UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549



# FORM 10-K

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



For the fiscal year
ended December 31, 2003Commission File Number
0-18649



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



|Delaware                                                      | 63-1020300                          
|------------------------------------------------------------- | ------------------------------------
|(State or other jurisdiction ofincorporation or organization) | (IRS Employer identification number)
|                                                              |                                     

661 East Davis
Street Elba, Alabama 36323(Address of principal executive
offices) (Zip code)



Registrants
telephone number, including area code (334) 897-2273

Securities
registered pursuant to Section 12(b) of the Act: None



Securities registered
pursuant to Section 12(g) of the Act:Common stock par
value $1.00 per shareTitle of Each Class





Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. (X) 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
amendments to this Form 10-K. (X)

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

Aggregate market value of the voting
stock held by nonaffiliates of the Registrant as of February 27, 2004 (based upon the bid
price of these shares on NASDAQ on such date)  $24,819,690.

Number of Shares of Common Stock
outstanding as of February 27, 2004  2,466,600

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

Total Number of
Sequentially Numbered Pages: 65

---

THE NATIONAL SECURITY
GROUP, INC.INDEX TO THE ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 2003





|         |                                                                                       |     
|-------- | ------------------------------------------------------------------------------------- | ----
|Part I   |                                                                                       | Page
|Item 1   | Business                                                                              | 3   
|Item 2   | Properties                                                                            | 12  
|Item 3   | Legal Proceedings                                                                     | 12  
|Item 4   | Submission of Matters to a Vote of Security Holders                                   | 12  
|Part II 
|Item 5   | Market for Registrant's Common Equity and Related Stockholder Matters                 | 13  
|Item 6   | Selected Financial Data                                                               | 14  
|Item 7   | Management's Discussion and Analysis of Financial Condition and Results of Operations | 15  
|Item 7A  | Quantitative and Qualitative Disclosures About Market Risk                            | 22  
|Item 8   | Consolidated Financial Statements and Supplementary Data                              | 23  
|Item 9   | Changes in and Disagreements with Accountants on Financial Disclosure                 | 58  
|Part III
|Item 10  | Directors and Executive Officers of the Registrant                                    | 59  
|Item 11  | Executive Compensation                                                                | 59  
|Item 12  | Security Ownership of Certain Beneficial Owners and Management                        | 59  
|Item 13  | Certain Relationships and Related Transactions                                        | 59  
|Item 14  | Controls and Procedures                                                               | 59  
|Part IV 
|Item 15  | Exhibits, Financial Statement Schedules and Reports of Form 8-K                       | 60  
|         | Signature Page                                                                        | 61  
|         | Certifications                                                                        | 62  
|        

-2-

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# 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. The Company, through its life insurance subsidiary, offers
a basic line of life, and health and accident insurance products. Property-casualty
insurance is the most significant segment, accounting for 88% of total premium revenues.

Industry Segment and
Geographical Area Information

# Property and Casualty
Insurance Segment

The Companys property and
casualty insurance business is conducted through National Security Fire & Casualty
Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One
Insurance Company (Omega), a wholly owned subsidiary of National Security Fire &
Casualty Company organized in 1992. NSFC is licensed to write insurance in the states of
Alabama, Arkansas, Florida, Georgia, Mississippi, Oklahoma, South Carolina, and Tennessee,
and operates on a surplus lines basis in the states of Kentucky, Louisiana, Missouri, and
Texas. Omega is licensed to write insurance in Alabama and Louisiana. The following table
indicates those states, which accounted for more than five percent of direct written
premium during 2003:

|State          | Percent of direct written premium
|-------------- | ---------------------------------
|Alabama        | 37.71                            
|Arkansas       | 8.49                             
|Georgia        | 6.83                             
|Louisiana      | 5.85                             
|Mississippi    | 21.93                            
|South Carolina | 8.06                             

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

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

-3-

---

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

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

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

# Life Insurance Segment

National Security Insurance Company
(NSIC), a wholly owned subsidiary organized in 1947, conducts the Companys life
insurance business. NSIC is licensed to write insurance in six states: Alabama, Florida,
Georgia, Mississippi, South Carolina, and Texas. The following table indicates NSIC direct
premiums collected by state in 2003:

|State       | Percentage of Total Direct Premiums
|----------- | -----------------------------------
|Alabama     |                                    
|Georgia     |                                    
|Mississippi |                                    
|Florida     |                                    
|            |                                    

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 53% 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 of the
Company. The independent agent distribution method accounts for 39% 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 products offered by NSIC primarily consist of
term and whole life insurance and supplemental accident and health insurance. NSIC does
not sell annuities.

-4-

---

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.

The sale of accident and health
insurance products through the independent agent method of distribution have increased
significantly over the past three years and is now the primary method of distribution of
accident and health products. NSIC also sells accident policies through schools, however
this product now accounts for less than 10% of total accident and health insurance premium
revenue. Accident and health insurance provides coverage for losses sustained through
sickness or accident and includes individual hospitalization and accident policies, group
supplementary health policies and specialty products, such as cancer policies. These
policies generally provide a stated benefit and have not experienced the escalating health
care costs, which many health and accident insurance policies have experienced in recent
years.

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

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

-5-

---

# Selected Segment
Financial Information

The Companys operating segments
are organized by line of business: property and casualty insurance, life insurance, and
noninsurance operations. Presented below is the summarized financial information for the
Companys three business segments as of the years ended December 31, 2003, 2002 and
2001:

|                                                 | 2003 | 2002 | 2001
|------------------------------------------------ | ---- | ---- | ----
|Premiums and other revenues                      |      |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|Noninsurance operations                          |      |      |     
|                                                 |      |      |     
|Total premiums and other revenues                |      |      |     
|                                                 |      |      |     
|Net Investment Income                            |      |     
|Insurance operations                             |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|Noninsurance operations                          |      |      |     
|                                                 |      |      |     
|Total net investment income                      |      |      |     
|                                                 |      |      |     
|Net Realized Investment Gains                    |      |     
|Insurance operations                             |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|Noninsurance operations                          |      |      |     
|                                                 |      |      |     
|Total net realized investment gains              |      |      |     
|                                                 |      |      |     
|Other Income                                     |      |     
|Insurance operations                             |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|Noninsurance operations                          |      |      |     
|                                                 |      |      |     
|Total other income                               |      |      |     
|                                                 |      |      |     
|Total Income                                     |      |      |     
|                                                 |      |      |     
|Insurance Expenses                               |      |     
|Benefits, claims, losses and settlement expenses |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|Amortization of Deferred Acquisition Cost        |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|Commissions                                      |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|                                                 |      |      |     
|Total insurance expenses                         |      |      |     
|                                                 |      |      |     
|General Expenses, Taxes, Licenses and Fees       |      |     
|Insurance operations                             |      |     
|Property and casualty insurance                  |      |      |     
|Life insurance                                   |      |      |     
|Noninsurance operations                          |      |      |     
|                                                 |      |      |     
|Total General Expenses, Taxes, Licenses and Fees |      |      |     
|                                                 |      |      |     
|Total Expenses                                   |      |      |     
|                                                 |      |      |     
|Income Before Taxes                              |      |      |     
|                                                 |      |      |     

-6-

---

# Investments

The 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. Through its investment policy, the Company
seeks to conserve its capital resources and assets, meet the investment requirements of
its reserves and provide a reasonable return on investments.

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

|                                                             | Year Ended December 31
(Amounts in thousands)
|------------------------------------------------------------ | ---------------------------------------------
|
|Fixed Maturities held-to-maturity, at amortized cost         |                                              
|(estimated fair value: 2003 - $18,198 , 2002 - $20, 267)     |                                              
|Fixed Maturities available-for-sale, at estimated fair value |                                              
|(cost: 2003 - $53,300, 2002 - $41,219)                       |                                              
|Equity securities available-for-sale at estimated fair value |                                              
|(cost: 2003 - $10,205, 2002 - $11,091)                       |                                              
|Receivable for securities sold                               |                                              
|Note Receivable from affiliate                               |                                              
|Mortgage loans on real estate, at cost                       |                                              
|Investment real estate, at cost                              |                                              
|Policy loans                                                 |                                              
|Investment in affiliate                                      |                                              
|Short-term investments                                       |                                              
|                                                             |                                              
|                                                             |                                              
|                                                             |                                              

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

|                                                  | Year Ended December 31
|------------------------------------------------- | ----------------------
|
|Net investment income                             |                       
|Average yield on investments                      |                       
|Economic  yield on investments (Includes realized |                       
|investment gains)                                 |                       
|Net realized gains on investments (before taxes)  |                       
|Changes in net unrealized gains on investments    |                       
|(before income taxes)                             |                       

-7-

---

As of December 31, 2003, the maturity
schedule for all bonds and notes held by the Company, stated at amortized cost, was as
follows:

Maturity Schedule
(Amounts in thousands)

|Maturity                     | Available
for sale | Held to
Maturity | Total | Percentage
of Total
|---------------------------- | ------------------ | ---------------- | ----- | -------------------
|Maturity in less than 1 year |                    |                  | $     | 1,895              
|Maturity in 1-5 years        |                    |                  |       | 16,792             
|Maturity in 5-10 years       |                    |                  |       | 19,533             
|Maturity after 10 years      |                    |                  |       | 15,080             
|                             |                    |                  |       |                    
|                             |                    |                  | $     | 53,300             
|                             |                    |                  |       |                    

Investments in affiliate:

In the fourth quarter of 2001 The
Company entered into a joint investment with a local manufacturing firm, Cash Brothers
Leasing, Inc and formed a new company, The Mobile Attic, Inc. The Mobile  Attic, Inc,
through a network of dealers, leases portable storage units. The primary customers of The
Mobile Attic are building contractors, retail establishments, and residential consumers.

At 12/31/2003 the Company held a 50%
equity investment in The Mobile Attic. The investment was accounted for in the financial
statements on the equity basis. Further details of the financial results of The Mobile
Attic, Inc. are discussed in the Management Discussion and Analysis Section of Form 10-K.

Certain Information
Regarding Insurance Activities

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. NSFCs products are marketed through a network of independent
agents and brokers, who are independent contractors and who generally maintain
relationships with one or more competing insurance companies.

Agents receive compensation for their
sales efforts. In the case of life insurance agents, compensation is paid in the form of
sales commissions plus a servicing commission. Commissions paid by NSIC in 2003 averaged
approximately 41% of premiums. Commissions paid by the NSFC in 2002 averaged approximately
22% of premiums and ranged from 12.5% to 25% depending on the type and amount of insurance
sold. During 2003, no one independent agent accounted for more than 10% of total net
earned premium of the property-casualty insurance subsidiaries.

At December 31, 2003 NSIC employed 17
home service agents and two managers. NSIC also had approximately 350 independent agents
actively producing new business.

At December 31, 2003 NSFC had
contracts with approximately 1,300 independent agents in twelve states.

-8-

---

Reinsurance

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

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 $125,000 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 2003, the property-casualty subsidiaries had catastrophe protection up
to a $27.5 million loss. On a 1 in 200 year loss, that is a loss that has only a 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 $17.9 million.

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

Reserve liabilities

NSIC maintains life insurance
reserves for future policy benefits to meet future obligations under outstanding policies.
These reserves are calculated to be sufficient to meet policy and contract obligations as
they arise. Liabilities for future policy benefits are calculated using assumptions for
interest, mortality, morbidity, expense, and withdrawals determined at the time the
policies were issued. As of December 31, 2003, 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 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, 2003, the property-casualty subsidiaries had
reserves for unpaid claims of approximately $11.3 million before subtracting unpaid claims which will be due from
reinsurers of $1.23 million leaving net unpaid claims of $10.07 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, 2003, 2002 or 2001. The
Company believes such reserves are adequate to provide for settlement of claims. Employees
of the Company calculate NSFC and Omega loss reserves. Milliman & Robertson, an
independent actuarial consulting firm, issues a Statement of Actuarial Opinion regarding
the adequacy of reserves.

-9-

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Underwriting Activities

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 fire
insurance, the underwriting staff assesses the risks involved in insuring a particular
dwelling. Where possible, the underwriting staff of the property-casualty insurance
subsidiary utilizes standard procedures as guides that quantify the hazards associated
with a particular occupancy. In general, the property-casualty subsidiaries specialize in
writing nonstandard risks.

The nonstandard market in which the
property-casualty subsidiaries operate reacts to general economic conditions in much the
same way as the standard market. When insurers profits and equity are strong,
companies generally cut rates or 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.

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.

-10-

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Competition

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

NSIC primarily markets its life and
health insurance products through the home service system 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.

-11-

---

The property-casualty subsidiaries
market their products through independent agents and brokers, concentrating 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.

# Item 2. Properties

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

# Item 3. Legal Proceedings

The Company and its subsidiaries 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 O 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, 2003.

-12-

---

# 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 number of shareholders of the
Companys capital stock as of January 31, 2004, was approximately 1,100.

|               | Stock Bid Prices | Dividends
|-------------- | ---------------- | ---------
|
|
|2003           |                  |          
|First Quarter  |                  |          
|Second Quarter |                  |          
|Third Quarter  |                  |          
|Fourth Quarter |                  |          
|2002           |                  |          
|First Quarter  |                  |          
|Second Quarter |                  |          
|Third Quarter  |                  |          
|Fourth Quarter |                  |          

-13-

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# Item 6. Selected
Financial Data

(Amounts
in thousands, except per share)

|Operating results             | 2003 | 2002 | 2001 | 2000   | 1999
|----------------------------- | ---- | ---- | ---- | ------ | ----
|Net premiums earned           |      |      | $    | 47,536 |     
|Net investment income         |      |      |      | 4,137  |     
|Net realized investment gains |      |      |      | 1,416  |     
|Other income                  |      |      |      | 1,395  |     
|                              |      |      |      |        |     
|Total revenues                |      |      | $    | 54,484 |     
|                              |      |      |      |        |     
|Net Income                    |      |      | $    | 4,090  |     
|                              |      |      |      |        |     
|Net income per share          |      |      | $    | 1.66   |     
|                              |      |      |      |        |     

|Other Selected Financial Data | 2003 | 2002 | 2001 | 2000    | 1999
|----------------------------- | ---- | ---- | ---- | ------- | ----
|Total shareholders' equity    |      |      | $    | 45,872  |     
|Book value per share          |      |      |      | 18.60   |     
|Dividends per share           |      |      |      | 0.825   |     
|Net change in unrealized      |      |     
|capital gains (net of tax)    |      |      |      | 1,658   |     
|Total assets                  |      |      | $    | 114,802 |     

-14-

---

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

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

Results of Operations

Consolidated Results of
Operations:

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

Premium revenue reached a record high
of $47.5 million in 2003, an increase of 45.3% over 2002 premium revenue of $32.6 million,
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 $41.7 million in 2003 compared to $27.2 million 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.

Consolidated net income for The
National Security Group (The Company) was $4.09 million 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 $1.42 million compared to $1.17 million in 2002. Pre-tax
earnings were $5.7 million in 2003 compared to $1.2 million in 2002, a tenfold increase. 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 O to the consolidated
financial statements.

A 50% owned subsidiary contributed
negatively to net income in the amount $29,000 in 2003. This subsidiary, The Mobile Attic,
Inc., is in the business of leasing portable storage containers through independent
dealers in Alabama, Florida, and Tennessee.

The operating results of the
subsidiaries are discussed in further detail in the sections that follow.

# Year Ended December 31,
2002 Compared to Year Ended December 31, 2001

Consolidated net income for The
National Security Group (The Company) was $908,000 in 2002 compared to $4.130 million in
2001. On a per share basis earnings were $.37 in 2002 compared to $1.67 in 2001. Adverse
underwriting results in the property/casualty insurance segment were the primary factor
contributing to the decline in earnings for 2002 compared to 2001. Information related to
the adverse underwriting results is discussed further in the property and casualty
insurance segment in the paragraphs that follow. Realized capital gains in 2002 were
$1.168 million and $1.64 million in 2001. Consolidated revenues were $39.1 million in
2002 compared to $32.8 million in 2001.

-15-

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Industry Segment Data

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

Premium revenues:

|                                    | 2003 | % | 2002 | %      | 2001 | %
|----------------------------------- | ---- | - | ---- | ------ | ---- | -
|Life, accident and health insurance |      |   | $    | 5,799  |      |  
|Property and casualty insurance     |      |   |      | 41,737 |      |  
|                                    |      |   |      |        |      |  
|                                    |      |   | $    | 47,536 |      |  
|                                    |      |   |      |        |      |  
|                                    |      |   |      |        |      |  

Income before
taxes and equity in income of affilitate:

|                                    | 2003 | %        | 2002 | %      | 2001 | %      
|----------------------------------- | ---- | -------- | ---- | ------ | ---- | -------
|Life, accident and health insurance |      | $    563 |      | 9.93   | %    | $ 1,118
|Property and casualty insurance     |      | 5,720    |      | 100.90 | %    | 518    
|Other                               |      | (411     | )    | -7.25  | %    | (196   
|Interest expense                    |      | (203     | )    | -3.58  | %    | (246   
|                                    |      |          |      |        |      |        
|                                    |      | $ 5,669  |      | 100.00 | %    | $ 1,194
|                                    |      |          |      |        |      |        

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,
2003 Compared to Year Ended December 31, 2002:

Income before income taxes in 2003
was $563,000 compared to $1,118,000 in 2002. Litigation related expenses decreased pretax
earnings by nearly $300,000 and was the primary factor contributing to the 50% decline in
pre-tax earnings. Pending litigation against NSIC is discussed further in Note O to the
consolidated financial statements.

Premium revenue increased to
$5,799,000 in 2003 compared to $5,396,000 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%. While management is pleased with new business production from the
independent agents distribution channel, an increased focus is now being placed on
increasing retention of new business. Increased retention and persistency will not only
further increase premium growth in the independent agent distribution channel, but also
reduce commission expense as a percent of premium because most commission paid on an
insurance contract sold through independent agents is paid in the first two years the
policy is in force.

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.

-16-

---

# Year Ended December 31,
2002 Compared to Year Ended December 31, 2001:

Income before income taxes in 2002
was $1,118,000 compared to $586,000 in 2001. A decrease in litigation related expenses
boosted income before income tax by over $200,000 during 2002. A decline in general
expenses is the other significant item contributing to the increase in income before
income taxes in 2002 compared to 2001.

NSIC increased premium income 4.6% to
$ 5,396,000 in 2002 compared to $5,161,000 in 2001. Life insurance premium income
increased 10.5% in 2002, and accident and health insurance also had an increase of 20.5%
in 2002. The life insurance sales through independent agents were the source of premium
growth in NSIC in 2002.

Commission expenses increased due to
the continued increase in new business production. Life insurance commissions are front
loaded, meaning that significantly higher commission rates are paid in the early years of
a policy and decrease significantly particularly after the first two years of the policy.

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,
2003 Compared to Year Ended December 31, 2002:

Property and casualty premium
revenues increased $14.5 million for the year ended December 31, 2003 compared to the same
period in 2002, an increase of over 53%. The acquisition of a book of business contributed
nearly $3.0 million to the total increase in premium revenue. Increased production in the
homeowners line of business added nearly $5.0 million in increased premium revenue.
NSFCs traditional dwelling fire line of business grew over 32% during the year and
added nearly $5.0 million in premium revenue.

Net income before income tax was
$5.72 million in 2003 compared to $ 518,000 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 were the primary reasons for the significant decrease in
income. Results for 2003 were much improved due to decreases in both severity and
frequency of losses. Prior year growth also helped 2003 results as a larger book of
renewal business helped significantly reduce NSFC loss ratios.

# Year Ended December 31,
2002 Compared to Year Ended December 31, 2001:

Net income before income tax was
$518,000 in 2002 compared to $5,440,000 in 2001. Adverse claims experience from hurricane
losses in the fourth quarter of 2002 and an increased severity of losses on new business
issued were the primary reasons for the significant decrease in income. In October of 2002
Hurricane Lili swept across Louisiana causing over $1,300,000 in insured losses in NSFC
and Omega. However, the most significant impact on property/casualty net income for the
year was poor underwriting results on new business issued. Historically, new property
insurance business issued has carried a higher loss ratio than renewal business. In 2002
the property/casualty subsidiaries issued more new business than has been issued in recent
history with an increase in premium revenue of over 35%. NSFC incurred numerous total
losses on business in force less than one year during 2002, mostly fire losses. 33% of all
dwelling property losses incurred in 2002 were attributable to fire losses of over $25,000
per occurrence. Historically, fire losses are more numerous in the winter months of
December and January, but a higher frequency of fire losses was experienced throughout the
year. It is difficult to prove that these higher frequency losses were connected to any
single cause, such as a colder than normal winter or lightning strikes. However, with the
overall economy in a downturn and personal bankruptcy at record highs in some of the
states in which NSFC and Omega writes business, management believes that at least some of
the losses could be attributable to arson, which in most cases is virtually impossible to
prove. In an effort to stem the frequency of total fire losses, we have instituted
additional underwriting standards in some states, such as providing proof of prior
insurance coverage and closer evaluation of prior claims history.

-17-

---

Property & Casualty
Combined Ratio:

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

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

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

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

|                           | 2003  | 2002   | 2001 
|-------------------------- | ----- | ------ | -----
|Loss and LAE Ratio         | 60.0% | 75.5%  | 54.3%
|Underwriting Expense Ratio | 30.8% | 31.9%  | 36.1%
|Combined Ratio             | 90.8% | 107.4% | 90.4%

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 2003 compared
to 2002 decreased 16.6 percentage points. The loss and LAE component of the combined ratio
decreased 15.5 percentage points. The lack of any major catastrophes during 2003 resulted
in the decrease in the combined ratio. The expense ratio declined 1.1 percentage points
during 2003. The 2003 combined ratio of the property and casualty subsidiaries was much
improved due to an absence of significant catastrophe related losses and a significant
decrease in frequency and severity of fire related losses. As discussed last year a
primary objective for us in 2004 was to focus on maintaining a manageable level of growth
while reducing the loss and LAE ratio. We will continue to be proactive in managing our
books of business with a primary focus on underwriting profitability.

# Leasing operations:

The Companys leasing operations
are conducted through its 50% owned subsidiary, Mobile Attic, Inc. The investment in
Mobile Attic is accounted for under the Equity Method in the Consolidated Financial
Statements of the Company. Mobile Attic was incorporated in August of 2001 and is a joint
venture with a manufacturing partner, Cash Brothers Leasing of Elba, Alabama.

Mobile Attic is in the business of
leasing portable storage containers to individual and commercial customers through an
independent dealer network primarily in Alabama, but also operating in Florida and
Tennessee. At December 31, 2003 Mobile Attic had available approximately 3,000 storage
containers for lease and thirteen independent dealers. 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.

-18-

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Mobile Attic began the steps to
franchise its business model during 2003. 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 will begin selling
franchised locations in the first quarter of 2004.

In 2003 Mobile Attic generated a
$29,000 net loss. The business generated positive cash flow for the year, but a decrease
in revenues from dealer fees and utilization fees below expected ultimate levels generated
a small operating loss for the year. Mobile Attic completed the construction of company
owned storage units in late 2003 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 2003 gross rental revenues were just under $1.5 million. It is
anticipated that Mobile Attic will produce rental revenue of over $2.0 million in 2004
with over 3400 storage containers available for lease by year-end 2004. Mobile Attic
expects to add 20 to 25 franchised locations during 2004.

# Asset Portfolio Review:

The life insurance and
property/casualty subsidiaries primarily invest in highly liquid investment grade debt and
equity securities. At December 31, 2003, the companys holdings in debt securities
amounted to 73.7% of total investments and 64.1% of total assets. The following is a
breakdown of the bond portfolio quality according to National Association of Insurance
Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the
nationally recognized rating organization equivalents of Moodys and Standard and
Poors:

|  | SVO Equivalents | % of Total  
|- | --------------- | ------------
|
|1 | Aaa to A3       | AAA to A-   
|2 | Baa to Baa3     | BBB+ to BBB-
|3 | Ba1 to Ba3      | BB+ to BB-  
|4 | B1 to B3        | B+ to B-    
|5 | Caa to Ca       | CCC+ to C   
|6 | C               | CI to D     

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 E to the consolidated financial
statements).

The insurance subsidiaries
fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage
obligations (CMOs), of $7.8 million and $5.4 million at December 31, 2003 and 2002
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.

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

-19-

---

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

The National Security Groups
consolidated statement of cash flows indicate that operating activities provided
cash of $10.7 million, $4.3 million, $2.9 million in 2003, 2002, and 2001 respectively.
Those statements also classify the other sources and uses of cash by investing activities,
and financing activities and disclose the amount of cash available at the end of the year
to meet the Companys obligations.

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

The Company has notes payable of $3.1
million at December 31, 2003. The notes payable are to be repaid in quarterly installments
over five years.

The ability of the Company to meet
its commitments for timely payment of claims and other expenses depends, in addition to
current cash flow, on the liquidity of its investments. On December 31, 2003, 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 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 O 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 L to the
consolidated financial statements, in 2003, the amount that The National Security
Groups insurance subsidiaries can transfer in the form of dividends to the parent
company is limited to $1.1 million in the life insurance subsidiary and $2.0 million in
the property/casualty insurance subsidiary. However, that condition poses no short-term or
long-term liquidity concerns for the parent company.

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.

-20-

---

The levels and ratios are as follows:

|Regulatory Event         | Ratio of Total Adjusted Capital to
Authorized Control Level RBC
(Less Than or Equal to)
|------------------------ | ---------------------------------------------------------------------------------------
|
|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 four to one at December 31,
2003.

National Security Insurance Company
(life insurer) has regulatory adjusted capital of $11.37 million and $11.47 million at
December 31, 2003 and 2002, respectively, and a ratio of regulatory total adjusted capital
to authorized control level RBC of 16.0 and 17.1 at December 31, 2003 and 2002
respectively. Accordingly, National Security Insurance Company meets the minimum RBC
requirements.

National Security Fire & Casualty
Company (property/casualty insurer) has regulatory adjusted capital of $23.1 million and
$20.2 million at December 31, 2003 and 2002, respectively, and a ratio of regulatory total
adjusted capital to authorized control level RBC of 4.0 and 5.3 at December 31, 2003 and
2002 respectively. Accordingly, National Security Fire & Casualty Company meets the
minimum RBC requirements.

Omega One Insurance Company
(property/casualty insurer), which began writing business in late 1995, has regulatory
adjusted capital of $6.7 million and $5.7 million at December 31, 2003 and 2002,
respectively, and a ratio of regulatory total adjusted capital to authorized control level
RBC of 9.3 and 8.7 at December 31, 2003 and 2002 respectively. Accordingly, Omega One
Insurance Company meets the minimum RBC requirements.

# Information about
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. Forward-looking statements are based
on assumptions and opinions concerning a variety of known and unknown risks, including but
not limited to changes in market conditions, natural disasters and other catastrophic
events, increased competition, changes in availability and cost of reinsurance, changes in
governmental regulations, technological changes, political and legal contingencies and
general economic conditions, as well as other risks and uncertainties more completely
described in the Companys filings with the Securities and Exchange Commission. If
any of these assumptions or opinions proves incorrect, any forward-looking statements made
on the basis of such assumptions or opinions may also prove materially incorrect in one or
more respects and may cause future results to differ materially from those contemplated,
projected, estimated or budgeted in such forward-looking statements.

-21-

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# 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
$18.9 million. If the market value of the S & P 500 Index decreased 10% from its
December 31, 2003 value, the fair value of the Companys common stock would decrease
by approximately $1.9 million.

Certain fixed interest rate market
risk sensitive instruments may not give rise to incremental income or loss during the
period illustrated but may be subject to changes in fair values. Note A 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.

-22-

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# Item 8. Consolidated
Financial Statements and Supplementary Data

|                                                                       |   
|---------------------------------------------------------------------- | --
|
|Index to Financial Statements                                          |   
|Consolidated Financial Statements:                                    
|Report of Independent Certified Public Accountants                     | 24
|Consolidated Statements of Income -                                   
|Years Ended December 31, 2003, 2002, and 2001                          | 25
|Consolidated Balance Sheets -                                         
|December 31, 2003 and 2002                                             | 26
|Consolidated Statements of Shareholders' Equity -                     
|Years Ended December 31, 2003, 2002, and 2001                          | 27
|Consolidated Statements of Cash Flows -                               
|Years Ended December 31, 2003, 2002, and 2001                          | 28
|Notes to Consolidated Financial Statements -                          
|December 31, 2003                                                      | 29
|Financial Statement Schedules:                                        
|Reports of Independent Certified Public Accountants                   
|on Financial Statement Schedules                                       | 50
|Schedule I.  Summary of Investments -                                 
|December 31, 2003 and 2002                                             | 51
|Schedule II.  Condensed Financial Information of Registrant -         
|December 31, 2003 and 2002                                             | 52
|Schedule III.  Supplementary Insurance Information -                  
|December 31, 2003, 2002, and 2001                                      | 56
|Schedule IV.  Reinsurance -                                           
|Years Ended December 31, 2003, 2002, and 2001                          | 57
|All other Schedules are not required under related instructions or are
|inapplicable and therefore have been omitted                          

-23-

---

# INDEPENDENT
AUDITORS REPORT

To the Board of Directorsand
Shareholders of

The National Security
Group, Inc.Elba, Alabama

We have audited the accompanying
consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of
December 31, 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, 2003. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of The National Security Group, Inc. and subsidiaries as
of December 31, 2003 and 2002, and the results of their operations and their cash flows
for each of the years in the three-year period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America.

Birmingham, AlabamaFebruary
26, 2004

-24-

---

# THE NATIONAL SECURITY
GROUP, INC.

CONSOLIDATED STATEMENTS
OF INCOME

|                                                             |  |  |  
|------------------------------------------------------------ |  |  | -
|
|REVENUES                                                     |  |  |  
|Net premiums earned                                          |  |  | $
|Net investment income                                        |  |  |  
|Net realized investment gains                                |  |  |  
|Other income                                                 |  |  |  
|                                                             |  |  |  
|                                                             |  |  |  
|BENEFITS AND EXPENSES                                        |  | 
|Policyholder benefits paid or provided                       |  |  |  
|Amortization of deferred policy acquisition costs            |  |  |  
|Commissions                                                  |  |  |  
|General insurance expenses                                   |  |  |  
|Insurance taxes, licenses and fees                           |  |  |  
|Interest expense                                             |  |  |  
|                                                             |  |  |  
|                                                             |  |  |  
|                                                             |  |  |  
|Income Before Income Taxes and Equity in Income of Affiliate |  |  |  
|INCOME TAX EXPENSE                                           |  | 
|Current                                                      |  |  |  
|Deferred                                                     |  |  |  
|                                                             |  |  |  
|                                                             |  |  |  
|                                                             |  |  |  
|Income Before Equity in Income of Affiliate                  |  |  |  
|Equity in Income of Affiliate                                |  |  |  
|                                                             |  |  |  
|Net Income                                                   |  |  | $
|                                                             |  |  |  
|EARNINGS PER COMMON SHARE                                    |  | 
|Net Income                                                   |  |  | $
|                                                             |  |  |  

See accompanying notes to
consolidated financial statements

-25-

---

# 

THE NATIONAL SECURITY
GROUP, INC.CONSOLIDATED BALANCE
SHEETS

|ASSETS                                                                                      | 2003 | 2002
|------------------------------------------------------------------------------------------- | ---- | ----
|
|Investments                                                                                 |      |     
|Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2003 -          |      |     
|$18,198; 2002 - $20,267)                                                                    |      |     
|Fixed maturities available-for-sale, at estimated fair value (cost: 2003 -                  |      |     
|$53,300; 2002 - $41,219)                                                                    |      |     
|Equity securities available-for-sale, at estimated fair value (cost: 2003 -                 |      |     
|$10,205; 2002 - $11,091                                                                     |      |     
|Notes receivable from affiliate                                                             |      |     
|Mortgage loans on real estate, at cost                                                      |      |     
|Investment real estate, at book value (accumulated depr.: 2003 - $17; 2002 -$17)            |      |     
|Policy loans                                                                                |      |     
|Investment in affiliate                                                                     |      |     
|Short-term investments                                                                      |      |     
|                                                                                            |      |     
|Total Investments                                                                           |      |     
|                                                                                            |      |     
|Cash                                                                                        |      |     
|Accrued investment income                                                                   |      |     
|Receivable from agents, less allowance for credit losses (2002-$176; 2001-$176)             |      |     
|Reinsurance recoverable                                                                     |      |     
|Deferred policy acquisition costs                                                           |      |     
|Prepaid reinsurance premiums                                                                |      |     
|Property and equipment, net                                                                 |      |     
|Other assets                                                                                |      |     
|                                                                                            |      |     
|Total Assets                                                                                |      |     
|                                                                                            |      |     
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                        |      |     
|Policy and claim reserves                                                                   |      |     
|Checks outstanding in excess of bank balance                                                |      |     
|Other policyholder funds                                                                    |      |     
|Long-term debt                                                                              |      |     
|Accrued income taxes                                                                        |      |     
|Other liabilities                                                                           |      |     
|Deferred income tax                                                                         |      |     
|                                                                                            |      |     
|Total Liabilities                                                                           |      |     
|Contingencies                                                                               |      |     
|Shareholders' Equity                                                                        |      |     
|Preferred stock, $1 par value, 500,000 shares authorized, none issued or outstanding        |      |     
|Class A common stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding |      |     
|Common stock, $1 par value, 2,500,000 shares authorized, 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

-26-

---

The National Security Group, Inc.Consolidated Statements of Shareholders'Equity

|                                     | Total | Comprehensive | Retained
Earnings | Accumulated
Other
Comprehensive
Income | Common
Stock | Paid-in
Capital | Treasury
Stock
|------------------------------------ | ----- | ------------- | ----------------- | -------------------------------------- | ------------ | --------------- | --------------
|Balance at December 31, 2000         |       |               | $                 | 43,780                                 |              |                 |               
|Comprehensive income:                |       |              
|Net income for 2001                  |       |               |                   | 4,130                                  |              | $               | 4,130         
|Other comprehensive loss, net of tax |       |              
|Unrealized loss on securities, net   |       |              
|of reclassification adjustment       |       |               |                   | (1,161                                 | )            |                 | (1,161        
|                                     |       |               |                   |                                        |              |                 |               
|Comprehensive income                 |       |               |                   |                                        |              | $               | 2,969         
|                                     |       |               |                   |                                        |              |                 |               
|Retirement of treasury stock         |       |               |                   | --                                     |              |                 |               
|Stock dividend                       |       |               |                   | --                                     |              |                 |               
|Cash dividends                       |       |               |                   | (1,865                                 | )            |                 |               
|                                     |       |               |                   |                                        |              |                 |               
|Balance at December 31, 2001         |       |               | $                 | 44,884                                 |              | $               | 28,848        
|Comprehensive income:                |       |              
|Net income for 2002                  |       |               |                   | 908                                    |              | $               | 908           
|Other comprehensive loss, net of tax |       |              
|Unrealized loss on securities, net   |       |              
|of reclassification adjustment       |       |               |                   | (1,647                                 | )            |                 | (1,647        
|                                     |       |               |                   |                                        |              |                 |               
|Comprehensive income                 |       |               |                   |                                        |              | $               | (739          
|                                     |       |               |                   |                                        |              |                 |               
|Cash dividends                       |       |               |                   | (1,986                                 | )            |                 |               
|                                     |       |               |                   |                                        |              |                 |               
|Balance at December 31, 2002         |       |               |                   | 42,159                                 |              |                 |               
|Comprehensive loss:                  |       |              
|Net income for 2003                  |       |               |                   | 4,090                                  |              |                 | $   4,090     
|Other comprehensive loss, net of tax |       |              
|Unrealized loss on securities, net   |       |              
|of reclassification adjustment       |       |               |                   | 1,658                                  |              |                 | 1,658         
|                                     |       |               |                   |                                        |              |                 |               
|Comprehensive loss:                  |       |               |                   |                                        |              | $               | 5,748         
|                                     |       |               |                   |                                        |              |                 |               
|Cash dividends                       |       |               |                   | (2,035                                 | )            |                 |               
|                                     |       |               |                   |                                        |              |                 |               
|Balance at December 31, 2003         |       |               | $                 | 45,872                                 |              |                 |               
|                                     |       |               |                   |                                        |              |                 |               
|                                     |       |               |                   |                                        |              |                 |               

See accompanying notes to
consolidated financial statements.

-27-

---

# THE NATIONAL SECURITY
GROUP, INC.

CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                                      | 2003 | 2002 | 2001
|--------------------------------------------------------------------- | ---- | ---- | ----
|Cash flows from operating activities:                                 |      |      |     
|Net income                                                            |      |      |     
|Adjustments to reconcile net income to net cash provided by (used in) |      |     
|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                                           |      |      |     
|Equity in earnings of investee                                        |      |      |     
|Other, net                                                            |      |      |     
|                                                                      |      |      |     
|Net cash provided (used in) 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 real estate held for investment                         |      |      |     
|Purchases of real estate held for investment                          |      |      |     
|Net (purchases) proceeds from short-term investment                   |      |      |     
|Advances on loans, net                                                |      |      |     
|Purchase of property and equipment                                    |      |      |     
|Proceeds from sale of property and equipment                          |      |      |     
|                                                                      |      |      |     
|Net cash (used in) provided by investing activities                   |      |      |     
|Cash flows from financing activities:                                 |      |     
|Proceeds from notes payable                                           |      |      |     
|Payments on notes payable                                             |      |      |     
|Change in other policyholder funds                                    |      |      |     
|Dividends paid                                                        |      |      |     
|Change in checks outstanding in excess of bank balances               |      |      |     
|                                                                      |      |      |     
|Net cash used in financing activities                                 |      |      |     
|                                                                      |      |      |     
|Net (decrease) increase in cash                                       |      |      |     
|Cash at beginning of year                                             |      |      |     
|                                                                      |      |      |     
|Cash at end of year                                                   |      |      | $   
|                                                                      |      |      |     

See accompanying notes to
consolidated financial statements.

-28-

---



THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES

# Principles of Consolidation

The accompanying consolidated
financial statements include the accounts of The National Security Group, Inc. (the
Company) and its wholly-owned subsidiaries: National Security Insurance Company (NSIC),
National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO). NSFC
includes a wholly-owned subsidiary  Omega One Insurance Company (Omega). Omega
included a wholly-owned subsidiary  Liberty Southern Insurance Company (LSIC)
through September 30, 2001. LSIC was liquidated on September 30, 2001. All significant
intercompany transactions and accounts have been eliminated.

# Investment in Affiliate

The companys investment in
affiliate consists of a 50% interest in Mobile Attic, Inc., a portable storage leasing
company. The company accounts for this investment using the equity method (see Notes B, O
and Q).

# Description of Major
Products

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

# Basis of Presentation

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

# Investments

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

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

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

The Company and its subsidiaries have
no trading securities.

-29-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

# Investments 
continued

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

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

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

# Receivable from Agents

Agent balances are reported at unpaid
balances, less a provision for credit losses.

# Property and Equipment

Property 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
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.

# Fair Value of Financial
Instruments

The 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.

Certain financial instruments,
particularly insurance liabilities other than financial guarantees and investment
contracts, leases and affiliate investments, 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.

-30-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

# Fair Value of Financial
Instruments  continued

The 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
sheets 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                      |                                        

# Statement of Cash Flows

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

# Premium Revenues

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

# Deferred Policy
Acquisition Costs

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

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

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

-31-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

# Policy Liabilities

The liability for future life
insurance policy benefits is computed using a net level premium method including the
following assumptions:

|               | 
|-------------- | 
|Years of Issue | 
|1947 - 1968    | 
|1969 - 1978    | 
|1979 - 2003    | 

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

# Claim Liabilities

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

# Earnings Per Share

Earnings per share of common stock is
based on the weighted average number of shares outstanding during each year. The adjusted
weighted average shares outstanding were 2,466,600 (2,466,600 in 2002 and 2001).

# Reinsurance

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

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

# Reclassifications

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

-32-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

# Use of Estimates

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

# Advertising

The Company expenses advertising
costs as incurred. Advertising costs were $89,000 for the year ended December 31, 2003
($101,000 and $110,000 for the years ended December 31, 2002 and 2001, respectively).

# Concentration of Credit
Risk

The 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. The
Company believes it is not exposed to any significant credit risk on cash and cash
equivalents. At December 31, 2003, the Companys uninsured cash balances totaled
$289,000.

# Recently Issued
Accounting Standards

In July 2002, the FASB issued SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which
addresses financial accounting and reporting for costs associated with exit or disposal
activities, and must be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The adoption of this statement did not have a material impact on
the Companys financial position or results of operations.

In April 2003, the FASB issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and HedgingActivities. SFAS No. 149 amends and clarifies certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 was effective for certain contracts entered into or modified by the company
after June 30, 2003. The Company adopted SFAS No. 149 effective July 1,
2003 with no material impact on its financial condition or results of operations.

In May 2003, the FASB issued SFAS
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of both
liabilities and equity. Financial instruments that are within the scope of the statement,
which previously were often classified as equity, must now be classified as liabilities.
This statement is effective for financial instruments entered into or modified after May
31, 2003, and otherwise generally effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of this statement did not have a material
effect on the Companys results of operations or financial position.

-33-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE A 
SIGNIFICANT ACCOUNTING POLICIES  CONTINUED

# Recently Issued
Accounting Standards

In November 2002, the FASB issued
FASB Interpretation (FIN) 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.
FIN 45 expands the disclosures required by guarantors for obligations under certain types
of guarantees. It also requires initial recognition at fair value of a liability for such
guarantees. The Company adopted the disclosure requirements of FIN 45 for the quarter
ended December 31, 2002 and the liability recognition requirements to all guarantees
issued or modified after December 31, 2002. The adoption of these requirements did not
have a material impact on the Companys results of operations or financial position.

In January 2003, the FASB issued
FIN 46, Consolidation of Variable Interest Entitiesan Interpretation of
Accounting Research Bulletin No. 51. FIN No. 46 addresses consolidation by
business enterprises where equity investors do not bear the residual economic risks and
rewards. The underlying principle behind FIN 46 is that if a business enterprise has the
majority financial interest in an entity, which is defined in FIN 46 as a variable
interest entity, the assets, liabilities and results of the activities of the variable
interest entity should be included in the consolidated financial statements with those of
the business enterprise. In 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. 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 expects to consolidate its affiliate, Mobile Attic, Inc., upon
adoption of FIN 46R in the first quarter 2004. The consolidation of Mobile Attic is
expected to increase total assets by approximately $15 million, total liabilities by
approximately $13 million and total shareholders equity by approximately $1 million.
The consolidation of Mobile Attic is not expected to have a material impact on the results
of operations as the Company is currently accounting for the investment under the equity
method. See Notes B, O and Q for additional information related to the VIE.

34-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE B  INVESTMENT
IN AFFILIATE

Summarized  financial  information
for the Company's  investment in Mobile Attic, Inc., accounted for by the equity method,
follows:

|                       | (Dollars in thousands)
|---------------------- | ----------------------
|
|
|Current assets         |                       
|Noncurrent assets      |                       
|Current liabilities    |                       
|Noncurrent liabilities |                       

|                   | (Dollars in thousands)
|------------------ | ----------------------
|
|
|Gross revenue      |                       
|Operating expenses |                       
|Net (loss) income  |                       

# NOTE C  STATUTORY
ACCOUNTING PRACTICES

The accompanying consolidated
financial statements have been prepared in conformity with generally accepted accounting
principles (GAAP) which vary in certain respects from reporting practices prescribed or
permitted by insurance regulatory authorities. The significant differences for statutory
reporting include: (a) acquisition costs of acquiring new business are charged to
operations as incurred, (b) life policy liabilities are established utilizing interest and
mortality factors specified by regulatory authorities, (c) the Asset Valuation Reserve
(AVR) and the Interest Maintenance Reserve (IMR) are recorded as liabilities, and (d)
non-admitted assets (furniture and equipment, agents debit balances and prepaid
expenses) are charged directly to surplus.

-35-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

Statutory net gains from operations
and capital and surplus, excluding intercompany transactions, are summarized as follows:

|                                                                 | (Dollars in thousands)
Year Ended December 31,
|---------------------------------------------------------------- | ----------------------------------------------
|
|NSIC - including realized capital gains of  $287, $356 and $652, |                                               
|respectively                                                     |                                               
|                                                                 |                                               
|NSFC - including realized capital gains of $203, $622 and        |                                               
|$875, respectively                                               |                                               
|                                                                 |                                               
|Omega - including realized capital gains of $257, $150, and      |                                               
|$152, respectively                                               |                                               
|                                                                 |                                               
|Statutory capital and surplus:                                   |                                               
|NSIC - including AVR of $1,180, $580 and $1,586,                 |                                               
|respectively                                                     |                                               
|                                                                 |                                               
|NSFC                                                             |                                               
|                                                                 |                                               
|Omega                                                            |                                               
|                                                                 |                                               

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

-36-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE D  INVESTMENT
SECURITIES

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

|                                                 | (Dollars in thousands)
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                                            |                                         
|                                                 |                                         

|                                                 | December 31, 2002
|------------------------------------------------ | -----------------
|
|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                                            |                  
|                                                 |                  

-37-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE D  INVESTMENT
SECURITIES  CONTINUED

|                                                 | (Dollars in thousands)
December 31, 2002
|------------------------------------------------ | ----------------------------------------
|
|Corporate debt securities                        |                                         
|Obligations of states and political subdivisions |                                         
|U.S. Treasury securities and obligations of      |                                         
|U.S. government corporations and agencies        |                                         
|                                                 |                                         
|Total                                            |                                         
|                                                 |                                         

The amortized cost and aggregate fair
value of debt securities at December 31, 2003, 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 2003, gross gains of $2,266,000
($1,412,000 for 2002 and $1,785,000 for 2001) and gross losses of $858,000 ($318,000 for
2002 and $324,000 for 2001) were realized on sales of available-for-sale-securities.

-38-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE E  INVESTMENT
SECURITIES  CONTINUED

During the first quarter of 2003 the
Company transferred certain corporate bonds from the SFAS 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 Treasuries, the Company intends to sell certain (primarily
corporate) bonds which were previously held in the SFAS 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, 2003 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              |                       
|                               |                       
|                               |                       
|                               |                       

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.

-39-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE E  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 increase
(decrease) in unrealized appreciation on available-for-sale securities follows:

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

-40-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE F  PROPERTY
AND EQUIPMENT

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

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

Depreciation expense for the year
ended December 31, 2003 was $419,000 ($206,000 for the year ended December 31, 2002 and
$197,000 for the year ended December 31, 2001).

# NOTE H  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.

-41-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE G  INCOME
TAXES  CONTINUED

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

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

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 |                        
|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, 2003, 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,
2003.

-42-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE H  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 LIBOR          |                       
|(3.87% at December 31, 2003 and 4.18% at December 31, 2002)        |                       
|dated March 28, 2002; matures March 28, 2007. Payments of          |                       
|$112,953 due quarterly with balloon payment at maturity. Unsecured |                       
|                                                                   |                       
|                                                                   |                       

Aggregate maturities of long-term
debt for each of the four years subsequent to December 31, 2003 are as follows (dollars in
thousands): 2004-$339; 2005-$351; 2006-$365; 2007-$2,004.

# NOTE I  POLICY AND
CLAIM RESERVES

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

|                           | (Dollars in thousands)
|-------------------------- | ----------------------
|
|Benefit and loss reserves  |                       
|Property and casualty      |                       
|Accident and health        |                       
|Life and annuity           |                       
|Unearned premiums          |                       
|Policy and contract claims |                       
|                           |                       
|                           |                       
|                           |                       

-43-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE I  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                     |                       
|                                            |                       

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 2003, 2002 and 2001 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.

-44-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE J  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, 2003, reinsurance receivables with a carrying value of $765,000 ($220,000
at December 31, 2002) and prepaid reinsurance premiums of $496,000 ($343,000 at December
31, 2002) were associated with a single reinsurer. The amounts of recoveries pertaining to
reinsurance contracts that were deducted from losses incurred during 2003, 2002 and 2001
were approximately $580,000, $374,000, and $989,000, respectively

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

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

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

|        | 2001
|------- | ----
|
|
|Direct  |     
|Assumed |     
|Ceded   |     
|        |     
|Net     |     
|        |     

-45-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE K  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 2003, 2002, and 2001 amounted to
$228,000, $177,000, and $130,000, 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 2003, 2002, and 2001 amounted to approximately $421,000, $19,000,
and $35,000, respectively.

# NOTE L  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, 2003,
NSICs retained earnings unrestricted for the payment of dividends in 2004 amounted
to $1,019,000.

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. As a result, dividends from NSFC to the Company are limited to $2,526,000 in 2004.

At December 31, 2003, securities with
market values of $3,606,000 ($3,564,000 at December 31, 2002) 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 M 
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.

-46-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE M 
SHAREHOLDERS EQUITY

# Common Stock

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

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

# NOTE N  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, 2003, 2002 and 2001 are summarized
below:

|                                                                  | (Dollars in thousands)
Year ended December 31,
|----------------------------------------------------------------- | ----------------------------------------------
|
|Premium revenues:                                                 |                                               
|Individual life and accident and health insurance                 |                                               
|Property and casualty insurance                                   |                                               
|                                                                  |                                               
|                                                                  |                                               
|                                                                  |                                               
|Income (loss) before income taxes:                                |                                               
|Individual life and accident and health insurance                 |                                               
|Property and casualty insurance                                   |                                               
|Other                                                             |                                               
|                                                                  |                                               
|                                                                  |                                               
|Interest expense                                                  |                                               
|                                                                  |                                               
|                                                                  |                                               
|                                                                  |                                               
|Assets                                                            |                                               
|Individual life and accident and health insurance                 |                                               
|Property and casualty insurance                                   |                                               
|Other                                                             |                                               
|                                                                  |                                               
|                                                                  |                                               
|                                                                  |                                               
|Amortization of deferred policy aquisition costs and depreciation |                                               
|expense:                                                          |                                               
|Individual life and accident and health insurance                 |                                               
|Property and casualty insurance                                   |                                               
|                                                                  |                                               
|                                                                  |                                               
|                                                                  |                                               

-47-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE N  INDUSTRY
SEGMENTS  CONTINUED

Capital expenditures during the year
ended December 31, 2003, were $645,000 for the individual life and accident and health
insurance segment, $118,000 for the property and casualty insurance segment and $88,000
for other segments.

# NOTE O 
CONTINGENCIES

# Financial Guarantee

At December 31, 2003, the Company
guaranteed the $13 million lines of credit of its affiliate, Mobile Attic, Inc. The
Company is paid a guaranty fee based on the average balance of the line of credit. In
2003, the Company received $114,000 ($15,000 in 2002) in guaranty fees. The term of the
guarantee is two years. Credit risk represents the accounting loss that would be
recognized at the reporting date if Mobile Attic, Inc. failed to perform completely as
contracted. The credit risk of $13 million assumes that no amounts could be recovered from
other parties.

# 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.

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.

-48-

---

# THE NATIONAL SECURITY
GROUP, INC.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  CONTINUED

# NOTE P 
SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest during 2003
was $204,000 ($261,000 in 2002 and $241,000 in 2001). Cash paid for income taxes in 2003
was $400,000 ($76,000 in 2002 and $800,000 in 2001). In 2002, noncash investing activity
consisted of the conversion of a $725,000 note receivable to an equity investment.

# NOTE Q  RELATED
PARTY TRANSACTIONS

At December 31, notes receivable from
affiliate consisted of the following:

|                                                      | Dollars in thousands
|----------------------------------------------------- | --------------------
|
|5.25% short-term note dated December 18, 2002;        |                     
|matured February 16, 2003. Principle and interest due |                     
|February 16, 2003, secured by portable storage units  |                     
|6.25% term note dated October 1, 2002; matures        |                     
|October 1, 2007. Payments of $16,116 due quarterly,   |                     
|secured by portable storage units                     |                     
|                                                      |                     
|                                                      |                     
|                                                      |                     
|                                                      |                     

During 2003, the company advance a
total of $3,074,000 to its affiliate, Mobile Attic, Inc., under various short-term notes
payable. All advances were fully repaid in 2003. The company received $25,000 in interest
on the advances.

During 2002, the balance on the
convertible line of credit was increased to $1 million and, under the terms of the line of
credit, $725,000 of the balance was converted to common equity of the affiliate. The
remaining $275,000 was converted to the long-term note described above.

-49-

---

# INDEPENDENT
AUDITORS REPORTON FINANCIAL STATEMENT
SCHEDULES

# 

To the Board of Directorsand
Shareholders ofThe National Security
Group, Inc.Elba, Alabama



Under the date of February 26, 2004,
we reported on the balance sheets of The National Security Group, Inc. as of December 31,
2003 and 2002, and the related statements of income, shareholders equity and cash
flows for each of the years in the three year period ended December 31, 2003, which are
included in this Form 10-K. In connection with our audit of the aforementioned financial
statements, we also audited the related financial statement schedules listed in the
accompanying index. These financial statement schedules are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial
statement schedules based on our audit.

In our opinion, such financial
statement schedules, when considered in relation to the basic financial statements taken
as a whole, present fairly, in all material respects, the information set forth therein.

Birmingham, AlabamaFebruary
26, 2004

-50-

---

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

|                                  |  | 31-Dec-03 |  |         | 31-Dec-02 |        
|--------------------------------- |  | --------- |  | ------- | --------- | -------
|
|Securities Held to Maturity:      |  |           |  |         |           |        
|United States government          |  | $18,631   |  | $18,198 |           | $18,631
|States, municipalities and        | 
|political subdivisions            |  |           |  |         |           |        
|Public Utilities                  |  |           |  |         |           |        
|Industrial and Miscellaneous      |  |           |  |         |           |        
|                                  |  |           |  |         |           |        
|Total Securities Held to Maturity |  | 18,631    |  | 18,198  |           | 18,631 
|Securities Available for Sale:    | 
|Equity Securities:                | 
|Public utilities                  |  | 718       |  | 1,078   |           | 1,078  
|Banks and insurance companies     |  | 1,557     |  | 4,799   |           | 4,799  
|Industrial and all other          |  | 7,930     |  | 14,853  |           | 14,853 
|                                  |  |           |  |         |           |        
|Total equity securities           |  | 10,205    |  | 20,730  |           | 20,730 
|Debt Securities:                  | 
|United States government          |  | 24,766    |  | 24,811  |           | 24,811 
|States, municipalities and        | 
|political subdivisions            |  | 9,192     |  | 9,496   |           | 9,496  
|Public Utilities                  |  | 1,056     |  | 1,117   |           | 1,117  
|Industrial and Miscellaneous      |  | 18,286    |  | 19,591  |           | 19,591 
|                                  |  |           |  |         |           |        
|Total Debt Securities             |  | 53,300    |  | 55,015  |           | 55,015 
|Total Available for Sale          |  | 63,505    |  | 75,745  |           | 75,745 
|                                  |  |           |  |         |           |        
|Total Securities                  |  | 82,136    |  | 93,943  |           | 94,376 
|Receivable for securities         |  | --        |  |         |           |        
|Note Receivable From Affiliate    |  | --        |  |         |           | --     
|Mortgage loans on real estate     |  | 245       |  |         |           | 245    
|Investment real estate            |  | 1,564     |  |         |           | 1,564  
|Policy loans                      |  | 730       |  |         |           | 730    
|Investment in Affiliate           |  | 885       |  |         |           | 885    
|Short term investments            |  | 2,190     |  |         |           | 2,190  
|Total investments                 |  | 86,557    |  |         |           | 99,990 

-51-

---

# 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              |             
|Notes Receivable - Affiliates              |             
|Other assets                               |             
|                                           |             
|Total Assets                               |             
|                                           |             
|Liabilities and Shareholders' Equity       |             
|Accrued general expenses                   |             
|Notes Payable - Affiliates                 |             
|Notes Payable                              |             
|                                           |             
|Total Liabilities                          |             
|                                           |             
|Total Shareholders' Equity                 |             
|                                           |             
|Total Liabilities and Shareholders' Equity |             
|                                           |             

-52-

---

THE NATIONAL SECURITY
GROUP, INC. (PARENT COMPANY)SCHEDULE II  CONDENSED FINANCIAL INFORMATION OF
REGISTRANTSTATEMENTS 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 (losses) earnings of subsidiaries |                                 
|                                                          |                                 
|Net Income                                                |                                 
|                                                          |                                 

-53-

---

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

|                                                      | For the Years Ended December 31,
|----------------------------------------------------- | --------------------------------
|
|Cash flows from operating activities:                 |                                 
|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 and due from banks at beginning of year          |                                 
|                                                      |                                 
|Cash and due from banks at end of year                |                                 
|                                                      |                                 

-54-

---

# 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 22.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 2-Cash Dividends
from Subsidiaries

| | Dividends of $2.3 million in 2003, $2.7 million in 2002 and $2.55 million in 2001 were
paid to the   Registrant by its subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------

-55-

---

# 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, 2003:                  |                            |                        |                  
|Life and accident and health insurance |                            | $3,702                 |                  
|Property and casualty insurance        |                            | 2,115                  |                  
|                                       |                            |                        |                  
|Total                                  |                            | $5,817                 |                  
|                                       |                            |                        |                  
|At December 31, 2002:                  |                           
|Life and accident and health insurance |                            | $3,516                 |                  
|Property and casualty insurance        |                            | 1,727                  |                  
|                                       |                            |                        |                  
|Total                                  |                            | $5,243                 |                  
|                                       |                            |                        |                  
|At December 31, 2001:                  |                           
|Life and accident and health insurance |                            | $3,306                 |                  
|Property and casualty insurance        |                            | 1,309                  |                  
|                                       |                            |                        |                  
|Total                                  |                            | $4,615                 |                  
|                                       |                            |                        |                  

|                                       | 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, 2003:  |                 |                       |              |                                                  |                                                                |                                           
|Life and accident and health insurance |                 | $  5,799              |              | $  1,860                                         |                                                                | $     11                                  
|Property and casualty insurance        |                 | 41,737                |              | 2,135                                            |                                                                | 1,384                                     
|Other                                  |                 | --                    |              | 142                                              |                                                                | --                                        
|                                       |                 |                       |              |                                                  |                                                                |                                           
|Total                                  |                 | $47,536               |              | $4,137                                           |                                                                | $1,395                                    
|                                       |                 |                       |              |                                                  |                                                                |                                           
|For the year ended December 31, 2002:  |                
|Life and accident and health insurance |                 | $  5,395              |              | $  1,970                                         |                                                                | $       2                                 
|Property and casualty insurance        |                 | 27,236                |              | 2,192                                            |                                                                | 1,049                                     
|Other                                  |                 | --                    |              | 73                                               |                                                                | --                                        
|                                       |                 |                       |              |                                                  |                                                                |                                           
|Total                                  |                 | $32,631               |              | $4,235                                           |                                                                | $1,051                                    
|                                       |                 |                       |              |                                                  |                                                                |                                           
|For the year ended December 31, 2001:  |                
|Life and accident and health insurance |                 | $  5,161              |              | $  2,303                                         |                                                                | $       4                                 
|Property and casualty insurance        |                 | 20,196                |              | 2,203                                            |                                                                | 1,276                                     
|Other                                  |                 | --                    |              | --                                               |                                                                | --                                        
|                                       |                 |                       |              |                                                  |                                                                |                                           
|Total                                  |                 | $25,357               |              | $4,506                                           |                                                                | $1,280                                    
|                                       |                 |                       |              |                                                  |                                                                |                                           

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

-56-

---

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

|                                                 | Gross
Amount | Ceded
to Other
Companies | Assumed
from Other
Companies | Net
Amount | Percentof AmountAssumedto Net
|------------------------------------------------ | ------------ | ------------------------ | ---------------------------- | ---------- | -----------------------------
|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     |                              
|                                                 |              |                          |                              |            |                              
|For the year ended December 31, 2001:            |             
|Life insurance in force                          |              | $184,128                 |                              | $6,555     |                              
|                                                 |              |                          |                              |            |                              
|Premiums:                                        |             
|Life insurance and accident and health insurance |              | 5,206                    |                              | 45         |                              
|Property and casualty insurance                  |              | 21,777                   |                              | 1,581      |                              
|Total premiums                                   |              | $  26,983                |                              | $1,626     |                              
|                                                 |              |                          |                              |            |                              

None.

-57-

---

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

-58-

---

# PART III

# Item 10. Directors and
Executive Officers of the Registrant

The
information contained on pages 3-5 of The National Security Groups Proxy Statement
dated March 15, 2004, with respect to directors and executive officers of the Company, is
incorporated herein by reference in response to this item.

The
Company's Code of Ethics for Senoir Financial Officers is available at www.nationalsecuritygroup.com.
The Company intends to disclose any amendments or waivers with respect to its Code of Ethics for Senior Financial Officers on its website at
www.nationalsecuritygroup.com.The Board of Directors has determined that Walter P. Wilkerson, CPA, qualifies as a financial expert on the Audit Committee within the meaning of Securities and Exchange Commission rules.

# Item 11. Executive
Compensation

The
information contained on pages 9 and 10 of The National Security Groups Proxy
Statement dated March 15, 2004, with respect to executive compensation and transactions,
is incorporated herein by reference in response to this item.

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

The information
contained on page 7 of The National Security Groups Proxy Statement dated March 15,
2004, with respect to security ownership of certain beneficial owners and management, is
incorporated herein by reference to this item.

# Item 13. Certain
Relationships and Related Transactions

The
information contained on page 8 of The National Security Groups Proxy Statement
dated March 15, 2004, with respect to certain relationships and related transactions, is
incorporated herein by reference in response to this item.

# Item 14. 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.

-59-

---

# PART IV

# Item 15.    Exhibits,
financial statement schedules, and reports on Form 8-K

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

|                                                                                               |        | 
|---------------------------------------------------------------------------------------------- | ------ | 
|                                                                                               | Page # | 
|Reports of Independent Certified Public Accountants                                            | 24    
|Consolidated Statements of Income--Years Ended  December 31, 2003, 2002, and 2001              | 25    
|Consolidated Balance Sheets--December 31, 2002 and 2001                                        | 26    
|Consolidated Statements of Shareholders ́ Equity--Years Ended December 31, 2003, 2002, and 2001 | 27    
|Consolidated Statements of Cash Flows--Years Ended December 31, 2003, 2002, 2001               | 28    
|Notes To Consolidated Financial Statements--December 31, 2003                                  | 29    
|Schedule I. Summary Of Investments--December 31, 2003 and 2002                                 | 51    
|Schedule II. Condensed Financial Information of Registrant--December 31, 2003 and 2002         | 52    
|Schedule III. Supplementary Insurance InformationDecember 31, 2003, 2002, and 2001            | 56    
|Schedule IV. Reinsurance--Years Ended December 31, 2003, 2002, 2001                            | 57    
|Exhibit 99.1.ãCertification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to         
|Section 302 of the Sarbanes-Oxley Act of 2002                                                  | 62    
|Exhibit 99.2.ãCertification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to         
|Section 302 of the Sarbanes-Oxley Act of 2002                                                  | 63    
|Exhibit 99.3. Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to         
|Section 906 of the Sarbanes-Oxley Act of 2002                                                  | 64    
|Exhibit 99.4. Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to         
|Section 906 of the Sarbanes-Oxley Act of 2002                                                  | 65    

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

b.
Reports on Form 8-K              None

-60-

---

# 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. McLeod                                   | /s/ William L. Brunson, Jr.                                          
|                                                      |                                                                      
|Brian R. McLeod Chief Financial Officer and Treasurer | William L. Brunson, Jr.President, Chief ExecutiveOfficer and Director

Date:     March
31, 2004

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, 2004.

|SIGNATURE                  
|---------------------------
|/s/ Winfield Baird         
|/s/ Carolyn Brunson        
|/s/ Jack R. Brunson        
|/s/ Jack E. Brunson        
|/s/ William L. Brunson, Jr.
|/s/ Fred D. Clark, Jr.     

-61-

---

The National Security
Group, Inc.CERTIFICATION PURSUANT
TO SECTION 302 OF THE SARBANES-OXLEY ACT OF
2002







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

3.    
          Based on my knowledge, the financial statements, and other financial information
          included in this annual 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 annual report;

4.    
          The registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)    
          designed such disclosure controls and procedures 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 annual report is being prepared; b) evaluated the
          effectiveness of the registrants disclosure controls and procedures as of
          a date within 90 days prior to the filing date of this annual report (the
          Evaluation Date); and c) presented in this annual report our
          conclusions about the effectiveness of the disclosure controls and procedures
          based on our evaluation as of the Evaluation Date;

5.    
          The registrants other certifying officers and I have disclosed, based on
          our most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent function):

a)    
          all significant deficiencies in the design or operation of internal controls
          which could adversely affect the registrants ability to record, process,
          summarize and report financial data and have identified for the
          registrants auditors any material weakness in internal controls: and b)
          any fraud, whether or not material, that involves management or other employees
          who have a significant role in the registrants internal controls; and

6.    
          The registrants other certifying officers and I have indicated in this
          annual report whether or not there were significant changes in internal controls
          or in other factors that could significantly affect internal controls subsequent
          to the date of our most recent evaluation, including any corrective actions with
          regard to significant deficiencies and material weakness.

Date: March 30, 2004

/s/ W L Brunson Jr.

---

William L. Brunson, Jr.Chief
Executive Officer

-62-

---

The National Security
Group, Inc.CERTIFICATION PURSUANT
TO SECTION 302 OFTHE SARBANES-OXLEY ACT OF
2002







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

3.    
          Based on my knowledge, the financial statements, and other financial information
          included in this annual 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 annual report;

4.    
          The registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)    
          designed such disclosure controls and procedures 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 annual report is being prepared; b) evaluated the
          effectiveness of the registrants disclosure controls and procedures as of
          a date within 90 days prior to the filing date of this annual report (the
          Evaluation Date); and c) presented in this annual report our
          conclusions about the effectiveness of the disclosure controls and procedures
          based on our evaluation as of the Evaluation Date;

5.    
          The registrants other certifying officers and I have disclosed, based on
          our most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent function):

a)    
          all significant deficiencies in the design or operation of internal controls
          which could adversely affect the registrants ability to record, process,
          summarize and report financial data and have identified for the
          registrants auditors any material weakness in internal controls: and b)
          any fraud, whether or not material, that involves management or other employees
          who have a significant role in the registrants internal controls; and

6.    
          The registrants other certifying officers and I have indicated in this
          annual report whether or not there were significant changes in internal controls
          or in other factors that could significantly affect internal controls subsequent
          to the date of our most recent evaluation, including any corrective actions with
          regard to significant deficiencies and material weakness.

Date: March 30, 2004

/s/ Brian R McLeod

---

Brian R. McLeod, CPAChief
Financial Officer

-63-

---

The National Security
Group, Inc.CERTIFICATION PURSUANT
TO SECTION 906 OFTHE SARBANES-OXLEY ACT OF
2002







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

| | 1. 
The periodic report containing the financial statements fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and
2.  Information contained in the periodic report fairly presents, in all material
respects, the financial condition and results of operations of the issuer.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 30, 2004

/s/ W L Brunson Jr.

---

William L. Brunson, Jr.Chief
Executive Officer

-64-

---

The National Security
Group, Inc. CERTIFICATION PURSUANT
TOSECTION 906 OFTHE SARBANES-OXLEY ACT OF
2002







I, Brian R. McLeod certify that:

| | 1. 
The periodic report containing the financial statements fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and
2.  Information contained in the periodic report fairly presents, in all material
respects, the financial condition and results of operations of the issuer.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 30, 2004

/s/ Brian R McLeod

---

Brian R. McLeod, CPAChief
Financial Officer

-65-

---