                        
|Mortgage loans                      |                                        
|Policy loans                        |                                        
|Liabilities and related instruments |                                        
|Other policyholder funds            |                                        
|Long-term debt                      |                                        

| | (h) | Statement
of Cash Flows
| | --- | -----------------------

| | F | or purposes
of reporting cash flows, cash includes cash-on-hand, demand deposits with banks and
overnight investments.
| | - | ----------------------------------------------------------------------------------------------------------------------

36

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

NOTE 1  SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

| | (i) | Premium Revenues
| | --- | ----------------

| | L | ife 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (j) | Deferred Policy Acquisition Costs
| | --- | ---------------------------------

| | T | he 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A | cquisition 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | (k) | Policy Liabilities
| | --- | ------------------

| | T | he 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 - 2004    | 7% graded to 6%

| | M | ortality  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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (l) | Claim Liabilities
| | --- | -----------------

| | T | he 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (m) | Earnings Per Share
| | --- | ------------------

| | E | arnings per
share of common stock is based on the weighted average number of shares outstanding
during each year. The adjusted weighted average shares outstanding were 2,466,600
(2,466,600 in 2003 and 2002).
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (n) | Reinsurance
| | --- | -----------

| | I | n 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES  CONTINUED

| | (n) | Reinsurance
| | --- | -----------

| | I | n 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (o) | Reclassifications
| | --- | -----------------

| | C | ertain 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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (p) | Use of Estimates
| | --- | ----------------

| | T | he  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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (q) | Advertising
| | --- | -----------

| | T | he Company
expenses advertising costs as incurred. Advertising costs were $142,000 for the year
ended December 31, 2004 ($118,000 and $114,000 for the years ended December 31, 2003 and
2002, respectively).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (r) | Concentration of Credit Risk
| | --- | ----------------------------

| | T | he Company
maintains cash depository accounts which, at times, may exceed federally insured limits.
These amounts represent actual account balances held by financial institutions at the end
of the period, and unlike the balance reported in the financial statements, the account
balances do not reflect timing delays inherent in reconciling items such as outstanding
checks and deposits in transit. The Company has not experienced any losses in such
accounts. At December 31, 2004, the Companys uninsured cash balances
totaled $313,000.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (s) | Recently Issued Accounting Standards
| | --- | ------------------------------------

| | I | n December
2004, the Financial Accounting Standards Board (FASB) issued two pronouncements and a
revision of Statement of Financial Accounting Standards (SFAS) No. 123:
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SFAS No.
153, Exchanges of Nonmonetary Assetsan amendment of APB Opinion No. 29, Eliminates the exception for nonmonetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of nonmonetary assets that do not have
commercial substance. The adoption of this statement is not expected to have a material
impact on the Companys financial position or results of operations.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SFAS No.
152, Accounting for Real Estate Time-Sharing Transactions-an amendment of SFAS No. 66 and
67,amends SFAS No. 66 to reference the financial accounting and reporting guidance for
real estate time-sharing transactions that is provided in American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 04-02. This statement also amends
SFAS No. 67 to state that the guidance for incidental operations and costs incurred to
sell real estate projects does not apply to real estate time-sharing transactions. The
accounting for those operations and costs is subject to the guidance of SOP 04-2. The adoption of this statement is not expected to have a material impact on the Companys financial position or results of operations.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

38

---

|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES  CONTINUED

| | (s) | Recently Issued Accounting Standards  continued
| | --- | ------------------------------------------------

| |  | SFAS No.
123 revised, Share-Based Payment, establishes standards for the accounting of
transactions in which an entity exchanges its equity instruments for goods or services.
The adoption of this statement is not expected to have a material impact on the Companys
financial position or results of operations.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I | n November
2004, the FASB issued SFAS No. 151, Inventory Costs--an amendment of Accounting
Research Bulletin (ARB)No. 43, Chapter 4, which clarifies the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material.
The adoption of this statement is not expected to have a material impact on the
Companys financial position or results of operations.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 2  VARIABLE
INTEREST ENTITY

| | I | n December 2003,
the FASB issued Revised FIN 46 (FIN 46R) to clarify certain aspects of FIN 46 including
the determination of who is the primary beneficiary of a variable interest entity (VIE).
FIN 46R postponed the effective date as to when companies are required to apply the
provisions prospectively for all variable interest entities in existence prior to January 31,
2003 until the first financial reporting period that ends after March 15, 2004.
However, for entities that are considered to be special purpose entities, the effective
date of FIN 46R is financial reporting periods after December 15, 2003. The Company
does not have an interest in any special purpose entities. The Company consolidated its
affiliate, Mobile Attic, Inc., upon adoption of FIN 46R in the first quarter 2004 due to
the Companys guarantee of Mobile Attics line of credit. The consolidation of
Mobile Attic increased total assets by approximately $15 million and total liabilities by
approximately $13 million. There was no effect on total shareholders equity. The
consolidation of Mobile Attic did not have a material impact on the results of operations
as the Company previously accounted for the investment under the equity method. See Note
17 for additional information related to the VIE.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 3  STATUTORY
ACCOUNTING PRACTICES

| | T | he 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, and (d) non-admitted assets (furniture and equipment, agents debit
balances and prepaid expenses) are charged directly to surplus.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

39

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 3  STATUTORY
ACCOUNTING PRACTICES  CONTINUED

|S | tatutory net
gains from operations and capital and surplus, excluding intercompany transactions, are
summarized as follows:
|- | ---------------------------------------------------------------------------------------------------------------------------

|                                                                          | 2004 | 2003 | 2002
|------------------------------------------------------------------------- | ---- | ---- | ----
|NSIC - excluding realized capital (losses) gains of $(56), $287 and $356, |      |      |     
|respectively                                                              |      |      | $   
|                                                                          |      |      |     
|NSFC - including realized capital gains of $1,847, $203 and $622,         |      |     
|respectively                                                              |      |      | $   
|                                                                          |      |      |     
|Omega - including realized capital gains of $35, $257 and $150,           |      |     
|respectively                                                              |      |      | $   
|                                                                          |      |      |     
|                                                                          |      |      |     
|Statutory capital and surplus:                                            |      |     
|NSIC - including AVR of $1,153, $1,180 and $580, respectively             |      |      | $   
|                                                                          |      |      |     
|NSFC                                                                      |      |      | $   
|                                                                          |      |      |     
|Omega                                                                     |      |      | $   
|                                                                          |      |      |     

|T | he 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.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

40

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 4  INVESTMENT
SECURITIES

| |  | The amortized
cost and aggregate fair values of investments in securities are as follows:
| |  | -----------------------------------------------------------------------------------------

|                                                   | (Dollars in thousands)
December 31, 2004
|-------------------------------------------------- | ----------------------------------------
|
|Available-for-sale securities:                     |                                         
|Corporate debt securities                          |                                         
|Obligations of states and political subdivisions   |                                         
|U.S. Treasury securities and obligations of        |                                         
|U.S. government corporations and agencies          |                                         
|                                                   |                                         
|Total fixed maturities                             |                                         
|Equity securities                                  |                                         
|                                                   |                                         
|Total                                              |                                         
|                                                   |                                         
|Held-to-maturity securities:                       |                                         
|Obligations of states and political subdivisions $ |                                         
|U.S. Treasury securities and obligations of        |                                         
|U.S. government corporations and agencies          |                                         
|                                                   |                                         
|Total                                              |                                         
|                                                   |                                         

|                                                   | December 31, 2003
|-------------------------------------------------- | -----------------
|
|Available-for-sale securities:                     |                  
|Corporate debt securities                          |                  
|Obligations of states and political subdivisions   |                  
|U.S. Treasury securities and obligations of        |                  
|U.S. government corporations and agencies          |                  
|                                                   |                  
|Total fixed maturities                             |                  
|Equity securities                                  |                  
|                                                   |                  
|Total                                              |                  
|                                                   |                  
|Held-to-maturity securities:                       |                  
|Obligations of states and political subdivisions $ |                  
|U.S. Treasury securities and obligations of        |                  
|U.S. government corporations and agencies          |                  
|                                                   |                  
|Total                                              |                  
|                                                   |                  
|                                                   |                  

41

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 4  INVESTMENT
SECURITIES  CONTINUED

The amortized cost and aggregate
fair value of debt securities at December 31, 2004, 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 or prepayment
penalties.

|                                       | (Dollars in Thousands)
|-------------------------------------- | ----------------------
|
|Due in one year or less                |                       
|Due after one year through five years  |                       
|Due after five years through ten years |                       
|Due after ten years                    |                       
|                                       |                       
|Total                                  |                       
|                                       |                       
|Held-to-maturity securities:           |                       
|Due in one year or less                |                       
|Due after one year through five years  |                       
|Due after five years through ten years |                       
|Due after ten years                    |                       
|                                       |                       
|Total                                  |                       
|                                       |                       

For 2004, gross gains of $2,218,867
($2,266,000 for 2003 and $1,412,000 for 2002) and gross losses of $129,880 ($858,000 for
2003 and $318,000 for 2002) were realized on sales of available-for-sale-securities.

During the first quarter of 2003 the
Company transferred certain corporate bonds from the SFAS No. 115 classification of
held-to-maturity to available-for -sale. This decision was made due to circumstances
considered by the Company to be both unusual and nonrecurring, which could not have been
reasonably anticipated. With interest rates at four decade lows and corporate bond spreads
extremely tight relative to U.S Treasury securities, the Company intends to sell certain
(primarily corporate) bonds which were previously held in the SFAS No. 115 classification
of held-to-maturity. The proceeds of these bonds will be reinvested primarily in agency
securities and in the process raise the overall credit quality of the portfolio. The net
carrying amount of the securities transferred was $9,833,000 and unrealized gains (net of
tax) on these securities totaled $467,000 at the transfer date.

The gross unrealized investment
losses and related fair value for securities available-for-sale at December 31, 2004 were
as follow:

|                               | (Dollars in thousands)
|------------------------------ | ----------------------
|
|
|Fixed maturities               |                       
|Corporate                      |                       
|Obligations of state and       |                       
|political subdivisions         |                       
|U.S. Treasury securities and   |                       
|obligations of U.S. government |                       
|corporations and agencies      |                       
|Equity securities              |                       
|                               |                       
|                               |                       
|                               |                       

42

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 4  INVESTMENT
SECURITIES  CONTINUED

All unrealized losses are reviewed to
determine whether the losses are other than temporary.  Factors considered include
whether the securities are backed by the U.S. Government or its agencies and concerns
surrounding the recovery of full principal.  Management believes the unrealized
losses are market driven and no ultimate loss will occur.

# NOTE 5  NET
INVESTMENT INCOME

Major categories of investment income
are summarized as follows:

|                                          | (Dollars in thousands)
Year ended December 31,
|----------------------------------------- | ----------------------------------------------
|
|Fixed maturities                          |                                               
|Equity securities                         |                                               
|Mortgage loans on real estate             |                                               
|Investment real estate                    |                                               
|Policy loans                              |                                               
|Other, principally short-term investments |                                               
|                                          |                                               
|                                          |                                               
|Less: Investment expenses                 |                                               
|                                          |                                               
|Net investment income                     |                                               
|                                          |                                               

|An analysis of investment gains follows: | Year ended December 31,
|---------------------------------------- | -----------------------
|
|Net realized investment gains (losses):  |                        
|Fixed maturities                         |                        
|Other, principally equity securities     |                        
|                                         |                        
|                                         |                        
|                                         |                        

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

|                                                                 | Year ended December 31,
|---------------------------------------------------------------- | -----------------------
|
|Net (decrease) increase in unrealized appreciation on available- |                        
|for-sale securities before deferred tax                          |                        
|Deferred income tax                                              |                        
|                                                                 |                        
|Net (decrease) increase in unrealized appreciation on available- |                        
|for-sale securities                                              |                        
|                                                                 |                        

43

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 6 - PROPERTY AND
EQUIPMENT

At December 31, property and
equipment consisted of the following:

|                                     | (Dollars in Thousands)
|------------------------------------ | ----------------------
|
|Building and improvements            |                       
|Electronic data processing equipment |                       
|Leasing equipment                    |                       
|Furniture and fixtures               |                       
|                                     |                       
|                                     |                       
|Less accumulated depreciation        |                       
|                                     |                       
|                                     |                       
|                                     |                       

Depreciation expense for the year ended
December 31, 2004 was $805,000 ($686,000 for the year ended December 31, 2003 and $289,000
for the year ended December 31, 2002).

NOTE 7  INCOME TAXES

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

|                                                     | (Dollars in thousands)
|---------------------------------------------------- | ----------------------
|
|
|Federal income tax rate applied to pre-tax income    |                       
|Dividends received deduction and tax-exempt interest |                       
|Small life insurance company deduction               |                       
|Other, net                                           |                       
|                                                     |                       
|Federal income tax expense                           |                       
|                                                     |                       

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

44

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 7  INCOME TAXES  CONTINUED

The tax effect of significant differences representing deferred assets and liabilities are as follows:

|                                                  | (Dollars in Thousands)
|------------------------------------------------- | ----------------------
|
|
|General insurance expenses                        |                       
|Unearned premiums                                 |                       
|Claim liabilities                                 |                       
|Policy liabilities                                |                       
|                                                  |                       
|Deferred tax assets                               |                       
|Depreciation                                      |                       
|Deferred policy acquisition costs                 |                       
|Unrealized gains on securities available-for-sale |                       
|                                                  |                       
|Deferred tax liabilities                          |                       
|                                                  |                       
|Net deferred tax liability                        |                       
|                                                  |                       

The appropriate income tax effects of changes in temporary differences are as follows:

|                                             | Year ended December 31,
|-------------------------------------------- | -----------------------
|
|Deferred policy acquisition costs            |                        
|Policy liabilities                           |                        
|Unearned premiums                            |                        
|General insurance expenses                   |                        
|Alternative minimum tax credit carryforwards |                        
|Depreciation                                 |                        
|Claim liabilities                            |                        
|                                             |                        
|                                             |                        
|                                             |                        

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, 2004, 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 income tax liability not recognized is approximately $1,270,000 at December 31,
2004.

45

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 8  NOTES PAYABLE AND LONG-TERM DEBT

Long-term debt consisted of the following as of December 31:

|                                                                        | (Dollars in thousands)
|----------------------------------------------------------------------- | ----------------------
|
|Note payable to bank with an interest rate based on prime plus 50 basis |                       
|points which was 4.5% at December 31, 2003; matured April 2004          |                       
|                                                                        |                       
|Note payable to bank with an interest rate based on LIBOR               |                       
|(5.15% at December 31, 2004 and 3.87% at December 31, 2003)             |                       
|dated March, 2002; maturity March, 2007. Payments  of $112,953          |                       
|due quarterly with balloon payment at maturity. Unsecured               |                       
|Note payable to bank with an interest rate based on prime minus 25      |                       
|basis points (5.00% at December 31, 2004) dated June, 2004;             |                       
|maturity June, 2007. Interest payments due quarterly.  Secured by       |                       
|$14,462 of leasing equipment                                            |                       
|                                                                        |                       
|                                                                        |                       
|                                                                        |                       

Aggregate maturities of long-term
debt for each of the three years subsequent to December 31, 2004 are as follows (dollars
in thousands): 2005-$351; 2006-$365; 2007-$15,120.

# NOTE 9  POLICY AND CLAIM RESERVES

At December 31, policy and claim reserves consisted of the following:

|                           | 2004 | 2003
|-------------------------- | ---- | ----
|Benefit and loss reserves  |      |     
|Property and casualty      |      |     
|Accident and health        |      |     
|Life and annuity           |      |     
|Unearned premiums          |      |     
|Policy and contract claims |      |     
|                           |      |     
|                           |      |     
|                           |      |     

46

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 9  POLICY AND CLAIM RESERVES  CONTINUED

The following table is a
reconciliation of beginning and ending property and casualty reserve balances for claims
and claim adjustment expense for the years ended December 31:

|                                            | (Dollars in thousands)
|------------------------------------------- | ----------------------
|
|Claims and claim adjustment expense         |                       
|reserves at beginning of year               |                       
|Less reinsurance recoverables on            |                       
|unpaid losses                               |                       
|                                            |                       
|Net balances at beginning of year           |                       
|Provision for claims and claim adjustment   |                       
|expenses for claims arising in current year |                       
|Estimated claims and claim adjustment       |                       
|expenses for claims arising in prior years  |                       
|                                            |                       
|Total increases                             |                       
|Claims and claim adjustment expense         |                       
|payments for claims arising in:             |                       
|Current year                                |                       
|Prior years                                 |                       
|                                            |                       
|Total payments                              |                       
|                                            |                       
|Net balance at end of year                  |                       
|Plus reinsurance recoverables on            |                       
|unpaid losses                               |                       
|                                            |                       
|Claims and claim adjustment expense         |                       
|reserves at end of year                     |                       
|                                            |                       

The provision for claims and claim
adjustment expenses for prior years (net of reinsurance recoveries) decreased in 2004 and
2003 because of lower-than-anticipated losses in homeowners and dwelling fire lines of
business. As a result of changes in estimates of insured events in prior years, the
provision for claims and claim adjustment expenses (net of reinsurance recoveries)
decreased in 2002 because of lower-than-anticipated losses in commercial and private
passenger automobile lines of business.

The Company has a geographic exposure
to catastrophe losses in certain areas of the country. Catastrophes can be caused by
various events including hurricanes, windstorms, earthquakes, hail, severe winter weather,
explosions and fires, and the incidence and severity of catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of both the total
amount of insured exposure in the area affected by the event and the severity of the
event. Most catastrophe losses are restricted to small geographic areas; however,
hurricanes and earthquakes may produce significant damage in large, heavily populated
areas. The Company generally seeks to reduce its exposure to catastrophes through
individual risk selection and the purchase of catastrophe reinsurance.

# NOTE 10  REINSURANCE

The Companys insurance operations participate in reinsurance in order to limit losses,
minimize exposure to large risks, provide additional capacity for future growth and effect
business-sharing arrangements. Life reinsurance is accomplished through yearly renewable
term. Property and casualty reinsurance is placed on both a quota-share and excess of loss
basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the
primary insurer, except for cases involving a novation. Failure of reinsurers to honor
their obligations could result in losses to the insurance subsidiaries. The insurance
subsidiaries evaluate the financial conditions 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, 2004,

47

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 10  REINSURANCE  CONTINUED

reinsurance receivables with a
carrying value of $326,000 ($765,000 at December 31, 2003) and prepaid reinsurance
premiums of $467,000 ($496,000 at December 31, 2003) were associated with a single
reinsurer. The amounts of recoveries pertaining to reinsurance contracts that were
deducted from losses incurred during 2004, 2003 and 2002 were approximately $11,284,000,
$580,000, and $374,000, respectively. The significant increase in recoveries pertaining to
reinsurance contracts in 2004 compared to prior years was due to reinsurance associated
will losses incurred from hurricane Ivan. The effect of reinsurance on premiums written
and earned was as follows:

|        | (Dollars in Thousands)
|------- | ----------------------
|
|
|
|Direct  |                       
|Assumed |                       
|Ceded   |                       
|        |                       
|Net     |                       
|        |                       

|        | 2003
|------- | ----
|
|
|Direct  |     
|Assumed |     
|Ceded   |     
|        |     
|Net     |     
|        |     

|        | 2002
|------- | ----
|
|
|Direct  |     
|Assumed |     
|Ceded   |     
|        |     
|Net     |     
|        |     

# NOTE 11  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 2004, 2003, and 2002 amounted to
$189,000, $228,000, and $177,000, 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 2004, 2003, and 2002 amounted to

48

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 11  EMPLOYEE BENEFIT PLAN  CONTINUED

approximately $208,000, $421,000, and $19,000, respectively. The deferred
compensation plan was frozen on December 31, 2004. It is anticipated that a new plan will
be adopted during 2005 to allow directors to defer fees under a non-qualified plan. Until
such plan is adopted all fees will be paid in cash.

# NOTE 12  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, 2004,
NSICs retained earnings unrestricted for the payment of dividends in 2005 amounted
to $1,029,000.

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. At December 31, 2004, NSFCs retained earnings unrestricted for the payment of
dividends in 2005 amounted to $2,376,000.

At December 31, 2004, securities with
market values of $3,655,000 ($3,606,000 at December 31, 2003) 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 13 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.

49

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 14  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, 2004, 2003 and 2002 are summarized
below:

|(Dollars in thousands)                           |  |  |   |        
|------------------------------------------------ |  |  | - | -------
|
|Year ended December 31, 2004                     |  |  |   |        
|Revenues                                         |  | 
|Net premiums earned                              |  |  | $ | 52,985 
|Net investment income                            |  |  |   | 4,328  
|Net realized investment gains                    |  |  |   | 2,162  
|Net revenues from leasing operations             |  |  |   | 2,459  
|Other income (loss)                              |  |  |   | 1,312  
|                                                 |  |  |   |        
|                                                 |  |  | $ | 63,246 
|                                                 |  |  |   |        
|Income (loss) before income taxes:               |  |  | $ | 4,580  
|Interest expense                                 |  |  |   | 727    
|                                                 |  |  |   |        
|                                                 |  |  | $ | 3,853  
|                                                 |  |  |   |        
|Assets                                           |  |  | $ | 128,631
|                                                 |  |  |   |        
|Amortization of deferred policy aquisition costs |  |  | $ | 2,221  
|                                                 |  |  |   |        
|Depreciation expense                             |  |  | $ | 805    
|                                                 |  |  |   |        
|Capital expenditures                             |  |  | $ | 1,327  
|                                                 |  |  |   |        

50

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 14  INDUSTRY SEGMENTS  CONTINUED

|(Dollars in thousands)                           |  |  |   |        
|------------------------------------------------ |  |  | - | -------
|
|Year ended December 31, 2003                     |  |  |   |        
|Revenues                                         |  | 
|Net premiums earned                              |  |  | $ | 47,536 
|Net investment income                            |  |  |   | 4,080  
|Net realized investment gains                    |  |  |   | 1,416  
|Net revenues from leasing operations             |  |  |   | 1,433  
|Other income                                     |  |  |   | 1,395  
|                                                 |  |  |   |        
|                                                 |  |  | $ | 55,860 
|                                                 |  |  |   |        
|Income (loss) before income taxes:               |  |  | $ | 6,260  
|Interest expense                                 |  |  |   | 632    
|                                                 |  |  |   |        
|                                                 |  |  | $ | 5,628  
|                                                 |  |  |   |        
|Assets                                           |  |  | $ | 127,236
|                                                 |  |  |   |        
|Amortization of deferred policy aquisition costs |  |  | $ | 1,825  
|                                                 |  |  |   |        
|Depreciation expense                             |  |  | $ | 686    
|                                                 |  |  |   |        
|Capital expenditures                             |  |  | $ | 8,079  
|                                                 |  |  |   |        

51

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 14  INDUSTRY SEGMENTS  CONTINUED

|(Dollars in thousands)                           |  |  |   |        
|------------------------------------------------ |  |  | - | -------
|
|Year ended December 31, 2002                     |  |  |   |        
|Revenues                                         |  | 
|Net premiums earned                              |  |  | $ | 32,631 
|Net investment income                            |  |  |   | 4,235  
|Net realized investment gains                    |  |  |   | 1,168  
|Net revenues from leasing operations             |  |  |   | 942    
|Other income                                     |  |  |   | 1,051  
|                                                 |  |  |   |        
|                                                 |  |  | $ | 40,027 
|                                                 |  |  |   |        
|Income (loss) before income taxes:               |  |  | $ | 1,880  
|Interest expense                                 |  |  |   | 410    
|                                                 |  |  |   |        
|                                                 |  |  | $ | 1,470  
|                                                 |  |  |   |        
|Assets                                           |  |  | $ | 108,098
|                                                 |  |  |   |        
|Amortization of deferred policy aquisition costs |  |  | $ | 1,406  
|                                                 |  |  |   |        
|Depreciation expense                             |  |  | $ | 289    
|                                                 |  |  |   |        
|Capital expenditures                             |  |  | $ | 7,658  
|                                                 |  |  |   |        

# NOTE 15  CONTINGENCIES

Litigation

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.

In two separate actions, NSIC is
named as a defendant in purported class actions relating to the past sale of industrial
burial insurance. The actions address whether the premiums charged were
excessive relative to the benefit provided and whether the premiums charged
were in any manner discriminatory relative to the race of the person insured. In addition,
several individual actions on behalf of specifically named persons have been filed with
similar allegations. No class has been certified in either of the purported class actions
although a Motion for Class Certification has been filed in one of the actions. While NSIC
did at one time sell industrial burial insurance, no such plans have been sold for several
decades.

NSFC was named a defendant in a
Washington County, Alabama action alleging fraud and bad faith in connection with a claim
for wind damage to a mobile home. This action was settled in January 2004 under terms
which required that the amount be kept confidential. The amount of this settlement has
been reflected in the financial statements for the period ending December 31, 2003.

52

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|                                           |                                  
|------------------------------------------ | ---------------------------------
|Notes to Consolidated Financial Statements | The National Security Group, Inc.

# NOTE 15  CONTINGENCIES  CONTINUED

The company establishes and maintains
reserves on contingent liabilities. In many instances, however, it is not feasible to
predict the ultimate outcome with any degree of accuracy. While a resolution of these
matters may significantly impact consolidated earnings and the Companys consolidated
financial position, it remains managements opinion, based on information presently
available, that the ultimate resolution of these matters will not have a material impact on the Companys
consolidated financial position. However, it should be noted that instances of class action lawsuits against insurance companies appear
to be increasing in several states in which insurance subsidiaries of the company operate.

# NOTE 16 SUPPLEMENTAL
CASH FLOW INFORMATION

Cash paid for interest during 2004
was $645,000 ($611,000 in 2003 and $361,000 in 2002). Cash paid for income taxes in 2004
was $2,000,000 ($400,000 in 2003 and $110,000 in 2002). In 2003, Mobile Attic acquired
$7,134,950 of assets through debt ($4,637,743 in 2002).

# NOTE 17  RELATED
PARTY TRANSACTIONS

During the years ended December 31,
2004, 2003 and 2002 the Companys affiliate Mobile Attic acquired $1,389,404,
$7,199,700 and $6,497,400, respectively, of equipment from Cash Brothers Leasing, Inc.
(Cash Brothers). The principal owners of Cash Brothers are also stockholders in Mobile
Attic. Cash Brothers is also a distributor of the mobile storage units. During 2004, 2003
and 2002 Mobile Attic paid $100,526, $82,892 and $43,256, respectively, in commissions to
Cash Brothers. At December 31, 2004, Mobile Attic had accrued expenses due Cash Brothers
of $22,195.

53

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|                                                                |                                  
|--------------------------------------------------------------- | ---------------------------------
|Item 8.Consolidated Financial Statements and Supplementary Data | The National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC.          SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED)
              (Dollars in Thousands)

|                                  | December 31, 2004 | December 31, 2003
|--------------------------------- | ----------------- | -----------------
|
|United States government          |                   |                  
|States, municipalities and        |                   |                  
|political subdivisions            |                   |                  
|Public Utilities                  |                   |                  
|Industrial and Miscellaneous      |                   |                  
|                                  |                   |                  
|Total Securities Held to Maturity |                   |                  
|Securities Available for Sale:    |                   |                  
|Equity Securities:                |                   |                  
|Public utilities                  |                   |                  
|Banks and insurance companies     |                   |                  
|Industrial and all other          |                   |                  
|                                  |                   |                  
|Total equity securities           |                   |                  
|Debt Securities:                  |                   |                  
|United States government          |                   |                  
|States, municipalities and        |                   |                  
|political subdivisions            |                   |                  
|Public Utilities                  |                   |                  
|Industrial and Miscellaneous      |                   |                  
|                                  |                   |                  
|Total Debt Securities             |                   |                  
|Total Available for Sale          |                   |                  
|                                  |                   |                  
|Total Securities                  |                   |                  
|Receivable for securities         |                   |                  
|Note Receivable From Affiliate    |                   |                  
|Mortgage loans on real estate     |                   |                  
|Investment real estate            |                   |                  
|Policy loans                      |                   |                  
|Other invested assets             |                   |                  
|Short term investments            |                   |                  
|                                  |                   |                  
|Total investments                 |                   |                  
|                                  |                   |                  

54

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC. (PARENT COMPANY)                   SCHEDULE II - CONDENSED FINANCIAL
INFORMATION OF REGISTRANT                                  BALANCE SHEETS
                             (Amounts in thousands)

|                                           | December 31,
|------------------------------------------ | ------------
|
|Assets                                     |             
|Cash                                       |             
|Investment in subsidiaries (equity method) |             
|eliminated upon consolidation              |             
|Other assets                               |             
|                                           |             
|Total Assets                               |             
|                                           |             
|Liabilities and Shareholders' Equity       |             
|Accrued general expenses                   |             
|Notes Payable                              |             
|                                           |             
|Total Liabilities                          |             
|                                           |             
|Total Shareholders' Equity                 |             
|                                           |             
|Total Liabilities and Shareholders' Equity |             
|                                           |             

55

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME  (Amounts in thousands)

|                                                          | For the Years Ended December 31,
|--------------------------------------------------------- | --------------------------------
|
|Income                                                    |                                 
|From subsidiaries-eliminated upon consolidation           |                                 
|Dividends                                                 |                                 
|Other Income                                              |                                 
|                                                          |                                 
|                                                          |                                 
|                                                          |                                 
|Expenses                                                  |                                 
|State taxes                                               |                                 
|Other expenses                                            |                                 
|                                                          |                                 
|                                                          |                                 
|                                                          |                                 
|Income before income taxes and equity in                  |                                 
|undistributed earnings of subsidiaries                    |                                 
|Income tax benefit                                        |                                 
|                                                          |                                 
|Income before equity in undistributed earnings            |                                 
|of subsidiaries                                           |                                 
|Equity in undistributed earnings (losses) of subsidiaries |                                 
|                                                          |                                 
|Net Income                                                |                                 
|                                                          |                                 

56

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

# THE NATIONAL SECURITY
GROUP, INC. (PARENT COMPANY)                  SCHEDULE II - CONDENSED FINANCIAL
INFORMATION OF REGISTRANT                                  STATEMENTS OF CASH FLOWS
                                  (Amounts in thousands)

|                                                      | For the Years Ended December 31,
|----------------------------------------------------- | --------------------------------
|
|Cash flows from operatingactivities:                  |                                 
|Net income                                            |                                 
|Adjustments to reconcile net income to net            |                                 
|cash provided by operating activities:                |                                 
|Equity in undistributed (income) loss of subsidiaries |                                 
|Change in other assets                                |                                 
|Change in other liabilities                           |                                 
|                                                      |                                 
|Net cash provided by                                  |                                 
|operating activities                                  |                                 
|                                                      |                                 
|Cash flows from investing activities:                 |                                 
|Capital contribution to subsidiary                    |                                 
|                                                      |                                 
|Net cash used in                                      |                                 
|investing activities                                  |                                 
|                                                      |                                 
|Cash flows from financing activities:                 |                                 
|Proceeds from notes payable                           |                                 
|Payments on notes payable                             |                                 
|Cash dividends                                        |                                 
|                                                      |                                 
|Net cash used in                                      |                                 
|financing activities                                  |                                 
|                                                      |                                 
|Net increase (decrease) in cash and cash equivalents  |                                 
|Cash at beginning of year                             |                                 
|                                                      |                                 
|Cash at end of year                                   |                                 
|                                                      |                                 

57

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

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 28.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 2-Cash Dividends
from Subsidiaries

| | Dividends of $2.8 million in 2004, $2.3 million in 2003 and $2.7 million in 2002 were paid
to the   Registrant by its subsidiaries.
| | -----------------------------------------------------------------------------------------------------------------------------------

58

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

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

|                                       | Deferred
Acquisition
Costs | Future
Policy
Benefits | Unearned
Premiums
|-------------------------------------- | -------------------------- | ---------------------- | -----------------
|At December 31, 2004:                  |                            |                        |                  
|Life and accident and health insurance |                            |                        | $                
|Property and casualty insurance        |                            |                        |                  
|                                       |                            |                        |                  
|Total                                  |                            |                        | $                
|                                       |                            |                        |                  
|At December 31, 2003:                  |                            |                       
|Life and accident and health insurance |                            |                        | $                
|Property and casualty insurance        |                            |                        |                  
|                                       |                            |                        |                  
|Total                                  |                            |                        | $                
|                                       |                            |                        |                  
|                                       |                            |                        |                  
|At December 31, 2002:                  |                            |                       
|Life and accident and health insurance |                            |                        | $                
|Property and casualty insurance        |                            |                        |                  
|                                       |                            |                        |                  
|Total                                  |                            |                        | $                
|                                       |                            |                        |                  
|                                       |                            |                        |                  

|                                            | Premium
Revenue | Net
Investment
Income | Other
Income | Benefits,
Claims,
Losses and
Settlement
Expenses | Commissions,
Amortization
of Deferred
Policy
Acquisition
Costs | General
Expenses,
Taxes,
Licenses
and Fees
|------------------------------------------- | --------------- | --------------------- | ------------ | ------------------------------------------------ | -------------------------------------------------------------- | ------------------------------------------
|For the year ended December 31, 2004:       |                 |                       |              |                                                  |                                                                |                                           
|Life and accident and health insurance      |                 |                       | $            | 6,173                                            |                                                                | $                                         
|Property and casualty insurance             |                 |                       |              | 46,812                                           |                                                                |                                           
|Other                                       |                 |                       |              | --                                               |                                                                |                                           
|                                            |                 |                       |              |                                                  |                                                                |                                           
|Total                                       |                 |                       | $            | 52,985                                           |                                                                | $                                         
|                                            |                 |                       |              |                                                  |                                                                |                                           
|For the year ended December 31, 2003:       |                 |                      
|Life and accident and health insurance      |                 |                       | $            | 5,799                                            |                                                                | $                                         
|Property and casualty insurance . . . . . . |                 |                       |              | 41,737                                           |                                                                |                                           
|Other                                       |                 |                       |              | --                                               |                                                                |                                           
|                                            |                 |                       |              |                                                  |                                                                |                                           
|Total                                       |                 |                       | $            | 47,536                                           |                                                                | $                                         
|                                            |                 |                       |              |                                                  |                                                                |                                           
|For the year ended December 31, 2002:       |                 |                      
|Life and accident and health insurance      |                 |                       | $            | 5,395                                            |                                                                | $                                         
|Property and casualty insurance             |                 |                       |              | 27,236                                           |                                                                |                                           
|Other                                       |                 |                       |              | --                                               |                                                                |                                           
|                                            |                 |                       |              |                                                  |                                                                |                                           
|Total                                       |                 |                       |              | 32,631                                           |                                                                |                                           
|                                            |                 |                       |              |                                                  |                                                                |                                           

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

59

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|                                                                 |                              
|---------------------------------------------------------------- | -----------------------------
|Item 8. Consolidated Fianacial Statements and Supplementary Data | National Security Group, Inc.

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

|                                                 | Gross
Amount | Ceded
to Other
Companies | Assumed
from Other
Companies | Net
Amount | Percentage
of Amount
Assumed
to Net |  
|------------------------------------------------ | ------------ | ------------------------ | ---------------------------- | ---------- | ----------------------------------- | -
|For the year ended December 31, 2004:            |              |                          |                              |            |                                     |  
|Life insurance in force                          |              | $   186,474              |                              | $   8,441  |                                     | $
|                                                 |              |                          |                              |            |                                     |  
|Premiums:                                        |             
|Life insurance and accident and health insurance |              | 6,200                    |                              | 27         |                                     |  
|Property and casualty insurance                  |              | 51,676                   |                              | 4,864      |                                     |  
|                                                 |              |                          |                              |            |                                     |  
|Total premiums                                   |              | $   57,876               |                              | $4,891     |                                     | $
|                                                 |              |                          |                              |            |                                     |  
|For the year ended December 31, 2003:            |             
|Life insurance in force                          |              | $   186,555              |                              | $7,803     |                                     | $
|                                                 |              |                          |                              |            |                                     |  
|Premiums:                                        |             
|Life insurance and accident and health insurance |              | 5,844                    |                              | 45         |                                     |  
|Property and casualty insurance . . . . . . . .  |              | 44,360                   |                              | 3,123      |                                     |  
|                                                 |              |                          |                              |            |                                     |  
|Total premiums                                   |              | $   50,204               |                              | $3,168     |                                     | $
|                                                 |              |                          |                              |            |                                     |  
|For the year ended December 31, 2002:            |             
|Life insurance in force                          |              | $   183,393              |                              | $6,920     |                                     | $
|                                                 |              |                          |                              |            |                                     |  
|Premiums:                                        |             
|Life insurance and accident and health insurance |              | 5,441                    |                              | 45         |                                     |  
|Property and casualty insurance                  |              | 29,350                   |                              | 2,115      |                                     |  
|                                                 |              |                          |                              |            |                                     |  
|Total premiums                                   |              | $   34,791               |                              | $2,160     |                                     | $
|                                                 |              |                          |                              |            |                                     |  

60

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| |                              
| | -----------------------------
| | National Security Group, Inc.

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

None.

# Item 9A. Controls and Procedures

Company management, including the
Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the
effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14.
Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this quarterly report has been made known to
them in a timely fashion. There have been no significant changes in internal controls, or
in factors that could significantly affect internal controls, subsequent to the date the
Chief Executive Officer and Chief Financial Officer completed their evaluation.

The National Security Group, Inc., as
a non-accelerated filer, must be in compliance with Section 404 of The Sarbanes-Oxley Act
for year end 2006. Management is currently performing documentation procedures in
preliminary assessment on internal controls over financial reporting in order to document
and evaluate the current controls in place in order to form a basis for future testing
required for compliance with Section 404 of the Sarbanes-Oxley Act. In the past,
management has relied on existing controls although said controls may not have been in
unabridged written form.

# Item 9B. Other Information

None

61

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|           |                              
|---------- | -----------------------------
|Signatures | National Security Group, Inc.

# PART III

# Item 10. Directors and Executive Officers of the Registrant

This item is omitted because a
definitive proxy statement that involves the election of directors will be filed with the
Securities and Exchange Commission not later than 120 days after the close of the
fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by
reference.

# Item 11. Executive Compensation

This item is omitted because a
definitive proxy statement that involves the election of directors will be filed with the
Securities and Exchange Commission not later than 120 days after the close of the
fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by
reference.

# Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

This item is omitted because a
definitive proxy statement that involves the election of directors will be filed with the
Securities and Exchange Commission not later than 120 days after the close of the
fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by
reference.

# Item 13. Certain Relationships and Related Transactions

This item is omitted because a
definitive proxy statement that involves the election of directors will be filed with the
Securities and Exchange Commission not later than 120 days after the close of the
fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by
reference.

# Item 14. Principal Accountant Fees and Services

This item is omitted because a
definitive proxy statement that involves the election of directors will be filed with the
Securities and Exchange Commission not later than 120 days after the close of the
fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by
reference.

62

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|           |                              
|---------- | -----------------------------
|Signatures | National Security Group, Inc.

# PART IV

# Item 15 (a) (1) Exhibits and Financial Statement Schedules

The following consolidated financial
statements, notes thereto and related information of The National Security Group, Inc.
(the Company) are included in Item 8 beginning on page 28.

Report of Independent Registered
Public Accounting Firm

Consolidated Statements of Income

Consolidated Balance Sheets

Consolidated Statements of
Shareholders' Equity

Consolidated Statements of Cash Flows

Consolidated Notes to the Financial
Statements

# Item 15 (a) (2)

The following additional financial
statement schedules are furnished herewith pursuant to the requirements of Form 10-K.

|The National Security Group, Inc. | Page                                              
|--------------------------------- | --------------------------------------------------
|Schedule I                        | Summary of Investments                            
|Schedule II                       | Condensed Financial Information of the Registrant 
|Schedule III                      | Supplementary Insurance Information (Consolidated)
|Schedule IV                       | Reinsurance (Consolidated)                        

# Item 15 (a) (3)

The following is a list of the
exhibits filed as part of this Form 10-K:

|3      | Amended Certificate of Incorporation filed with the Secretary of State of Delaware on August 2, 2004.                   
|------ | ------------------------------------------------------------------------------------------------------------------------
|11     | Computation of Earnings Per Share Filed Herewith, See Note 1 to Consolidated Financial Statements                       
|21     | Subsidiaries of the registrant.                                                                                         
|31.1   | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|31.2   | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|32.1   | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|32.1.1 | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes Oxley Act of 2002

63

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|           |                              
|---------- | -----------------------------
|Signatures | National Security Group, Inc.

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

# Item 15 (b)

During the last fiscal quarter of the
period covered by this Report, the Company filed the following Current Reports on Form
8-K:

|Date of Report    | Date Filed        | Description                                                                        
|----------------- | ----------------- | -----------------------------------------------------------------------------------
|November 2, 2004  | November 2, 2004  | Press release, dated November 2, 2004, issued by The National Security Group, Inc. 
|November 12, 2004 | November 12, 2004 | Press release, dated November 12, 2004, issued by The National Security Group, Inc.

64

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|           |                              
|---------- | -----------------------------
|Signatures | National Security Group, Inc.

# 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/ Brian R. McLeodBrian R. McLeod Chief Financial Officer andTreasurer | /s/ William L. Brunson, JrWilliam L.Brunson, Jr.President, Chief Executive Officer and Director

Date: March 31, 2005 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 March 31, 2005.

SIGNATURE

|/s/ Winfield Baird         | /s/ Mickey L. Murdock  
|-------------------------- | -----------------------
|/s/ Carolyn Brunson        | /s/ Donald Pittman     
|/s/ Jack R. Brunson        | /s/ Fleming Brooks     
|/s/ Jack E. Brunson        | /s/ Paul C. Wesch      
|/s/ William L. Brunson, Jr | /s/ L. Brunson White   
|/s/ Fred D. Clark, Jr      | /s/ Walter P. Wilkerson
|/s/ Frank B. O'Neil       

65

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|         |                              
|-------- | -----------------------------
|Exhibits | National Security Group, Inc.

# Exhibit 31.1CERTIFICATION

Certification of Chief Executive Officer

I, William L. Brunson, Jr. certify
that:

| | 1. | I
have reviewed this annual report on Form 10-K of The National Security Group, Inc.;
| | -- | -------------------------------------------------------------------------------------

| | 2. | Based
on my knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
   with respect to the period covered by this report;
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Based
on my knowledge, the financial statements, and other financial information included in this report, fairly present   3 in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | The registrants other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (a) | Designed such disclosure controls and procedures, or caused such disclosure
               controls and procedures to be designed under our supervision, to ensure that
               material information relating to the registrant, including its  
               consolidated subsidiaries, is made known to us by others within those entities,
               particularly during the period in which this report is being prepared;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Evaluated the effectiveness of the registrants disclosure controls and
               procedures and presented in this report   our conclusions about the
               effectiveness of the disclosure controls and procedures, as of the end of the
               period covered by this report based on such evaluation; and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Disclosed in this report any change in the registrants internal control
               over financial reporting that occurred during the registrants most recent
               fiscal quarter (the registrants fourth fiscal quarter in the case of an
                 annual report) that has materially affected, or is reasonably likely to
               materially affect, the registrants internal control over financial
               reporting; and
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
registrants other certifying officer(s) and I have disclosed, based on
               our most recent evaluation of internal control over financial
               reporting, to the registrants auditors and the audit committee of
the                registrants board of directors (or persons performing the equivalent functions):
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | All significant deficiencies and material weaknesses in the design or operation
               of internal control over financial reporting which are reasonably likely to
               adversely affect the registrants ability to record, process, summarize and
               report financial information; and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrants internal control over financial
reporting.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 31, 2005

| |  | BY: /S/ William L. Brunson Jr.
William L. Brunson, Jr.Chief Executive Officer
| |  | -------------------------------------------------------------------------------------------

66

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|                                      |                              
|------------------------------------- | -----------------------------
|Certification Chief Financial Officer | National Security Group, Inc.

# Exhibit 31.2CERTIFICATION

Certification of Chief Financial Officer

I, Brian R. McLeod, certify that:

| | 1. | I
have reviewed this annual report on Form 10-K of The National Security Group, Inc.;
| | -- | -------------------------------------------------------------------------------------

| | 2. | Based
on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were  made, not misleading with respect to the period covered by this report;
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Based
on my knowledge, the financial statements, and other financial information
               included in this report, fairly present in all material respects
the                financial condition, results of operations and cash flows of the
registrant as                of, and for, the periods presented in this report;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | The registrants other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (a) | Designed such disclosure controls and procedures, or caused such disclosure
               controls and procedures to be designed under our supervision, to ensure that
               material information relating to the registrant, including its  
               consolidated subsidiaries, is made known to us by others within those entities,
               particularly during the period in which this report is being prepared;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Evaluated the effectiveness of the registrants disclosure controls and
               procedures and presented in this report   our conclusions about the
               effectiveness of the disclosure controls and procedures, as of the end of the
               period covered by this report based on such evaluation; and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Disclosed in this report any change in the registrants internal control
               over financial reporting that occurred during the registrants most recent
               fiscal quarter (the registrants fourth fiscal quarter in the case of an
                 annual report) that has materially affected, or is reasonably likely to
               materially affect, the registrants internal control over financial
               reporting; and
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5 . | The
registrants other certifying officer(s) and I have disclosed, based on
               our most recent evaluation of internal control over financial
               reporting, to the registrants auditors and the audit committee of
the                registrants board of directors (or persons performing the equivalent functions):
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) | All significant deficiencies and material weaknesses in the design or operation
               of internal control over   financial reporting which are reasonably likely
               to adversely affect the registrants ability to record, process, summarize
               and report financial information; and
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Any
fraud, whether or not material, that involves management or other employees who have a
significant role in the registrants internal control over financial reporting.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date:  March 31, 2005

| |  | BY: /S/ Brian R. McLeod
Brian R. McLeod, CPAChief Financial Officer
| |  | ---------------------------------------------------------------------------------

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|                                      |                              
|------------------------------------- | -----------------------------
|Certification Chief Financial Officer | National Security Group, Inc.

# Exhibit 32.1CERTIFICATION

Certification of Chief Executive Officer

Pursuant to 18 U.S.C. § 1350,
the undersigned officer of the National Security Group, Inc. (the Company),
hereby certifies, to such officers knowledge, that the Companys Quarterly
Report on Form 10-K for the fiscal year ended December 31, 2004 (the Report)
fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the
Securities Exchange Act of 1934 and the information contained in the Report fairly
presents, in all material respects, the financial condition and results of operations of
the Company.

Date: March 31, 2005

| |  | BY: /S/ William L. Brunson Jr.
Name: William L. Brunson, Jr.Title: Chief Executive Officer
| |  | --------------------------------------------------------------------------------------------------------

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|                                      |                              
|------------------------------------- | -----------------------------
|Certification Chief Financial Officer | National Security Group, Inc.

# Exhibit 32.2 CERTIFICATION

Certification of Chief Financial Officer

Pursuant to 18 U.S.C. § 1350,
the undersigned officer of The National Security Group, Inc. (the Company),
hereby certifies, to such officers knowledge, that the Companys Quarterly
Report on Form 10-K for the fiscal year ended December 31, 2004 (the Report)
fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the
Securities Exchange Act of 1934 and the information contained in the Report fairly
presents, in all material respects, the financial condition and results of operations of
the Company.

Date: March 31, 2005

| |  | BY: /S/ Brian R. McLeod
Name: Brian R. McLeod, CPATitle: Chief Financial Officer
| |  | ----------------------------------------------------------------------------------------------

69

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