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            UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                       WASHINGTON, DC 20549
                            FORM 10-K

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

             For the Fiscal Year Ended December 31, 1998
                  Commission File Number 33-94670-01

                        FARMERS GROUP, INC.

Incorporated in Nevada                      I.R.S. Employer Identification No.
4680 Wilshire Boulevard                                 95-0725935
Los Angeles, California 90010
(323) 932-3200


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

                                                      Name of Each Exchange
Title of Each Class                                    on Which Registered
- -------------------                                    -------------------
8.45% Cumulative Quarterly Income                     New York Stock Exchange
Preferred Securities, Series A (QUIPS) 
(liquidation preference $25 per share)*

8.25% Cumulative Quarterly Income                     New York Stock Exchange
Preferred Securities, Series B (QUIPS) 
(liquidation preference $25 per share)*

*Issued by Farmers Group Capital (Series A) and Farmers Group Capital II 
(Series B) and the payments of trust distributions and payments on 
liquidation or redemption are guaranteed under certain circumstances by 
Farmers Group, Inc., the owner of 100% of the common securities issued by 
Farmers Group Capital and Farmers Group Capital II, Delaware statutory 
business trusts.

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

Indicate by check mark whether the registrant (1) has filed all reports 
required to be filed by Section 13 or 15(d) of the Securities Exchange 
Act of 1934 during the preceding 12 months (or for such shorter period that 
the registrant was required to file such reports), and (2) has been subject 
to such filing requirements for the past 90 days.  
Yes  /X/        No  / /	    

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

Registrant's Common Stock outstanding on December 31, 1998 was 1,000 shares.


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[THIS PAGE INTENTIONALLY LEFT BLANK]


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                             FARMERS GROUP, INC.
                              AND SUBSIDIARIES

                              TABLE OF CONTENTS
                                                                      Page
                                                                     ------ 

PART I  
  ITEM 1.  Business                                                     4
  ITEM 2.  Properties                                                  11
  ITEM 3.  Legal Proceedings                                           11
  ITEM 4.  Submission of Matters to a Vote of Security Holders         12

PART II
  ITEM 5.  Market for Farmers Group, Inc.'s Common Equity and
            Related Stockholders Matters                               12
  ITEM 6.  Selected Financial Data                                     12
  ITEM 7.  Management's Discussion and Analysis of Financial
            Condition and Results of Operations                        14
  ITEM 7a. Quantitative and Qualitative Disclosures about Market 
            Risks                                                      21
  ITEM 8.  Financial Statements and Supplementary Data                 22
  ITEM 9.  Changes in and Disagreements with Accountants on
            Accounting and Financial Disclosures                       62

PART III
  ITEM 10.  Directors and Executive Officers of Farmers Group, Inc.    62
  ITEM 11.  Executive Compensation                                     65
  ITEM 12.  Security Ownership of Certain Beneficial Owners
             and Management                                            68
  ITEM 13.  Certain Relationships and Related Transactions             69

PART IV
  ITEM 14.  Exhibits, Financial Statement Schedules and Reports
             on Form 8-K                                               69

SIGNATURES                                                             71


<PAGE>   4

                        DOCUMENT SUMMARY

     The following summary is qualified in its entirety by the more detailed 
information and the Consolidated Financial Statements of the Company, 
including the notes thereto, appearing elsewhere in this document. Unless the 
context requires otherwise, (i) references to the Company are to Farmers 
Group, Inc. ("FGI") and its subsidiaries, (ii) references to the P&C Group are 
to Farmers Insurance Exchange, Fire Insurance Exchange and Truck 
Insurance Exchange (each an "Exchange" and collectively, the "Exchanges"), 
their respective subsidiaries and Farmers Texas County Mutual Insurance 
Company ("FTCM"), (iii) references to Farmers Life are to Farmers New World 
Life Insurance Company, (iv) references to the Life Insurance Subsidiaries are 
to Farmers Life, The Ohio State Life Insurance Company ("OSL") and Investors 
Guaranty Life Insurance Company ("IGL") and (v) references to the Insurance 
Subsidiaries are to Farmers Life and Farmers Reinsurance Company ("Farmers 
Re") in 1998, to Farmers Life, OSL, IGL and Farmers Re in 1997 and to Farmers 
Life, OSL and IGL in 1996.  Unless otherwise indicated, financial information, 
operating statistics and ratios applicable to the Company and the Insurance 
Subsidiaries set forth in this document are based on generally accepted 
accounting principles ("GAAP") and the same information with regard to the P&C 
Group is based on statutory accounting practices ("SAP"). Unless otherwise 
specified, the financial information for the P&C Group is on a statutory 
combined basis.  Any reference to the "Subsidiary Trusts" is to Farmers Group 
Capital and Farmers Group Capital II, consolidated wholly owned subsidiaries 
of Farmers Group, Inc..  Any reference to "Note" is to the Notes to 
Consolidated Financial Statements included in Item 8 of this Report.

                                 PART I

ITEM 1.   Business

The Company

     General.   The Company's principal activities are the provision of 
management services to the P&C Group and the ownership and operation of the 
Insurance Subsidiaries.  As of December 31, 1998, the Company had total assets 
of $12.7 billion, stockholders' equity of $7.0 billion and for the period 
ended December 31, 1998, the Company had consolidated operating revenues of 
$3.0 billion.  As of December 31, 1998, the Insurance Subsidiaries had total 
assets of $6.4 billion, combined SAP capital and surplus (including asset 
valuation reserve) of $1.4 billion, life policies-in-force of 1.1 million and 
for the period ended December 31, 1998, the Insurance Subsidiaries had 
combined SAP life premiums and deposits received of $0.5 billion and non-life 
reinsurance premiums of $1.0 billion. The financial results and assets and 
liabilities of the P&C Group are not reflected in the consolidated financial 
statements of the Company.

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

     On December 22, 1997, a definitive agreement was reached to merge B.A.T's 
Financial Services Businesses, which included the Company, with Zurich 
Insurance Company ("Zurich").  In June 1998, the merger was approved by the 
shareholders of B.A.T and Zurich.  In September 1998, this merger was 
completed and the businesses of Zurich and B.A.T's Financial Services 
Businesses were transferred to Zurich Financial Services ("ZFS"), a new Swiss 
company with headquarters in Zurich.  As a result, each two shares of the 
Company's prior outstanding stock were recapitalized into one share of Class A 
Common Stock, par value $1.00 per share ("Ordinary Share"), and one share of 
Class B Common Stock, par value $1.00 per share ("Income Share").  Under the 
merger agreement, all Ordinary Shares became wholly owned by ZFS and all 
Income Shares became wholly owned by Allied Zurich Holdings Limited, an 
affiliated company created during the restructuring of B.A.T.  This merger was 
accounted for by ZFS as a pooling of interests and, therefore, no purchase 
accounting adjustments were made to the Company's assets and liabilities.

Operating Segments

     Financial information by operating segment can be found in Note Z.  
Following are descriptions of the Company's operating segments.

     Provision of Management Services to the P&C Group; and Other.  The P&C 
Group is owned by the policyholders of the Exchanges and FTCM.  Accordingly, 
the Company has no ownership interest in the P&C Group. The policyholders each 
appoint the Company as the exclusive attorney-in-fact ("AIF") to provide 
management services to the P&C Group. For such services, the Company earns 
management fees based primarily on the gross premiums earned by 


<PAGE>   5

the P&C Group. Consequently, the Company is not directly affected by the 
underwriting results of the P&C Group. This is in contrast to a typical 
property and casualty insurance holding company which depends on dividends 
from owned and operated subsidiaries which are subject to fluctuations in 
underwriting results.  The management fees comprise a major part of the 
Company's revenue and, as a result, the Company's ongoing financial 
performance depends on the volume of business written by, and the business 
efficiency and financial strength of, the P&C Group.

     As AIF of the P&C Group, the Company selects risks, prepares and mails 
policy forms and invoices, collects premiums and performs certain other 
administrative and managerial functions.  The P&C Group is responsible for its 
own claims functions, including the settlement and payment of claims and 
claims adjustment expenses.  The P&C Group is also responsible for the payment 
of commissions, benefits for agents and district managers, and its premium and 
income taxes. 

     The Company is entitled to receive a management fee of up to 20% (25% in 
the case of Fire Insurance Exchange) of the gross premiums earned by the P&C 
Group.  In order to enable the P&C Group to maintain appropriate capital and 
surplus while offering competitive insurance rates, the Company has 
historically charged a lower management fee than permitted. The Company has 
been able to do this while maintaining appropriate profit margins through 
enhanced operating efficiencies that encompass the use of economies of scale, 
the use of technology and the standardization of procedures. The range of fees 
has varied by line of business over time and from year to year.  During the 
past five years, aggregate management fees averaged between 12% and 13% of 
gross premiums earned by the P&C Group. The P&C Group has reported a growing 
volume of premiums which has generated a corresponding rise in management fee 
income to the Company. Gross premiums earned by the P&C Group were $10.3 
billion, $10.1 billion and $9.5 billion for 1998, 1997 and 1996, respectively, 
giving rise to management fee revenues to the Company of $1.27 billion, $1.24 
billion and $1.17 billion, respectively, for the same years. 

     The P&C Group markets personal auto, homeowners and selected commercial 
insurance products in 31 states. For the year ended December 31, 1998, 
approximately 67.4% of net premiums earned was from auto insurance policies, 
22.3% was from homeowner policies and the remainder was primarily from 
commercial policies. As of December 31, 1998, the P&C Group had total assets 
of $14.8 billion, surplus as regards policyholders of $4.5 billion, policies-
in-force of 15.9 million and for the year ended December 31, 1998, had gross 
premiums earned of $10.3 billion.

     The Company, through its wholly owned subsidiary Prematic Service 
Corporation ("Prematic"), enables individuals and businesses purchasing 
insurance from one or more members of the P&C Group and Farmers Life to 
combine all premiums due into a single monthly payment. In practice, Prematic 
combines amounts due from a single insured associated with auto, fire, 
commercial and life policies into a single amount and then bills the insured 
on a monthly basis for all policies-in-force.  For this service, Prematic 
collected service fees totaling $77 million in 1998 and generated net income 
of approximately $25 million for the year.  The Company has certain other 
nonmaterial subsidiaries, the results of which are included in the Company's 
consolidated results.  

     Life Insurance. On April 15, 1997, the Company sold two of its life 
insurance subsidiaries, OSL and IGL, to Great Southern Life Insurance Company, 
a subsidiary of Americo Life, Inc..  These subsidiaries contributed $5,502,000 
to net income in 1997 and their combined net assets as of April 15, 1997 were 
$316,448,000.

     The Company's remaining life insurance subsidiary, Farmers Life, markets 
a broad line of individual life insurance products, including universal life, 
term life and whole life insurance and annuity products, predominantly 
flexible premium deferred annuities.  As of December 31, 1998, Farmers Life 
provided insurance to more than one million people and managed more than $1.6 
billion of annuity funds.  Farmers Life's investment philosophy emphasizes 
long-term fundamental value in the selection of the investment mix for its 
portfolio.  As of December 31, 1998, approximately 89.7% of Farmers Life's 
portfolio was invested in fixed income securities and cash and 1.4% in equity 
securities and owned real estate.  As of December 31, 1998, approximately 
91.7% of Farmers Life's fixed income securities were rated investment grade.  
Farmers Life's ratio of SAP capital and surplus (including asset valuation 
reserve) to total assets as of December 31, 1998 was 21.4%, well over the 
industry average of approximately 12.4% as of September 30, 1998, as 
published in the Statistical Bulletin issued by the American Council of Life 
Insurance.


<PAGE>   6

     Farmers Reinsurance Company.  Farmers Re is a wholly owned subsidiary of 
the Company.  On January 1, 1998, Farmers Re entered into an auto physical 
damage reinsurance agreement with the P&C Group.  This agreement provided for 
monthly premiums of $83.3 million and recoveries of a quota share percentage 
of ultimate net losses sustained by the P&C Group in its auto physical damage 
lines of business.  This agreement also provided for the P&C Group to receive 
a provisional ceding commission of 20% of premiums with additional experience 
commissions that depend on loss experience.  This experience commission 
arrangement limits Farmers Re's potential underwriting gain on the assumed 
business to 2.5% of premiums assumed. 

     In 1998, the first accident year under the reinsurance treaty, losses 
paid by Farmers Re were $543,445,000, loss adjustment expenses were 
$5,736,000, reinsurance commissions were $319,875,000 and premiums assumed 
were $1,000,000,000.   As of December 31, 1998, Farmers Re had loss reserves 
of $105,944,000.

Employees	 

     As of December 31, 1998, the Company had 6,753 employees. 

Business Environment

     Strategic Objectives.   The  Company's strategic objectives are to assist 
the P&C Group in growing the volume of profitably underwritten insurance and 
to increase life insurance and annuity sales to the P&C Group's existing 
policyholder base.  The Company intends to achieve these objectives by (i) 
cross-selling insurance products and services to the P&C Group's nearly 8.3 
million existing households while focusing its efforts on the growth of 
Farmers Life, (ii) investing in technology to improve the efficiency and 
quality of service, (iii) maintaining its long-standing tradition of providing 
high-quality customer service, (iv) capitalizing on the strong brand name 
recognition of Farmers Insurance Group of Companies( in its 31 state operating 
territory,  (v) selectively expanding into new geographic markets and (vi) 
expanding the products and services offered to its policyholders by taking 
advantage of horizontal marketing opportunities.

     Year 2000 Project.  In 1995, the Company initiated the "Year 2000 
Project" in order to prepare for the information processing challenges 
presented by the approach of the new millennium.  This project encompasses all 
major areas of the Company's operations, including internal and vendor 
mainframe applications, mainframe systems software, third party interfaces, 
non-mainframe systems software, forms, facilities and equipment.  As the 
Company and the P&C Group rely on computer software logic to maintain accurate 
records, the impact of the issues relating to the approach of the new 
millennium is significant to the Company's ongoing performance.  As such, a 
phased plan has been developed for completing this project.  As of December 
31, 1998, the first two phases of the project (the "Awareness and Initial 
Impact Assessment" and the "Year 2000 Workpackage and Development Blueprint 
Project" phases) have been successfully completed.  The project is currently 
in its final phase (the "Year 2000 Conversion and Implementation" phase) which 
is expected to be completed in mid-1999.  Additional information relating to 
the Year 2000 Project can be found in the "Management's Discussion and 
Analysis of Financial Condition and Results of Operations" section of this 
Report.

     Marketing and Distribution.  The P&C Group and Farmers Life operate using 
common trade names and logos, including Farmers Insurance Group of Companies(, 
Farmers Insurance Group( and Farmers(, and distribute their respective 
insurance products in 31 states (primarily in western and midwestern states) 
through a common network of direct writing agents and district managers.  As 
of December 31, 1998, this network consisted of 14,743 direct writing agents 
and 499 district managers, each of whom is an independent contractor.  The 
size, efficiency and scope of this agency force have made it a major factor in 
the Company's growth. Each agent is required to first submit business to the 
insurers in the Farmers Insurance Group of Companies within the classes and 
lines of business written by such insurers.  To the extent that such insurers 
decline such business or do not underwrite it, the agents may offer the 
business to other insurers. 


<PAGE>   7

     The Farmers' agents direct their marketing efforts toward family accounts 
and small businesses. They leverage these relationships using an extensive 
portfolio of products to increase the number of policies per household or 
account. The P&C Group's existing relationships with nearly 8.3 million 
households provide a potential resource for future growth in policies-in-force 
and life insurance sales.  Higher retention rates and profitability are 
expected to be achieved on business written with households having multiple 
policies. 

     Farmers maintains its brand name recognition throughout its operating 
territory through television, radio and print advertising on both a national 
and local basis. To further assist the agency force in marketing Farmers' 
products, they are provided access to the Farmers Agency Information 
Management System which enables the agent to deliver high-quality consumer 
focused service at the point of sale.  Furthermore, Farmers' formalized 
policyholder recontact program, the "Farmers Friendly Review(", builds 
customer loyalty and provides a vehicle for enhanced policy retention and 
future internal growth through the cross-selling of property and casualty and 
life products. 

     As part of the merger with Zurich, Zurich Personal Insurance employees, 
based in Baltimore, Maryland will assist FGI and the P&C Group with their 
expansion efforts into new states in the eastern United States.  These Zurich 
Personal Insurance employees will also help the P&C Group expand into new 
specialty lines of business, such as recreational vehicles and non-standard 
auto, thereby increasing the range of products available to meet the P&C 
Group's customers' needs.

     Competition.  Property and casualty insurance is a very competitive 
industry with over 3,600 insurers operating in the United States.  Many 
property and casualty insurers with a small all-lines national market share 
have a significant market share within a single state or a specialty market. 
The P&C Group competes in its selected markets through brand name recognition 
of the Farmers Insurance Group of Companies, customer service, product 
features, financial strength, price and the direct writing agency force.

     There is substantial competition among insurance companies seeking 
customers for the types of products sold by Farmers Life.  Nearly 1,800 life 
insurance companies in the United States offer products similar to those 
offered by Farmers Life, and many use similar marketing techniques. Farmers 
Life competes on the basis of customer service, product features, financial 
strength and price.  Many of the products offered by Farmers Life contain 
significant cash accumulation features; therefore, these products compete with 
product offerings of banks, mutual funds and other financial institutions as 
well.

     Regulatory and Related Matters.  The Insurance Subsidiaries and the P&C 
Group are subject to extensive state regulatory oversight in the jurisdictions 
in which they do business. The Company and the P&C Group constitute an 
insurance holding company system as defined by the insurance laws and 
regulations of various jurisdictions.  As such, certain transactions between 
an insurance company and any other member company of the system, including 
investments in subsidiaries and distributions by an insurance company to its 
shareholders, are subject to regulation and oversight by the state of domicile 
of the applicable insurance company.  Insurers having insufficient statutory 
capital and surplus are subject to varying degrees of regulatory action 
depending on the level of capital inadequacy.  As of December 31, 1998, 
neither the P&C Group nor the Insurance Subsidiaries were subject to such 
regulatory actions.  Most of Farmers Life's and the P&C Group's business is 
subject to regulation with respect to policy rates and related matters. In 
addition, assessments are levied against Farmers Life and the P&C Group as a 
result of participation in various types of mandatory state guaranty 
associations. Existing federal laws and regulations affect the taxation of 
life insurance products and insurance companies.

Investments

     During the years ended December 31, 1998, 1997 and 1996, the Insurance 
Subsidiaries had pretax net investment income and realized investment gains/
(losses) of $292.6 million, $306.4 million and $355.6 million, respectively, 
and the Company other than the Insurance Subsidiaries (collectively, the 
"Noninsurance investment portfolio") had pretax net investment income and 
realized investment gains of $197.5 million, $217.6 million and $117.9 
million, respectively.  As of December 31, 1998, the book value of the 
Insurance Subsidiaries investment portfolio was approximately $5.0 billion and 
the book value of the Noninsurance investment portfolio was approximately 


<PAGE>   8

$2.4 billion.  The Board of Directors of the Company is responsible for 
developing investment policies and the Investment Committee, which is 
comprised of 10 officers of the Company who are appointed by the Board of 
Directors, is responsible for administering such policies.  During 1998, 
Scudder Kemper Investments, Inc. took over management of the Insurance 
Subsidiaries investment portfolio and the Noninsurance investment portfolio in 
accordance with these policies.  Prior to that, the Company's investment 
department managed these portfolios. 

     The investment philosophy for both the Insurance Subsidiaries investment 
portfolio and the Noninsurance investment portfolio emphasizes long-term 
fundamental value in the selection of the investment mix. For the Insurance 
Subsidiaries, the assets backing the Farmers Life interest sensitive 
investment portfolio are internally segregated along product lines in order to 
closely match the funding assets with the underlying liabilities to 
policyholders. The asset/liability matching system is the basis by which 
credited interest rates are determined. In the Noninsurance investment 
portfolio, excluding certificates of contribution of the P&C Group, relatively 
short maturities are maintained for capital preservation purposes and to 
ensure liquidity. 

     The Insurance Subsidiaries investment portfolio and the Noninsurance 
investment portfolio are both comprised of a broad range of assets, 
including corporate fixed income securities, mortgage-backed securities, 
taxable and tax-exempt government securities, preferred stock, common stock, 
owned real estate, mortgage loans and short-term instruments.  The Insurance 
Subsidiaries investment portfolio also includes policy loans and Standard & 
Poor's 500 Composite Stock Price Index ("S&P 500") call options.  
Approximately 43.6% of the Noninsurance investment portfolio consists of notes 
issued by British American Financial Services (UK and International), Ltd. 
("BAFS"), a subsidiary of ZFS. Approximately 1.4% of the Noninsurance 
investment portfolio consists of certificates of contribution of the P&C Group 
and approximately 2.4% of the Insurance Subsidiaries investment portfolio 
consists of a surplus note of the P&C Group.  See Item 13 and Notes F and T.

     Approximately 92.6% of the fixed income securities in the Insurance 
Subsidiaries investment portfolio are rated investment grade and approximately 
98.9% of the fixed income securities in the Noninsurance investment portfolio 
are rated investment grade.  Approximately 62.7% of the mortgage-backed 
securities in the Insurance Subsidiaries investment portfolio are guaranteed 
by the Government National Mortgage Association ("GNMA"), Federal Housing 
Authority ("FHA"), Federal National Mortgage Association ("FNMA"), or 
Federal Home Loan Mortgage Corporation ("FHLMC"), and approximately 75.2% of 
the remaining 37.3% are rated "AAA".  Approximately 60.2% of the mortgage-
backed securities in the Noninsurance investment portfolio are guaranteed by 
GNMA, FHA, FNMA, or FHLMC, and the remaining 39.8% are rated "AAA".


<PAGE>   9

     The following table sets forth the book value of each portfolio, by asset 
category, as of December 31, 1998 and 1997.

                                      Book Value of Invested Assets
                                             ($ in millions)
<TABLE>
<CAPTION>
                                                          As of December 31,                      
                                      -------------------------------------------------------------
                                                1998                               1997         
                                      -------------------------         --------------------------- 
                                      Book Value          %             Book Value           %    
                                      ----------      ---------         ----------       ----------
<S>                                   <C>             <C>               <C>              <C>
Insurance Subsidiaries       
Fixed income securities               $ 4,356.1        87.5 %           $  3,578.9           90.5 %
Mortgage loans                             52.9         1.1                   89.9            2.3
Equity securities                         107.4         2.1                    1.3            0.0
Owned real estate                          59.0         1.2                   67.2            1.7
Cash and cash equivalents                  73.7         1.5                   36.3            0.9
Surplus note of the P&C Group             119.0         2.4                    0.0            0.0
Policy loans                              185.2         3.7                  165.9            4.2
S&P 500 call options                       14.8         0.3                    3.3            0.1
Other                                       8.5         0.2                   11.6            0.3
                                      ---------       -------           ----------       ----------
    Total                             $ 4,976.6       100.0 %           $  3,954.4          100.0 %
                                      =========       =======           ==========       ==========

Noninsurance
Fixed income securities               $   662.1        27.3 %           $    592.8           22.6 %
Mortgage loans                              0.2         0.0                    0.2            0.0
Equity securities                         354.5        14.6                  389.0           14.9
Owned real estate                          62.8         2.6                   63.5            2.4
Cash and cash equivalents                 253.8        10.5                  479.9           18.3
Certificates of contribution of 
  the P&C Group                            34.4         1.4                  684.4           26.1
BAFS notes                              1,057.0        43.6                    0.0            0.0 
B.A.T Capital Corporation notes             0.0         0.0                  407.0           15.5
Other                                       0.8         0.0                    4.8            0.2
                                      ---------       -------           ----------       ----------
    Total                             $ 2,425.6       100.0 %           $  2,621.6          100.0 %
                                      =========       =======           ==========       ==========

</TABLE>

     Investment Accounting Policies. The Company follows the provisions of 
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for 
Certain Investments in Debt and Equity Securities".  This Statement addresses 
the accounting and reporting for investments in equity securities that have 
readily determinable market values and for all investments in debt securities. 
As of December 31, 1998 and 1997, the Company classified all investments in 
equity and debt securities as available-for-sale under SFAS No. 115, with the 
exception of $53.0 million in 1998 and $47.0 million in 1997 which relate to a 
grantor trust and are classified as trading securities under SFAS No. 115.  
The available-for-sale investments are reported on the balance sheet at market 
value, with unrealized gains and losses, net of tax, excluded from earnings 
and reported as a component of stockholders' equity.  The trading investments 
are reported on the "Other assets" line of the consolidated balance sheet at 
market value with both realized and unrealized gains and losses included in 
earnings, net of tax, in the year in which they occur.

     In compliance with a Securities and Exchange Commission ("SEC") staff 
announcement, the Company has recorded certain entries to the Deferred Policy 
Acquisition Costs ("DAC") and Value of Life Business Acquired ("VOLBA") line 
of the consolidated balance sheet in connection with SFAS No. 115.  The SEC 
requires that companies record entries to those assets and liabilities that 
would have been adjusted had the unrealized investment gains or losses from 
securities classified as available-for-sale actually been realized, with 
corresponding credits or charges reported directly to stockholders' equity.


<PAGE>   10

     Bonds acquired prior to the December 31, 1988 acquisition of the Company 
by B.A.T were marked-to-market at the time of the acquisition and the 
resulting net writedown was amortized over a period approximately equal to the 
remaining time to maturity.  As of December 31, 1998, this writedown was fully 
amortized.

     Real estate investments are accounted for on a depreciated cost basis.  
Real estate acquired in foreclosure and held for sale is carried at the lower 
of market value or depreciated cost less a valuation allowance.  Marketable 
securities are carried at cost.  Other investments, which consist primarily of 
the BAFS notes receivable, certificates of contribution of the P&C Group, a 
surplus note of the P&C Group and policy loans, are carried at the unpaid 
principal balances.
 
     S&P 500 call options, which are held by Farmers Life, are carried at 
estimated fair value.  Unrealized gains and losses resulting from changes in 
the estimated fair value of the call options are recorded as an adjustment to 
the interest liability credited to policyholders.  In addition, realized gains 
and losses from maturity or termination of the call options are offset against 
the interest credited to policyholders during the period incurred.  Premiums 
paid on call options are amortized to net investment income over the term of 
the contracts.

     Fixed Income Securities.  As of December 31, 1998, approximately 87.5% of 
the Insurance Subsidiaries investment portfolio and 27.3% of the Noninsurance 
investment portfolio were invested in fixed income securities. These 
investments included taxable and tax-exempt government securities, domestic 
and foreign corporate bonds, redeemable preferred stock and mortgage-backed 
securities.  Approximately 92.6% and 98.9% of the fixed income securities in 
the Insurance Subsidiaries investment portfolio and Noninsurance investment 
portfolio, respectively, were rated investment grade.  The following table 
sets forth the market values of the various categories of fixed income 
securities included within the portfolios as of December 31, 1998.

                                      Value of Fixed Income Securities
                                               ($ in millions)

<TABLE>
<CAPTION>
                              Insurance Subsidiaries         Noninsurance                 Total        
                              ----------------------   -----------------------   -----------------------
                                 Market                   Market                    Market              
                                 Value          %         Value          %          Value          %    
                              -----------   --------   -----------   ---------   -----------   ---------
<S>                            <C>           <C>         <C>           <C>         <C>          <C>
Mortgage-backed                $ 1,978.9      45.4 %     $   53.8        8.1 %     $ 2,032.7     40.5 %
Corporate                        1,053.1      24.1           44.4        6.7         1,097.5     21.9
U.S. Government                    504.4      11.6            0.3        0.0           504.7     10.1
Municipal                          651.6      15.0          539.0       81.5         1,190.6     23.7
Foreign                             81.4       1.9            0.0        0.0            81.4      1.6
Redeemable preferred stock          86.7       2.0           24.6        3.7           111.3      2.2
                               ---------     -------     --------      -------     ---------    -------
    Total                      $ 4,356.1     100.0 %     $  662.1      100.0 %     $ 5.018.2    100.0 %
                               =========     =======     ========      =======     =========    =======

</TABLE>

      Credit Ratings.  The National Association of Insurance Commissioners 
("NAIC") maintains a valuation system that assigns quality ratings known as 
"NAIC designations" to publicly traded and privately placed fixed income 
securities.  The NAIC designations range from 1 to 6, with categories 1 
(highest) and 2 considered investment grade and categories 3 through 6 
(lowest) considered non-investment grade.  As of December 31, 1998, the 
Insurance Subsidiaries held $323.1 million in below investment grade bonds, 
representing 6.5% of total invested assets, and the Noninsurance investment 
portfolio held $6.5 million in below investment grade bonds, representing 0.3% 
of total invested assets.

     Mortgage-backed Securities.  Mortgage-backed securities ("MBS") are the 
largest component of the Insurance Subsidiaries fixed income portfolio, 
representing approximately 45.4% of its fixed income portfolio, as of December 
31, 1998. The Noninsurance investment portfolio's MBS represented 
approximately 8.1% of its fixed income portfolio as of December 31, 1998. 
Approximately 62.7% of the MBS in the Insurance Subsidiaries investment 
portfolio are guaranteed by various government agencies and government 
sponsored entities, including the GNMA, FHA, FNMA or FHLMC, and 75.2% of the 
remaining 37.3% are rated "AAA".  Approximately 60.2% of the MBS in the 
Noninsurance investment portfolio are guaranteed by GNMA, FHA, FNMA or FHLMC, 
and the remaining 39.8% are rated "AAA".  


<PAGE>   11

The primary risk in holding MBS is the cash flow uncertainty that arises from 
changes to prepayment speeds as interest rates fluctuate. To reduce the 
uncertainties surrounding the cash flows of MBS, the Insurance Subsidiaries 
investment portfolio held significant MBS investments in collateralized 
mortgage obligations ("CMOs") including $624.9 million of planned amortization 
classes ("PACs") and $20.6 million of targeted amortization classes ("TACs") 
and the Noninsurance investment portfolio held $23.1 million of PACs. These 
securities provide protection by passing a substantial portion of the risk of 
prepayment uncertainty to other tranches. 

     Equity Investments-Common Stock.   In 1997, the Company restructured its 
common stock portfolio to diversify and to limit its exposure in any one 
market sector.  As a result, the Company's common stock portfolio is invested 
in the equities of many of the 3,000 largest United States Companies, which 
represent approximately 98% of the investable United States equity market.

     Mortgage Loans.  As of December 31, 1998, the Insurance Subsidiaries 
investment portfolio included mortgage loans with an aggregate book value of 
approximately $52.9 million (net of loss provisions of $7.3 million), or 1.1% 
of total invested assets, and the Noninsurance investment portfolio included 
mortgage loans of $0.2 million.

     All mortgage loans included in the Insurance Subsidiaries investment 
portfolio are secured by first mortgages. The majority of the mortgage loan 
portfolio consists of loans secured by office buildings, light industrial 
properties and retail properties located primarily in unanchored shopping 
centers.  Exposure to potential losses from future mortgage loan foreclosures 
and the operation or sale of properties acquired through foreclosures is 
limited because the Insurance Subsidiaries have not issued any mortgage loans 
since 1989, and the majority of the individual remaining mortgage loan 
balances are less than $1.0 million.

     Owned Real Estate Investments.  As of December 31, 1998, the Insurance 
Subsidiaries investment portfolio included owned real estate investments with 
a book value of $59.0 million (net of loss provisions of $3.2 million), or 
1.2% of total invested assets, and the Noninsurance investment portfolio 
included owned real estate investments with a book value of $62.8 million, or 
2.6% of total invested assets. The Insurance Subsidiaries real estate holdings 
fall into two categories: real property assets that were acquired directly as 
an equity investment and foreclosed equity real estate properties. The 
Noninsurance investment portfolio owned real estate holdings were all acquired 
directly as equity investments.

     Problem Investments-Fixed Income Securities.  As of December 31, 1998, 
none of the fixed income securities held in the Insurance Subsidiaries 
investment portfolio or the Noninsurance investment portfolio were classified 
as "problem" or "potential problem" assets.

     Problem Investments-Mortgage Loan Investments.  As of December 31, 1998, 
none of the mortgage loans held by the Insurance Subsidiaries investment 
portfolio or the Noninsurance investment portfolio were classified as 
"troubled loans".


ITEM 2.   Properties

     The Company owns three buildings in Los Angeles and thirteen business 
service centers in which its administrative operations are conducted.  In 
addition, the Company owns a building in the state of Washington in which the 
operations of Farmers Life are conducted.


ITEM 3.   Legal Proceedings

     The Company is a party to numerous lawsuits arising from its normal 
business activities. These actions are in various stages of discovery and 
development, and some seek punitive as well as compensatory damages.  In the 
opinion of management, the Company has not engaged in any conduct which should 
warrant the award of any material punitive or compensatory damages. The 
Company intends to vigorously defend its position in each case, and management 
believes 


<PAGE>   12

that, while it is not possible to predict the outcome of such matters with 
absolute certainty, ultimate disposition of these proceedings should not have 
a material adverse effect on the Company's consolidated results of operations 
or financial position. In addition, the Company is, from time to time, 
involved as a party in various governmental and administrative proceedings.


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

     On September 4, 1998, at a special meeting of the Stockholder, the 
Company's sole Stockholder, B.A.T,  approved an amendment to Article Fourth of 
the Restated Articles of Incorporation which restructured the capital 
structure of the Company.  For additional information, refer to the Form 8-K 
filed by the Company dated September 6, 1998.


                          PART II

ITEM 5.   Market for Farmers Group, Inc.'s Common Equity and Related 
          Stockholders Matters

     On September 4, 1998, after approval by the Company's Stockholder, each 
two shares of the Company's outstanding stock were recapitalized into the 
following:

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

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

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

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

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


ITEM 6.   Selected Financial Data

     The following table sets forth summary consolidated income statement 
data, consolidated balance sheet data and other operating data for the periods 
indicated. The following consolidated income statement data of the Company for 
each of the years in the five-year period ended December 31, 1998, and the 
consolidated balance sheet data of the Company as of December 31, 1998 and 
each of the preceding four years ended December 31, have been derived from the 
Company's audited consolidated financial statements. The following data should 
be read in conjunction with the Company's Consolidated Financial Statements 
and related notes, "Management's Discussion and Analysis of Financial 
Condition and Results of Operations" and other financial information appearing 
elsewhere herein. 

     Income statement data includes the effect of amortizing the purchase 
accounting entries related to B.A.T's acquisition of the Company in December 
1988. Major items incorporated in the purchase price of the Company include 
goodwill and the value of the AIF contracts of the P&C Group (see Note A).  
The amortization of these two items, which is being taken on a straight-line 
basis over forty years, reduced annual pretax income by approximately $102.8 
million in each of the years 1994 through 1998.


<PAGE>   13

<TABLE>
<CAPTION>

                                                           Year Ended December 31,                       
                                     ------------------------------------------------------------------- 
                                        1998          1997          1996          1995          1994     
                                     -----------   -----------   -----------   -----------   ----------- 
                                                           ($ in millions)
<S>                                  <C>           <C>           <C>           <C>           <C>

INCOME STATEMENT DATA
Consolidated operating revenues      $   3,031.2   $   2,009.0   $   2,013.2   $   1,892.4   $   1,779.2 
                                     ===========   ===========   ===========   ===========   =========== 
Management services to property
  and casualty insurance companies;
  and other:
    Operating revenues               $   1,358.2   $   1,324.9   $   1,245.4   $   1,183.1   $   1,130.1 
                                     -----------   -----------   -----------   -----------   ----------- 
  Salaries and employee benefits           328.6         335.8         337.2         348.8         348.8 
  Buildings and equipment expenses         145.4          95.8          87.3          75.0          55.1 
  Amortization of AIF contracts   
    and goodwill                           102.8         102.8         102.8         102.8         102.8 
  General and administrative expenses      204.1         202.6         170.3         170.5         172.8 
                                     -----------   -----------   -----------   -----------   ----------- 
    Total operating expenses               780.9         737.0         697.6         697.1         679.5
                                      
  Merger related expenses(see Note E)       21.1           0.0           0.0           0.0           0.0
                                     -----------   -----------   -----------   -----------   -----------
    Total expenses                         802.0         737.0         697.6         697.1         679.5
                                     -----------   -----------   -----------   -----------   ----------- 
    Operating income                       556.2         587.9         547.8         486.0         450.6 
  Net investment income                    135.1         144.2         112.8          78.0          59.1 
  Net realized gains                        62.4          73.4           5.1           1.5           2.7 
  Gain on sale of subsidiaries               0.0          19.0           0.0           0.0           0.0 
  Dividends on preferred securities  
    of subsidiary trusts                   (42.1)        (42.1)        (42.1)        (10.4)          0.0 
                                     -----------   -----------   -----------   -----------   ----------- 
    Income before provision for 
      taxes                                711.6         782.4         623.6         555.1         512.4 
  Provision for income taxes               290.8         332.2         275.1         224.3         208.1 
                                     -----------   -----------   -----------   -----------   ----------- 
    Management services income             420.8         450.2         348.5         330.8         304.3 
                                     -----------   -----------   -----------   -----------   ----------- 

Insurance Subsidiaries:
  Life premiums                            173.9         161.1         170.4         158.8         153.1 
  Non-life reinsurance premiums          1,000.1           0.0           0.0           0.0           0.0 
  Life policy charges                      206.4         216.6         241.7         220.6         197.6 
  Investment income, net of expenses       307.4         293.2         317.7         298.3         251.6
  Net realized gains/(losses)              (14.8)         13.2          38.0          31.6          46.8 
                                     -----------   -----------   -----------   -----------   ----------- 
    Total revenues                       1,673.0         684.1         767.8         709.3         649.1
                                     -----------   -----------   -----------   -----------   ----------- 
  Non-life losses and loss adjustment
    expenses                               655.1           0.0           0.0           0.0           0.0  
  Life policyholders' benefits             308.3         294.4         335.1         316.7         276.4
  Amortization of deferred policy 
    acquisition costs and value of 
    life business acquired                  90.1         104.0         108.8         103.2          92.8 
  Life commissions                          18.9          18.2          21.0          20.1          18.7 
  Non-life reinsurance commissions         319.9           0.0           0.0           0.0           0.0 
  General and administrative expenses       41.7          47.8          63.4          60.9          57.4 
                                     -----------   -----------   -----------   -----------   ----------- 
    Total operating expenses             1,434.0         464.4         528.3         500.9         445.3 
                                     -----------   -----------   -----------   -----------   ----------- 

    Income before provision for 
      taxes                                239.0         219.7         239.5         208.4         203.8 
  Provision for income taxes                83.0          76.4          80.1          68.5          67.7 
                                     -----------   -----------   -----------   -----------   ----------- 
    Insurance Subsidiaries 
      income                               156.0         143.3         159.4         139.9         136.1  
                                     -----------   -----------   -----------   -----------   -----------
Consolidated net income before
    cumulative effect of accounting 
    change                                 576.8         593.5         507.9         470.7         440.4 
Cumulative effect of accounting 
    change                                   0.0           0.0           0.0           0.0          (4.7)(1) 
                                     -----------   -----------   -----------   -----------   ----------- 
Consolidated net income              $     576.8   $     593.5   $     507.9   $     470.7   $     435.7
                                     ===========   ===========   ===========   ===========   =========== 

BALANCE SHEET DATA
  Total investments (2)              $   7,402.2   $   6,576.0   $   6,605.3   $   6,545.7   $   5,181.9 
  Total assets                          12,682.1      12,117.4      12,928.8      12,630.6      11,270.9 
  Total short term debt                      0.0           0.0           0.0         200.0           0.0
  Total long term debt                       0.0           0.1           0.2           0.3         200.4
  Company obligated mandatorily
    redeemable preferred securities                                                                      
    of subsidiary trusts holding 
    solely junior subordinated
    debentures ("QUIPS")                   500.0         500.0         500.0         500.0           0.0 
  Stockholders' equity                   7,034.4       6,781.6       6,503.8       6,493.6       6,148.0 

OTHER OPERATING DATA (unaudited)
  Ratio of debt to total 
    capitalization                           6.6 %         6.9 %         7.1 %         9.7 %         3.2 %
  Ratio of earnings to fixed 
    charges (3)                             19.5 x        20.2 x        15.5 x        21.5 x        28.9 x

</TABLE>

----------------------------
 (1) Net income reflects the charge resulting from expensing the transition 
     obligation upon the implementation of SFAS No. 112, "Employers' 
     Accounting for Postemployment Benefits". Such amounts were $4.5 million 
     and $0.2 million, after tax, for Management services to property and 
     casualty insurance companies; and other and the Insurance
     Subsidiaries, respectively, for the year ended December 31, 1994.
(2)  Includes cash and cash equivalents, marketable securities and notes 
     receivable-affiliate.
(3)  The ratio of earnings to fixed charges has been determined by dividing 
     the sum of net income before income taxes plus fixed charges by fixed 
     charges.  Fixed charges consist of interest, capitalized interest, 
     dividends paid to QUIPS holders, amortization of QUIPS offering expenses 
     and that portion of rent expenses deemed to be interest.


<PAGE>   14

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

General

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

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

     The Company provides reinsurance coverage to the P&C Group through its 
subsidiary, Farmers Re, which was formed and licensed to conduct business in 
December 1997.  In January 1998, Farmers Re entered into a quota share 
reinsurance treaty with the P&C Group under which it reinsures a percentage of 
the auto physical damage business written by the P&C Group (see Note C).


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

   Management Services to Property and Casualty Insurance Companies; and Other

     Operating Revenues.  Operating revenues increased from $1,324.9 million 
in 1997 to $1,358.2 million in 1998, an increase of $33.3 million, or 2.5%.  
Operating revenues primarily consist of management fees paid to the Company as 
a percentage of gross premiums earned by the P&C Group.  Such premiums 
increased from $10,070.1 million in 1997 to $10,331.0 million in 1998 due 
primarily to an increase in the number of Auto and Fire policies-in-force 
between years and higher average premium levels in the Fire line of business.

     Total Expenses.  Total expenses as a percentage of operating revenues 
increased from 55.6% in 1997 to 59.0% in 1998, an increase of 3.4 percentage 
points. This increase was due to $21.1 million of merger related expenses and 
a $46.0 million write-off of impaired assets in 1998.  Excluding these two 
items, expenses as a percentage of revenues decreased by 1.5 percentage points 
between years. 

          Salaries and Employee Benefits.  Salaries and employee benefits 
     decreased from $335.8 million in 1997 to $328.6 million in 1998, a 
     decrease of $7.2 million, or 2.1%, primarily due to a reduction in 
     employee complement due to increased operating efficiency as a result of 
     automation through the greater use of information technology systems.

          Buildings and Equipment Expenses.  Buildings and equipment expenses 
     increased from $95.8 million in 1997 to $145.4 million in 1998, an 
     increase of $49.6 million, or 51.8%.  A review of capitalized software in 
     1998 resulted in a write-off of $43.6 million of capitalized costs that 
     were no longer expected to be recoverable.  In addition, expenses 
     increased between years due to higher amortization expense associated 
     with information technology systems software. 


<PAGE>   15

          Amortization of AIF Contracts and Goodwill.  The purchase accounting 
     entries related to the acquisition of the Company by B.A.T in December 
     1988 include goodwill (capitalized at $2.4 billion) and the value of the 
     AIF contracts of the P&C Group (capitalized at $1.7 billion).  The 
     amortization of these two items, which is being taken on a straight-line 
     basis over forty years, reduced pretax income by approximately $102.8 
     million for both 1998 and 1997.

          General and Administrative Expenses.  General and administrative 
     expenses increased from $202.6 million in 1997 to $204.1 million in 1998 
     due to a $2.4 million write-off of impaired assets as well as a $0.8 
     million increase in Year 2000 Project related expenses.  Despite these 
     two items, the Company has held the increase in general and 
     administrative expenses between years to less than one percent as a 
     result of continued attention to cost control and automation through the 
     greater use of information technology systems.

          Merger Related Expenses.  Expenses incurred by the Company as a 
     result of the merger between B.A.T's Financial Services Businesses and 
     Zurich amounted to $21.1 million for the year ended December 31, 1998 
     (see Note E).

     Net Investment Income.  Net investment income decreased from $144.2 
million in 1997 to $135.1 million in 1998, a decrease of $9.1 million, or 
6.3%.  Of this decrease, $8.6 million was due to the redemption of 
certificates of contribution of the P&C Group and the subsequent issuance of 
the BAFS notes receivable at lower interest rates (see Note T).  The remaining 
decrease was due substantially to lower market yield rates.

     Net Realized Gains.  Net realized gains decreased from $73.4 million in 
1997 to $62.4 million in 1998, a decrease of $11.0 million, due to the fact 
that significant gains were realized in 1997 in connection with restructuring 
the equities portfolio.  

     Gain on Sale of Subsidiaries.  The gain recorded on the April 15, 1997 
sale of OSL and IGL amounted to $19.0 million in 1997.

     Dividends on Preferred Securities of Subsidiary Trusts.   Dividends 
expense related to the $500.0 million of Cumulative Quarterly Income Preferred 
Securities ("QUIPS") issued in 1995 was $42.1 million in both 1997 and 1998.

     Provision for Income Taxes.  Provision for income taxes decreased from 
$332.2 million in 1997 to $290.8 million in 1998, a decrease of $41.4 million, 
or 12.5%. This decrease was due to the decrease in pretax income between years 
as well as the fact that $26.8 million of taxes were recorded in 1997 related 
to the sale of OSL and IGL.

     Management Services Income.  As a result of the foregoing, management 
services income decreased from $450.2 million for the year ended December 31, 
1997 to $420.8 million for the year ended December 31, 1998, a decrease of 
$29.4 million, or 6.5%.  Exclusive of the merger related expenses and the 
write-off of impaired assets, management services income increased $12.5 
million, or 2.8%, between years. 

  Insurance Subsidiaries

     In 1998, Farmers Re assumed $1.0 billion of premiums, incurred $655.1 
million of non-life losses and loss adjustment expenses and incurred $319.9 
million of non-life reinsurance commissions expense.  For the year ended 
December 31, 1998, Farmers Re contributed $37.2 million to income before taxes 
and $25.4 million to net income. 

     On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance 
Company, a subsidiary of Americo Life, Inc..  As a result, there was no 
contribution to net income from OSL or IGL in 1998, compared to $5.5 million 
in 1997.  The following commentary addresses the results of the Company's 
remaining life insurance subsidiary, Farmers Life.

     Total Revenues. Total revenues increased from $638.6 million in 1997 to 
$660.6 million in 1998, an increase of $22.0 million, or 3.4%.  


<PAGE>   16

          Life Premiums.  Premiums increased $22.0 million, or 14.5%, between 
     years.  This increase was due to a 15.8% growth in the average volume of 
     insurance in-force which was driven by sales of the Premier Whole Life 
     ("PWL") and the Farmers Premier 20 Year Term ("FP20") products.  Also 
     contributing to the increase in premiums was an increase in the number 
     of annuities in the payment phase ("AIP").

          Life Policy Charges.  Policy charges increased $5.6 million in 1998, 
     or 2.8% over 1997, reflecting growth in the average volume of universal 
     life-type insurance in-force.

          Investment Income.  Net investment income increased $18.0 million in 
     1998, or 6.5% over 1997, due to a higher invested asset base.

          Net Realized Gains/(Losses).  Net realized gains/(losses) decreased 
     $23.6 million, from a $10.1 million gain in 1997 to a $13.5 million loss 
     in 1998.  This decrease was due mainly to realized losses recognized as a 
     result of a $26.0 million writedown of Russian bond holdings in 1998.

     Total Operating Expenses.  Total operating expenses increased from $427.0 
million in 1997 to $458.8 million in 1998, an increase of $31.8 million, or 
7.4%.

          Life Policyholders' Benefits and Charges.  Life policyholders' 
     benefits expense and charges increased from $274.5 million in 1997 to 
     $308.3 million in 1998, an increase of $33.8 million, or 12.3%.

               Policy Benefits.  Policy benefits, which consist primarily of 
          death and surrender benefits on life products, increased $21.6 
          million over 1997 to $134.0 million, due to growth in the volume of 
          life insurance in-force and an increase in mortality experience 
          between periods.

               Increase in Liability for Future Benefits.  Increase in 
          liability for future benefits expense increased from $15.7 million 
          in 1997 to $23.7 million in 1998. This increase was primarily 
          attributable to an increase in AIP and sales of the PWL and Farmers 
          Premier Term products, particularly the FP20 product introduced in 
          October 1997.

               Interest Credited to Policyholders.  Interest credited to 
          policyholders, which represents the amount credited to policyholder 
          funds on deposit under universal life-type contracts and deferred 
          annuities, increased from $146.4 million in 1997 to $150.6 million 
          in 1998, or 2.9%, reflecting growth in the universal life fund 
          balance.

          General Operating Expenses.  General operating expenses decreased 
     from $152.5 million in 1997 to $150.5 million in 1998, a decrease of $2.0 
     million, or 1.3%.

               Amortization of DAC and VOLBA.  Amortization expense decreased 
          from $94.7 million in 1997 to $90.1 million in 1998 due to higher 
          universal life death claims experience in 1998.

               Commissions.  Commissions increased from $17.3 million in 1997 
          to $19.0 million in 1998 due to the increase in the volume of 
          business-in-force. 

               General and Administrative Expenses. General and administrative 
          expenses increased from $40.5 million in 1997 to $41.5 million in 
          1998, an increase of just $1.0 million.  This increase resulted 
          mainly from increased premium taxes.

     Provision for Income Taxes.  Provision for income taxes decreased from 
$73.8 million in 1997 to $71.2 million in 1998, a decrease of $2.6 million, 
due to the decrease in pretax operating income.


<PAGE>   17

     Farmers Life Income.  As a result of the foregoing, Farmers Life income 
decreased from $137.8 million in 1997 to $130.6 million in 1998, a decrease of 
$7.2 million, or 5.2%.

  Consolidated Net Income

     Consolidated net income of the Company decreased from $593.5 million in 
1997 to $576.8 million in 1998, a decrease of $16.7 million, or 2.8%, due 
primarily to the merger related expenses and the write-off of impaired assets.


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

  Management Services to Property and Casualty Insurance Companies; and Other

     Operating Revenues. Operating revenues increased from $1,245.4 million in 
1996 to $1,324.9 million in 1997, an increase of $79.5 million, or 6.4%.  This 
growth reflects higher gross premiums earned by the P&C Group, which increased 
from $9,458.2 million in 1996 to $10,070.1 million in 1997 due primarily to 
higher average premium levels for the Auto and Fire lines of business and an 
increase in the number of policies-in-force between years reflecting stricter 
enforcement of the California mandatory auto insurance law following the 
enactment of California Assembly Bill 650 and the P&C Group's re-entry into 
the California homeowners' market.  Partially offsetting these increases is 
the fact that, in recognition of expense savings realized as a result of 
improved operating efficiencies, the Company waived 0.43% from the Farmers 
Preferred Auto Management fee rate that was in effect prior to November 1, 
1996.  This rate waiver resulted in a $22.3 million reduction in management 
fees in 1997 from what such fees would have been using the rates in effect 
during 1996.  

     Total Operating Expenses. Total operating expenses as a percentage of 
operating revenues decreased from 56.0% in 1996 to 55.6% in 1997, a decrease 
of 0.4 percentage points. 

          Salaries and Employee Benefits.  Salaries and employee benefits 
     decreased from $337.2 million in 1996 to $335.8 million in 1997, a 
     decrease of $1.4 million, or 0.4%, primarily due to a reduction in 
     employee complement.

          Buildings and Equipment Expenses.  Buildings and equipment expenses 
     increased from $87.3 million in 1996 to $95.8 million in 1997, an 
     increase of $8.5 million, or 9.7%.  This increase was primarily due to 
     higher amortization expense associated with information technology 
     systems software.

          Amortization of AIF Contracts and Goodwill.  The amortization of 
     these two items, which is being taken on a straight-line basis over forty 
     years, reduced pretax income by approximately $102.8 million for both 
     1997 and 1996.

          General and Administrative Expenses.  General and administrative 
     expenses increased from $170.3 million in 1996 to $202.6 million in 1997, 
     an increase of $32.3 million, or 19.0%.  This increase was primarily due 
     to higher expenses attributable to increased business levels and the 
     re-entry of the P&C Group into the California homeowners' market.  Also 
     contributing to the increase in expense was a $4.6 million increase in 
     Year 2000 Project costs.

     Net Investment Income.  Net investment income increased from $112.8 
million in 1996 to $144.2 million in 1997, an increase of $31.4 million, or 
27.8%.  This increase was primarily due to a larger invested asset base as a 
result of common stock received as part of a $374.9 million dividend from 
Farmers Life to Farmers Group, Inc. in December 1996 and the reinvestment of 
cash generated by the sale of OSL and IGL. 

     Net Realized Gains.  Net realized gains increased from $5.1 million in 
1996 to $73.4 million in 1997, an increase of $68.3 million, due primarily to 
gains realized on equities formerly held by Farmers Life that were sold while 
restructuring the portfolio. 


<PAGE>   18

     Gain on Sale of Subsidiaries.  The gain recorded on the April 15, 1997 
sale of OSL and IGL amounted to $19.0 million in 1997.

     Dividends on Preferred Securities of Subsidiary Trusts.   Dividends 
expense related to the $500.0 million of QUIPS issued in 1995 was $42.1 
million in both 1996 and 1997.

     Provision for Income Taxes.  Provision for income taxes increased from 
$275.1 million in 1996 to $332.2 million in 1997, an increase of $57.1 
million, or 20.8%. This increase was due to the increase in pretax income 
between years and the $26.8 million of taxes associated with the sale of OSL 
and IGL.

     Management Services Income.  As a result of the foregoing, management 
services income increased from $348.5 million for the year ended December 31, 
1996 to $450.2 million for the year ended December 31, 1997, an increase of 
$101.7 million, or 29.2%. 

   Insurance Subsidiaries

     Since OSL and IGL were sold to Great Southern Life Insurance Company on 
April 15, 1997, they contributed only $5.5 million to net income in 1997 
compared to $17.2 million in 1996.  The following commentary addresses the 
results of the Company's remaining life insurance subsidiary, Farmers Life.

     Total Revenues. Total revenues increased from $613.3 million in 1996 to 
$638.6 million in 1997, an increase of $25.3 million, or 4.1%.  

          Life Premiums.  Premiums increased $15.0 million, or 11.0% between 
     years.  This increase was due to growth in renewal and first year 
     business resulting from increased sales of the PWL product.

          Life Policy Charges.  Policy charges increased $12.5 million in 
     1997, or 6.6% over 1996, reflecting a 4.2% growth in universal life-type 
     insurance in-force.  

          Investment Income.  Net investment income increased $17.9 million in 
     1997, or 6.9% over 1996, due largely to higher bond interest income 
     resulting primarily from an increase in bond investments.

          Net Realized Gains.  Net realized gains decreased by $20.1 million, 
     from $30.2 million in 1996 to $10.1 million in 1997, due to the fact that 
     Farmers Life's common stock portfolio was transferred to FGI as part of 
     the 1996 dividend.

     Total Operating Expenses.  Total operating expenses increased from $399.9 
million in 1996 to $427.0 million in 1997, an increase of $27.1 million, or 
6.8%.

          Life Policyholders' Benefits and Charges.  Life policyholders' 
     benefits expense and charges increased from $260.3 million in 1996 to 
     $274.5 million in 1997, an increase of $14.2 million, or 5.5%.  

               Policy Benefits.  Policy benefits increased $1.5 million over 
          1996 to $112.4 million, due to an increase in death claims resulting 
          from an increase in insurance in-force.  

               Increase in Liability for Future Benefits. Increase in 
          liability for future benefits expense increased from $11.4 million 
          in 1996 to $15.7 million in 1997.  This increase was primarily 
          attributable to lower terminations on older whole life business 
          carrying higher future benefit provisions and increased PWL sales in 
          1997 and 1996.


<PAGE>   19

               Interest Credited to Policyholders. Interest credited to 
          policyholders increased from $138.0 million in 1996 to $146.4 
          million in 1997, or 6.1%, reflecting a 4.2% growth in universal 
          life-type insurance in-force and a 3.5% increase in annuity funds on 
          deposit. 

          General Operating Expenses.  General operating expenses increased 
     from $139.6 million in 1996 to $152.5 million in 1997, an increase of 
     $12.9 million, or 9.2%.

               Amortization of DAC and VOLBA. Amortization expense increased 
          from $80.8 million in 1996 to $94.7 million in 1997.  This increase 
          reflects the continued growth in the volume of universal life-type 
          and traditional business in-force.

               Commissions.  Commissions decreased from $18.3 million in 1996 
          to $17.3 million in 1997, or 5.5%.  The decrease results from IGL's 
          commutation, in the third quarter of 1997, of the block of business 
          ceded to Farmers Life under a reinsurance treaty.  

               General and Administrative Expenses.  General and 
          administrative expenses remained unchanged from the 1996 level of 
          $40.5 million. 

     Provision for Income Taxes.  Provision for income taxes increased from 
$71.1 million in 1996 to $73.8 million in 1997, an increase of $2.7 million, 
due to a decrease in tax preference items, particularly tax exempt interest.

     Farmers Life Income.  As a result of the foregoing, Farmers Life income 
decreased from $142.3 million in 1996 to $137.8 million in 1997, a decrease of 
$4.5 million, or 3.2%.

  Consolidated Net Income

     Consolidated net income of the Company increased from $507.9 million in 
1996 to $593.5 million in 1997, an increase of $85.6 million, or 16.9%.


Year 2000 Issue

     Many computer systems in use today were designed and developed using two 
digits, rather than four, to specify the year.  As a result, such systems will 
recognize "00" as the year 1900 rather than the year 2000.  This could cause 
many computer applications to fail completely or to create erroneous results 
unless corrective measures are taken.  As early as 1995, the Company's 
management recognized that its information systems were at risk to produce 
erroneous results due to the effect of the century rollover.  Significant 
efforts have been expended to gain a complete understanding of Year 2000 
implications and to develop a strategy to make the Company's and the P&C 
Group's systems Year 2000 compliant.  The costs associated with the Year 2000 
Project are being expensed as incurred. The cumulative costs through December 
31, 1998 totaled $17.3 million, of which $3.5 million was allocated to the P&C 
Group.  Total costs of the project are expected to be approximately $23.2 
million, of which approximately $5.4 million is expected to be allocated to 
the P&C Group. 

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

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


<PAGE>   20

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

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

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

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

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


Liquidity and Capital Resources

     General.  The principal uses of funds by the Company are (i) operating 
expenses, (ii) dividends to the shareholders of the Company's QUIPS, (iii) 
capital expenditures and (iv) dividends to its stockholders.  In 1998, 
dividends paid on the QUIPS totaled $42.1 million, capital expenditures 
totaled $59.9 million and cash dividends paid to the stockholders totaled 
$355.2 million.

     The principal sources of funds available to the Company are (i) the 
management fees that it receives for providing management services to the P&C 
Group, (ii) investment income and (iii) dividends from its subsidiaries.  
Historically, funds available from the first two of these sources have been 
sufficient to satisfy the liquidity needs of the Company, and the Company 
anticipates that such funds will continue to be adequate to satisfy such needs 
in the future.  A portion of the net income of Farmers Life is available for 
payment as a dividend to the Company, subject to certain limitations imposed 
by the insurance laws of the State of Washington and additional state 
taxation. As of December 31, 1998, an aggregate of $115.9 million is available 
for distribution as a dividend without approval of the state insurance 
department (see Note I). Additionally, as of December 31, 1998, the Company 
had available revolving credit facilities enabling it to borrow up to $500.0 
million in the event such a need should arise (see Note V). 

     In order to maintain the policyholders' surplus of the P&C Group, Farmers 
Life purchased a $119.0 million surplus note of the P&C Group in 1998 (see 
Note F).  The Company has, from time to time, made other surplus contributions 
to the P&C Group totaling approximately $684.4 million, receiving certificates 
of contribution which bear interest at various rates. In 1998, $650.0 million 
of these certificates of contribution of the P&C Group were repaid.  The 
Company believes that these purchases of certificates of contribution and the 
surplus note have helped to support the historical growth in premiums earned 
by the P&C Group and the related growth in management fees paid to the Company.


<PAGE>   21

     In 1998, the $407.0 million of B.A.T Capital Corporation notes receivable 
was settled.  Using the $650.0 million of proceeds received from the 
redemption of the certificates of contribution mentioned above, and the 
settlement of the $407.0 million B.A.T notes receivable, the Company issued 
$1,057.0 million of notes receivable to BAFS in September 1998 (see Note T).

     Net cash provided by operating activities increased from $660.4 million 
in 1997 to $1,092.2 million in 1998, an increase in cash of $431.8 million, 
or 65.4%.  This increase in cash was principally due to a $163.2 million 
increase in reinsurance payables to the P&C Group in 1998, a $105.9 million 
increase in the Farmers Re provision for non-life losses and loss adjustment 
expenses in 1998 and a $131.3 million decrease in non-current liabilities in 
1997. 

     Net cash used in investing activities increased from $356.9 million in 
1997 to $951.1 million in 1998, a decrease in cash of $594.2 million, or 
166.5%, between years.  This decrease in cash was primarily due to the 
$1,057.0 million of notes receivable issued to BAFS in 1998, the $119.0 
million surplus note of the P&C Group purchased by Farmers Life in 1998 and 
the fact that $336.7 million of proceeds were received from the sale of OSL 
and IGL in 1997.  Partially offsetting these decreases in cash were $650.0 
million of proceeds received from the redemption of certificates of 
contribution of the P&C Group in 1998 and $407.0 million of proceeds received 
from the settlement of the B.A.T Capital Corporation notes receivable in 1998.

     Net cash used in financing activities increased from $286.5 million in 
1997 to $329.8 million in 1998, a decrease in cash of $43.3 million, or 15.1%. 
This decrease in cash was due to a $41.1 million increase in annuity contract 
withdrawals by policyholders between years and an $18.0 million increase in 
dividends paid to the Company's stockholders in 1998.

     Farmers Life.  The principal uses of funds by Farmers Life are (i) policy 
benefits and claims, (ii) loans to policyholders, (iii) capital expenditures, 
(iv) operating expenses and (v) stockholder's dividends. The principal sources 
of funds available to Farmers Life are premiums and amounts earned from the 
investment of premiums and deposits.  These sources of funds have historically 
satisfied the liquidity needs of Farmers Life.

     Farmers Re.   The principal uses of funds by Farmers Re are (i) the 
payment of non-life losses and loss adjustment expenses, (ii) the payment of 
reinsurance commissions and (iii) operating expenses.  The principal sources 
of funds available to Farmers Re are premiums assumed from the P&C Group and 
investment income.


ITEM 7a.   Quantitative and Qualitative Disclosures about Market Risks

     The information required is presented under the caption "Risk Management" 
in Exhibit No. 99 of this Report.


<PAGE>   22

ITEM 8.  Financial Statements and Supplementary Data

                Index for Financial Statements and Supplementary Data


                                                                         Page
                                                                         ----

Independent Auditors' Report                                              23
Consolidated Financial Statements of Farmers Group, Inc.
 and Subsidiaries
  Consolidated Balance Sheets as of December 31, 1998 and 1997            24
  Consolidated Statements of Income for the years ended 
     December 31, 1998, 1997 and 1996                                     26
  Consolidated Statements of Comprehensive Income for the years ended
     December 31, 1998, 1997 and 1996                                     27
  Consolidated Statements of Stockholders' Equity for the years ended
     December 31, 1998, 1997 and 1996                                     28
  Consolidated Statements of Cash Flows for the years ended 
     December 31, 1998, 1997 and 1996                                     29
  Notes to Consolidated Financial Statements                              30
Quarterly Financial Data (Unaudited)                                      61


<PAGE>   23

INDEPENDENT AUDITORS' REPORT

To the Board of Directors of Farmers Group, Inc.

     We have audited the accompanying consolidated balance sheets of Farmers 
Group, Inc. and subsidiaries (the "Company") as of December 31, 1998 and 1997, 
and the related consolidated statements of income, comprehensive income, 
stockholders' equity, and cash flows for each of the three years in the period 
ended December 31, 1998.  Our audits also included the financial statement 
schedules listed in the Table of Contents at Item 14.  These financial 
statements and financial statement schedules are the responsibility of the 
Company's management.  Our responsibility is to express an opinion on these 
financial statements and financial statement schedules based on our audits.

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

     In our opinion, such consolidated financial statements present fairly, 
in all material respects, the financial position of the Company as of December 
31, 1998 and 1997, and the results of its operations and its cash flows for 
each of the three years in the period ended December 31, 1998 in conformity 
with generally accepted accounting principles.  

     Our audits were conducted for the purpose of forming an opinion on the 
basic financial statements taken as a whole.  The financial statement 
schedules listed in the Table of Contents at Item 14 are presented for the 
purpose of additional analysis and are not a required part of the basic 
financial statements.  These schedules are the responsibility of the Company's 
management.  Such schedules have been subjected to the auditing procedures 
applied in our audits of the basic financial statements and, in our opinion, 
are fairly stated in all material respects when considered in relation to the 
basic financial statements as a whole.

/s/  Deloitte & Touche  LLP

DELOITTE & TOUCHE LLP
Los Angeles, California
March 11, 1999


<PAGE>   24

                                   FARMERS GROUP, INC.
                                    AND SUBSIDIARIES
                              CONSOLIDATED BALANCE SHEETS
                                 (Amounts in thousands)
                                         ASSETS
<TABLE>
<CAPTION>
                                                                        December 31,
                                                                -----------------------------
                                                                     1998             1997
                                                                -------------   -------------
<S>                                                             <C>             <C>  
Current assets, excluding Insurance Subsidiaries:
 Cash and cash equivalents                                      $     253,828   $     479,935
 Marketable securities, at market value                                53,536         104,485
 Accrued interest                                                      32,542          43,849
 Accounts receivable, principally from the P&C Group                   35,271          34,804
 Notes receivable - affiliate                                               0         137,000
 Deferred taxes                                                        27,044          28,925
 Prepaid expenses and other                                            22,126          13,725
                                                                -------------   -------------
  Total current assets                                                424,347         842,723
                                                                -------------   -------------
Investments, excluding Insurance Subsidiaries:
 Fixed maturities available-for-sale, at market value
  (cost: $597,262 and $482,355)                                       608,539         488,245
 Mortgage loans on real estate                                            196             240
 Common stocks available-for-sale, at market value
  (cost: $278,107 and $322,741)                                       354,465         388,966
 Certificates of contribution of the P&C Group                         34,380         684,380
 Real estate, at cost (net of accumulated depreciation:
  $32,363 and $29,212)                                                 62,820          63,512
 Joint ventures, at equity                                                840           4,825
                                                                -------------   -------------
                                                                    1,061,240       1,630,168
                                                                -------------   -------------
Other assets, excluding Insurance Subsidiaries:
 Notes receivable - affiliate                                       1,057,000         270,000
 Goodwill (net of accumulated amortization: $600,440 
   and $540,396)                                                    1,801,315       1,861,359
 Attorney-in-fact contracts (net of accumulated 
   amortization: $427,260 and $384,534)                             1,281,783       1,324,509
 Securities lending collateral                                              0          49,908
 Other assets                                                         258,912         297,602
                                                                -------------   -------------
                                                                    4,399,010       3,803,378
                                                                -------------   -------------
Properties, plant and equipment, at cost:  (net of 
  accumulated depreciation: $293,425 and $242,392)                    402,061         450,880
                                                                -------------   -------------
Investments of Insurance Subsidiaries:
 Fixed maturities available-for-sale, at market value
  (cost: $4,178,305 and $3,408,426)                                 4,356,066       3,555,148
 Mortgage loans on real estate                                         52,879          89,903
 Non-redeemable preferred stocks available-for-sale, at market
  value (cost: $1,153 and $1,153)                                       1,270           1,227
 Common stocks available-for-sale, at market value
  (cost: $98,399 and $0)                                              106,095             120
 Surplus note of the P&C Group                                        119,000               0   
 Policy loans                                                         185,211         165,894
 Real estate, at cost (net of accumulated depreciation:
  $28,366 and $27,714)                                                 59,047          67,214
Joint ventures, at equity                                               8,456          11,566
S&P 500 call options, at fair value (cost: $11,305 and $3,450)         14,817           3,299
                                                                -------------   -------------
                                                                    4,902,841       3,894,371
                                                                -------------   -------------
Other assets of Insurance Subsidiaries:
 Cash and cash equivalents                                             73,724          36,318
 Marketable securities, at market value                                     0          23,731
 Reinsurance premiums receivable - P&C Group                           75,576               0 
 Accrued investment income                                             59,910          52,017
 Deferred policy acquisition costs and value of life business
  acquired                                                            801,690         798,725
 Securities lending collateral                                        461,801         544,580
 Other assets                                                          19,856          40,542
                                                                -------------   -------------
                                                                    1,492,557       1,495,913
                                                                -------------   -------------
   Total assets                                                 $  12,682,056   $  12,117,433
                                                                =============   =============
             The accompanying notes are an integral part of these financial statements.

</TABLE>


<PAGE>   25

                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                             (Amounts in thousands)
                      LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                         December 31,
                                                                 -----------------------------
                                                                     1998            1997
                                                                 -------------   -------------
<S>                                                              <C>             <C>
Current liabilities, excluding Insurance Subsidiaries:
 Notes and accounts payable:
  P&C Group                                                      $         137   $       2,547
  Other                                                                 28,420          28,204
 Accrued liabilities:
  Profit sharing                                                        50,404          51,067
  Income taxes                                                          69,906          82,279
  Other                                                                 30,724          12,245
                                                                 -------------   -------------
   Total current liabilities                                           179,591         176,342
                                                                 -------------   -------------
Other liabilities, excluding Insurance Subsidiaries:
 Real estate mortgages payable                                              25              92
 Non-current deferred taxes                                            601,047         643,910
 Securities lending liability                                                0          49,908
 Other                                                                 136,135         131,056
                                                                 -------------   -------------
                                                                       737,207         824,966
                                                                 -------------   -------------
Liabilities of Insurance Subsidiaries:
 Policy liabilities:
  Future policy benefits                                             3,184,248       3,010,162
  Claims                                                                26,177          22,156
  Policyholder dividends                                                     1               0
  Other policyholder funds                                              57,357          60,072
 Provision for non-life losses and loss adjustment expenses            105,944               0
 Income taxes (including deferred taxes: $164,729 and $153,006)        168,618         148,868
 Unearned investment income                                                971           1,016
 Reinsurance payable - P&C Group                                       163,161               0
 Securities lending liability                                          461,801         544,580
 Other liabilities                                                      62,573          47,697
                                                                 -------------   -------------
                                                                     4,230,851       3,834,551
                                                                 -------------   -------------
   Total liabilities                                                 5,147,649       4,835,859
                                                                 -------------   -------------

Commitments and contingencies

Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures                                                500,000         500,000
                                                                 -------------   -------------
Stockholders' Equity:
 Common stock, $1 par value per share; authorized, issued
  and outstanding: as of December 31, 1997 - 1,000 shares                    0               1
 Class A common stock, $1 par value per share; authorized,                   
  issued and outstanding: as of December 31, 1998 - 500 shares             0.5               0
 Class B common stock, $1 par value per share; authorized,
  issued and outstanding: as of December 31, 1998 - 500 shares             0.5               0
 Additional capital                                                  5,212,618       5,212,618
 Accumulated other comprehensive income (net of deferred taxes:
  $77,897 and $61,193)                                                 144,742         113,549
 Retained earnings                                                   1,677,046       1,455,406
                                                                 -------------   -------------
   Total stockholders' equity                                        7,034,407       6,781,574
                                                                 -------------   -------------
     Total liabilities and stockholders' equity                  $  12,682,056   $  12,117,433
                                                                 =============   =============
             The accompanying notes are an integral part of these financial statements.

</TABLE>


<PAGE>   26

                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                             (Amounts in thousands)
<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                               -------------------------------------
                                                                   1998          1997        1996
                                                               -----------  -----------  -----------
<S>                                                            <C>          <C>          <C>        
Consolidated operating revenues                                $ 3,031,191  $ 2,008,988  $ 2,013,152
                                                               ===========  ===========  ===========
Management services to property and casualty
 insurance companies; and other:
  Operating revenues                                           $ 1,358,175  $ 1,324,895  $ 1,245,375
                                                               -----------  -----------  -----------
  Salaries and employee benefits                                   328,611      335,781      337,238
  Buildings and equipment expenses                                 145,461       95,833       87,276
  Amortization of AIF contracts and goodwill                       102,770      102,770      102,770
  General and administrative expenses                              204,101      202,607      170,256
                                                               -----------  -----------  -----------
    Total operating expenses                                       780,943      736,991      697,540
  Merger related expenses                                           21,056            0            0
                                                               -----------  -----------  -----------
    Total expenses                                                 801,999      736,991      697,540
                                                               -----------  -----------  -----------
    Operating income                                               556,176      587,904      547,835
  Net investment income                                            135,062      144,131      112,780
  Net realized gains                                                62,428       73,403        5,079
  Gain on sale of subsidiaries                                           0       19,019            0
  Dividends on preferred securities of subsidiary trusts          (42,070)     (42,070)     (42,070)
                                                               -----------  -----------  -----------
    Income before provision for taxes                              711,596      782,387      623,624
  Provision for income taxes                                       290,752      332,184      275,152
                                                               -----------  -----------  -----------
    Management services income                                     420,844      450,203      348,472
                                                               -----------  -----------  -----------
Insurance Subsidiaries:
  Life premiums                                                    173,936      161,058      170,421
  Non-life reinsurance premiums                                  1,000,104            0            0
  Life policy charges                                              206,393      216,609      241,737
  Investment income, net of expenses                               307,391      293,190      317,630
  Net realized gains/(losses)                                      (14,808)      13,236       37,989
                                                               -----------  -----------  -----------
    Total revenues                                               1,673,016      684,093      767,777
                                                               -----------  -----------  -----------
  
  Non-life losses and loss adjustment expenses                     655,125            0            0
  Life policy benefits                                             133,984      124,261      155,110
  Increase in liability for future life policy benefits             23,711       14,863       11,089
  Interest credited to life policyholders                          150,618      155,301      168,912
  Amortization of deferred policy acquisition costs and
   value of life business acquired                                  90,082      103,975      108,802
  Life commissions                                                  18,972       18,188       20,986
  Non-life reinsurance commissions                                 319,875            0            0
  General and administrative expenses                               41,683       47,786       63,359
                                                               -----------  -----------  -----------
    Total operating expenses                                     1,434,050      464,374      528,258
                                                               -----------  -----------  -----------
    Income before provision for taxes                              238,966      219,719      239,519
  Provision for income taxes                                        82,970       76,424       80,050
                                                               -----------  -----------  -----------
    Insurance Subsidiaries income                                  155,996      143,295      159,469
                                                               -----------  -----------  -----------

Consolidated net income                                        $   576,840  $   593,498  $   507,941
                                                               ===========  ===========  ===========

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

</TABLE>


<PAGE>   27

                               FARMERS GROUP, INC.
                                AND SUBSIDIARIES
                           CONSOLIDATED STATEMENTS OF 
                              COMPREHENSIVE INCOME
                             (Amounts in thousands)
  
<TABLE>
<CAPTION>
                                                                      
                                                                        Year ended December 31, 
                                                                  -------------------------------------
                                                                      1998        1997         1996    
                                                                  -----------  -----------  -----------
<S>                                                               <C>          <C>          <C>  
Consolidated net income                                           $   576,840  $   593,498  $   507,941
                                                                  -----------  -----------  -----------
Other comprehensive income, net of tax:
  Unrealized holding gains/(losses) on securities:
    Unrealized holding gains arising during the period,
      net of tax of $26,193                                            48,738
    Less: reclassification adjustment for gains
      included in net income, net of tax of ($7,105)                  (13,195)
                                                                  -----------  -----------  -----------
  Net unrealized holding gains/(losses) on securities,        
      net of tax of $19,088, $16,844 and ($23,036)                     35,543       31,533      (42,649)     
  Change in effect of unrealized gains/(losses) on other 
      insurance accounts, net of tax of ($1,949),($5,432)  
      and $5,272                                                       (3,619)     (10,088)       9,791
  Minimum pension liability adjustment, net of tax of ($435)             (731)           0            0
                                                                  -----------  -----------  -----------
  Other comprehensive income                                           31,193       21,445      (32,858)
                                                                  -----------  -----------  -----------
Comprehensive income                                              $   608,033  $   614,943  $   475,083
                                                                  ===========  ===========  ===========

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

</TABLE>


<PAGE>   28

                                   FARMERS GROUP, INC.
                                    AND SUBSIDIARIES
                    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                     Years ended December 31, 1998, 1997 and 1996
                                (Amounts in thousands)
<TABLE>
<CAPTION>
                                                 Accumulated Other                  Total
                            Common   Additional   Comprehensive     Retained     Stockholders'
                            Stock     Capital         Income        Earnings        Equity
                           --------  -----------  ---------------  ------------  ------------
<S>                        <C>       <C>          <C>              <C>           <C>
Balance, December 31, 1995 $      1  $ 5,212,618  $     124,962    $  1,156,067  $  6,493,648

Net income, 1996                                                        507,941       507,941

Change in other 
  comprehensive income,
  net of tax of ($17,764)                               (32,858)                      (32,858)
  
Cash dividends paid                                                    (464,900)     (464,900)
                           --------  -----------  -------------    ------------  ------------
Balance, December 31, 1996        1    5,212,618         92,104       1,199,108     6,503,831

Net income, 1997                                                        593,498       593,498

Change in other 
  comprehensive income,
  net of tax of $11,412                                  21,445                        21,445

Cash dividends paid                                                    (337,200)     (337,200)
                           --------  -----------  -------------    ------------  ------------
Balance, December 31, 1997        1    5,212,618        113,549       1,455,406     6,781,574

Net income, 1998                                                        576,840       576,840

Unrealized holding gains
  arising during the period, 
  net of tax of $26,193                                  48,738                        48,738

Reclassification adjustment
  for gains included in net
  income, net of tax of 
  ($7,105)                                              (13,195)                      (13,195)

Change in effect of 
  unrealized losses on other
  insurance accounts, net of 
  tax of ($1,949)                                        (3,619)                       (3,619)

Minimum pension liability
  adjustment, net of tax
  of ($435)                                                (731)                         (731)

Cash dividends paid                                                    (355,200)     (355,200)
                           --------  -----------  -------------    ------------   -----------
Balance, December 31, 1998 $      1  $ 5,212,618  $     144,742    $  1,677,046   $ 7,034,407
                           ========  ===========  =============    ============   ===========

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

</TABLE>


<PAGE>   29

                                       FARMERS GROUP, INC.
                                        AND SUBSIDIARIES
                              CONSOLIDATED STATEMENTS OF CASH FLOWS
                                     (Amounts in thousands)
<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                                  ------------------------------------
                                                                     1998         1997         1996
                                                                  ----------   ----------   ----------
<S>                                                               <C>          <C>          <C>
Cash Flows from Operating Activities:
 Consolidated net income                                          $  576,840   $  593,498   $  507,941
 Non-cash and operating activities adjustments:
  Depreciation and amortization                                      180,089      176,899      168,263
  Amortization of deferred policy acquisition costs and
    value of life business acquired                                   84,514      103,975      108,802
  Policy acquisition costs deferred                                  (93,047)     (98,372)    (129,922)
  Life insurance policy liabilities                                   25,085       15,001        3,468
  Provision for non-life losses and loss 
    adjustment expenses                                              105,944            0            0
  Universal life type contracts:
    Deposits received                                                299,007      295,747      317,742
    Withdrawals                                                     (241,765)    (232,728)    (235,658)
    Interest credited                                                 67,585       62,247       78,112
  Equity in earnings of joint ventures                                (4,275)      (4,046)      (1,332)
  Gain on sales of assets                                            (48,154)     (87,760)     (44,584)
  Gain on sale of subsidiaries                                             0      (19,019)           0
 Changes in assets and liabilities:
  Current assets and liabilities                                     110,354       31,182       10,068 
  Non-current assets and liabilities                                  63,351     (153,157)     (64,024)
 Other, net                                                          (33,345)     (23,075)     (24,597)
                                                                  ----------   ----------   ----------
 Net cash provided by operating activities                         1,092,183      660,392      694,279
                                                                  ----------   ----------   ----------
Cash Flows from Investing Activities:
 Purchases of investments available-for-sale                      (1,869,877)  (1,685,693)  (1,279,073)
 Purchases of properties                                             (37,806)     (36,532)     (43,546)
 Purchases of notes receivable - affiliate                        (1,057,000)           0            0
 Purchase of a surplus note of the P&C Group                        (119,000)           0            0
 Purchase of certificates of contribution of the P&C Group                 0            0     (400,000)
 Proceeds from sales and maturities of investments
  available-for-sale                                               1,032,173    1,001,351      979,701
 Proceeds from sales of properties                                    27,329       16,778       27,822
 Proceeds from redemption of certificates of contribution
  of the P&C Group                                                   650,000            0      200,000
 Proceeds from redemption of notes receivable - affiliate            407,000            0            0
 Proceeds from sale of subsidiaries                                        0      336,714            0
 Mortgage loan collections                                            36,883       32,849       23,624
 Increase in policy loans                                            (19,317)     (17,836)     (22,020)
 Other, net                                                           (1,481)      (4,554)     (24,199)
                                                                  ----------   ----------   ----------
 Net cash used in investing activities                              (951,096)    (356,923)    (537,691)
                                                                  ----------   ----------   ----------
Cash Flows from Financing Activities:
 Dividends paid to stockholders                                     (355,200)    (337,200)    (464,900)
 Annuity contracts:
   Deposits received                                                 144,793      131,651      141,046
   Withdrawals                                                      (202,244)    (161,150)    (133,018)
   Interest credited                                                  82,930       80,280       87,160
 Issuance cost of cumulative quarterly income 
  preferred securities                                                     0            0         (438)
 Payment of long-term notes payable                                      (67)           0     (200,000)
 Payment of real estate mortgages payable                                  0         (125)        (116)
                                                                  ----------   ----------   ----------
 Net cash used in financing activities                              (329,788)    (286,544)    (570,266)
                                                                  ----------   ----------   ----------
Increase/(decrease) in cash and cash equivalents                    (188,701)      16,925     (413,678)
Cash and cash equivalents - at beginning of year                     516,253      499,328      913,006
                                                                  ----------   ----------   ----------
Cash and cash equivalents - at end of year                        $  327,552   $  516,253   $  499,328
                                                                  ==========   ==========   ==========

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

</TABLE>


<PAGE>   30

                                 FARMERS GROUP, INC.
                                  AND SUBSIDIARIES
                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


A.   Basis of presentation and summary of significant accounting policies

     The accompanying consolidated financial statements of Farmers Group, Inc. 
("FGI") and its subsidiaries (together "the Company") have been prepared in 
accordance with generally accepted accounting principles ("GAAP").  All 
material inter-company transactions have been eliminated.  Certain amounts 
applicable to prior years have been reclassified to conform with the 1998 
presentation.  The preparation of the Company's financial statements in 
conformity with GAAP requires management to make estimates and assumptions 
that affect the reported amounts of assets and liabilities and the disclosure 
of contingent assets and liabilities at the date of the financial statements 
as well as the reported amounts of revenues and expenses during the reporting 
periods.  Actual results could differ from those estimates.

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

     The Company is attorney-in-fact ("AIF") for three inter-insurance 
exchanges: Farmers Insurance Exchange, Fire Insurance Exchange and Truck 
Insurance Exchange (collectively the "Exchanges"), which operate in the 
property and casualty insurance industry.  As AIF, FGI, or its subsidiaries, 
as applicable, provides certain management services to the Exchanges, their 
respective subsidiaries and Farmers Texas County Mutual Insurance Company 
(collectively the "P&C Group") and receives compensation based on a percentage 
of gross earned premiums. The management services generate a substantial 
portion of the Company's revenue and profits and, as a result, the Company's 
ongoing financial performance depends on the volume of business written by, 
and the efficiency and financial strength of, the P&C Group.  A portion of the 
purchase price ($1,709,043,000) associated with B.A.T's acquisition of the 
Company was assigned to these AIF contract relationships. The value so 
assigned is being amortized on a straight-line basis over forty years. 

     The excess of the purchase price over the fair value of the net assets 
("Goodwill") of the Company at the date of the Company's acquisition by B.A.T 
($2,401,755,000) is being amortized on a straight-line basis over forty years. 
The carrying amount of the Goodwill is regularly reviewed for indications of 
impairment in value which in the view of management are other than temporary, 
including unexpected or adverse changes in the following: (1) the economic or 
competitive environments in which the Company operates, (2) profitability 
analyses and (3) cashflow analyses. As of December 31, 1998, management 
believes that the reported value is recoverable and the remaining life of 
Goodwill is appropriate.

     Prior to April 15, 1997 the Company's life insurance operations were 
conducted by its three wholly owned subsidiaries.  A portion of the purchase 
price ($662,778,000) was assigned to the "Value of Life Business Acquired" 
("VOLBA"), which represented an actuarial determination of the expected 
profits from the business in force at the date of B.A.T's acquisition of the 
Company.  The amount so assigned is being amortized over its actuarially 
determined useful life with the unamortized amount included in "Deferred 
Policy Acquisition Costs and Value of Life Business Acquired" in the 
accompanying consolidated balance sheets.

     On April 15, 1997, upon receipt of regulatory approval, the Company sold 
two of its life insurance subsidiaries, The Ohio State Life Insurance Company 
("OSL") and Investors Guaranty Life Insurance Company ("IGL"), to Great 
Southern Life Insurance Company, a subsidiary of Americo Life, Inc..  The sale 
of these subsidiaries resulted in a $19,019,000 gain and was reported on the 
"Gain on sale of subsidiaries" line of the income statement.  In addition, 
taxes 


<PAGE>   31

associated with the sale increased 1997 tax expense by $26,826,000 and were 
reflected on the "Provision for income taxes" line.  Both of these amounts 
were reflected in the "Management services to property and casualty insurance 
companies; and other" section of the Company's consolidated income statement 
for the year ended December 31, 1997.  The decision to sell these subsidiaries 
was part of the Company's strategic plan to focus its life insurance efforts 
on the growth of its remaining life insurance subsidiary, Farmers New World 
Life Insurance Company ("Farmers Life"), by far its largest life insurance 
company, through increased sales to the P&C Group's customer base.  Farmers 
Life markets a broad line of individual life insurance products, including 
universal life, term life and whole life insurance, and annuity products, 
predominately flexible premium deferred annuities.  These products and 
services are sold directly by the P&C Group's agents. 

     In December 1997, Farmers Reinsurance Company ("Farmers Re"), a wholly 
owned property and casualty insurance subsidiary of FGI, was formed and 
licensed to conduct business.  In January 1998, Farmers Re entered into a 
quota share reinsurance treaty with the P&C Group under which it reinsures a 
percentage of the auto physical damage business written by the P&C Group. 

     As a result of the foregoing, references to the "Insurance Subsidiaries" 
within the 1998 consolidated financial statements and the 1997 balance sheet 
are to Farmers Life and Farmers Re, whereas, references to the "Insurance 
Subsidiaries" within the 1997 consolidated statements of income and 
comprehensive income and consolidated statement of cash flows and to the 1996 
consolidated financial statements are to Farmers Life, OSL and IGL.

     On December 22, 1997, a definitive agreement was reached to merge B.A.T's 
Financial Services Businesses, which included the Company, with Zurich 
Insurance Company ("Zurich").  In June 1998, the merger was approved by the 
shareholders of B.A.T and Zurich.  In September 1998, this merger was 
completed and the businesses of Zurich and B.A.T's Financial Services 
Businesses were transferred to Zurich Financial Services ("ZFS"), a new Swiss 
company with headquarters in Zurich.  As a result, each two shares of the 
Company's prior outstanding stock were recapitalized into one share of Class A 
Common Stock, par value $1.00 per share ("Ordinary Share"), and one share of 
Class B Common Stock, par value $1.00 per share ("Income Share").  Under the 
merger agreement, all Ordinary Shares became wholly owned by ZFS and all 
Income Shares became wholly owned by Allied Zurich Holdings Limited, an 
affiliated company created during the restructuring of B.A.T.  This merger was 
accounted for by ZFS as a pooling of interests and, therefore, no purchase 
accounting adjustments were made to the Company's assets and liabilities.

     The Company's properties are depreciated over the following estimated 
useful lives: 

          Buildings and improvements                  10 to 35 years
          Furniture and equipment                      5 to 10 years
          Data processing equipment and software       5 to 10 years

     Depreciation is calculated for financial statement purposes by the 
straight-line method. Repairs and maintenance are charged to operations; 
significant renewals and betterments are capitalized. 

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

     In 1998, the Company adopted SFAS No. 129, "Disclosure of Information 
about Capital Structure".  This Statement, effective for financial statements 
issued for periods ending after December 15, 1997, established standards for 
disclosing information about an entity's capital structure.

     In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive 
Income".  This Statement, effective for fiscal periods beginning after 
December 15, 1997, established standards for reporting and displaying 
comprehensive income and its components.  This Statement mandated that all 
items that are required to be recognized under accounting standards as 
components of comprehensive income be reported in a financial statement with 
the same prominence as 


<PAGE>   32

other financial statements.  As a result of adopting this Statement, the 
components of comprehensive income are now stated in the consolidated 
statements of comprehensive income.

     In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of 
an Enterprise and Related Information".  This Statement, effective for 
financial statements of public enterprises issued for periods beginning after 
December 15, 1997, established standards for reporting information about 
operating segments in annual financial statements and required the reporting 
of selected information about operating segments in interim financial reports 
issued to shareholders.  It also established standards for related disclosures 
about products and services, geographic areas and major customers.  This 
Statement superseded SFAS No. 14, "Financial Reporting for Segments of a 
Business Enterprise", and amended SFAS No. 94, "Consolidation of All Majority-
Owned Subsidiaries".

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

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

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

     In 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of Start 
Up Activities".  This SOP, effective for financial statements issued for 
periods beginning after December 15, 1998, addresses the recording of costs 
associated with a one-time activity related to opening a new facility, 
introducing a new product or service, conducting business in a new territory 
or conducting business with a new class of customer.  The Company does not 
expect the adoption of this Statement to have a material impact on its 
consolidated financial statements. 

B.   Life insurance accounting

     Traditional product premiums are recognized as revenues when they become 
due and future benefits and expenses are matched with such premiums so that 
the majority of profits are recognized over the premium-paying period of the 
policy.  This matching of revenues and expenses is accomplished through the 
provision for future policy benefits and the amortization of deferred policy 
acquisition costs ("DAC").

     Certain policy acquisition costs, principally first-year commissions and 
other expenses for policy underwriting and issuance (which are primarily 
related to and vary with the production of new business), are deferred and 
amortized proportionately over the estimated period during which the related 
premiums will be recognized as income, based on the 


<PAGE>   33

same assumptions that are used for computing the liabilities for future policy 
benefits.  Liabilities for future policy benefits are computed principally by 
means of a net level premium method reflecting estimated future investment 
yields, mortality, morbidity and withdrawals.  Interest rate assumptions range 
from 2.25% to 9.00%, depending on the year of policy issue.  Mortality is 
calculated principally on select and ultimate tables in common usage in the 
industry, modified for actual experience, and withdrawals are estimated based 
primarily on experience.

     Revenues associated with universal life products consist of policy 
charges for the cost of insurance, policy administration fees, surrender 
charges and investment income on assets allocated to support policyholder 
account balances.  Revenues for deferred annuity products consist of 
surrender charges and investment income on assets allocated to support 
policyholder account balances.  Expenses include interest credited to 
policyholder account balances and benefit claims incurred in excess of 
policyholder account balances.  Liabilities for future policy benefits on 
universal life and deferred annuity products are determined under the 
retrospective deposit method.  DAC is amortized in relation to the present 
value of expected gross profit margins on the policies, after giving 
recognition to differences between actual and expected gross profit margins to 
date.  DAC and VOLBA also include amounts associated with the unrealized gains 
and losses recorded as a component of stockholders' equity in accordance with 
the application of SFAS No. 115, "Accounting for Certain Investments in Debt 
and Equity Securities".  Accordingly, DAC and VOLBA are increased or decreased 
to reflect what would have been the impact on estimated future gross profits, 
had net unrealized gains or losses on securities been realized at the balance 
sheet date.  Net unrealized gains or losses on securities, within 
stockholders' equity, also reflect this impact.  These entries decreased the 
DAC and VOLBA assets by $49,015,000 and $43,447,000 as of December 31, 1998 
and 1997, respectively.

C.   Non-life reinsurance  

     Farmers Re is a wholly owned subsidiary of the Company.  On January 1, 
1998, Farmers Re entered into an auto physical damage reinsurance agreement 
with the P&C Group.  This agreement provided for monthly premiums of $83.3 
million and recoveries of a quota share percentage of ultimate net losses 
sustained by the P&C Group in its auto physical damage lines of business.  
This agreement also provided for the P&C Group to receive a provisional ceding 
commission of 20% of premiums with additional experience commissions that 
depend on loss experience.  This experience commission arrangement limits 
Farmers Re's potential underwriting gain on the assumed business to 2.5% of 
premiums assumed. 

     In 1998, the first accident year under the reinsurance treaty, losses 
paid by Farmers Re were $543,445,000, loss adjustment expenses were 
$5,736,000, reinsurance commissions were $319,875,000 and premiums assumed 
were $1,000,000,000.  As of December 31, 1998, Farmers Re had loss reserves 
of $105,944,000.

D.   Property, plant and equipment

     A schedule of the Company's operating properties, plant and equipment at 
cost as of December 31 follows: 

<TABLE>
<CAPTION>
                                                    1998             1997
                                                -----------      -----------
                                                    (Amounts in thousands)
     <S>                                        <C>              <C>
     Buildings and improvements                 $   218,268      $   227,406
     Data processing equipment and software         291,159          283,923
     Furniture and equipment                        117,233          111,489
                                                -----------      -----------
                                                    626,660          622,818
     Land                                            68,826           70,454
                                                -----------      -----------
                                                $   695,486      $   693,272
                                                ===========      ===========

</TABLE>


<PAGE>   34

E.   Merger related expenses

     As a result of the merger between B.A.T's Financial Services Businesses 
and Zurich in 1998, the Company recorded various merger related expenses 
totaling $21,056,000, of which $16,545,000 related to losses the Company will 
incur in connection with taking over the management of Zurich's United States 
personal lines business.  In addition, $2,728,000 related to the write-off of 
redundant capitalized software and $1,783,000 related to miscellaneous audit, 
legal and travel expenses incurred by the Company in connection with the 
merger. 

F.   Certificates of contribution and surplus note of the P&C Group

     On September 8, 1998, Farmers Life purchased a $119,000,000 surplus note 
of the P&C Group which bears interest at 6.10% annually.  In addition, the 
Company has from time to time made surplus contributions to the P&C Group and, 
in return, received certificates of contribution of the P&C Group which bear 
interest at various rates.  As of December 31, 1998, the Company held 
certificates of contribution of the P&C Group totaling $34,380,000.

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

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

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

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

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

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

    -   A $25,647,000 repayment of accrued interest.

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

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


<PAGE>   35

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

     As of December 31, 1998 and 1997, a total of 20,000,000 shares of QUIPS 
were outstanding.

H.   Employees' profit sharing plans

     The Company has two profit sharing plans providing for cash payments to 
all eligible employees.  The two plans, Deferred Profit Sharing and Cash 
Profit Sharing (consisting of Cash and Quest for Gold in 1998 and Cash and 
Cash Plus in 1997 and 1996), provide for a maximum aggregate expense of 16.25% 
of the Company's consolidated annual pretax earnings, as adjusted. The 
Deferred Profit Sharing Plan, limited to 10% of pretax earnings, as adjusted, 
or 15% of the salary or wage paid or accrued to the eligible employee, 
provides for an annual contribution by the Company to a trust for eventual 
payment to employees as provided in the Plan.  The Cash Profit Sharing Plan 
and Quest for Gold Program provide for annual cash distributions to eligible 
employees.  The Cash Profit Sharing Plan is limited to 5% of pretax earnings, 
as adjusted, or 5% of employee salaries or wages paid or accrued.  The Quest 
for Gold Program is limited to 1.25% of pretax earnings, as adjusted, or 6% of 
eligible employee salaries or wages paid or accrued.  The Cash Plus Plan was 
limited to 1.25% of pretax earnings, as adjusted.

     Expense under these plans was $51,869,000, $52,235,000 and $55,772,000 in 
1998, 1997 and 1996, respectively. 

I.   Retained earnings

     Statutory capital and surplus of Farmers Life was $922,426,000 and 
$817,588,000 as of December 31, 1998 and 1997, respectively. Statutory net 
income for the year ended December 31, 1998 was $98,796,000, while statutory 
net income for the year ended December 31, 1997 was $128,461,000, reflecting 
the results of Farmers Life for the year and the results of OSL and IGL 
through April 15, 1997.  Combined statutory net income of the Life Insurance 
Subsidiaries was $167,517,000 for the year ended December 31, 1996.  

     There are certain statutory limitations on the distribution of surplus.  
As of December 31, 1998, $115,923,000 is available for distribution without 
approval from the Washington State Department of Insurance, the state in which 
Farmers Life is domiciled.

J.   Investments

     The Company follows the provisions of SFAS No. 115.  This Statement 
addresses the accounting and reporting for investments in equity securities 
that have readily determinable market values and for all investments in debt 
securities.  As of December 31, 1998 and 1997, the Company classified all 
investments in equity and debt securities as available-for-sale under SFAS No. 
115 with the exception of $53.0 million in 1998 and $47.0 million in 1997 
which relate to a grantor trust and are classified as trading securities under 
SFAS No. 115.  The available-for-sale investments are reported on the balance 
sheet at market value, with unrealized gains and losses, net of tax, excluded 
from earnings and reported as a component of stockholders' equity.  The 
investments classified as trading investments are reported on the "Other 
assets" line of the consolidated balance sheet at market value with both 
realized and unrealized gains and losses included in earnings, net of tax, in 
the year in which they occur.  Real estate investments are accounted for on a 
depreciated cost basis.  Real estate acquired in foreclosure and held for sale 
is carried at the lower of market value or depreciated cost less a valuation 
allowance.  Marketable securities are carried at cost.  The Standard & Poor's 
500 Composite Stock Price Index 


<PAGE>   36

("S&P 500") call options are carried at estimated fair value.  Other 
investments, which consist primarily of certificates of contribution of the 
P&C Group, a surplus note of the P&C Group, policy loans, B.A.T Capital 
Corporation notes and British American Financial Services (UK and 
International), Ltd. ("BAFS") notes, are carried at the unpaid principal 
balances.

     In compliance with a Securities and Exchange Commission ("SEC") staff 
announcement, the Company has recorded certain entries to the DAC and VOLBA 
line of the consolidated balance sheet in connection with SFAS No. 115. The 
SEC requires that companies record entries to those assets and liabilities 
that would have been adjusted had the unrealized investment gains or losses 
from securities classified as available-for-sale actually been realized, with 
corresponding credits or charges reported directly to stockholders' equity.

     The sources of investment income on securities owned by the Company 
(excluding the Insurance Subsidiaries) for the years ended December 31 are:

<TABLE>
<CAPTION>
                                         1998             1997              1996
                                      ----------       ----------        ---------
                                                 (Amounts in thousands)          
<S>                                   <C>              <C>              <C>       
Related parties:
  B.A.T Capital Corporation notes     $   14,672       $   23,620       $   18,151
  BAFS notes                              19,481                0                0
                                      ----------       ----------       ----------
  Total related parties                   34,153           23,620           18,151
                                      ----------       ----------       ----------
Non-related parties:
  Interest income-
      certificates of contribution
      of the P&C Group                    33,417           61,131           45,448
  Interest income-
      fixed income securities             50,373           36,264           41,714
  Dividend income                          7,825            9,268            4,863
  Interest income-
      marketable securities                4,205           10,263           11,385
  Interest expense                             0                0           (8,938)
  Other *                                  5,089            3,585              157 
                                      ----------       ----------       ----------
  Total non-related parties              100,909          120,511           94,629
                                      ----------       ----------       ----------
Total investment income                                                             
     by component                     $  135,062       $  144,131       $  112,780
                                      ==========       ==========       ==========

</TABLE>

*  Includes $3.4 million, $1.6 million and $0.7 million in 1998, 1997 and 
   1996, respectively, of unrealized gains associated with the trading 
   securities reported on the "Other assets" line of the balance sheet.

     The sources of investment income on securities owned by the Insurance 
Subsidiaries for the years ended December 31 are: 

<TABLE>
<CAPTION>
                                         1998             1997             1996
                                      ----------       ----------       ----------
                                                 (Amounts in thousands)          
<S>                                   <C>              <C>              <C>       
Fixed income securities               $  279,157       $  251,727       $  258,828
Equity securities                            249           12,863           25,299
Mortgage loans                             8,789           12,205           14,721
Owned real estate                          9,907            9,575           10,477
Policy loans                              12,993           12,118           12,152
Marketable securities                      7,302            2,552            4,097
Surplus note of the P&C Group              2,279                0                0
Investment expenses                      (13,658)         (13,442)         (13,430)
Other                                        373            5,592            5,486
                                      ----------       ----------       ----------
Total investment income                                                           
     by component                     $  307,391       $  293,190       $  317,630
                                      ==========       ==========       ==========

</TABLE>


<PAGE>  37

     Realized gains and losses on sales, redemptions and writedowns of 
investments owned by the Company (excluding the Insurance Subsidiaries) are 
determined based on either the cost of the individual securities or the 
amortized cost of real estate.  Net realized investment gains or losses for 
the years ended December 31 are: 

<TABLE>
<CAPTION>
                                          1998             1997             1996
                                       ----------       ----------       ----------
                                                  (Amounts in thousands)          
<S>                                    <C>              <C>              <C>      
Bonds                                  $      280       $      (12)      $    1,626
Redeemable preferred stocks                    57              365              623
Common stocks                              59,864           69,505             (524)
Investment real estate                        (34)               0            2,528
Other                                       2,261            3,545              826
                                       ----------       ----------       ----------
Net realized investment gains/(losses) $   62,428       $   73,403       $    5,079
                                       ==========       ==========       ==========

</TABLE>

     Realized gains and losses on sales, redemptions and writedowns of 
investments owned by the Insurance Subsidiaries are determined based on either 
the cost of the individual securities or the amortized cost of real estate.  
Net realized investment gains or losses for the years ended December 31 are:

<TABLE>
<CAPTION>
                                          1998             1997             1996
                                       ----------       ----------       ----------
                                                  (Amounts in thousands)          
<S>                                    <C>               <C>             <C>       
Bonds                                  $  (16,461)      $    8,619       $      874
Redeemable preferred stocks                    25            1,734            1,738
Non-redeemable preferred stocks                 0               71           (2,799)
Common stocks                                 117            2,798           41,007
Investment real estate                      1,393                3           (2,131)
Other                                         118               11             (700)
                                       ----------       ----------       ----------
Net realized investment gains/(losses) $  (14,808)      $   13,236       $   37,989
                                       ==========       ==========       ==========

</TABLE>


<PAGE>   38

     The amortized cost, gross unrealized gains and losses, and estimated 
market values of investments in equity securities pertaining to non-redeemable 
preferred stocks and common stocks owned by the Company (excluding the 
Insurance Subsidiaries) are as follows:

<TABLE>
<CAPTION>
                                                         As of December 31, 1998
                                              --------------------------------------------
                                                           Gross       Gross     Estimated
                                              Amortized  Unrealized  Unrealized   Market
                                                 Cost      Gains       Losses     Value
                                              ---------  ----------  ----------  ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>         <C>         <C>  
Equity Securities Available-for-Sale
Non-redeemable preferred stocks               $       0  $        0  $        0  $       0
Common stocks                                   278,107      87,372     (11,014)   354,465
                                              ---------  ----------  ----------  ---------
Total                                         $ 278,107  $   87,372  $  (11,014) $ 354,465
                                              =========  ==========  ==========  =========

</TABLE>

<TABLE>
<CAPTION>

                                                           As of December 31, 1997
                                              ---------------------------------------------
                                                           Gross       Gross      Estimated
                                              Amortized  Unrealized  Unrealized    Market
                                                 Cost      Gains       Losses      Value
                                              ---------  ----------  ----------   ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>         <C>          <C>  
Equity Securities Available-for-Sale
Non-redeemable preferred stocks               $       0  $        0  $        0   $       0
Common stocks                                   322,741      76,153      (9,928)    388,966
                                              ---------  ----------  ----------   ---------
Total                                         $ 322,741  $   76,153  $   (9,928)  $ 388,966
                                              =========  ==========  ==========   =========

</TABLE>

     The amortized cost, gross unrealized gains and losses, and estimated 
market values of investments in equity securities pertaining to non-redeemable 
preferred stocks and common stocks owned by the Insurance Subsidiaries in 1998 
and 1997 are as follows:

<TABLE>
<CAPTION>
                                                         As of December 31, 1998
                                              ---------------------------------------------
                                                           Gross       Gross      Estimated
                                              Amortized  Unrealized  Unrealized    Market
                                                 Cost      Gains       Losses      Value
                                              ---------  ----------  ----------   ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>         <C>          <C>  
Equity Securities Available-for-Sale
Non-redeemable preferred stocks               $   1,153  $      165  $      (48)  $   1,270
Common stocks                                    98,399       9,751      (2,055)    106,095
                                              ---------  ----------  ----------   ---------
Total                                         $  99,552  $    9,916  $   (2,103)  $ 107,365
                                              =========  ==========  ==========   =========

</TABLE>

<TABLE>
<CAPTION>
                                                       As of December 31, 1997
                                              ---------------------------------------------
                                                           Gross       Gross      Estimated
                                              Amortized  Unrealized  Unrealized    Market
                                                 Cost      Gains       Losses      Value
                                              ---------  ----------  ----------   ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>         <C>          <C>  
Equity Securities Available-for-Sale
Non-redeemable preferred stocks               $   1,153  $      111  $      (37)  $   1,227
Common stocks                                         0         120           0         120
                                              ---------  ----------  -----------  ---------
Total                                         $   1,153  $      231  $      (37)  $   1,347
                                              =========  ==========  ===========  =========

</TABLE>


<PAGE>   39

     The amortized cost, gross unrealized gains and losses, and estimated 
market values of investments in debt securities, including bonds and 
redeemable preferred stocks, owned by the Company (excluding the Insurance 
Subsidiaries) are as follows:

<TABLE>
<CAPTION>
                                                         As of December 31, 1998
                                              ---------------------------------------------
                                                           Gross       Gross      Estimated
                                              Amortized  Unrealized  Unrealized    Market
                                                 Cost      Gains       Losses      Value
                                              ---------  ----------  ----------   ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>         <C>          <C>  
Debt Securities Available-for-Sale,
 including Marketable Securities
U.S. Treasury securities and obligations of
 U.S. government corporations and agencies    $     242  $       10  $        0   $     252
Obligations of states and political
 subdivisions                                   530,322       8,667           0     538,989
Corporate securities                             43,474         885           0      44,359
Mortgage-backed securities                       53,316         594         (71)     53,839
Other debt securities                            23,444       1,192           0      24,636
                                              ---------  ----------  -----------  ---------
 Total                                        $ 650,798  $   11,348  $      (71)  $ 662,075
                                              =========  ==========  ===========  =========

</TABLE>

<TABLE>
<CAPTION>
                                                         As of December 31, 1997
                                              ----------------------------------------------
                                                           Gross       Gross       Estimated
                                              Amortized  Unrealized   Unrealized    Market
                                                 Cost      Gains       Losses       Value
                                              ---------  ----------   ----------   ---------
                                                         (Amounts in thousands)
<S>                                           <C>        <C>          <C>          <C>  
Debt Securities Available-for-Sale,
 including Marketable Securities
U.S. Treasury securities and obligations of
 U.S. government corporations and agencies    $  25,000   $     338   $        0   $  25,338
Obligations of states and political
 subdivisions                                   392,962       3,578         (235)    396,305
Corporate securities                             63,837         684            0      64,521
Mortgage-backed securities                       67,149         541          (22)     67,668
Other debt securities                            37,892       1,202         (196)     38,898
                                              ---------   ---------   -----------  ---------
 Total                                        $ 586,840   $   6,343   $     (453)  $ 592,730
                                              =========   =========   ===========  =========

</TABLE>


<PAGE>   40

     The amortized cost, gross unrealized gains and losses, and estimated 
market values of investments in debt securities, including bonds and 
redeemable preferred stocks, owned by the Insurance Subsidiaries in 1998 and 
1997 are as follows:

<TABLE>
<CAPTION>
                                                            As of December 31, 1998
                                               -----------------------------------------------------
                                                                Gross         Gross        Estimated
                                                Amortized    Unrealized     Unrealized       Market
                                                   Cost         Gains         Losses         Value
                                               -----------   -----------   ------------    ---------
                                                               (Amounts in thousands)
<S>                                            <C>           <C>           <C>             <C>
Debt Securities Available-for-Sale 
U.S. Treasury securities and obligations of
 U.S. government corporations and agencies     $   460,097   $    44,434   $      (124)    $  504,407
Obligations of states and political 
 subdivisions                                      620,279        31,444          (149)       651,574
Debt securities issued by foreign governments       95,077         2,446       (16,144)        81,379
Corporate securities                               999,412        59,625        (5,938)     1,053,099
Mortgage-backed securities                       1,921,350        67,598       (10,003)     1,978,945
Other debt securities                               82,090         4,747          (175)        86,662
                                               -----------   -----------   ------------   -----------
 Total                                         $ 4,178,305   $   210,294   $   (32,533)   $ 4,356,066
                                               ===========   ===========   ============   ===========

</TABLE>

<TABLE>
<CAPTION>
                                                            As of December 31, 1997
                                              -----------------------------------------------------
                                                               Gross          Gross       Estimated
                                                Amortized    Unrealized     Unrealized      Market
                                                   Cost        Gains          Losses        Value
                                               -----------   -----------   ------------   ----------
                                                               (Amounts in thousands)
<S>                                            <C>           <C>           <C>            <C>
Debt Securities Available-for-Sale, 
  including Marketable Securities
U.S. Treasury securities and obligations of
 U.S. government corporations and agencies     $   393,538   $    24,174   $       (104)  $  417,608
Obligations of states and political 
 subdivisions                                      294,233        13,346            (58)     307,521
Debt securities issued by foreign governments      136,127        15,686         (5,113)     146,700
Corporate securities                               842,838        48,429         (1,578)     889,689
Mortgage-backed securities                       1,655,679        56,243         (5,376)   1,706,546
Other debt securities                              109,742         3,628         (2,555)     110,815
                                               -----------   -----------   ------------   ----------
 Total                                         $ 3,432,157   $   161,506   $    (14,784)  $3,578,879
                                               ===========   ===========   ============   ==========

</TABLE>


<PAGE>   41

     The amortized cost and estimated market value of debt securities,
including marketable securities, owned by the Company (excluding the Insurance
Subsidiaries) as of December 31, 1998, by contractual maturity, are shown 
below.  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.

<TABLE>
<CAPTION>
                                                                        Estimated
                                                         Amortized       Market
                                                            Cost          Value
                                                        -----------    ----------
                                                         (Amounts in thousands)
<S>                                                     <C>            <C>
Debt Securities Available-for-Sale,
  including Marketable Securities
Due in one year or less                                 $   53,536     $   53,536
Due after one year through five years                      340,779        347,001
Due after five years through ten years                      15,359         15,621
Due after ten years                                        164,364        167,442
                                                        -----------    ----------
                                                           574,038        583,600
Mortgage-backed securities                                  53,316         53,839
Redeemable preferred stocks
  with no stated maturities                                 23,444         24,636
                                                        ----------     ----------
                                                        $  650,798     $  662,075
                                                        ==========     ==========
</TABLE>

     The amortized cost and estimated market value of debt securities owned by
the Insurance Subsidiaries as of December 31, 1998, by contractual maturity,
are shown below.  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.

<TABLE>
<CAPTION>
                                                                        Estimated
                                                         Amortized       Market
                                                            Cost          Value
                                                        -----------    ----------
                                                         (Amounts in thousands)
<S>                                                     <C>            <C>
Debt Securities Available-for-Sale 
Due in one year or less                                 $   23,445     $   23,813
Due after one year through five years                      615,476        632,423
Due after five years through ten years                     785,720        819,956
Due after ten years                                        750,224        814,267
                                                        -----------    ----------
                                                         2,174,865      2,290,459
Mortgage-backed securities                               1,921,350      1,978,945
Redeemable preferred stocks
  with no stated maturities                                 82,090         86,662
                                                        -----------    ----------
                                                        $4,178,305     $4,356,066
                                                        ==========     ==========
</TABLE>

     Proceeds from sales of available-for-sale securities received by the
Company were $1,504,131,000, $735,192,000 and $551,122,000 in 1998, 1997 and
1996, respectively.  Gross gains of $88,751,000, $100,269,000 and $76,431,000
and gross losses of $50,798,000, $21,274,000 and $32,009,000 were realized on
sales and writedowns during 1998, 1997 and 1996, respectively. 


<PAGE>   42

     The change in the net unrealized gains or (losses) of the Company
(excluding the Insurance Subsidiaries) for the years ended December 31 are as
follows:

<TABLE>
<CAPTION>
                                         1998             1997          
                                      ----------       ----------       
                                        (Amounts in thousands)           
<S>                                   <C>              <C>            
Fixed maturities                      $    5,387       $    3,535      
Equity securities                         10,133            8,823       

</TABLE>

     The change in the net unrealized gains or (losses) of the Insurance 
Subsidiaries in 1998 and 1997 are as follows: 

<TABLE>
<CAPTION>
                                         1998             1997   
                                      ----------       ----------
                                        (Amounts in thousands)    
<S>                                   <C>              <C>        
Fixed maturities                      $   31,039       $   56,788 
Equity securities                          7,619          (18,462)

</TABLE>

K.   Equity-indexed annuities 

     During 1997, Farmers Life began selling an equity-indexed annuity product.
At the end of its seven year term, this product credits interest to the annuity
participant at a rate based on a specified portion of the change in the value
of the S&P 500, subject to a guaranteed annual minimum return.  In order to
hedge the interest liability generated on the annuities as the index rises,
Farmers Life purchases call options on the S&P 500.  Farmers Life considers
such S&P 500 call options to be held as a hedge.  As of December 31, 1998 and
1997, Farmers Life had S&P 500 call options with contract values of $40,229,000
and $13,180,000, respectively, and carrying values of $14,817,000 and
$3,299,000, respectively.

     Hedge accounting is used to account for the call options as Farmers Life
believes that the options reduce the risks associated with increases in the
account value of the annuities that result from increases in the S&P 500.  The
call options effectively hedge the annuity contracts since they are both
purchased and sold with identical parameters.  Periodically, the value of the
assets (S&P 500 call options) are matched to the potential liability (annuity
contracts) to ensure the hedge has remained effective.  The annuities were
written based on a seven year investment term, absent early termination by
participants.  Therefore, the anticipated hedged transaction (i.e., payment of
interest to the policyholder at the end of the investment term and maturity of
the call option) for each annuity is generally expected to occur in seven years
or less.  The amount of unrealized hedging gains/(losses) was $3,511,000 and
($151,000) in 1998 and 1997, respectively.

     The S&P 500 call options are carried at estimated fair value.  Unrealized
gains and losses resulting from changes in the estimated fair value of the call
options are recorded as an adjustment to the interest credited to 
policyholders.  In addition, realized gains and losses from maturity or
termination of the call options are offset against the interest credited to
policyholders during the period incurred.  Premiums paid on call options are
amortized to net investment income over the term of the contracts.  There were
no early terminations by annuity participants, or maturities or sales of the
S&P 500 call options during 1998.

     The cash requirement of the call options consists of the initial premium
paid to purchase the call options.  Should a liability exist to the annuity
participant at maturity of the annuity policy, the termination or maturity of
the option contracts will generate positive cash flow to Farmers Life.  The
appropriate amount of cash will then be remitted to the annuity participant
based on the respective participation rate.  The call options are generally
expected to be held for a seven year term, but can be terminated at any time.

     There are certain risks associated with the call options, primarily with
respect to significant movements in the United States stock market and
counterparty nonperformance.  The Company believes that the counterparties to
its call option agreements are financially responsible and that the
counterparty risk associated with these transactions is minimal.

<PAGE>   43

L.   Fair value of financial instruments

     The estimated fair values of financial instruments disclosed have been
determined using available market information and appropriate valuation
methodologies.  However, considerable judgment is required to interpret market
data to develop the estimates of fair value.  Accordingly, the estimates
presented may not be indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies could have a significant effect on the estimated fair
value amounts. 

<TABLE>
<CAPTION>
                                                             December 31, 1998
                                                        ---------------------------
                                                         Carrying        Estimated
                                                          Value          Fair Value
                                                        -----------     -----------
                                                           (Amounts in thousands)
<S>                                                      <C>             <C>
Assets and liabilities excluding Insurance 
 Subsidiaries:
Assets:
  Cash and cash equivalents                              $  253,828      $  253,828
  Marketable securities                                      53,536          53,536
  Fixed maturities available-for-sale                       608,539         608,539
  Common stocks available-for-sale                          354,465         354,465
  Mortgage loans                                                196             214
  Certificates of contribution of the P&C Group              34,380          34,380
  Notes receivable - affiliate                            1,057,000       1,087,259
  Grantor trust                                              53,016          53,016
  Other assets                                               20,695          15,148
Liabilities:
  Real estate mortgages payable                                  25              27
  Company obligated mandatorily redeemable
    preferred securities of subsidiary trusts 
    holding solely junior subordinated debentures           500,000         513,608

Insurance Subsidiaries:
Assets:
  Cash and cash equivalents                                  73,724          73,724
  Fixed maturities available-for-sale                     4,356,066       4,356,066
  Non-redeemable preferred stocks
    available-for-sale                                        1,270           1,270
  Common stocks available-for-sale                          106,095         106,095
  Mortgage loans                                             52,879          67,615
  Surplus note of the P&C Group                             119,000         119,000
  Policy loans                                              185,211         192,620
  Joint ventures, at equity                                   8,456           6,668
  S&P 500 call options                                       14,817          14,817
Liabilities:
  Future policy benefits - deferred annuities             1,492,032       1,433,494

</TABLE>


<PAGE>   44

<TABLE>
<CAPTION>

                                                             December 31, 1997
                                                        ---------------------------
                                                         Carrying        Estimated
                                                          Value          Fair Value
                                                        -----------     -----------
                                                           (Amounts in thousands)
<S>                                                     <C>             <C>
Assets and liabilities excluding Insurance
 Subsidiaries:
Assets:
  Cash and cash equivalents                             $   479,935     $   479,935
  Marketable securities                                     104,485         104,485
  Fixed maturities available-for-sale                       488,245         488,245
  Common stocks available-for-sale                          388,966         388,966
  Mortgage loans                                                240             256
  Certificates of contribution of the P&C Group             684,380         684,380
  Notes receivable - affiliate                              407,000         404,256
  Grantor trust                                              46,969          46,969
  Joint ventures, at equity                                   4,825           6,897
  Other assets                                               20,746          17,219
Liabilities:
  Real estate mortgages payable                                  92              96
  Company obligated mandatorily redeemable
    preferred securities of subsidiary trusts 
    holding solely junior subordinated debentures           500,000         518,332

Insurance Subsidiaries:
Assets:
  Cash and cash equivalents                                  36,318          36,318
  Marketable securities                                      23,731          23,731
  Fixed maturities available-for-sale                     3,555,148       3,555,148
  Non-redeemable preferred stocks
    available-for-sale                                        1,227           1,227
  Common stocks available-for-sale                              120             120
  Mortgage loans                                             89,903         105,235
  Policy loans                                              165,894         172,115
  Joint ventures, at equity                                  11,566          10,037
  S&P 500 call options                                        3,299           3,299
Liabilities:
 Future policy benefits - deferred annuities              1,473,578       1,403,455

</TABLE>


<PAGE>   45

     The following methods and assumptions were used to estimate the fair value
of financial instruments as of December 31, 1998 and 1997: 

     Cash and cash equivalents and marketable securities.  The carrying amounts
of these items are a reasonable estimate of their fair values.

     Fixed maturities, non-redeemable preferred stocks and common stocks.  The
estimated fair values of bonds, redeemable and non-redeemable preferred stocks
and common stocks are based upon quoted market prices, dealer quotes, and
prices obtained from independent pricing services. 

     Mortgage loans.  The estimated fair value of the mortgage loans portfolio
is determined by discounting the estimated future cash flows, using a year-end
market rate which is applicable to the yield, credit quality and average
maturity of the composite portfolio. 

     Certificates of contribution and surplus note of the P&C Group.  The
carrying amounts of these items are a reasonable estimate of their fair values.

     Notes receivable-affiliate.  The fair values are estimated by discounting
the future cash flows using the current rates at which similar loans would be
made by the Company to borrowers for the same remaining maturities. 

     Grantor trust.  The carrying amount is a reasonable estimate of its fair
value.

     Joint ventures, at equity.  The estimated fair values are based upon
quoted market prices, current appraisals, and independent pricing services.

     Other assets.  Other assets consist primarily of advances to agents, the
fair value of which is determined by discounting the estimated future cash
flows using credit quality, the average maturity of related advances, and the
current rates at which similar loans would be made to borrowers by the Company.

     Policy loans.  The estimated fair values of policy loans are determined by
discounting the future cash flows using the current rates at which similar
loans would be made. 

     S&P 500 call options.  S&P 500 call options are purchased as hedges
against the interest liabilities generated on the equity-indexed annuity
products.  These call options are carried at an estimated fair value based on
stock price, strike price, time to expiration, interest rates, dividends and
volatility per the methodology of the Black-Scholes Option Pricing Formula. 

     Real estate mortgages payable.  The estimated fair values are determined
by discounting the estimated future cash flows at a rate which approximates the
Company's incremental borrowing rate. 

     Company obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures.   The
estimated fair values are based on quoted market prices.

     Future policy benefits-deferred annuities.  The estimated fair values of
flexible premium and single premium deferred annuities are based on their cash
surrender values. 


<PAGE>   46

M.     Value of Life Business Acquired

       The changes in the Value of Life Business Acquired were as follows:

<TABLE>
<CAPTION>
                                                 1998             1997              1996
                                              ----------       ----------        ----------
                                                          (Amounts in thousands)           
        <S>                                   <C>              <C>               <C>        
        Balance, beginning of year            $  359,146       $  443,318        $  473,398
        Amortization related to operations       (53,598)         (60,134)          (69,894)
        Interest accrued                          29,701           36,207            41,714
        Amortization related to net
         unrealized losses                          (807)          (1,700)           (1,900)
        Sale of OSL and IGL                            0          (58,545)                0
                                              ----------       ----------        ----------
        Balance, end of year                  $  334,442       $  359,146        $  443,318
                                              ==========       ==========        ==========

</TABLE>

     Based on current conditions and assumptions as to future events, Farmers
Life expects to amortize the December 31, 1998 balance as follows:
approximately 3.5% in 1999, 3.7% in 2000, 3.9% in 2001, 4.2% in 2002 and 4.3%
in 2003.  The discount rate used to determine the amortization rate of the
VOLBA ranged from 12.5% to 7.5%. 

N.   Mortgage loans

     The Company follows the principles of SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan" (which amends SFAS No. 114).  This
Statement requires that an impaired loan be measured based on the present value
of expected future cash flows discounted at the loan's effective interest rate
or, as a practical expedient, at the loan's observable market price or the fair
value of the collateral, if the loan is collateral dependent.

     The total recorded investment in impaired mortgage loans and the amount of
recorded investment for which an allowance for credit losses exists as of
December 31 follows:

<TABLE>
<CAPTION> 
                                                               1998              1997
                                                            ----------        ----------
                                                               (Amounts in thousands)
     <S>                                                    <C>               <C>     
     Total recorded investment in impaired mortgage
      loans and for which an allowance for
      credit losses exists                                  $   1,567         $   5,819
     Total allowance for credit losses
      related to impaired mortgage loans                          437             1,409

</TABLE>

     The Company records interest income received on impaired mortgage loans on
a cash basis. The average recorded investment and income recognized on impaired
mortgage loans follows:

<TABLE>
<CAPTION>
                                                               1998              1997
                                                            ----------        --------- 
                                                               (Amounts in thousands)
     <S>                                                    <C>               <C>      
     Average recorded investment in impaired
       loans during the period                               $   1,570        $   5,860
     Interest income recognized on the 
       impaired mortgage loans during the period                   131              230

</TABLE>


<PAGE>   47

     The activity in the total allowance for credit losses related to impaired
mortgage loans follows: 

<TABLE>
<CAPTION>
                                                               1998              1997
                                                            ---------        ----------
                                                               (Amounts in thousands)
     <S>                                                    <C>               <C>
     Beginning balance                                      $   1,409         $   1,394
     Additions/(deductions) charged to operations                (972)               15
     Direct writedowns charged against the allowance                0                 0
                                                            ---------         ---------
     Ending balance                                         $     437         $   1,409
                                                            =========         =========
</TABLE>

O.   Security lending arrangements 

     The Company has security lending agreements with a financial institution.
The agreements in effect as of December 31, 1998 authorize the institution to
lend securities held in the Company's portfolio to a list of authorized
borrowers.  Concurrent with delivery of the securities, the borrower provides
the Company with cash collateral equal to at least 102% of the market value of
domestic securities and 105% of the market value of other securities subject to
the "loan".

     The securities are marked-to-market on a daily basis and the collateral is
adjusted on the next business day.  The collateral is invested in highly
liquid, fixed income assets with a maturity of less than one year.  Income
earned from the security lending arrangements was allocated 60% to the Company
and 40% to the institution.  Income earned by the Company was $968,000,
$856,000 and $422,000 in 1998, 1997 and 1996, respectively.  The collateral
under these agreements as of December 31, 1998 and 1997 was $461,801,000 and
$594,488,000, respectively.

P.   Employees' retirement plans

     The Company has two noncontributory defined benefit pension plans (the
Regular Plan and the Restoration Plan). The Regular Plan covers substantially
all employees of the Company and the P&C Group who have reached age 21 and have
rendered one year of service.  Benefits are based on years of service and the
employee's compensation during the last five years of employment.  The
Restoration Plan provides supplemental retirement benefits for certain key
employees of the Company and the P&C Group. 

     The Company's policy is to fund the amount determined under the aggregate
cost method, provided it does not exceed funding limitations.  There has been
no change in funding policy from prior years. 

     Assets of the Regular Plan are held by an independent trustee.  Assets
held are primarily in fixed maturity and equity investments. The principal
liability is for annuity benefit payments of current and future retirees.
Assets of the Restoration Plan are considered corporate assets and are held in
a grantor trust. 


<PAGE>   48

     Information regarding the Regular Plan's and the Restoration Plan's funded
status is not developed separately for the Company and the P&C Group.  The
funded status of the Plans for the Company and the P&C Group as of December 1,
1998 and 1997 (the latest date for which information is available) was as
follows:

<TABLE>
<CAPTION>
                                                          1998            1997
                                                      ----------       ----------
                                                         (Amounts in thousands)
<S>                                                   <C>              <C>
Change in Benefit Obligation
Net benefit obligation at beginning of the year       $  747,069       $  695,346
Service cost                                              26,423           26,229
Interest cost                                             54,998           51,890
Plan participants' contributions                               0                0
Plan amendments                                                0            7,722
Actuarial (gain)/loss                                     54,218           (5,213)
Benefits paid                                            (29,534)         (28,905)
                                                      ----------       ----------
                                                      $  853,174       $  747,069
                                                      ==========       ==========
<S>                                                   <C>              <C>
Change in Plan Assets
Fair value of plan assets at beginning of the year    $  817,552       $  744,340
Actual return on plan assets                             135,313          101,303
Employer contributions                                         0                0
Plan participants' contributions                               0                0
Benefits paid                                            (28,564)         (28,091)
                                                      ----------       ----------
Fair value of plan assets at end of the year          $  924,301       $  817,552
                                                      ==========       ==========
<S>                                                   <C>              <C>
Funded status at end of the year                      $   71,127       $   70,483
Unrecognized net actuarial (gain)/loss                  (140,910)        (136,691)
Unrecognized prior service cost                           31,255           34,555
Unrecognized net transition obligation/(asset)           (26,186)         (30,862)
                                                      ----------       ----------
Net amount recognized at end of the year              $  (64,714)      $  (62,515)
                                                      ==========       ==========
<S>                                                   <C>              <C>
Amounts recognized in the statement of
  financial position consist of:
     Prepaid benefit cost                             $        0       $        0
     Accrued benefit cost                                (64,714)         (62,515)
     Additional minimum liability                         (7,263)          (3,685)
     Intangible asset                                      6,097            3,685
     Accumulated other comprehensive income                1,166                0
                                                      ----------       ----------
Net amount recoginized at end of the year             $  (64,714)      $  (62,515)
                                                      ==========       ========== 

</TABLE>

     Upon B.A.T's purchase of the Company in 1988, the Company allocated part
of the purchase price to its portion of the Regular Plan assets in excess of
the projected benefit obligation at the date of acquisition. The asset is being
amortized for the difference between the Company's net pension cost and amounts
contributed to the Plan. The unamortized balance as of December 31, 1998 and
1997 was $20,622,000 and $24,304,000, respectively.


<PAGE>   49

     Components of net periodic pension expense for the Company follow: 


<TABLE>
<CAPTION>
                                              1998             1997              1996
                                           ----------       ----------        ----------
                                                       (Amounts in thousands)           
     <S>                                   <C>              <C>               <C>      
     Service costs                         $   13,240       $   14,238        $   15,275
     Interest costs                            27,810           28,362            27,409
     Return on plan assets                    (35,817)         (35,116)          (35,671)
     Amortization of:
        Transition obligation                   1,365            1,229             1,264
        Prior service cost                      1,986            2,298             1,359
        Actuarial (gain)/loss                  (2,447)          (1,248)             (624)
                                           ----------       ----------        ----------
     Net periodic pension expense          $    6,137       $    9,763        $    9,012
                                           ==========       ==========        ==========

</TABLE>

     The Company uses the projected unit credit cost actuarial method for
attribution of expense for financial reporting purposes. The interest cost and
the actuarial present value of benefit obligations were computed using a
weighted average interest rate of 6.75% in 1998 and 7.25% in 1997 and 1996,
while the expected return on plan assets was computed using a weighted average
interest rate of 9.25% in 1998 and 9.00% in 1997 and 1996.  The weighted
average rate of increase in future compensation levels used in determining the
actuarial present value of the projected benefit obligation was 4.50% in 1998
and 5.00% in 1997 and 1996.

     The Company's postretirement benefits plan is a contributory defined
benefit plan for employees who were retired or who were eligible for early
retirement as of January 1, 1995, and is a contributory defined dollar plan for
all other employees retiring after January 1, 1995.  Health benefits are
provided for all employees who participated in the Company's and the P&C
Group's group medical benefits plan for 15 years prior to retirement at age 55
or later.  A life insurance benefit of $5,000 is provided at no cost to
retirees who maintained group insurance coverage for 15 years prior to
retirement at age 55 or later.

     There are no assets separated and allocated to this plan. 


<PAGE>   50

     The funded status of the entire plan, which includes the Company and the
P&C Group, as of December 1, 1998 and 1997 (the latest date for which
information is available), was as follows:

<TABLE>
<CAPTION>

                                                         1998            1997
                                                      ----------       ---------- 
                                                          (Amounts in thousands)
<S>                                                   <C>              <C>
Change in Benefit Obligation
Net benefit obligation at beginning of the year       $   70,758       $   75,142
Service cost                                               1,280            1,395
Interest cost                                              5,080            5,402
Plan participants' contributions                           1,297            1,216
Plan amendments                                                0                0
Actuarial (gain)/loss                                      6,936           (8,205)
Benefits paid                                             (4,984)          (4,192)
                                                      ----------       ----------
                                                      $   80,367       $   70,758
                                                      ==========       ==========

<S>                                                   <C>              <C>
Change in Plan Assets
Fair value of plan assets at beginning of the year    $        0       $        0
Actual return on plan assets                                   0                0
Employer contributions                                         0                0
Plan participants' contributions                               0                0
Benefits paid                                                  0                0
                                                      ----------       ----------
Fair value of plan assets at end of the year          $        0       $        0
                                                      ==========       ==========

<S>                                                   <C>              <C>
Funded status at end of the year                      $  (80,367)      $  (70,758)
Unrecognized net actuarial (gain)/loss                    (8,193)         (15,976)
Unrecognized prior service cost                                0                0
Unrecognized net transition obligation/(asset)            18,354           19,665
                                                      ----------       ----------
Net amount recognized at end of the year              $  (70,206)      $  (67,069)
                                                      ==========       ==========

<S>                                                   <C>              <C>
Amounts recognized in the statement of
  financial position consist of:
     Prepaid benefit cost                             $        0       $        0
     Accrued benefit cost                                (70,206)         (67,069)
     Additional minimum liability                              0                0
     Intangible asset                                          0                0
     Accumulated other comprehensive income                    0                0
                                                      ----------       ----------
Net amount recognized at end of the year              $  (70,206)      $  (67,069)
                                                      ==========       ==========

</TABLE>


<PAGE>   51

     The Company's share of the accrued postretirement benefit cost was
approximately $53,206,000 in 1998 and $51,930,000 in 1997.  The unrecognized
net transition obligation of $18,354,000 in 1998 and $19,665,000 in 1997
represents the remaining transition obligation of the P&C Group.

     Components of postretirement benefits expense for the Company follow:

<TABLE>
<CAPTION>
                                              1998             1997              1996
                                           ----------       ----------        ----------
                                                       (Amounts in thousands)           
     <S>                                   <C>              <C>               <C>       
     Service costs                         $      636       $      753        $    1,016
     Interest costs                             2,527            2,918             3,018
     Return on plan assets                          0                0                 0
     Amortization of:
        Transition obligation                       0                0                 0
        Prior service cost                          0                0                 0
        Actuarial (gain)/loss                    (435)             (13)                0
                                           ----------       ----------        ----------
     Net periodic expense                  $    2,728       $    3,658        $    4,034
                                           ==========       ==========        ==========

</TABLE>

     The weighted average interest rate used in the above benefit computations
was 6.75% in 1998 and 7.25% in 1997 and 1996.  Beginning in 1996, the initial
medical inflation rate was 7.50%, to be graded over a 3-year period to 6.00%
and level thereafter, and contribution levels from retirees were the same as
applicable medical cost increases where defined benefits exist. The weighted
average rate of increase in future compensation levels used in determining the
actuarial present value of the accumulated benefit obligation was 4.50% in 1998
and 5.00% in 1997 and 1996.

     A 1.00% increase or decrease in the medical inflation rate assumption
would have resulted in the following:

<TABLE>
<CAPTION>

                                                            1% increase      1% decrease
                                                           -------------    ------------- 
                                                               (Amounts in thousands)
     <S>                                                    <C>              <C>
     Effect on 1998 service and interest components
       of net periodic cost                                 $         64     $       (59)
     
     Effect on accumulated postretirement benefit
       obligation at December 31, 1998                               772            (710)

</TABLE>

<PAGE>   52

Q.   Commitments and contingencies

     Rental expense incurred by the Company was $22,332,000, $20,322,000 and
$20,121,000 in 1998, 1997 and 1996, respectively. 

     The Company has long-term operating lease commitments on equipment and
buildings, with options to renew at the end of the lease periods.  As of
December 31, 1998, the remaining commitments payable over the next five years
under these leases were: 

<TABLE>
<CAPTION>
                                                           Equipment        Buildings
                                                          -----------      -----------
                                                               (Amounts in thousands)
          <S>                                             <C>              <C>
          1999                                            $    16,148      $     1,336
          2000                                                  7,077              796
          2001                                                  3,332              648
          2002                                                     87              518
          2003                                                     15              132
                                                          -----------      -----------
                                                          $    26,659      $     3,430
                                                          ===========      ===========
</TABLE>

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

     The Company has entered into employment agreements with certain 
executives of the Company.  Each agreement obligates the Company to compensate 
the executive should the executive's employment be terminated due to a 
qualifying event, as defined within the agreement.  In the opinion of 
management, any payments made as a result of these agreements would not have a 
material adverse effect on the Company's consolidated results of operations or 
financial position.

R.   Income taxes

     The Company follows the provisions of SFAS No. 109, "Accounting for 
Income Taxes".  Deferred tax assets and deferred tax liabilities are recorded 
to reflect the tax consequences in future years of differences between the tax 
bases of assets and liabilities and the corresponding bases used for financial 
statements.   On April 15, 1997, OSL and IGL were sold pursuant to Internal 
Revenue Code 338(h)(10).  Federal and state taxes incurred as a result of 
this transaction amounted to $26,826,000.


<PAGE>   53

     The components of the provision for income taxes are:

<TABLE>
<CAPTION>
                                              1998             1997             1996
                                           ----------       ----------       ----------
                                                       (Amounts in thousands)          
     <S>                                   <C>              <C>              <C>       
     Management services to the P&C 
     Group; and other:
       Current
         Federal                           $  302,669       $  317,396       $  240,918
         State                                 38,271           42,601           63,963
       Deferred
         Federal                              (46,701)         (25,286)         (27,959)
         State                                 (3,487)          (2,527)          (1,770)
                                          -----------       ----------       ----------
           Total                              290,752          332,184          275,152
                                          -----------       ----------       ----------

     Insurance Subsidiaries:
       Current
         Federal                               83,981           80,119          101,712
         State                                  1,089            1,704              869
       Deferred
         Federal                               (2,100)         (5,399)          (22,531)
         State                                      0                0                0
                                          -----------       ----------       ----------
           Total                               82,970           76,424           80,050
                                          -----------       ----------       ----------
     Consolidated total                   $   373,722       $  408,608       $  355,202
                                          ===========       ==========       ==========

</TABLE>

     The table below reconciles the provision for income taxes computed at 
the U.S. statutory income tax rate of 35% to the Company's provision for 
income taxes: 

<TABLE>
<CAPTION>
                                              1998             1997               1996
                                          -----------        ----------        ----------
                                                       (Amounts in thousands)            
     <S>                                  <C>                <C>               <C>       
     Management services to the P&C 
     Group; and other:
       Expected tax expense               $   249,059        $  273,836        $  218,268
       State income taxes, net of 
         federal income tax benefits           22,059            21,152            40,100
       Tax exempt investment income           (11,086)           (8,490)           (8,571)
       Tax-effect of gain on sale of                                                  
         OSL and IGL in excess of U.S.                                 
         statutory rate                             0            20,169                 0 
       Goodwill                                21,015            21,015            21,015
       Other, net                               9,705             4,502             4,340
                                          -----------        ----------        ----------
           Reported income tax expense        290,752           332,184           275,152
                                          -----------        ----------        ----------

     Insurance Subsidiaries:
       Expected tax expense                    83,637            76,902            83,832
       Tax exempt investment income            (3,013)           (2,337)           (3,843)
       State taxes                                362             1,704               869
       Other, net                               1,984               155              (808)
                                          -----------       -----------        ----------
           Reported income tax expense         82,970            76,424            80,050
                                          -----------       -----------        ----------
     Consolidated income tax expense      $   373,722       $   408,608        $  355,202
                                          ===========       ===========        ==========

</TABLE>


<PAGE>   54

     The tax effects of temporary differences that give rise to significant 
portions of the deferred tax assets and deferred tax liabilities as of 
December 31, 1998 and 1997 are presented in the following tables: 

<TABLE>
<CAPTION>
                                                     As of December 31, 1998
                                          -----------------------------------------------
                                             Current        Non-current         Total
                                          ------------     -------------     ------------
                                                       (Amounts in thousands)           
     <S>                                  <C>              <C>               <C>        
     Management services to the P&C 
     Group; and other:
       Depreciation                       $         0      $    (68,069)     $    (68,069)
       Achievement awards                         693                 0               693
       Employee benefits                        5,381            12,982            18,363 
       Capitalized expenditures                     0           (50,441)          (50,441)
       California franchise tax                23,779                 0            23,779
       Postretirement benefits                      0            22,416            22,416
       Postemployment benefits                      0               161               161
       Valuation of investments 
         in securities                         (3,947)          (25,439)          (29,386)
       Attorney-in-fact contracts                   0          (483,232)         (483,232)
       Other                                    1,138            (9,425)           (8,287)
                                          -----------      ------------      ------------
          Total deferred tax 
             asset/(liability)                 27,044          (601,047)         (574,003)
                                          -----------      ------------      ------------

     Insurance Subsidiaries:
       Deferred policy acquisition 
         costs and value of life 
         business acquired                                     (251,626)         (251,626)
       Future policy benefits                                   135,215           135,215
       Investments                                               10,842            10,842 
       Valuation of investments 
         in securities                                          (47,659)          (47,659)
       Depreciable assets                                        (5,520)           (5,520)
       Loss reserves                                              2,596             2,596
       Other                                                     (8,577)           (8,577)
                                          -----------        ----------        ----------
           Total deferred tax liability                        (164,729)         (164,729)
                                          -----------        ----------        ----------
     Consolidated total deferred tax
       asset/(liability)                  $    27,044        $ (765,776)       $ (738,732)
                                          ===========        ==========        ==========

</TABLE>


<TABLE>
<CAPTION> 
                                                      As of December 31, 1997
                                           ----------------------------------------------
                                             Current        Non-current          Total
                                           ----------       -----------       -----------
                                                       (Amounts in thousands)           
     <S>                                   <C>               <C>              <C>        
     Management services to the P&C 
     Group; and other:
       Depreciation                        $        0        $  (72,028)      $   (72,028)
       Achievement awards                       1,269                 0             1,269
       Employee benefits                        5,368             4,481             9,849
       Capitalized expenditures                     0           (77,718)          (77,718)
       California franchise tax                20,973                 0            20,973
       Postretirement benefits                      0            28,678            28,678
       Postemployment benefits                      0               165               165
       Valuation of investments 
         in securities                           (254)          (21,284)          (21,538)
       Attorney-in-fact contracts                   0          (499,340)         (499,340)
       Other                                    1,569            (6,864)           (5,295)
                                           ----------       -----------       -----------
          Total deferred tax 
             asset/(liability)                 28,925          (643,910)         (614,985)
                                           ----------       -----------       -----------


     Insurance Subsidiaries:
       Deferred policy acquisition 
         costs and value of life 
         business acquired                                     (243,270)         (243,270)
       Future policy benefits                                   145,733           145,733
       Investments                                                5,323             5,323 
       Valuation of investments 
         in securities                                          (43,320)          (43,320)
       Depreciable assets                                        (6,425)           (6,425)
       Other                                                    (11,047)          (11,047) 
                                          -----------       -----------        ----------
         Total deferred tax liability                          (153,006)         (153,006)
                                          -----------       -----------       -----------
     Consolidated total deferred tax
       asset/(liability)                  $    28,925       $  (796,916)      $  (767,991)
                                          ===========       ===========       ===========

</TABLE>


<PAGE>   55

S.   Management fees

     As AIF, the Company, or its subsidiaries, as applicable, manages the 
affairs of the P&C Group and receives management fees for the services 
rendered.  As a result, the Company received management fees from the P&C 
Group of $1,271,763,000, $1,241,153,000 and $1,167,704,000 in 1998, 1997 and 
1996, respectively.

T.   Related parties

     Certain directors of the Company are partners in legal firms that 
received fees for legal services from the Company and the P&C Group.  These 
fees totaled $6,544,000, $5,208,000 and $1,853,000 in 1998, 1997 and 1996, 
respectively.

     On September 3, 1998, the Company received $423,734,000 from B.A.T 
Capital Corporation, a subsidiary of B.A.T, in settlement of $407,000,000 of 
notes receivable and $16,734,000 of accrued interest.  These notes were fixed 
rate medium-term notes with maturity dates as follows:  $137,000,000 in 
October 1998, $135,000,000 in October 1999 and $135,000,000 in October 2000. 
Interest on these notes was paid semi-annually at coupon rates of 5.35%, 6.68% 
and 6.33%, respectively.  On October 7, 1997, a four year $135,000,000 note 
with an interest rate of 5.10% matured and the $135,000,000 note that would 
have matured in October 2000 was subsequently issued at an interest rate of 
6.33%.  Income earned on the notes for the years ended December 31, 1998 and 
December 31, 1997 was $16,734,000 and $23,620,000, respectively.

     In addition, on September 3, 1998, the Company, using $407,000,000 of 
proceeds from the B.A.T notes redemption and $650,000,000 of proceeds from 
the redemption of the certificates of contribution of the P&C Group 
(see Note F), issued $1,057,000,000 of notes receivable to BAFS.  These 
notes are fixed rate medium-term notes with maturity dates as follows: 
$200,000,000 in September 2000, $207,000,000 in September 2001, $200,000,000 
in September 2002, $200,000,000 in September 2003 and $250,000,000 in 
September 2004.  Interest on these notes is paid semi-annually at coupon 
rates of 5.44%, 5.48%, 5.67%, 5.71% and 5.78%, respectively.  Income earned 
on these notes through December 31, 1998 was $19,481,000.

U.   Supplemental cash flow information

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

<TABLE>
<CAPTION>
                                                 Excluding    
                                                 Insurance      Insurance
                                                Subsidiaries   Subsidiaries  Consolidated
                                                ------------   ------------  ------------
                                                        (Amounts in thousands)
<S>                                             <C>            <C>             <C>
Cash and cash equivalents --December 31, 1995   $  763,212     $   149,794     $  913,006
                              1996 Activity                                      (413,678)
                                                                               ----------
Cash and cash equivalents --December 31, 1996      412,018          87,310        499,328
                              1997 Activity                                        16,925
                                                                               ----------
Cash and cash equivalents --December 31, 1997      479,935          36,318        516,253 
                              1998 Activity                                      (188,701) 
                                                                               ----------
Cash and cash equivalents --December 31, 1998      253,828          73,724     $  327,552
                                                                               ==========
</TABLE>

     Cash payments for interest were $2,671,000, $2,247,000 and $17,305,000 
in 1998, 1997 and 1996, respectively, while cash payments for dividends to 
the holders of the Company's QUIPS were $42,070,000 in 1998, 1997 and 1996. 
Cash payments for income taxes were $423,803,000, $430,588,000 and 
$379,455,000 in 1998, 1997 and 1996, respectively.


<PAGE>   56

     In 1998, the Company used $650,000,000 of proceeds it received from the 
redemption of the certificates of contribution of the P&C Group (see Note F) 
and $407,000,000 of proceeds it received from the settlement of the B.A.T 
Capital Corporation notes receivable (see Note T), to issue $1,057,000,000 
of notes receivable to BAFS (see Note T), a subsidiary of ZFS.  In addition, 
Farmers Life purchased a $119,000,000 surplus note of the P&C Group on 
September 8, 1998 (see Note F).

     In 1997, net cash proceeds from the sale of OSL and IGL amounted to 
$336,714,000 and were in consideration primarily for the following:

     Investments                                              $   823,666,000
     Deferred policy acquisition costs and Value of Life                     
       Business Acquired                                          181,196,000
     Life insurance policy liabilities                           (690,426,000)

     In July 1996, the Company used $200,000,000 of proceeds it received 
from the P&C Group in connection with the redemption of $200,000,000 of 
certificates of contribution of the P&C Group, made in 1986, to extinguish 
$200,000,000 of 8.25% Notes Payable the Company issued in July 1986.

     As a result of the adoption of SFAS No. 115, Farmers Life decreased the 
DAC asset and increased the VOLBA asset to account for the impact on 
estimated future gross profits of the net unrealized gains or losses on 
securities.

V.   Revolving credit agreement

     As of December 31, 1998 and 1997, the Company had a revolving credit 
agreement with certain financial institutions and had an aggregate borrowing 
facility of $500,000,000.  The proceeds of the facility were available to 
the Company for general corporate purposes, including loans to the P&C Group. 
As of December 31, 1998 and 1997, facility fees were payable on the aggregate 
borrowing facility in the amount of 7 basis points per annum and were 
reimbursable to the Company by the P&C Group.  In the case of a draw on the 
facility, the Company has the option to borrow at annual rates equal to the 
prime rate, the banks' certificate of deposit rate plus one percentage point, 
the federal funds effective rate plus 1/2 of one percentage point or the 
London Interbank Offered Rate plus certain percentages.  As of December 31, 
1998 and 1997, the Company did not have any outstanding borrowings under the 
revolving credit agreement.  Facility fees were $350,000, $399,000 and 
$592,000 for the years ended December 31, 1998, 1997 and 1996, respectively, 
and were reimbursed by the P&C Group.  The revolving credit agreement in 
effect as of December 31, 1998 expires on July 1, 2002.

W.   Participating policies

     Participating business, which consists of group business, comprised 
approximately 8.6% of Farmers Life's total insurance in-force as of December 
31, 1998 and 8.8% of its total insurance in-force as of December 31, 1997. 
In addition, participating business represented 2.1% and 2.2% of Farmers 
Life's premium income for the years ended December 31, 1998 and December 
31, 1997 and 2.2% of the Life Insurance Subsidiaries' premium income for the 
year ended December 31, 1996.

     The amount of dividends paid on participating business is determined by 
the Farmers Life Board of Directors and is paid annually on the 
policyholder's anniversary date.  Amounts allocable to participating 
policyholders are based on published dividend projections or expected 
dividend scales.


<PAGE>   57

X.   Life reinsurance

     In 1997, Farmers Life raised the retention limit for automatic 
reinsurance ceded.  The primary change was to set the maximum retention on 
new issues at $2,000,000 per life for the Farmers Flexible Universal Life 
policy; $1,500,000 per life for all Traditional policies except Farmers 
Yearly Renewable Term; and $800,000 per life for Farmers Yearly Renewable 
Term. The excess is reinsured with a third party reinsurer and is not 
material.  Premiums ceded under these agreements totaled $3,728,000 in 1998 
and $4,236,000 in 1997. Life reinsurance receivables, which totaled 
$8,453,000 and $8,627,000 for Farmers Life at December 31, 1998 and 1997, 
respectively, were included in "Other assets" of the Insurance Subsidiaries. 

Y.   Current liabilities accrued, other

     Current liabilities accrued, other consisted of the following:

<TABLE>
<CAPTION>
                                                           As of December 31,
                                                    ------------------------------
                                                        1998               1997
                                                    ------------      ------------
                                                        (Amounts in thousands)
<S>                                                 <C>               <C>
Accrued employee bonuses                            $     9,403       $      9,390
Accrued restructuring costs (see Note E)                 16,545                  0
Other                                                     4,776              2,855
                                                    -----------       ------------
                                                    $    30,724       $     12,245
                                                    ===========       ============
</TABLE>

Z.   Operating segments

     The Company's principal activities are the provision of management 
services to the P&C Group and the ownership and operation of the life and 
reinsurance subsidiaries.  These activities are managed separately as each 
offers a unique set of services.  As a result, the Company is comprised of 
the following three reportable operating segments as defined in SFAS No. 
131: the management services segment, the life insurance segment and the 
reinsurance segment.

     As the Company is the exclusive AIF of the P&C Group, the management 
services segment is primarily responsible for providing management services 
to the P&C Group.  Management fees earned from the P&C Group totaled 
$1,271,763,000, $1,241,153,000 and $1,167,704,000 for the years ended 1998, 
1997 and 1996, respectively.  The life insurance segment provides individual 
life insurance products, including universal life, term life and whole life 
insurance and annuity products.  Finally, the reinsurance segment provides 
reinsurance coverage to a percentage of the auto physical damage business 
written by the P&C Group.

     The basis of accounting used by the Company's management in evaluating 
segment performance and determining how resources should be allocated is 
referred to as the Company's GAAP historical basis, which excludes the 
effects of the purchase accounting ("PGAAP") adjustments related to the 
acquisition of the Company by B.A.T in December 1988 (see Note A). 
This differs from the basis used in preparing the Company's financial 
statements included in the SEC Form 10-K and 10-Q Reports, which 
incorporates the effects of the PGAAP adjustments.

     The Company accounts for intersegment transactions as if they were to 
third parties and, as such, records the transactions at current market 
prices.  There were no intersegment revenues among the Company's three 
reportable operating segments for the years ended 1998, 1997 or 1996.

     The Company operates in 31 states and does not earn revenues or hold 
assets in any foreign countries.


<PAGE>   58

  Information regarding the Company's reportable operating segments follows:

<TABLE>
<CAPTION>
                                          Year ended December 31, 1998
             ---------------------------------------------------------------------------------------------------------
                        GAAP historical basis                            PGAAP adjustments               Consolidated
             ------------------------------------------------------  -------------------------------------
              Management      Life                                   Management      Life                     PGAAP
               services    insurance      Reinsurance       Total     services     insurance     Total        basis   
             ------------------------------------------------------  ------------------------------------- -----------
                                             (Amounts in thousands)
<S>          <C>           <C>            <C>            <C>         <C>           <C>         <C>         <C>     
Revenues     $1,358,175    $  660,419 (a) $1,012,390 (a) $3,030,984  $        0    $    207    $      207 $ 3,031,191

Investment      
 income         136,024       307,221         13,621        456,866        (962)        207          (755)    456,111

Investment
 expenses             0       (13,658)             0        (13,658)          0           0             0     (13,658)

Net realized 
 gains/(losses)  64,430       (13,473)        (1,335)        49,622      (2,002)          0        (2,002)     47,620

Dividends
 on preferred
 securities of 
 subsidiary
 trusts         (42,070)            0              0        (42,070)          0           0             0     (42,070)

Income before
 provision for
 taxes          821,885 (b)   199,609         37,178      1,058,672    (110,289)(c)   2,179      (108,110)    950,562

Provision for
 income taxes   309,992        71,072         11,784        392,848     (19,240)        114       (19,126)    373,722

Assets        3,089,150     5,437,577        793,436      9,320,163   3,183,651 (d) 178,242 (e) 3,361,893  12,682,056

Capital
 expenditures    59,300           572              0         59,872           0           0             0      59,872

Depreciation &
 amortization    71,658        89,334 (f)          0        160,992     104,891 (c)  (1,280)(g)   103,611     264,603
-----------------------
</TABLE>

(a) Revenues for the insurance operating segments include net investment 
    income and net realized gains/(losses).

(b) Amount includes $35.1 million of corporate expenses.

(c) Amount includes PGAAP adjustments associated with the amortization of 
    the AIF contracts ($42.7 million) and goodwill ($60.0 million).

(d) Amount includes PGAAP adjustments associated with the AIF contracts 
    ($1,281.8 million) and goodwill ($1,801.3 million).

(e) Amount includes PGAAP adjustments related to the DAC (($168.3) million) 
    and VOLBA ($334.4 million) assets. 

(f) Amount includes the historical basis amortization associated with the 
    DAC asset.

(g) Amount includes PGAAP adjustments related to the amortization of the DAC 
    (($26.2) million) and VOLBA ($23.9 million) assets. 


<PAGE>   59

<TABLE>
<CAPTION>
                                           Year ended December 31, 1997
             ---------------------------------------------------------------------------------------------------------
                           GAAP historical basis                             PGAAP adjustments           Consolidated
             ------------------------------------------------------  -------------------------------------
              Management      Life                                   Management      Life                    PGAAP
               services     insurance      Reinsurance     Total      services     insurance     Total        basis   
             ------------------------------------------------------  ------------------------------------- -----------
                                                (Amounts in thousands)
<S>          <C>           <C>            <C>            <C>         <C>           <C>       <C>          <C>     
Revenues     $1,324,895    $  683,330 (a) $       47 (a) $2,008,272  $        0    $    716  $        716 $ 2,008,988

Investment      
 income         144,525       305,869             47        450,441        (394)        716           322     450,763

Investment
 expenses             0       (13,442)             0        (13,442)          0           0             0     (13,442)

Net realized 
 gains           73,403        13,236              0         86,639           0           0             0      86,639

Gain on sale
 of subsidiaries 12,044             0              0         12,044       6,975           0         6,975      19,019

Dividends
 on preferred
 securities of 
 subsidiary
 trusts         (42,070)            0              0        (42,070)          0           0             0     (42,070)

Income before
 provision for
 taxes          883,234 (b)   223,156              9      1,106,399    (100,847)(c)  (3,446)     (104,293)  1,002,106

Provision for
 income taxes   350,557        78,266              3        428,826     (18,373)     (1,845)      (20,218)    408,608

Assets        3,418,785     5,177,311         50,115      8,646,211   3,293,963 (d) 177,259 (e) 3,471,222  12,117,433

Capital
 expenditures    64,534         1,696              0         66,230           0           0             0      66,230

Depreciation &
 amortization    68,916       102,958 (f)          0        171,874     104,437 (c)   4,563 (g)   109,000     280,874
-----------------------
</TABLE>

(a)  Revenues for the insurance operating segments include net investment 
    income and net realized gains/(losses).

(b) Amount includes $35.1 million of corporate expenses.

(c) Amount includes PGAAP adjustments associated with the amortization of the 
    AIF contracts ($42.7 million) and goodwill ($60.0 million).

(d) Amount includes PGAAP adjustments associated with the AIF contracts 
    ($1,324.5 million) and goodwill ($1,861.4 million).

(e) Amount includes PGAAP adjustments related to the DAC (($195.2) million) 
    and VOLBA ($359.1 million) assets.

(f) Amount includes the historical basis amortization associated with the 
    DAC asset.

(g) Amount includes PGAAP adjustments related to the amortization of the DAC 
    (($20.2) million) and VOLBA ($23.9 million) assets. 


<PAGE>   60

<TABLE>
<CAPTION>
                                            Year ended December 31, 1996
             ---------------------------------------------------------------------------------------------------------
                            GAAP historical basis                            PGAAP adjustments           Consolidated
             -----------------------------------------------------  -------------------------------------
              Management       Life                                 Management      Life                     PGAAP
               services     insurance   Reinsurance       Total      services     insurance     Total        basis 
             -----------------------------------------------------  -------------------------------------  -----------
                                                 (Amounts in thousands)
<S>          <C>            <C>           <C>           <C>         <C>           <C>        <C>          <C>     
Revenues     $1,245,375     $ 767,767 (a) $       0     $2,013,142  $        0    $      10  $        10  $ 2,013,152

Investment      
 income         123,087       331,050             0        454,137      (1,369)          10       (1,359)     452,778

Investment
 expenses        (8,938)      (13,430)            0        (22,368)          0            0            0      (22,368)

Net realized 
 gains            5,079        37,989             0         43,068           0            0            0       43,068

Dividends
 on preferred
 securities of 
 subsidiary
 trusts         (42,070)            0             0        (42,070)          0            0            0      (42,070)

Income before
 provision for
 taxes          732,880 (b)   243,068             0        975,948    (109,256)(c)  (3,549)     (112,805)     863,143

Provision for
 income taxes   294,245        96,234             0        390,479     (19,093)    (16,184)      (35,277)     355,202

Assets        2,967,434     6,356,131             0      9,323,565   3,396,894 (d) 208,368 (e) 3,605,262   12,928,827

Capital
 expenditures    75,679           132             0         75,811           0           0             0       75,811

Depreciation &
 amortization    59,476       108,815 (f)         0        168,291     105,005 (c)   3,769 (g)   108,774      277,065
-----------------------
</TABLE>

(a) Revenues for the insurance operating segments include net investment 
    income and net realized gains/(losses).

(b) Amount includes $34.0 million of corporate expenses.

(c) Amount includes PGAAP adjustments associated with the amortization of the 
    AIF contracts ($42.7 million) and goodwill ($60.0 million).

(d) Amount includes PGAAP adjustments associated with the AIF contracts 
    ($1,367.2 million) and goodwill ($1,921.4 million).

(e) Amount includes PGAAP adjustments related to the DAC (($250.7) million) 
    and VOLBA ($443.3 million) assets.

(f) Amount includes the historical basis amortization associated with 
    the DAC asset.

(g) Amount includes PGAAP adjustments related to the amortization of the DAC 
    (($25.2) million) and VOLBA ($28.1 million) assets.


<PAGE>   61

                                               FARMERS GROUP, INC.
                                                AND SUBSIDIARIES
                                            QUARTERLY FINANCIAL DATA
                                                  (Unaudited)

<TABLE>
<CAPTION>

                                                    Three months ended                       Year ended
                                --------------------------------------------------------    ------------
                                   Mar. 31       June 30        Sept. 30        Dec. 31        Dec. 31
                                -----------    -----------    -----------    -----------    ------------
                                                         (Amounts in thousands)

<S>                             <C>            <C>            <C>            <C>             <C>

1998
------
Revenues:
    Management services         $   335,539    $   336,373    $   343,904    $   342,359    $  1,358,175
    Insurance Subsidiaries          417,609        422,838        430,450        402,119       1,673,016
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  753,148        759,211        774,354        744,478       3,031,191
                                -----------    -----------    -----------    -----------    ------------
Income before provision for
  income taxes:
    Management services             190,985        185,975        110,259        224,377         711,596
    Insurance Subsidiaries           64,205         64,710         68,617         41,434         238,966
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  255,190        250,685        178,876        265,811         950,562
                                -----------    -----------    -----------    -----------    ------------

Provision for income taxes:
    Management services              76,826         74,300         47,329         92,297         290,752
    Insurance Subsidiaries           23,652         22,585         23,965         12,768          82,970
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  100,478         96,885         71,294        105,065         373,722
                                -----------    -----------    -----------    -----------    ------------
Consolidated net income         $   154,712    $   153,800    $   107,582    $   160,746    $    576,840
                                ===========    ===========    ===========    ===========    ============

1997
------
Revenues:
    Management services         $   320,852    $   328,686    $   331,569    $   343,788    $  1,324,895
    Insurance Subsidiaries          194,094        166,678        162,453        160,868         684,093
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  514,946        495,364        494,022        504,656       2,008,988
                                -----------    -----------    -----------    -----------    ------------

Income before provision for
  income taxes:
    Management services             194,635        197,906        190,058        199,788         782,387
    Insurance Subsidiaries           55,359         54,835         57,384         52,141         219,719
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  249,994        252,741        247,442        251,929       1,002,106
                                -----------    -----------    -----------    -----------    ------------

Provision for income taxes:
    Management services              96,692         79,282         76,861         79,349         332,184
    Insurance Subsidiaries           18,265         18,346         19,475         20,338          76,424
                                -----------    -----------    -----------    -----------    ------------
      Consolidated                  114,957         97,628         96,336         99,687         408,608
                                -----------    -----------    -----------    -----------    ------------
Consolidated net income         $   135,037    $   155,113    $   151,106    $   152,242    $    593,498
                                ===========    ===========    ===========    ===========    ============

</TABLE>


<PAGE>   62

ITEM 9.  Changes in and Disagreements With Accountants on Accounting and 
         Financial Disclosures

     None.


                                 PART III

ITEM 10.  Directors and Executive Officers of Farmers Group, Inc.

                              MANAGEMENT

Executive Officers and Directors

     The following table sets forth certain information concerning each
person who is an executive officer or director of FGI as of the filing 
date:

<TABLE>
<CAPTION>

Name                             Age     Position
------                          -----    -----------

<S>                              <C>     <C>

Martin D. Feinstein (1)          50      Chairman of the Board, President and Chief Executive Officer
Jason L. Katz (1)                51      Executive Vice President, General Counsel and Director
James A. Mackinnon               63      Executive Vice President, Chief Operating Officer and Director
Keitha T. Schofield              47      Executive Vice President - Support Services and Director
Cecilia Claudio                  44      Senior Vice President and Chief Information Officer
Gerald E. Faulwell               57      Senior Vice President and Chief Financial Officer
Leonard H. Gelfand               54      Senior Vice President and President of Farmers Business Insurance 
Paul N. Hopkins                  42      Senior Vice President and Chief Marketing Officer
John H. Lynch                    47      Senior Vice President and President of Farmers Personal Lines
Paul G. Secord                   52      Senior Vice President and Chief Investment Officer
David P. Allvey (2) (3)          54      Director
Edwin A. Heafey, Jr. (3)         68      Director
Benjamin C. Neff (2)             64      Director
Jack C. Parnell (1) (2) (3)      63      Director
Cornelius J. Pings (2) (3)       70      Director
Van Gordon Sauter (3)            63      Director
M. Faye Wilson (2)               61      Director
Clayton Yeutter (2) (3)          68      Director
- -----------------
(1) Member of the Executive Committee
(2) Member of the Audit Committee
(3) Member of the Compensation Committee

</TABLE>

     The present position and principal occupation during each of the last 
five years of the executive officers and directors named above are set forth 
below.

     Martin D. Feinstein has served as Chairman of the Board since November 
1997, Chief Executive Officer of FGI since January 1997, President of FGI 
since January 1995 and as a director of FGI since February 1995. 
Mr. Feinstein also has served as a director of Allied Zurich p.l.c. since 
March 1998 and is a member of the Group Executive Board of Zurich Financial 
Services.  In addition, Mr. Feinstein served as a director of B.A.T from 
January 1997 to September 1998.  Previously, Mr. Feinstein held various 
positions with FGI, including serving as Vice President-Sales and Marketing 
from November 1989 to January 1993, as Senior Vice President-Special 
Projects from January 1993 to October 1993, as Senior Vice President-Property 
and Casualty Staff from October 1993 to January 1995 and as Chief Operating 
Officer of FGI from January 1995 to January 1997. 


<PAGE>   63

     Jason L. Katz has served as Executive Vice President and General Counsel 
of FGI since June 1998 and as a director of FGI since May 1986.  Previously, 
Mr. Katz served as Vice President and General Counsel of FGI from August 1984 
through February 1992 and Senior Vice President and General Counsel of FGI 
from February 1992 to June 1998.

     James A. MacKinnon has served as Executive Vice President and Chief 
Operating Officer since July 1998 and as a director of FGI since May 1997. 
Previously, Mr. MacKinnon served as Senior Vice President-Field Operations- 
Mid-West Zone of FGI from January 1992 to January 1996, Senior Vice 
President-Property and Casualty of FGI from January 1996 to January 1997 and 
Executive Vice President-Insurance Operations from January 1997 to July 1998. 
Mr. MacKinnon will retire effective May 1, 1999, pursuant to normal retirement 
policy.

     Keitha T. Schofield has served as Executive Vice President-Support 
Services since January 1998 and as a director of FGI since May 1997.  Ms. 
Schofield served as Senior Vice President and Chief Information Officer of 
FGI from May 1995 to January 1997 and Executive Vice President-Support 
Services and Chief Information Officer from January 1997 to January 1998. 
Previously, Ms. Schofield served as Vice President-Technology Division of 
Continental Airlines, Inc. from 1988 to May 1995.

     Cecilia Claudio has served as Senior Vice President and Chief 
Information Officer of FGI since July 1998.  Previously, Ms. Claudio served 
as Chief Information Officer and Senior Vice President of Information 
Technology of Harvard Pilgrim Health Care from 1994 to 1996 and Chief 
Information Officer and Senior Vice President of Information Technology 
of Anthem, Inc. from 1996 to May 1998.

     Gerald E. Faulwell has served as Senior Vice President and Chief 
Financial Officer of FGI since September 1998.  Previously, Mr. Faulwell 
served as Vice President-Corporate Investments and Treasurer of FGI from 
October 1987 to January 1993, Vice President-Strategic Planning, Budgeting 
and Administration of FGI from January 1993 to January 1996 and Senior Vice 
President-Strategic Planning, Budgeting and Administration of FGI from 
January 1996 to September 1998.

     Leonard H. Gelfand has served as Senior Vice President of FGI and 
President of Farmers Business Insurance since July 1998. Previously, Mr. 
Gelfand served as Vice President-Commercial of FGI and President-Truck 
Underwriters Association from April 1991 to January 1995 and Senior Vice 
President-Commercial of FGI and President-Truck Underwriters Association 
from January 1995 to July 1998. 

     Paul N. Hopkins has served as Senior Vice President and Chief Marketing 
Officer of FGI since September 1998.  Previously, Mr. Hopkins served as 
Assistant Vice President-Regional Operations of FGI from June 1992 to 
November 1994, Vice President-Agencies of FGI from November 1994 to October 
1997 and Senior Vice President-Agencies of FGI from October 1997 to September 
1998.
 
     John H. Lynch has served as Senior Vice President of FGI and President-
Farmers Personal Lines since July 1998.  Previously, Mr. Lynch served as 
Vice President of FGI and Regional Manager of the Pleasanton Region from 
January 1993 to January 1995, Vice President-Personal Lines Operations of 
FGI from January 1995 to October 1995, Vice President of FGI and Regional 
Manager of the Colorado Springs Region from October 1995 to January 1997, 
Vice President-Personal Lines Operations of FGI from January 1997 to October 
1997 and Senior Vice President-Personal Lines Operations of FGI from October 
1997 to July 1998.

     Paul G. Secord has served as Senior Vice President and Chief Investment 
Officer of FGI since September 1998.  Mr. Secord served as Senior Vice 
President-Asset Management of FGI from December 1995 to September 1998. 
Previously, Mr. Secord served as Vice President-Equity of John Hancock 
Advisors from 1990 to 1993 and Senior Vice President-Equity of Penn Mutual 
from 1993 to 1995.  

     David P. Allvey has served as a director of FGI since February 1995. 
Mr. Allvey has also served as Chief of Corporate Operations of Zurich 
Financial Services since September 1998, director of Allied Zurich p.l.c. 
since March 1998 and as a member of the Group Executive Board of Zurich 
Financial Services.  Previously, Mr. Allvey held various positions 


<PAGE>   64

at B.A.T including serving as Finance Adviser and Manager of Taxation 
at British-American Tobacco Co., Head of Finance of B.A.T and Finance 
Director of B.A.T.

     Edwin A. Heafey, Jr. has served as a director of FGI since 1978. Mr. 
Heafey is a practicing attorney and has been a partner of the law firm of 
Crosby, Heafey, Roach and May since 1962. 

     Benjamin C. Neff has served as a director of FGI since 1995. Mr. Neff 
has served as Chairman of NECO Financial Services, Inc. since May 1995. 
During the period from May 1992 through May 1995, Mr. Neff was the Managing 
Director of Seabury & Smith, Inc., a wholly owned subsidiary of Marsh & 
McClennan, Inc.. Prior to May 1992, Mr. Neff served as the President of 
Smith Sternau Insurance Services, Inc., a wholly owned subsidiary of Marsh 
& McClennan, Inc..

     Jack C. Parnell has served as a director of FGI since 1995. Mr. Parnell 
has served as a Governmental Relations Advisor to the law firm of Kahn, 
Soares & Conway and the public relations firm of Fleishman, Hilliard since 
1991. Previously, Mr. Parnell served as the Deputy Secretary-United States 
Department of Agriculture from 1989 to 1991.  Mr. Parnell also serves on the 
Board of Directors of Neogen Corporation, a company engaged in the veterinary 
instruments and diagnostics business. 

     Cornelius J. Pings has served as a director of FGI since August 1991. 
Dr. Pings served as the President of the Association of American Universities 
from February 1993 to June 1998 and served as the Provost (Senior Vice 
President for Academic Affairs) for the University of Southern California 
from 1981 to early 1993.  Dr. Pings also serves as Chairman of the Board of 
Directors of Pacific Horizon Funds, Inc..  He previously served on the 
boards of Hughes Aircraft Co. and Maxtor, Inc., a company engaged in the 
disk drive business.

     Van Gordon Sauter has served as a director of FGI since May 1996.  Mr. 
Sauter previously served as President and General Manager of PBS affiliate 
KVIE in Sacramento, California and President of CBS News and Fox News.

     M. Faye Wilson has served as a director of FGI since May 1996.  Ms. 
Wilson has served as Senior Vice President of Home Depot since June 1998 
and also serves on the Board of Directors of Home Depot.  Previously, Ms. 
Wilson served as Executive Vice President of BankAmerica from 1977 to June
1998.

     Clayton Yeutter has served as a director of FGI since 1994.  Mr. 
Yeutter has served as a non-executive director of Zurich Financial Services 
and Allied Zurich p.l.c. since March 1998 and as a non-executive director of 
Zurich Allied AG since September 1998.  Previously, Mr. Yeutter served as a 
non-executive director of B.A.T from January 1993 until September 1998.  Mr. 
Yeutter has been Of Counsel to the law firm of Hogan and Hartson since 
February 1993.  During the preceding four years, he served in a series of 
positions in the Bush Administration, first as Secretary of Agriculture, 
then as Chairman of the Republican National Committee and finally as 
Counselor to the President for Domestic Policy.


<PAGE>   65

ITEM 11.   Executive Compensation

     The following table sets forth the annual compensation for services 
in all capacities to FGI for the fiscal years ended December 31, 1998, 1997 
and 1996 of those persons who were, as of December 31, 1998, (i) FGI's Chief 
Executive Officer and (ii) the other four most highly compensated executive 
officers of FGI (the "Named Executive Officers").

                              SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>

                                   Annual Compensation      Long Term Compensation
                                 ------------------------  -------------------------
                                                             Awards       Payouts
                                                           -----------  ------------
                                                             Securities
                                                             Underlying
       Name and                                               Options/    LTIP Payouts       All Other
    Principal Position      Year   Salary ($)  Bonus ($)(1)    SARs (#)      ($)(2)     Compensation ($)(3)
--------------------------  -----  ----------  ------------  -----------  ------------  -------------------
<S>                        <C>     <C>         <C>           <C>          <C>              <C>
Martin D. Feinstein        1998    900,000     948,192            0            0            135,000
  Chairman of the          1997    600,000     615,477            0            0             91,582
  Board, President         1996    400,000     279,918            0            0             61,235
  and Chief Executive
  Officer   

Jason L. Katz              1998    345,000     407,642            0            0             51,750
  Executive Vice President 1997    328,800     351,813            0            0             50,187
  and General Counsel      1996    317,800     222,653            0            0             48,651

James A. MacKinnon         1998    345,000     326,642            0            0             51,750
  Executive Vice           1997    318,300     335,701            0            0             48,584
  President                1996    257,300     172,077            0            0             39,390

Keitha T. Schofield        1998    332,500     330,784            0            0             49,875
  Executive Vice           1997    275,000     275,489            0            0             41,975
  President                1996    215,000     151,046            0            0             16,457

Paul G. Secord             1998    255,000     248,192            0            0             38,250
  Senior Vice President    1997    241,900     231,025            0            0             36,923
                           1996    230,267     161,670            0            0                  0
</TABLE>
---------------------
(1)  Bonus amounts reported in the year in which service related to such 
     bonus is rendered. Payment does not occur until the year subsequent to 
     the year of service. 

(2)  In 1998, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms. Schofield 
     received awards of 90,000, 17,000, 17,000, 12,750 and 15,750 Long Term 
     Incentive Plan Units ("LTIPs"), respectively, under FGI's 1998 Long 
     Term Incentive Plan.  The Value of the LTIPs is linked to performance 
     goals set by the Compensation Committee based on the financial and 
     operating results of the Company and the P&C Group over a three year 
     period.

     In 1997, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms. Schofield 
     received awards of 17,982, 8,200, 8,000, 6,000 and 8,200 Premier Award 
     Units ("PAUs"), respectively, under FGI's Premier Award Units Plan.  In 
     1996, Mr. Secord received an interim award of 5,620 PAUs.  The value of 
     the PAUs is linked to performance goals set by the Compensation 
     Committee based on the financial and operating results of the Company 
     and the P&C Group and the price of B.A.T ADRs over a four-year period. 
     Effective September 8, 1998, the B.A.T ADR performance category was 
     replaced by a measurement of Allied Zurich p.l.c. and Zurich Allied AG 
     stock performance.   

     The value of the LTIPs and PAUs will be paid to eligible employees in 
     cash.  The receipt of such amounts may be deferred at the election of 
     participants, subject to the approval of the Compensation Committee.
     In the event of certain changes in the capital structure of FGI or 
     other events relating to control of FGI, the Compensation Committee has 
     the discretion to pay out the value of outstanding LTIPs and PAUs 
     immediately or make other appropriate adjustments to the LTIPs and PAUs. 

(3)  Represents estimated amounts to be contributed by FGI under the 
     Employees' Profit Sharing Savings Plan Trust (the "Deferred Plan") 
     and reported in the year of service as earned. To the extent that a 
     participant's annual benefits under the Deferred Plan exceed certain 
     limits imposed by law, such amounts will be paid under FGI's 
     nonqualified Employee Benefits Restoration Plan (the "Benefits 
     Restoration Plan"), which is funded through a grantor trust. 


<PAGE>   66

Employees' Pension Plan

     In addition to the compensation set forth above, the Named Executive 
Officers participate with all eligible employees of the Company in the 
Company's tax-qualified Employees' Pension Plan (the "Pension Plan"). 
The Named Executive Officers also participate in the Benefits Restoration 
Plan, funded through a grantor trust, which provides supplemental benefits 
to the extent amounts otherwise payable under the Pension Plan and the 
Deferred Plan are limited under applicable laws. (Together, the Pension 
Plan and the Benefits Restoration Plan are referred to as the "Retirement 
Plans"). 

     Effective May 7, 1997, the Employee Benefits Restoration Plan was 
amended to include awards made under the Executive Incentive Plan as 
compensation in calculating pension benefits, starting with the 1996 awards 
paid in 1997.  The entire benefit derived from inclusion of the Executive 
Incentive Plan award(s) will be paid from the Employee Benefits Restoration 
Plan.  This amendment impacts certain key officers and includes the Named 
Executive Officers. 

     The Pension Plan bases retirement benefits upon the employee's final 
five-year average annual base salary and the total years of credited 
service, subject to a maximum of 35 years of credited service. Employees 
who are at least 21 years of age and who have completed one year of service 
participate in the Pension Plan retroactive to the first day of the month 
following their hire date. Eligible participants become vested and earn a 
nonforfeitable right to Pension Plan benefits after completing five years 
of service or upon reaching the first day of the month in which they become 
age 65.  In addition, the Pension Plan provides that if, following a Change 
in Control of the Company (as defined in the Pension Plan), the Pension Plan 
is terminated or the employment of a participant in the Pension Plan is 
terminated, and if at the time of such termination there are surplus assets 
in the Pension Plan, such surplus assets shall be used to increase the 
benefits payable to each affected plan participant. The Retirement Plans 
both provide for the full vesting of accrued benefits in the event of a 
Change in Control. 

     Unreduced monthly pension benefits begin at age 62 with 30 years of 
service and at age 65 with less than 30 years of service, but participants 
may retire as early as age 55 at actuarially reduced rates, provided that 
they have at least 15 years of service. Participants who become totally and 
permanently disabled may qualify for disability retirement benefits if they 
have 10 or more years of service and are between the ages of 35 and 65. 

     For purposes of illustration, the following table provides examples of 
the annual pension benefits payable at age 65 pursuant to the defined 
benefit portions of the Retirement Plans, assuming benefits are paid in the 
form of a straight life annuity. Such benefits are not reduced for Social 
Security payments or other offset amounts.


<TABLE>
<CAPTION>

                                          PENSION PLAN TABLE

                                                       Years of Credited Service                     
                                 -----------------------------------------------------------------------
Five-Year Average Remuneration        15            20             25             30             35   
------------------------------   -----------   ------------   ------------   ------------   ------------
<S>                              <C>           <C>            <C>            <C>            <C>       
$  150,000                       $   38,268    $   51,024     $   63,780     $   76,536     $   89,292
   200,000                           51,393        68,524         85,655        102,786        119,917
   250,000                           64,518        86,024        107,530        129,036        150,542
   300,000                           77,643       103,524        129,405        155,286        181,167
   350,000                           90,768       121,024        151,280        181,536        211,792
   400,000                          103,893       138,524        173,155        207,786        242,417
   450,000                          117,018       156,024        195,030        234,036        273,042
   500,000                          130,143       173,524        216,905        260,286        303,667
   600,000                          156,393       208,524        260,655        312,786        364,917
   700,000                          182,643       243,524        304,405        365,286        426,167
   800,000                          208,893       278,524        348,155        417,786        487,417
   900,000                          235,143       313,524        391,905        470,286        548,667
   
</TABLE>

<PAGE>   67

     At the end of 1998, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms. 
Schofield were credited under the Pension Plans with 25.0, 14.4, 35.0, 3.0 
and 3.6 years of service, respectively.  The average annual salary for the 
five-year period ended December 31, 1998 for Messrs. Feinstein, Katz, 
MacKinnon, Secord and Ms. Schofield was $608,573, $424,100, $369,850, 
$365,422 and $374,279, respectively.  These figures include the 1996 and 
1997 Executive Incentive Plan Awards paid in 1997 and 1998. 

Employment Agreements and Change-in-Control Arrangements

     The Company has entered into employment agreements with each of Messrs. 
Feinstein, Katz, MacKinnon, Secord and Ms. Schofield.  Each of the agreements 
provide that if the executive's employment is terminated following a 
"Change-in-Control" (as defined in the agreement), the executive will 
receive a severance payment equal to two (2) times the executive's "Cash 
Compensation" (as defined in the agreement, but generally including certain 
base salary, bonus and profit sharing plan allocation amounts).  In addition 
to the Cash Compensation amount payable, the executive is also entitled to 
(i) continued coverage under applicable group welfare benefit plans of the 
Company (for example, the Company's life, disability and health 
insurance plans), (ii) a benefit under the Company's long-term incentive 
plan (determined as if the executive terminated employment due to 
retirement,  and as if any remaining performance criteria had been waived) 
and (iii) a lump sum payment of certain enhanced benefit amounts under the 
Company's pension plans (including the supplemental pension plan).  In the 
cases of Messrs. Feinstein and Katz, the agreements provide for a tax gross 
-up payment equal to the amount of any excise tax payable under Section 
4999 of the Internal Revenue Code of 1986, as amended.  In the case of the 
other executives, amounts payable under the agreements will be reduced to
the extent necessary to avoid the application of such excise tax.

     The payments under the agreement will be made if the executive is 
employed at the time of the Change-in-Control and his or her termination 
is (i) by the Company other than for "Cause" (as defined in the agreement), 
(ii) by the executive for "Good Reason" (as defined in the agreement) or 
(iii) other than due to the executive's death, disability or retirement. 

     The agreement provides for an extension of the "Initial Term" (as 
defined in the agreement), in the event of a Change-in-Control.  As a Change 
-in-Control occurred in 1998, the agreements have been extended to October 
31, 2000.  In all cases, however, the agreements will expire upon the death, 
retirement or disability termination of the executive.

Compensation of Directors

     Directors who are not employees of FGI or of Zurich Financial Services 
receive an annual retainer of $25,000, together with $1,000 plus expenses 
for each FGI Board of Directors (the "Board") meeting attended in 1998. 
Additionally, committee members of the Board receive $950 plus expenses 
for each committee meeting attended and Committee Chairs receive $1,100 
plus expenses for each committee meeting attended.  Directors who are 
employees of FGI or Zurich Financial Services do not receive the retainer 
fees, Board meeting fees or committee fees referred to above. Total 
payments, excluding reimbursement of expenses, to Messrs. Heafey, Neff, 
Parnell, Pings, Sauter, Yeutter and Ms. Wilson amounted to $28,300, $29,800, 
$33,600, $34,200, $29,800, $30,700 and $29,800, respectively, in 1998 for 
services rendered in that year. 

     FGI has established an Outside Directors' Retirement Benefit Program. 
Any director who is not an employee of FGI or of Zurich Financial Services 
who has attained age 70 at the time such director retires from service as a 
member of the Board and has either accrued 10 or more calendar years of 
service as a Board member or who was a Board member as of August 7, 1987, 
the inception date of this Program, is entitled to an annual benefit 
commencing in May of the calendar year following the director's retirement 
from the Board. Such annual benefit is equal to 100% of the annual retainer 
fee in effect during the last year the director served on the Board. Benefit 
payments are made for five or more years, depending on the director's length 
of service on the Board. Based on their tenure as Board members, Mr. Heafey 
has accrued benefits of ten annual payments, and Messrs. Neff, Parnell, 
Pings, Sauter, Yeutter and Ms. Wilson have accrued no benefits under this 
Program. Benefits for this Program were funded through a grantor trust 
through 1995. 

<PAGE>   68

Effective January 1, 1996, retirement payments to directors retiring after 
January 1, 1996 will be paid directly by FGI. Payments under this Program 
to former Board members amounted to $51,000 in 1998.

Compensation Committee Interlocks and Insider Participation

     During 1998, FGI's Compensation Committee (the "Committee") consisted 
of Mr. Heafey, who is Chairman, and Messrs. Allvey, Parnell, Pings, Sauter 
and Yeutter.  None of these individuals is now or has ever been an officer 
or employee of the Company.

     The Committee receives compensation recommendations from the Chief 
Executive Officer and amends or revises them as appropriate. The Committee 
then submits a recommendation regarding executive compensation to the Board. 
Compensation levels for Mr. Feinstein and certain senior officers are 
approved by the Chairman of Zurich Financial Services.

     The law firm of Crosby, Heafey, Roach and May received fees of 
$6,206,000 for legal services rendered to the Company or the P&C Group in 1998.
Mr. Heafey is a partner in such firm and has been a director of FGI 
since 1978.  The law firm of Kahn, Soares and Conway received $329,000 
for legal services rendered to the Company or the P&C Group in 1998.  Mr. 
Parnell is an advisor to such firm and has been a director of FGI since 1995.
In addition, the law firm of Hogan and Hartson, LLP, received fees 
of $9,000 for legal services rendered to the Company or the P&C Group 
in 1998.  Mr. Yeutter is Of Counsel in such firm and has been a director 
of FGI since 1994. 

ITEM 12.   Security Ownership of Certain Beneficial Owners and Management

     All of the outstanding Class A common stock, which has 90% of the 
voting power of FGI, are owned beneficially and of record by Zurich 
Financial Services, Mythenquai 2, P.O. Box 8022, Zurich, Switzerland. 
All of the outstanding Class B common stock, which has the remaining 10% 
of the voting power of FGI, are owned beneficially and of record by 
Allied Zurich Holdings Limited, Mourant du Feu & Jeune, P.O. Box 87, 
22 Grenville Street, St. Helier, Jersey JE4 8PX, Channel Islands.

     The following table sets forth information regarding beneficial 
ownership of Allied Zurich p.l.c. ADRs and ordinary shares as of 
December 31, 1998 by (a) the Chief Executive Officer of FGI, (b) each 
of the four most highly compensated executive officers of FGI other than 
the Chief Executive Officer and (c) all directors and executive officers 
of FGI, as a group. 

<TABLE>
<CAPTION>

                                                       Allied Zurich p.l.c.   Allied Zurich p.l.c.
                                                              ADRs              Ordinary Shares
                                                       Beneficially Owned      Beneficially Owned
                                                       -------------------   ----------------------
Name                                                    Number    Percent      Number      Percent
------                                                 --------- ---------   ----------   ---------
<S>                                                      <C>       <C>       <C>           <C>
Martin D. Feinstein                                          0                17,564          (1)
Jason L. Katz                                                0                     0
James A. MacKinnon                                           0                     0
Keitha T. Schofield                                          0                     0
Paul G. Secord                                               0                     0
All Directors and Executive Officers as a group            994      (2)      102,390          (1)

</TABLE>
------------


(1)  Less than 1% of the outstanding Allied Zurich p.l.c. ordinary shares. 

(2)  Less than 1% of the outstanding Allied Zurich p.l.c. ADRs.


<PAGE>   69

ITEM 13.   Certain Relationships and Related Transactions

     Certain directors of the Company are partners in legal firms that 
received fees for legal services from the Company and the P&C Group.  These 
fees totaled $6,544,000, $5,208,000 and $1,853,000 in 1998, 1997 and 1996, 
respectively. 

     On September 3, 1998, the Company received $423,734,000 from B.A.T 
Capital Corporation, a subsidiary of B.A.T, in settlement of $407,000,000 
of notes receivable and $16,734,000 of accrued interest.  These notes were 
fixed rate medium-term notes with maturity dates as follows:  $137,000,000 
in October 1998, $135,000,000 in October 1999 and $135,000,000 in October 2000.
Interest on these notes was paid semi-annually at coupon rates of 
5.35%, 6.68% and 6.33%, respectively.  On October 7, 1997, a four year 
$135,000,000 note with an interest rate of 5.10% matured and the 
$135,000,000 note that would have matured in October 2000 was subsequently 
issued at an interest rate of 6.33%.  Income earned on the notes 
outstanding for the years ended December 31, 1998 and December 31, 1997 
was $16,734,000 and $23,620,000, respectively.

     In addition, on September 3, 1998, the Company, using $407,000,000 of 
proceeds from the B.A.T notes redemption and $650,000,000 of proceeds from 
the redemption of the certificates of contribution of the P&C Group 
(see Note F), issued $1,057,000,000 of notes receivable to BAFS.  These 
notes are fixed rate medium-term notes with maturity dates as follows:
$200,000,000 in September 2000, $207,000,000 in September 2001, 
$200,000,000 in September 2002, $200,000,000 in September 2003 and 
$250,000,000 in September 2004.  Interest on these notes is paid semi-
annually at coupon rates of 5.44%, 5.48%, 5.67%, 5.71% and 5.78%, 
respectively.  Income earned on these notes through December 31, 1998 
was $19,481,000. 


                                  PART IV

ITEM 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)  Exhibits and Financial Statement Schedules

  (1)  Exhibits

       3.1   Restated Articles of Incorporation of FGI, as amended 
             May 23, 1977, as further amended September 24, 1984, as further 
             amended May 19, 1986 (i), as further amended February 3, 1989 
             (ii), as further amended September 4, 1998(vi)
       3.2   Bylaws of FGI (i)
       3.3   Form of Certificate of Trust of the Issuer (ii)
       3.4   Trust Agreement (ii)
       4.1   Form of Amended and Restated Trust Agreement (ii)
       4.2   Form of Indenture among FGI and The Chase Manhattan Bank, N.A., 
             as Debenture Trustee (ii)
       4.3   Form of Preferred Security (included in Exhibit 4.1) (ii)
       4.4   Form of Junior Subordinated Debentures (included in 
             Exhibit 4.2) (ii)
       4.5   Form of Guarantee by FGI and The Chase Manhattan Bank, 
             N.A., as Guarantee Trustee (ii)
      10.1   Form of Subscription Agreement (Farmers Underwriters 
             Association) (ii)
      10.2   Form of Subscription Agreement (Truck Underwriters 
             Association) (ii)
      10.3   Form of Subscription Agreement (Fire Underwriters 
             Association) (ii)
      10.4   The Farmers Group, Inc. 1993 Premier Award Unit Plan, as amended 
             November 4, 1993 (ii), as further amended February 14, 1996 (iii),
             as further amended November 10, 1997 (v)
      10.5   Farmers Group, Inc. Executive Incentive Program (ii), as amended
             May 7, 1997 and August 13, 1997 (v)
      10.6   Description of Farmers Group, Inc. Outside Directors' Retirement 
             Program (ii)
      10.7   The Farmers Group, Inc. Discretionary Management Incentive 
             Program for Exceptional Performance (ii), as amended December 
             1996 (iv)


<PAGE>   70

      10.8   Farmers Group, Inc. Employee Benefits Restoration Plan (ii), as
             amended May 7, 1997 (v)
      10.10  Form of Employment Agreement with certain officers (v), as
             amended June 15, 1998       
      12     Statement of Computation of the Ratio of Earnings to Fixed Charges
      21     Subsidiaries of FGI (v)
      24     Power of Attorney (ii)
      99     Risk Manangment
--------------------
(i)   Incorporated by reference to the corresponding Exhibit to FGI's Annual 
      Report on Form 10-K for the year ended December 31, 1987.

(ii)  Incorporated by reference to the corresponding Exhibit to FGI's 
      Registration Statement No. 33-94670 and No. 33-94670-01 on Form S-1.

(iii) Incorporated by reference to the corresponding Exhibit to FGI's 
      Annual Report on Form 10-K for the year ended December 31, 1995.

(iv)  Incorporated by reference to the corresponding Exhibit to FGI's 
      Annual Report on Form 10-K for the year ended December 31, 1996.

(v)   Incorporated by reference to the corresponding Exhibit to FGI's 
      Annual Report on Form 10-K for the year ended December 31, 1997.

(vi)  Incorporated by reference to the corresponding Exhibit to FGI's 
      Quarterly Report on Form 10-Q for the quarterly period ended 
      September 30, 1998.


  (2)  Financial Statement Schedules
                                                                         Page
                                                                        ------
     a.  Financial Statements.  See Index to Financial Statements and 
         Supplementary Data for a list of financial statements 
         included in this Report.                                          22

     b.  Financial Statement Schedules
           Schedule I - Marketable Securities - Other Investments, as
             of December 31, 1998                                         S-1
           Schedule III - Supplementary Insurance Information, for the
             years ended December 31, 1998, 1997 and 1996                 S-2
           Schedule IV - Reinsurance, for the years ended 
             December 31, 1998, 1997 and 1996                             S-3
           Schedule V - Valuation and Qualifying Accounts, for the
             years ended December 31, 1998, 1997 and 1996                 S-4

(b)  Reports on Form 8-K

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

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


<PAGE>   71

                                        SIGNATURES

     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, in the City of 
Los Angeles, State of California on 

                                     FARMERS GROUP, INC.
                       ---------------------------------------------
                                       (Registrant)

Date: March 24, 1999   By:    /s/ Martin D. Feinstein              
                       ---------------------------------------------
                       Martin D. Feinstein, Chairman of the Board,
                       President and Chief Executive Officer


     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 the capacities and on the dates indicated.

        Signature                       Title                      Date
        ---------                       -----                      ----

Principal Executive Officer
/s/ Martin D. Feinstein         Chairman of the Board,         March 24, 1999
--------------------------------President and Chief                    
(Martin D. Feinstein)           Executive Officer



Principal Financial and            
  Accounting Officer
/s/ Gerald E. Faulwell          Senior Vice President and      March 24, 1999
--------------------------------Chief Financial Officer
(Gerald E. Faulwell)                                   

Directors
/s/ James A. MacKinnon          Executive Vice President,      March 24, 1999
--------------------------------Chief Operating Officer 
(James A. MacKinnon)            and Director 

/s/ Keitha T. Schofield         Executive Vice President       March 24, 1999
--------------------------------and Director
(Keitha T. Schofield)                                       

/s/ Jason L. Katz               Executive Vice President,      March 24, 1999
--------------------------------General Counsel and Director
(Jason L. Katz)         

/s/ David P. Allvey             Director                       March 24, 1999
--------------------------------
(David P. Allvey)   

/s/ Edwin A. Heafey, Jr.        Director                       March 24, 1999
--------------------------------
(Edwin A. Heafey, Jr.)

/s/ Benjamin C. Neff            Director                       March 24, 1999
--------------------------------
(Benjamin C. Neff)  

/s/ Jack C. Parnell             Director                       March 24, 1999
--------------------------------
(Jack C. Parnell)   

/s/ Cornelius J. Pings          Director                       March 24, 1999
--------------------------------
(Cornelius J. Pings)

/s/ Van Gordon Sauter           Director                       March 24, 1999
--------------------------------
(Van Gordon Sauter)

/s/ M. Faye Wilson              Director                       March 24, 1999
--------------------------------
(M. Faye Wilson)       

/s/ Clayton Yeutter             Director                       March 24, 1999
--------------------------------
(Clayton Yeutter)


<PAGE>   S-1

                                        FARMERS GROUP, INC.
                                         AND SUBSIDIARIES
                        SCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS
                                        December 31, 1998
                                     (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                       Market value      Amount at which
                                                                        at balance         shown in the
Type of Investment                                      Cost            sheet date         balance sheet
--------------------                                 ------------      -------------     ---------------

<S>                                                  <C>               <C>               <C>       
Insurance Subsidiaries:
  Marketable securities - available-for-sale:
    United States government and its agencies        $  1,762,608      $   1,846,606     $     1,846,606
    States and municipalities                             620,279            651,574             651,574
    Public utilities                                       65,287             69,949              69,949
    Foreign government                                     95,077             81,379              81,379
    All other corporate                                 1,552,964          1,619,896           1,619,896
    Preferred stocks (redeemable)                          82,090             86,662              86,662
                                                     ------------      -------------     ---------------
                                                        4,178,305          4,356,066           4,356,066
                                                     ------------      -------------     ---------------

  Preferred stocks (non-redeemable)                         1,153              1,270               1,270
                                                     ------------      -------------     ---------------
  Common stocks:
    Public utilities                                        2,581              2,758               2,758
    Banks, trusts and insurance companies                  11,151             11,539              11,539
    Industrial, miscellaneous and all other                84,668             91,798              91,798
                                                     ------------      -------------     ---------------
                                                           98,400            106,095             106,095
                                                     ------------      -------------     ---------------

  Mortgage loans on real estate                            52,879         xxxxx                   52,879
                                                     ------------      -------------     ---------------
  Policy loans                                            185,211         xxxxx                  185,211
                                                     ------------      -------------     ---------------
  Real estate (1)                                          59,047 (1)     xxxxx                   59,047
                                                     ------------      -------------     ---------------
  Joint ventures                                            8,456         xxxxx                    8,456
                                                     ------------      -------------     ---------------
  Surplus note of the P&C Group                           119,000         xxxxx                  119,000
                                                     ------------      -------------     ---------------
  S&P 500 call options                                     11,305             14,817              14,817
                                                     ------------      -------------     ---------------

    Total investments                                $  4,713,756      $   4,478,248     $     4,902,841
                                                     ============      =============     ===============

(1) Net of accumulated depreciation of $28,366.

</TABLE>


<PAGE>   S-2

                                    FARMERS GROUP, INC.
                                     AND SUBSIDIARIES
                     SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
                   For the years ended December 31, 1998, 1997 and 1996
                                   (Amounts in thousands)

<TABLE>
<CAPTION>

Column A             Column B      Column C      Column D    Column E     Column F    Column G
--------             --------      --------      --------    --------     --------    -------- 

                                 Future policy
                     Deferred      benefits,               Other policy   Premium
                      policy     losses, claims             claims and   and policy     Net
 Insurance          acquisition     and loss     Unearned    benefits      charge    investment
Subsidiaries         costs (1)      expenses     premiums    payable      revenues     income
--------------      -----------  --------------  --------   ----------   ---------   ----------

<S>                 <C>           <C>            <C>        <C>          <C>          <C>
December 31, 1998   $   801,690   $   3,316,369  $  1,696   $   55,661   $1,380,433   $  307,391
                    ===========   =============  ========   ==========   ==========   ==========

December 31, 1997       798,725       3,032,318     1,543       58,529      377,667      293,190
                    ===========   =============  ========   ==========   ==========   ==========

December 31, 1996                                                           412,158      317,630
                                                                         ==========   ==========

Column A             Column H      Column I      Column J
----------           --------      --------      --------

                     Benefits,    Amortization
                      claims,     of deferred
                    losses and       policy        Other
 Insurance          settlement    acquisition    operating
Subsidiaries         expenses      costs (1)     expenses
--------------      ----------  --------------  ------------

<S>                 <C>          <C>            <C>
December 31, 1998   $  812,820   $      90,082  $    380,530
                    ==========   =============  ============
                    
December 31, 1997      139,124         103,975        65,974
                    ==========   =============  ============

December 31, 1996      166,199         108,802        84,345
                    ==========   =============  ============

-------------------
(1) Includes value of life business acquired

</TABLE>


<PAGE>   S-3

                                           FARMERS GROUP, INC.
                                            AND SUBSIDIARIES
                                        SCHEDULE IV - REINSURANCE
                           For the years ended December 31, 1998, 1997 and 1996
                                         (Amounts in thousands)

<TABLE>
<CAPTION>

Column A                           Column B          Column C          Column D          Column E          Column F
---------                        ------------      ------------      ------------     -------------      ------------

                                                                                                          Percentage
                                                     Ceded to           Assumed                            of amount
                                    Gross             other            from other           Net             assumed
                                    amount          companies          companies          amount             to net
                                 ------------      ------------      ------------     -------------      ------------

<S>                              <C>               <C>               <C>              <C>                <C>
  1998
----------
Life insurance in-force          $ 96,883,459      $    968,606      $  8,893,263     $ 104,808,116              8.5%
                                 ------------      ------------      ------------     -------------      ------------
Life premium & policy charges         375,259             3,728             8,798           380,329              2.3
                                 ------------      ------------      ------------     -------------      ------------
Non-life premiums                         104                 0         1,000,000         1,000,104            100.0
                                 ------------      ------------      ------------     -------------      ------------

  1997
----------
Life insurance in-force          $ 89,613,224      $  1,209,978      $  8,428,465      $ 96,831,711              8.7%
                                 ------------      ------------      ------------     -------------      ------------
Life premiums & policy charges        371,606             4,236            10,297           377,667              2.7
                                 ------------      ------------      ------------     -------------      ------------

  1996
----------
Life insurance in-force          $100,529,124      $    847,883      $ 10,568,578     $ 110,249,819              9.6%
                                 ------------      ------------      ------------     -------------      ------------
Life premiums & policy charges        405,654             3,868            10,372           412,158              2.5
                                 ------------      ------------      ------------     -------------      ------------

</TABLE> 


<PAGE>   S-4

                           FARMERS GROUP, INC.
                            AND SUBSIDIARIES
               SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS
                          (Amounts in thousands)

<TABLE>
<CAPTION>
                                               Balance at        Balance at
                                                beginning          end of
                                                 of year            year
                                              ------------      ------------

<S>                                           <C>               <C>       
   YEAR
----------

   1998                                       $   15,118        $   14,206
   1997                                           18,960            15,118
   1996                                           14,164            18,960


</TABLE>