<PAGE>   1
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
 
                             WASHINGTON, D.C. 20549
                               ------------------
 
                                  FORM 10-K/A
 
                                AMENDMENT NO. 1
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998                COMM. FILE NO. 0-8483
 
                               CERES GROUP, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                                    Delaware
                          ---------------------------
                        (STATE OR OTHER JURISDICTION OF
                         INCORPORATION OR ORGANIZATION)
                                   34-1017531
                       ---------------------------------
                     I.R.S. EMPLOYER IDENTIFICATION NUMBER
 
<TABLE>
<S>                                                      <C>
        17800 Royalton Road, Strongsville, Ohio                                   44136
      -------------------------------------------                               ---------
        (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                                (ZIP CODE)
</TABLE>
 
                                 (440) 572-2400
                ------------------------------------------------
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
       Securities Registered Pursuant to Section 12(b) of the Act:  None
 
          Securities Registered Pursuant to Section 12(g) of the Act:
 
                   Common Shares, par value $0.001 per share
                ------------------------------------------------
                                (TITLE OF CLASS)
 
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
                                YES [X]  NO [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the 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.  [  ]
 
     State the aggregate market value of the voting stock held by non-affiliates
of the Registrant. (The Registrant considers affiliates to be directors,
executive officers and those persons subject to the Voting and Stockholders'
Agreements.)
 
 $28,494,220 computed based on the closing price of the Common Shares on March
                                   22, 1999.
 
     The number of Common Shares, par value $0.001 per share, outstanding as of
March 22, 1999:  13,497,732.
--------------------------------------------------------------------------------
 
                      DOCUMENTS INCORPORATED BY REFERENCE:
 
  Definitive Proxy Statement for the Annual Meeting of Shareholders to be held
             June 10, 1999, into Part III, Items 10, 11, 12 and 13.
--------------------------------------------------------------------------------
<PAGE>   2
                               EXPLANATORY NOTE

  This Form 10-K/A is being filed by Ceres Group, Inc., a Delaware corporation
(the "Company"), as an amendment to its annual report on Form 10-K for the
fiscal year ended December 31, 1998, filed March 31, 1999, to (1) amend the
Company's Consolidated Statements of Cash Flows to correct a document conversion
error contained in the December 31, 1998 column under "Changes to assets and
liabilities: Commissions payable" and a typographical error contained in the
December 31, 1998 column under "Other assets", (2) amend the information
regarding the Executive Officers of the Company to include Billy B. Hill, Jr.,
and (3) correct typographical errors in the Independent Auditors' Report of KPMG
LLP. "Commissions payable" was incorrectly reported as ($184,114) when that
figure is correctly reported as $184,114. "Other assets" was incorrectly
reported as (1,190,845) when that figure is correctly reported as (1,190,842).
All subtotals and totals were stated correctly. A corrected Consolidated
Statements of Cash Flows is filed herewith. The information regarding the
Company's Executive Officers incorrectly omitted Billy B. Hill, Jr. A corrected
page with the information regarding all of the Company's Executive Officers is
filed herewith. The Independent Auditors' Report of KPMG LLP contained two
typographical errors. A corrected Independent Auditors' Report of KPMG LLP is
filed herewith.

The remainder of the Company's Item 8, including the Financial Statements,
the Notes to Financial Statements and the Reports of Independent Auditors,
is unchanged.
    
<PAGE>   3
 
                                   SIGNATURES
 
     PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
 
<TABLE>
<S>                                                   <C>
                                                      CERES GROUP, INC.
 
                                                                       By:   /s/ PETER W. NAUERT
                                                         -----------------------------------------------------
                                                                      Peter W. Nauert, President
</TABLE>
 
     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 COMPANY
AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
   
<TABLE>
                        DATE                                            SIGNATURE AND CAPACITY
----------------------------------------------------- -----------------------------------------------------------
<S>                                                   <C>
 
April 27, 1999                                                         By:   /s/ FRED LICK, JR.
                                                         -----------------------------------------------------
                                                          Fred Lick, Jr., Chairman of the Board of Directors
 
April 27, 1999                                                         By:   /s/ PETER W. NAUERT
                                                         -----------------------------------------------------
                                                        Peter W. Nauert, President and Chief Executive Officer
 
April 27, 1999                                                     By:   /s/ CHARLES E. MILLER, JR.
                                                         -----------------------------------------------------
                                                           Charles E. Miller, Jr., Executive Vice President
                                                            and Principal Financial and Accounting Officer
 
April 27, 1999                                                         By:   /s/ ANDREW A. BOEMI
                                                         -----------------------------------------------------
                                                                       Andrew A. Boemi, Director
 
April 27, 1999                                                       By:   /s/ MICHAEL A. CAVATAIO
                                                         -----------------------------------------------------
                                                                     Michael A. Cavataio, Director
 
April 27, 1999                                                        By:   /s/ BRADLEY E. COOPER
                                                         -----------------------------------------------------
                                                                      Bradley E. Cooper, Director
 
April 27, 1999                                                      By:   /s/ JOHN F. NOVATNEY, JR.
                                                         -----------------------------------------------------
                                                                      John F. Novatney, Director
 
April 27, 1999                                                       By:   /s/ RICHARD M. OSBORNE
                                                         -----------------------------------------------------
                                                                     Richard M. Osborne, Director
 
April 27, 1999                                                         By:   /s/ ROBERT A. SPASS
                                                         -----------------------------------------------------
                                                                       Robert A. Spass, Director
 
April 27, 1999                                                          By:   /s/ MARK H. TABAK
                                                         -----------------------------------------------------
                                                                        Mark H. Tabak, Director
</TABLE>
    
 
                                       61
<PAGE>   4
 
EXECUTIVE OFFICERS OF THE COMPANY
 
     Pursuant to Instruction 3 to Item 401(b) of Regulation S-K, the current
executive officers of the Company are as follows:
 
   
<TABLE>
<CAPTION>
                  NAME                       AGE                    POSITION
                  ----                       ---                    --------
<S>                                          <C>    <C>
Fred Lick, Jr.                               67     Chairman of the Board and Director
Peter W. Nauert                              55     President, Chief Executive Officer and
                                                    Director
Glen A. Laffoon                              59     Executive Vice President and
                                                    Assistant Secretary
Val Rajic                                    39     Executive Vice President and Treasurer
Charles E. Miller, Jr.                       48     Executive Vice President and
                                                    Chief Financial Officer
Billy B. Hill, Jr.                           47     General Counsel*
</TABLE>
    
 
---------------
 
   
* Mr. Hill serves as a consultant to the Company pursuant to a retainer
  agreement dated as of June 30, 1998. Under the retainer agreement, he has the
  title of General Counsel.
    
 
     The current one year terms of office of the executive officers listed above
began December 7, 1998, with their election to office by the Board of Directors
at its meeting following the special meeting of shareholders held on such date.
There are no arrangements or understandings known to the Company between any
executive officer and any other person pursuant to which any officer was elected
to office. There is no family relationship between any director or executive
officer and any other director or executive officer of the Company.
 
     MR. LICK has served as an officer since 1974 and a director since 1976. He
is currently the Chairman of the Company and Chairman of Central. Prior to July
3, 1998, Mr. Lick was also President and Chief Executive Officer of the Company
and of Central.
 
     MR. NAUERT has served as President and Chief Executive Officer of the
Company since July 3, 1998. Mr. Nauert is also the principal investor in
Strategic Partners and is Principal of Geneva Consolidated, Inc., a company
providing consulting services to small group and life insurance companies. Mr.
Nauert served as President of Pioneer Financial Services from 1982 to 1988 and
1991 to 1995, and served as Chairman from 1988 to 1997. Mr. Nauert had been
employed in an executive capacity by one or more of the insurance subsidiaries
of Pioneer Financial Services from 1968 to 1997.
 
     MR. LAFFOON has served as an officer of the Company since 1991 and an
officer of Central since 1974 and has held various positions in both companies.
Since July 1998, he has served as Executive Vice President of the Company, since
December 1998, he has also served as Assistant Secretary of the Company, and
since June 1998, has served as President and Chief Executive Officer of Central.
 
     MR. RAJIC has served as an officer of the Company since December 1997 and
was a director and acting Chief Operating Officer of the Company from December
1997 to June 1998. Since June 1998, he has held the position of Executive Vice
President of the Company, and since December 1998, he has also served as
Treasurer of the Company. Mr. Rajic has served as President of Strategic
Partners since 1997. From 1993 to 1997, Mr. Rajic held various positions,
including Senior Vice President, at Pioneer Financial Services. Prior to 1993,
Mr. Rajic held various positions at American National Bank and Trust Company of
Chicago, a leading, middle-market business, bank.
 
     MR. MILLER has served as an officer of the Company since October 1998. He
holds the positions of Executive Vice President and Chief Financial Officer of
the Company. From 1996 to 1998, Mr. Miller served as a principal and President
of Wellington Partners, Inc., an insurance acquisition company. Mr. Miller was
also a consultant to IP Delaware. Prior to 1996, Mr. Miller was Executive Vice
President, Chief Financial Officer and a director of Harcourt General Insurance
Companies.
 
   
     MR. HILL has served as a consultant to the Company, with the title of
General Counsel, since July 3, 1998. He is a principal in the law firm of Hill &
Reagan, Dallas, Texas. Mr. Hill also served as general counsel of Pioneer
Financial Services from January 1996 to August 1997.
    
 
                                       12
<PAGE>   5
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     See "Market Risk and Management Policies" section under Item
7. -- Management's Discussion and Analysis of Financial Condition and Results of
Operation.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
 
                               CERES GROUP, INC.
 
                                     INDEX
 
<TABLE>
<CAPTION>
                                                                                   PAGE
                                                                                   ----
            <S>                                                          <C>
            Independent Auditors' Reports...............................            25
 
            Consolidated Balance Sheets as of December 31, 1998 and
              1997......................................................            27
 
            Consolidated Statements of Operations for the years ended
              December 31, 1998, 1997 and 1996..........................            28
 
            Consolidated Statements of Shareholders' Equity for the
              years ended December 31, 1998, 1997 and 1996..............            29
 
            Consolidated Statements of Cash Flows for the years ended
              December 31, 1998, 1997 and 1996..........................            30
 
            Notes to Consolidated Financial Statements for the years
              ended December 31, 1998, 1997 and 1996....................            31
 
            Schedule II -- Condensed Financial Information of
              Registrant -- Ceres Group, Inc. (Parent Only).............            50
 
            Schedule III -- Supplementary Insurance Information.........            53
 
            Schedule IV -- Reinsurance..................................            54
</TABLE>
 
                                       24
<PAGE>   6
 
                         REPORT OF INDEPENDENT AUDITORS
 
Shareholders and Board of Directors Ceres Group, Inc.
 
     We have audited the consolidated balance sheet of Ceres Group, Inc. and
subsidiaries (formerly Central Reserve Life Corporation) as of December 31,
1998, and the related consolidated statements of operations, shareholders'
equity, and cash flows for the year then ended. We have also audited the
information presented in the supplemental schedules as of and for the year ended
December 31, 1998. These consolidated financial statements and supplemental
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
supplemental schedules based on our audit. The consolidated balance sheet of
Ceres Group, Inc. and subsidiaries for the year ended December 31, 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the two years ended December 31, 1997, and the information
presented in the supplemental schedules for those years were audited by other
auditors, whose report dated February 20, 1998, except for Notes B and C, as to
which the date was March 30, 1998, expressed an unqualified opinion on those
statements and supplemental schedules and included an explanatory paragraph that
expressed substantial doubt about the Company's ability to continue as a going
concern, as discussed in Note C to these financial statements.
 
     We conducted our audit 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 audit and the report of other auditors provide a reasonable
basis for our opinion.
 
     In our opinion, based on our audit and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Ceres Group, Inc. and subsidiaries, at December 31,
1998 and 1997, and the results of its operations and cash flows for each of the
three years ended December 31, 1998, in conformity with generally accepted
accounting principles. Also in our opinion, the related supplemental schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.
 
                                                               Ernst & Young LLP
Cleveland, Ohio
March 17, 1999
 
                                       25
<PAGE>   7
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors and Shareholders
Central Reserve Life Corporation:
 
     We have audited the consolidated financial statements of Central Reserve
Life Corporation and subsidiaries as of and for each of the years in the
two-year period ended December 31, 1997 as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedules as of and for each of the years
in the two-year period ended December 31, 1997 as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedules based on our audits.
 
   
     We conducted our audits in accordance with 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 estimate made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
    
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Central
Reserve Life Corporation and subsidiaries as of December 31, 1997, and the
results of their operations and their cash flows for each of the years in the
two-year period ended December 31, 1997, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
 
   
     The accompanying consolidated financial statements and financial statement
schedules have been prepared assuming that the Company will continue as a going
concern. As discussed in Note C to the consolidated financial statements, the
Company has suffered substantial losses from operations in 1997 and 1996 that
resulted in a significantly reduced net capital position. The Company has
entered into an Amended and Restated Stock Purchase Agreement to issue and sell
7,300,000 Common Shares and warrants to purchase an additional 3,650,000 Common
Shares at an exercise price of $5.50 per share for an aggregate purchase price
of $40,150,000. The closing of the Amended and Restated Stock Purchase Agreement
is subject to shareholder approval and regulatory approvals. In December 1997,
the Company obtained an interim loan of $20 million and that loan is due June
30, 1998. Should the Amended and Restated Stock Purchase Agreement not be
completed before June 30, 1998, and due to regulatory limitations on the
Company's ability to receive dividends from its insurance subsidiary, the
Company, absent some alternative capital resource, will not have the ability to
repay the interim loan. These matters raise substantial doubt about the ability
of the Company to continue as a going concern. Management's plans in regard to
these matters are also described in Note C to the consolidated financial
statements. The accompanying consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
    
 
Columbus, Ohio                                                          KPMG LLP
February 20, 1998, except for Notes B and C,
     as to which the date is March 30, 1998.
 
                                       26
<PAGE>   8
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
                           DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                  1998           1997
                                                              ------------   ------------
<S>                                                           <C>            <C>
ASSETS
Investments
  Fixed maturities--Note E:
     Held-to-maturity, at amortized cost....................  $  8,899,659   $ 11,898,627
     Available-for-sale, at fair value......................    80,832,097     67,961,886
                                                              ------------   ------------
          Total fixed maturities............................    89,731,756     79,860,513
  Policy loans..............................................        94,432         96,211
                                                              ------------   ------------
          Total investments.................................    89,826,188     79,956,724
Cash and cash equivalents...................................    15,031,058      7,602,865
Cash--restricted--Note E....................................     4,345,322      3,930,956
Accrued investment income...................................     1,343,297      1,123,693
Premiums receivable.........................................     2,203,690      2,098,243
Note receivable--Note I.....................................     7,367,556             --
Reinsurance receivable--Note I..............................    41,417,031     26,215,765
Property and equipment, net.................................    10,061,688     10,966,512
Deferred federal income taxes--Note G.......................     1,409,479      1,356,000
Deferred acquisition costs..................................     3,809,737        325,572
Other assets................................................     3,418,089      2,227,247
                                                              ------------   ------------
          Total assets......................................  $180,233,135   $135,803,577
                                                              ============   ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
  Future policy benefits, losses and claims.................  $ 22,717,862   $ 24,903,497
  Other policy claims and benefits payable--Note H..........    74,395,205     56,186,802
                                                              ------------   ------------
                                                                97,113,067     81,090,299
Deferred reinsurance gain--Note I...........................    13,400,000     10,000,000
Other policyholders' funds..................................     8,845,829      7,565,341
Federal income taxes payable--Note G........................     1,105,834        385,834
Note payable--Note B........................................            --     20,000,000
Mortgage note payable--Note J...............................     8,283,884      8,399,028
Reinsurance payable.........................................     2,993,400             --
Commissions payable.........................................     2,978,140      2,794,026
Other liabilities...........................................     9,677,267      4,057,207
                                                              ------------   ------------
          Total liabilities.................................   144,397,421    134,291,735
Shareholders' equity:
  Non-voting preferred shares, $.001 par value, 2,000,000
     shares authorized, none issued--Note L.................            --             --
  Common shares, 30,000,000 shares authorized, $.001 par
     value, 11,495,172 shares issued and outstanding in
     1998, and 15,000,000 shares authorized, no par value,
     $.50 stated value, 4,195,172 shares issued and
     outstanding in 1997--Note B............................        11,495      2,097,586
  Additional paid-in capital................................    43,883,357      4,122,319
  Retained earnings (deficit)...............................    (9,154,986)    (5,319,327)
  Accumulated other comprehensive income....................     1,095,848        611,264
                                                              ------------   ------------
          Total shareholders' equity........................    35,835,714      1,511,842
                                                              ------------   ------------
          Total liabilities and shareholders' equity........  $180,233,135   $135,803,577
                                                              ============   ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
                                       27
<PAGE>   9
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                       1998            1997            1996
                                                   ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
REVENUES
  Premiums--Note I:
     Direct......................................  $264,868,186    $262,161,343    $260,076,097
     Assumed.....................................    45,922,385              --              --
     Ceded.......................................  (150,005,674)     (3,302,036)     (1,900,760)
                                                   ------------    ------------    ------------
                                                    160,784,897     258,859,307     258,175,337
  Net investment income--Note E..................     7,454,180       6,527,537       6,700,741
  Net realized gains--Note E.....................       210,857         146,478           9,517
  Other income...................................     1,096,690              --              --
  Amortization of deferred reinsurance gain--Note
     I...........................................       600,000              --              --
                                                   ------------    ------------    ------------
                                                    170,146,624     265,533,322     264,885,595
BENEFITS, LOSSES AND EXPENSES
  Benefits, claims, losses and settlement
     expenses....................................   116,058,675     210,776,366     203,677,232
  Underwriting, acquisition and insurance
     expenses--Note I............................    54,368,115      74,763,640      72,417,673
  Amortization of deferred acquisition costs.....       647,271           4,005         111,807
  Interest expense and financing costs...........     1,841,334       1,078,198         812,833
                                                   ------------    ------------    ------------
                                                    172,915,395     286,622,209     277,019,545
                                                   ------------    ------------    ------------
Loss before federal income taxes.................    (2,768,771)    (21,088,887)    (12,133,950)
Federal income tax expense (benefit)--Note G.....     1,066,888        (132,531)     (2,845,585)
                                                   ------------    ------------    ------------
NET LOSS.........................................  $ (3,835,659)   $(20,956,356)   $ (9,288,365)
                                                   ============    ============    ============
Basic and diluted loss per common share..........         $(.49)         $(5.01)         $(2.29)
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       28
<PAGE>   10
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
   
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
    
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                                ACCUMULATED
                                                                  RETAINED         OTHER
                                                  ADDITIONAL      EARNINGS     COMPREHENSIVE        TOTAL
                                       COMMON       PAID IN     (ACCUMULATED      INCOME        SHAREHOLDERS'
                                       STOCK        CAPITAL       DEFICIT)        (LOSS)           EQUITY
                                     ----------   -----------   ------------   -------------    -------------
<S>                                  <C>          <C>           <C>            <C>              <C>
Balance, January 1, 1996...........  $2,018,750   $ 3,476,940   $27,030,102     $   775,188      $33,300,980
  Cash dividends...................          --            --    (2,104,708)             --       (2,104,708)
  Exercise of stock options--Note
    K..............................      10,015        46,848                                         56,863
  Private placement................      43,821       482,031            --              --          525,852
  Comprehensive loss:
    Net loss.......................          --            --    (9,288,365)             --       (9,288,365)
    Other comprehensive loss, net:
       Unrealized loss on
         securities................          --            --            --      (1,029,106)      (1,029,106)
       Reclassification adjustment
         for loss included in
         operations................          --            --            --           6,281            6,281
                                     ----------   -----------   -----------     -----------      -----------
       Other comprehensive loss....          --            --            --              --       (1,022,825)
                                     ----------   -----------   -----------     -----------      -----------
    Comprehensive loss.............          --            --            --              --      (10,311,190)
                                     ----------   -----------   -----------     -----------      -----------
Balance, December 31, 1996.........   2,072,586     4,005,819    15,637,029        (247,637)      21,467,797
  Exercise of stock options--Note
    K..............................      25,000       116,500            --              --          141,500
  Comprehensive loss:
    Net loss.......................          --            --   (20,956,356)             --      (20,956,356)
    Other comprehensive income,
       net:
       Unrealized gain on
         securities................          --            --            --         955,576          955,576
       Reclassification adjustment
         for gains included in
         operations................          --            --            --         (96,675)         (96,675)
                                     ----------   -----------   -----------     -----------      -----------
       Other comprehensive
         income....................          --            --            --              --          858,901
                                     ----------   -----------   -----------     -----------      -----------
    Comprehensive loss.............          --            --            --              --      (20,097,455)
                                     ----------   -----------   -----------     -----------      -----------
Balance, December 31, 1997.........   2,097,586     4,122,319    (5,319,327)        611,264        1,511,842
  Issuance of common shares--Note
    B..............................   3,650,000    34,024,947            --              --       37,674,947
  Change to $.001 par value........  (5,736,091)    5,736,091            --              --               --
  Comprehensive loss:
    Net loss.......................          --            --    (3,835,659)             --       (3,835,659)
    Other comprehensive income,
       net:
       Unrealized gain on
         securities................          --            --            --         613,764          613,764
       Reclassification adjustment
         for gains included in
         operations................          --            --            --        (129,180)        (129,180)
                                     ----------   -----------   -----------     -----------      -----------
    Other comprehensive income.....          --            --            --              --          484,584
                                     ----------   -----------   -----------     -----------      -----------
Comprehensive loss.................          --            --            --              --       (3,351,075)
                                     ----------   -----------   -----------     -----------      -----------
Balance, December 31, 1998.........  $   11,495   $43,883,357   $(9,154,986)    $ 1,095,848      $35,835,714
                                     ==========   ===========   ===========     ===========      ===========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       29
<PAGE>   11
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                1998           1997          1996
                                                             -----------   ------------   -----------
<S>                                                          <C>           <C>            <C>
OPERATING ACTIVITIES
Net loss...................................................  $(3,835,659)  $(20,956,356)  $(9,288,365)
Adjustments to reconcile net loss to cash provided by (used
  in) operating activities:
  Depreciation and amortization............................      513,328        840,864     1,057,473
  Net realized gains.......................................     (210,857)      (146,478)       (9,517)
  Deferred federal income tax benefit......................     (382,240)      (722,531)      (36,673)
  Changes in assets and liabilities:
    Restricted cash........................................     (414,366)      (108,533)      164,081
    Premiums receivable....................................     (105,447)       950,783    (1,195,921)
    Reinsurance receivable.................................  (15,201,266)    (1,353,765)           --
    Federal income tax payable.............................      720,000
    Federal income taxes recoverable.......................                   2,245,530    (1,919,150)
    Accrued investment income..............................     (219,604)      (135,157)      (15,156)
    Other assets...........................................   (1,190,842)    (1,100,239)     (149,552)
    Future policy benefits, claims and funds payable.......   21,938,976      8,611,801    11,805,490
    Reinsurance payable....................................    2,993,400             --            --
    Commissions payable....................................      184,114             --            --
    Other liabilities......................................    5,620,060        981,720     1,366,844
    Deferred Policy acquisition costs......................    3,484,165             --            --
    Deferred Reinsurance gain..............................   (3,400,000)            --            --
                                                             -----------   ------------   -----------
Net cash provided by (used in) operating activities........   10,493,762    (10,892,361)    1,779,554
                                                             -----------   ------------   -----------
INVESTING ACTIVITIES
Net disposals (purchases) of furniture and equipment.......      301,954       (763,124)      244,652
Purchase of fixed maturities held-to-maturity..............                      (5,702)
Purchase of fixed maturities available-for-sale............  (33,099,685)   (22,113,291)  (10,977,540)
Decrease in Policy loans, net..............................       (1,779)       (15,435)       (5,205)
Proceeds from sale of fixed maturities
  available-for-sale.......................................    7,836,700      3,528,625       176,925
Proceeds from calls and maturities of fixed maturities
  available-for-sale.......................................   13,317,705     19,722,467    10,747,238
Proceeds from calls and maturities of fixed maturities
  held-to-maturity.........................................    3,023,009         13,131       102,803
                                                             -----------   ------------   -----------
Net cash (used in) provided by investing activities........   (8,622,096)       366,671       288,873
                                                             -----------   ------------   -----------
FINANCING ACTIVITIES
Increase in annuity account balances.......................      482,504      1,269,307     2,926,416
Decrease in annuity account balances.......................   (5,118,224)    (4,387,246)   (2,110,618)
Principal payments on long-term debt.......................     (115,144)      (104,748)      (95,291)
Increase in note receivable................................   (7,367,556)
Proceeds from notes payable................................           --     25,200,000            --
Repayment of note payable..................................  (20,000,000)    (5,200,000)           --
Proceeds from exercise of stock options....................                     141,500        56,863
Proceeds from issuance of common shares....................   37,674,947             --            --
Proceeds from private placement to agents, directors.......           --             --       525,852
Dividends..................................................           --             --    (2,104,708)
Reinsurance ceding allowance, net..........................           --    (14,550,000)           --
                                                             -----------   ------------   -----------
Net cash provided by (used in) financing activities........    5,556,527      2,368,813      (801,486)
                                                             -----------   ------------   -----------
Net increase (decrease) in cash............................    7,428,193     (8,156,877)    1,266,941
Cash and cash equivalents at beginning of year.............    7,602,865     15,759,742    14,492,801
                                                             -----------   ------------   -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR...................  $15,031,058   $  7,602,865   $15,759,742
                                                             ===========   ============   ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for interest.....................  $ 1,661,880   $  1,012,098   $   812,833
Cash paid (received) during the year for income taxes......  $   650,000   $    590,000   $  (889,762)
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       30
<PAGE>   12
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
 
SUMMARY OF BUSINESS
 
     Ceres Group, Inc. (the "Company"), known as Central Reserve Life
Corporation prior to December 8, 1998, operated in 1998 and prior periods
primarily through its wholly-owned subsidiary, Central Reserve Life Insurance
Company ("Central"). Central is a life and accident and health insurer,
domiciled in Ohio, offering a full range of life, health, and annuity products
distributed through general agents and independent writing agents. While Central
is licensed in 36 states, approximately 67% of premium volume is generated from
seven states: Ohio, Indiana, North Carolina, Arizona, Michigan, South Carolina,
and Tennessee. As described more fully in Notes D and I, in the latter half of
1998 and early 1999, the Company completed a quota share reinsurance transaction
and two acquisitions, which management anticipates will expand the business of
the Company.
 
SIGNIFICANT ACCOUNTING POLICIES
 
     The accompanying consolidated financial statements include the accounts of
Ceres Group, Inc. and its wholly-owned subsidiaries, including Central and
Provident American Life and Health Insurance Company, collectively referred to
herein as the "Company." All intercompany transactions have been eliminated in
consolidation.
 
     The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP"), which differ from accounting
practices prescribed or permitted by the Ohio Department of Insurance (see Note
M). A summary of significant accounting policies is as follows:
 
  CASH AND CASH EQUIVALENTS
 
     Cash and cash equivalents include cash and all highly-liquid securities
with maturities of 90 days or less when purchased.
 
  INVESTMENTS
 
     Investments in bonds and mandatory redeemable preferred stocks are
designated at purchase as held-to-maturity or available-for-sale.
Held-to-maturity investments are securities which management has the positive
intent and ability to hold until maturity, and are reported at amortized cost.
Available-for-sale investments are reported at fair value, with unrealized
holding gains and losses reported as a separate component of shareholders'
equity, net of deferred federal income taxes.
 
     Investments in equity securities and non-redeemable preferred stocks are
reported at fair value.
 
     Premiums and discounts arising from the purchase of mortgage-backed
securities are amortized using the interest method over the estimated remaining
term of the securities, adjusted for anticipated prepayments.
 
     Realized gains and losses on the sale of investments are determined using
the specific-identification method, and are credited or charged to income.
 
     The estimated fair value of investments is based upon quoted market prices,
where available, or on values obtained from independent pricing services.
 
                                       31
<PAGE>   13
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
  DEFERRED ACQUISITION COSTS
 
     The costs of acquiring and renewing traditional life insurance, principally
commissions, are deferred and amortized over the premium-paying period of the
related policies using assumptions consistent with those used in computing
policy benefit reserves. In 1998, deferred acquisition costs also include
amounts paid to acquire accident and health blocks of business via reinsurance
(see Note I).
 
  PROPERTY AND EQUIPMENT
 
     Property and equipment are carried at cost less allowances for depreciation
and amortization. The home office building is depreciated on the straight-line
method over 31.5 years, except for certain components which are depreciated over
15 years. Depreciation for other property and equipment is computed on the
straight-line basis over the estimated useful lives of the equipment,
principally five and seven years.
 
  POLICY RESERVES
 
     Liabilities for future policy reserves on ordinary life insurance have
generally been provided on a net level premium method based upon estimates of
future investment yield, mortality, and withdrawals using the Company's
experience and actuarial judgment with an allowance for possible unfavorable
deviation from the expected experience. Future policy benefits for annuity
policies in the accumulation phase have been calculated based on the
participant's aggregate account values. The liability for future policy benefit
reserves has been computed using the following assumptions: (i) the guaranteed
interest on policies currently being issued is 4.5%, and (ii) estimates of
future mortality and withdrawals are based on experience and established
industry tables.
 
  LIFE AND ACCIDENT AND HEALTH CLAIM RESERVES
 
     Liabilities for unpaid life and accident and health claims, which include a
provision for estimated costs to investigate and settle claims, are estimated
based upon past experience for pending, incurred but not reported, and reopened
claims. Accident and health claims incurred but not reported are computed using
actuarially-determined factors based on a combination of claim completion and
projected claim cost methods, utilizing durational experience, seasonal cycle,
changes in health care practice, changes in inflation rates, and the claims
backlog. Although considerable variability is inherent in such computations,
management believes that the liabilities for unpaid life and accident and health
claims are adequate. The estimates are continually reviewed and adjusted as
necessary as experience develops or new information becomes known; such
adjustments are included in current operations.
 
  DEFERRED REINSURANCE GAIN
 
     Deferred reinsurance gain consists of initial ceding allowances received
from reinsurers. Such amounts are amortized into income over the estimated
remaining life of the underlying policies reinsured.
 
  COMPREHENSIVE INCOME
 
     As of January 1, 1998, the Company adopted FASB Statement No. 130,
Reporting Comprehensive Income ("FAS 130"). FAS 130 establishes new rules for
the reporting and display of comprehensive income and its components; however,
the adoption of this Statement had no impact on the Company's net income or
shareholders' equity. FAS 130 requires unrealized gains or losses on the
Company's available-for-sale securities, which prior to adoption were reported
separately in shareholders' equity, to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of FAS 130.
 
                                       32
<PAGE>   14
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
  PREMIUM REVENUE
 
     Life premiums are recognized as revenue when they become due. Accident and
health premiums are recognized as revenue over the terms of the policies.
Amounts received from contracts which do not subject the Company to risks
arising from policyholder mortality or morbidity, principally certain deferred
and flexible annuity products, are not reflected in premium revenue; rather,
such amounts are accounted for as deposits and are included in future policy
benefits, losses and claims.
 
  FEDERAL INCOME TAXES
 
     Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
 
  STOCK-BASED COMPENSATION
 
     The intrinsic value method of accounting is used for stock-based
compensation plans. In accordance with the intrinsic value method, compensation
cost is measured as the excess, if any, of the quoted market price of the equity
instrument awarded at the measurement date over the amount an employee must pay
to acquire the equity instrument. Stock-based compensation costs are recognized
over the period in which employees render services associated with the awards.
 
  EARNINGS PER SHARE
 
     Basic earnings per share are computed by dividing the income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution that
could occur if common stock equivalents were exercised and shared in the
earnings of the Company. Only those potential common shares which are dilutive
are included in the computation of diluted earnings per share.
 
  USE OF ESTIMATES
 
     The consolidated financial statements reflect estimates and judgments made
by management that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and revenues and expenses for the reporting period. Actual results
could differ significantly from those estimates.
 
  OPERATING SEGMENTS
 
     In June 1997, the FASB issued Statement No. 131, Disclosures About Segments
of an Enterprise and Related Information ("FAS 131"). FAS 131 requires that a
public business enterprise report a measure of segment profit or loss, certain
specific revenue and expense items, and segment assets. It requires
reconciliations of total segment revenues, total segment profit or loss, total
segment assets, and other amounts disclosed for segments to corresponding
amounts in the enterprise's general-purpose financial statements. FAS 131 also
requires that a public business enterprise report descriptive information about
the way that the operating segments were determined, the products and services
provided by the operating segments, differences between the measurements used in
reporting segment information and those used in the enterprise's general-purpose
financial statements, and changes in the measurement of segment amounts from
period to period.
 
                                       33
<PAGE>   15
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
  RECLASSIFICATION
 
     Certain amounts presented in the prior year's financial statements have
been reclassified to conform to the current year's method of presentation.
 
B. EQUITY TRANSACTIONS
 
     In November 1997, the Company entered into a Stock Purchase Agreement
("Original Stock Purchase Agreement") with Strategic Acquisition Partners, LLC
("Strategic"), wherein the Company agreed to issue and sell 5,000,000 common
shares and warrants to purchase an additional 2,500,000 common shares at an
exercise price of $6.50 per share, for an aggregate purchase price of
$27,500,000. On March 30, 1998, the Company entered into an amended and restated
Stock Purchase Agreement ("New Stock Purchase Agreement") with Strategic and two
additional investors: Insurance Partners, L.P. and Insurance Partners Offshore
(Bermuda), L.P. (collectively, "Insurance Partners"). The New Stock Purchase
Agreement was subsequently approved by shareholders, and accordingly, in July
1998 the Company issued and sold 7,300,000 common shares at $5.50 per share and
warrants to purchase an additional 3,650,000 common shares at an exercise price
of $5.50 per share, which expire July 2, 2005, and received proceeds of
$37,675,000, which are net of transaction expenses.
 
     In connection with the Original Stock Purchase Agreement, Strategic
arranged an interim loan (the "Bridge Loan") of $20,000,000 to the Company. The
bridge loan was due June 30, 1998, and bore interest at the prime rate of a
major commercial bank. As consideration for the arrangement, the Company issued
Strategic warrants to purchase 800,000 common shares at $6.00 per share in
December 1997, which expire December 2002, and additional warrants to purchase
200,000 common shares at $6.00 per share in July 1998, which expire on July 2,
2003. Proceeds from the Bridge Loan were used as follows: (i) $5,200,000 was
used to repay outstanding bank debt, (ii) $14,000,000 was used by the Company to
invest in the statutory surplus of Central, and was evidenced by a surplus note
in favor of the Company from Central, and (iii) $800,000 was used to establish
an interest reserve at the Company and to pay transaction expenses. The Bridge
Loan was repaid in full by the Company in July 1998 from the proceeds received
in accordance with the New Stock Purchase Agreement.
 
C. PRIOR YEAR OPERATING RESULTS
 
     In 1997 and 1996, the Company incurred net losses of approximately
$21,000,000 and $9,300,000, respectively, which resulted in a significantly
reduced net capital position. In addition, at December 31, 1997, it was not
clear if shareholder approval would be granted for the Original Stock Purchase
Agreement or New Stock Purchase Agreement described in Note B. If shareholder
approval had not been granted, the Company would have been required to
immediately obtain an alternate source of funding in order to repay the Bridge
Loan and fund its operations. There was no assurance that such funding could
have been obtained at all or on terms favorable to the Company. The failure to
obtain such funding could have resulted in Strategic exercising its rights as a
secured creditor, and foreclosing upon all the common shares of Central, which
were pledged as collateral under the terms of the Bridge Loan. Such action would
have made it impossible for the Company to continue operations and/or forced the
Company to seek protection under federal bankruptcy law. These matters raised
significant doubt at December 31, 1997 about the Company's ability to continue
as a going concern.
 
     As discussed in Note B, the New Stock Purchase Agreement was approved by
shareholders, resulting in the Company's receipt of net proceeds of $37,675,000,
enabling the Company to satisfy the Bridge Loan obligation and fund operations.
In addition, as reported in the accompanying consolidated financial statements,
the Company reported profitable operations in the third and fourth quarters of
1998. Accordingly, the matters
 
                                       34
<PAGE>   16
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
which raised substantial doubt about the Company's ability to continue as a
going concern at December 31, 1997 have been alleviated.
 
D. BUSINESS COMBINATIONS
 
  PROVIDENT AMERICAN LIFE AND HEALTH INSURANCE COMPANY
 
     On December 31, 1998, Central acquired 100% of the outstanding common stock
of Provident American Life and Health Insurance Company ("PALHIC") from
Provident American Corporation ("PAMCO") for $5,505,000. PALHIC is a life and
accident and health insurer, domiciled in Pennsylvania, licensed in 40 states
and the District of Columbia, that markets managed care health insurance
products to individuals and small businesses, and critical illness coverage.
Funds for the acquisition were provided from Central's working capital. This
transaction has been accounted for in the accompanying consolidated financial
statements in accordance with the purchase method and accordingly, the purchase
price was allocated to assets and liabilities acquired based upon estimates of
their fair values. There is no impact on the accompanying consolidated statement
of operations for 1998 as a result of this transaction. Revenues of PALHIC are
not material to the consolidated revenues of the Company.
 
     The fair value of assets acquired totaled $6,472,000, consisted principally
of bonds and cash, and liabilities assumed of $967,000, which relate principally
to premiums taxes payable.
 
     Immediately prior to the completion of this transaction, PALHIC ceded 100%
of its insurance inforce to Provident Indemnity Life Insurance Company
("PILIC"), a subsidiary of PAMCO.
 
     Effective January 1, 1999, Reassurance Company of Hannover ("Hannover")
assumed from PILIC 100% of its accident and health block of business. As of
January 1, 1999, Central entered into a separate reinsurance agreement with
Hannover, wherein Central assumed from Hannover 10% of the block acquired by
Hannover from PILIC.
 
  CONTINENTAL GENERAL CORPORATION
 
     On February 17, 1999, the Company acquired 100% of the outstanding common
stock of Continental General Corporation ("Continental") from the Western &
Southern Life Insurance Company, a mutual life insurance company domiciled in
Ohio. Continental is a holding company that primarily conducts business through
its wholly-owned subsidiary, Continental General Insurance Company ("CGIC"), a
life and accident and health insurer domiciled in Nebraska, licensed in 49
states. CGIC offers Medicare supplement and individual major medical products,
distributed through independent agents. CGIC also offers long-term care,
ordinary life, universal life, and annuity policies. CGIC has approximately
$215,000,000 in premiums in 1998 and at December 31, 1998 had approximately
$400,000,000 in assets and $37,000,000 in statutory capital and surplus. Total
consideration paid by the Company for the common stock was approximately
$84,500,000, and was financed through reinsurance, debt, cash, and an equity
offering as described further below. This transaction will be accounted for in
accordance with the purchase method.
 
     Effective February 17, 1999, CGIC entered into a reinsurance treaty with
Hannover, whereby CGIC ceded 50% of its in force life, accident and health, and
annuity policies to Hannover, and retained the remaining risk. The treaty
provides an initial ceding allowance of $13,000,000, which will be accounted for
as a deferred reinsurance gain.
 
     On February 17, 1999, the Company entered into a $40,000,000 credit
facility with a syndicate of major commercial banks. In accordance with the
terms of the loan, the first principal payment of $3,000,000 is due February 17,
2000. Quarterly payments are due thereafter as follows: $1,000,000 through
February 17, 2001; $1,500,000 thereafter through February 17, 2002; and
$2,250,000 every three months thereafter to Febru-
 
                                       35
<PAGE>   17
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
ary 17, 2005. The loan bears interest at a variable rate (approximately 8.75% at
February 17, 1999). The Company has pledged the common stock of Continental and
Central as security for the loan. The credit facility prohibits the payment of
dividends upon the Company's Common Shares, except upon compliance with certain
conditions.
 
     Effective February 17, 1999, the Company entered into a series of stock
subscription agreements with a group of investors, principally Strategic and
Insurance Partners, wherein the Company issued 2,000,000 common shares at $7.50
per share for $15,000,000.
 
E. CASH AND INVESTMENTS
 
     The amortized cost and estimated fair value of securities held-to-maturity
and available-for-sale as of December 31, 1998, are as follows:
 
<TABLE>
<CAPTION>
                                                        GROSS UNREALIZED
                                        AMORTIZED    ----------------------    ESTIMATED
                                          COST         GAINS       LOSSES     FAIR VALUE
                                       -----------   ----------   ---------   -----------
<S>                                    <C>           <C>          <C>         <C>
Held-to-maturity:
  U.S. Treasury securities...........  $ 4,534,001   $   46,682   $      --   $ 4,580,683
  Mortgage-backed securities:
     Federal Home Loan Mortgage......    2,944,479       38,035          --     2,982,514
     Federal National Mortgage.......    1,421,179       33,574          --     1,454,753
                                       -----------   ----------   ---------   -----------
          Total held-to-maturity.....  $ 8,899,659   $  118,291   $      --   $ 9,017,950
                                       ===========   ==========   =========   ===========
Available-for-sale:
  U.S. Treasury securities...........  $11,137,331   $  243,367   $      --   $11,380,698
  U.S. Agencies......................    3,720,150      147,169          --     3,867,319
  Obligations of states,
     municipalities and political
     subdivisions....................      600,000       13,711          --       613,711
  Corporate bonds....................   43,388,321      866,933    (104,090)   44,151,164
  Canadian bonds.....................    6,800,033      172,228         (36)    6,972,225
  Mortgage-backed securities:
     Federal Home Loan Mortgage......    2,751,593       53,551          --     2,805,144
     Federal National Mortgage.......    3,221,119       26,887          --     3,248,006
     Other...........................    7,553,174      242,006      (1,350)    7,793,830
                                       -----------   ----------   ---------   -----------
          Total available-for-sale...  $79,171,721   $1,765,852   $(105,476)  $80,832,097
                                       ===========   ==========   =========   ===========
</TABLE>
 
     The amortized cost and estimated fair value of securities held-to-maturity
and available-for-sale as of December 31, 1997, are as follows:
 
<TABLE>
<CAPTION>
                                                        GROSS UNREALIZED
                                        AMORTIZED    ----------------------    ESTIMATED
                                          COST         GAINS       LOSSES     FAIR VALUE
                                       -----------   ----------   ---------   -----------
<S>                                    <C>           <C>          <C>         <C>
Held-to-maturity:
  U.S. Treasury securities...........  $ 7,549,309   $    7,869   $ (52,334)  $ 7,504,844
  Mortgage-backed securities:
     Federal Home Loan Mortgage......    2,928,408       11,389        (767)    2,939,030
     Federal National Mortgage.......    1,397,987       17,353          --     1,415,340
     Other...........................       22,923          163         (32)       23,054
                                       -----------   ----------   ---------   -----------
          Total held-to-maturity.....  $11,898,627   $   36,774   $ (53,133)  $11,882,268
                                       ===========   ==========   =========   ===========
</TABLE>
 
                                       36
<PAGE>   18
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                        GROSS UNREALIZED
                                        AMORTIZED    ----------------------    ESTIMATED
                                          COST         GAINS       LOSSES     FAIR VALUE
                                       -----------   ----------   ---------   -----------
<S>                                    <C>           <C>          <C>         <C>
Available-for-sale:
  U.S. Treasury securities...........  $ 8,554,542   $  194,270          --   $ 8,748,812
  U.S. Agencies......................    6,948,504      115,246          --     7,063,750
  Obligations of states,
     municipalities and political
     subdivisions....................      600,000        3,199          --       603,199
  Corporate bonds....................   29,137,110      598,824   $ (83,046)   29,652,888
  Canadian bonds.....................    1,531,661       17,356      (1,377)    1,547,640
  Mortgage-backed securities:
     Federal Home Loan Mortgage......    6,408,695      112,977      (6,415)    6,515,257
     Federal National Mortgage.......    5,427,383       51,161      (6,200)    5,472,344
     Other...........................    8,427,833      172,641    (242,478)    8,357,996
                                       -----------   ----------   ---------   -----------
          Total available-for-sale...  $67,035,728   $1,265,674   $(339,516)  $67,961,886
                                       ===========   ==========   =========   ===========
</TABLE>
 
     The amortized cost and estimated fair value of fixed maturities at December
31, 1998, by contractual maturity, are as follows:
 
<TABLE>
<CAPTION>
                                                             AMORTIZED     ESTIMATED
                                                               COST       FAIR VALUE
                                                            -----------   -----------
<S>                                                         <C>           <C>
Held-to-maturity:
  Due in one year or less.................................  $ 2,010,793   $ 2,020,348
  Due after one year through five years...................    2,523,208     2,560,335
                                                            -----------   -----------
                                                              4,534,001     4,580,683
  Mortgage-backed securities..............................    4,365,658     4,437,267
                                                            -----------   -----------
          Total held-to-maturity..........................  $ 8,899,659   $ 9,017,950
                                                            ===========   ===========
Available for sale:
  Due in one year or less.................................  $ 7,460,414   $ 7,519,857
  Due after one year through five years...................   40,066,150    40,902,033
  Due after five years through ten years..................   13,907,513    14,255,175
  Due after ten years.....................................    4,211,758     4,308,052
                                                            -----------   -----------
                                                             65,645,835    66,985,117
  Mortgage-backed securities..............................   13,525,886    13,846,980
                                                            -----------   -----------
          Total available-for-sale........................  $79,171,721   $80,832,097
                                                            ===========   ===========
</TABLE>
 
     Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
penalties.
 
     Proceeds, gross realized gains and gross realized losses from the sale
(excluding calls, maturities and pay downs) of fixed maturities
available-for-sale during each year were as follows:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31
                                                 ------------------------------------
                                                    1998          1997         1996
                                                 ----------    ----------    --------
<S>                                              <C>           <C>           <C>
Proceeds.......................................  $7,925,902    $3,528,625    $176,925
Gross realized gains...........................     165,261        56,282          --
Gross realized losses..........................      29,397         2,532       5,369
</TABLE>
 
                                       37
<PAGE>   19
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     The following is a summary of net investment income by category of
investments:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31
                                               --------------------------------------
                                                  1998          1997          1996
                                               ----------    ----------    ----------
<S>                                            <C>           <C>           <C>
Fixed maturities.............................  $5,433,022    $5,572,238    $5,826,478
Policy loans.................................       5,111         4,865         5,036
Cash equivalents.............................   1,181,595       757,829       688,911
Other........................................     834,452       192,605       180,316
                                               ----------    ----------    ----------
                                               $7,454,180    $6,527,537    $6,700,741
                                               ==========    ==========    ==========
</TABLE>
 
     At December 31, 1998, Central and PALHIC had certificates of deposit and
fixed maturity securities with a carrying value of $11,331,796 on deposit with
various state insurance departments to satisfy regulatory requirements.
 
     At December 31, 1998, cash includes $4,345,322 held for self-funded
accident and health accounts, which is restricted to use. Central is entitled to
investment income from these funds. A corresponding liability is included in the
accompanying consolidated financial statements.
 
     At December 31, 1998, the Company held no unrated or less-than-investment
grade bonds. The Company performs periodic evaluations of the relative credit
standings of the issuers of the bonds held in the Company's portfolio. These
evaluations are considered by the Company in its overall investment strategy.
 
F. PROPERTY AND EQUIPMENT
 
     Significant components of property and equipment are stated at cost and are
summarized as follows:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31
                                                          --------------------------
                                                             1998           1997
                                                          -----------    -----------
<S>                                                       <C>            <C>
Home office building....................................  $11,059,400    $11,059,400
Land....................................................    1,610,375      1,610,375
Other property and equipment............................    5,674,309      5,976,263
                                                          -----------    -----------
                                                           18,344,084     18,646,038
Less accumulated depreciation...........................    8,282,396      7,679,526
                                                          -----------    -----------
          Total.........................................  $10,061,688     10,966,512
                                                          ===========    ===========
</TABLE>
 
     Other property and equipment consists principally of furniture, fixtures,
and data processing equipment. Depreciation expense for the years ended December
31, 1998, 1997 and 1996 was $874,918, $1,104,230, and $1,136,390, respectively.
 
G. FEDERAL INCOME TAXES
 
     The Company files a consolidated federal income tax return with its
subsidiaries, except PALHIC which is required to file a separate return for five
years. The provision for federal income tax does not bear the customary
relationship to pretax accounting income because of special tax provisions
available to life insurance companies. Central receives a benefit provided for
"small" life insurance companies.
 
                                       38
<PAGE>   20
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     Federal income tax expense (benefit) is composed of the following:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31
                                               --------------------------------------
                                                  1998         1997          1996
                                               ----------    ---------    -----------
<S>                                            <C>           <C>          <C>
Current......................................  $1,449,128    $ 590,000    $(2,808,912)
Deferred.....................................    (382,240)    (722,531)       (36,673)
                                               ----------    ---------    -----------
                                               $1,066,888    $(132,531)   $(2,845,585)
                                               ==========    =========    ===========
</TABLE>
 
     Income tax expense attributable to income from operations differs from the
amounts computed by applying the U.S federal income tax rate of 35%. Those
effects are summarized as follows:
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED DECEMBER 31
                                             ----------------------------------------
                                                1998          1997           1996
                                             ----------    -----------    -----------
<S>                                          <C>           <C>            <C>
Expected tax benefit at 35%................  $ (969,070)   $(7,381,110)   $(4,246,883)
Special life insurance deduction...........    (367,254)            --      1,006,747
Tax exempt interest........................     (12,206)       (12,206)       (12,206)
Change in the beginning-of-the-year balance
  of the valuation allowance for deferred
  tax assets allocated to income tax
  expense..................................   2,327,077      6,367,801        (21,953)
Tax rate differential......................      27,688        210,889        121,340
Accrual adjustment.........................          --       (104,166)       (73,382)
IRS audit adjustment.......................          --        590,000             --
Alternative minimum tax....................          --             --        365,000
Other......................................      60,653        196,261         15,752
                                             ----------    -----------    -----------
                                             $1,066,888    $  (132,531)   $(2,845,585)
                                             ==========    ===========    ===========
</TABLE>
 
     The federal income tax returns for the Company and its subsidiaries have
been examined by the Internal Revenue Service ("IRS") for 1991 and 1992. During
the third quarter of 1994, the IRS issued a proposal for adjustments to the
Company's returns for 1991 and 1992. The proposed deficiencies were
approximately $2,400,000 of which $215,303 was paid in 1994 and $590,000 paid in
1997. The balance of approximately $1,600,000 relates to whether or not the
Company's subsidiary, Central, qualified as a life company for tax purposes. The
Company is vigorously protesting the proposed deficiency. Based on discussions
with counsel, management believes existing law supports the Company's position.
Therefore, the Company has not recorded a liability for the difference.
 
     If the IRS were to prevail in its position that Central no longer qualified
as a life company for tax purposes, approximately $2,600,000 of tax and interest
would be payable and federal income taxes would increase in the future.
Presently, as a small life company having less than $500,000,000 in total
assets, Central is permitted, among other things, a deduction from the first
$3,000,000 of income of 60% or $1,800,000. As Central's income increases above
$3,000,000, the special deduction is reduced proportionately.
 
                                       39
<PAGE>   21
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are presented below:
 
<TABLE>
<CAPTION>
                                                               1998          1997
                                                            ----------    ----------
<S>                                                         <C>           <C>
Deferred tax assets:
  Reinsurance transactions................................  $8,784,598    $3,400,000
  Deferred acquisition costs..............................      71,591        58,505
  Severance pay...........................................     231,200       238,000
  Alternative minimum tax.................................          --       337,002
  Difference in reserves established for financial
     statement purposes and those for income tax
     purposes.............................................     705,726       773,862
  Net operating loss carryforward.........................     841,340     3,390,010
  Advance premium.........................................     294,270       247,359
  Other...................................................     202,941        95,200
                                                            ----------    ----------
  Gross deferred tax assets...............................  11,131,666     8,539,938
Less valuation allowance..................................   8,987,539     6,660,462
                                                            ----------    ----------
Net deferred assets.......................................   2,144,127     1,879,476
                                                            ----------    ----------
Deferred tax liabilities:
  Net unrealized holding gain.............................     564,528       314,894
  Bond discount accretion.................................     102,120       118,595
  Difference in book and tax depreciation.................      68,000        89,987
                                                            ----------    ----------
Gross deferred tax liabilities............................     734,648       523,476
                                                            ----------    ----------
Deferred tax asset........................................  $1,409,479    $1,356,000
                                                            ==========    ==========
</TABLE>
 
     At December 31, 1998, the Company has a tax net operating loss ("NOL")
carryforward of approximately $2,500,000 for federal income tax purposes which
expires through 2012. Future changes in ownership, as defined by sections 382
and 383 of the Internal Revenue Code, could limit the amount of NOL
carryforwards used in any one year.
 
     The Company determines a valuation allowance based on an analysis of
amounts recoverable in the statutory carryback period and available tax planning
strategies. In assessing the valuation allowance established at December 31,
1998 and 1997, estimates were made as to the potential financial impact on the
Company of recent NOLs and the Company's financial condition described in Notes
B and C. Management believes that the Company will generate sufficient future
taxable income to realize the net deferred tax asset prior to the expiration of
any NOLs and that the realization of a $1,409,479 net deferred tax asset is more
likely than not.
 
     In accordance with federal tax law, a portion of insurance companies' net
income, prior to 1984, is not subject to federal income taxes (within certain
limitations) until it is distributed to policyholders, at which time it is taxed
at regular corporate rates. For federal income tax purposes this untaxed income
is accumulated in a memorandum account designated "policyholders' surplus." At
December 31, 1998, the accumulated untaxed policyholders' surplus for Central is
$2,869,768.
 
                                       40
<PAGE>   22
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
H. LIABILITY FOR OTHER POLICY CLAIMS AND BENEFITS PAYABLE
 
     The following table reflects the activity in the liability for other policy
claims and benefits payable, including the claims adjustment expenses ("CAE"),
net of reinsurance recoverables, as follows:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31
                                               ---------------------------------------
                                                  1998          1997          1996
                                               -----------   -----------   -----------
<S>                                            <C>           <C>           <C>
Balance at beginning of year.................  $56,186,802   $42,909,065   $35,125,467
Reserves on block of business reinsured in
  1998.......................................   23,500,000            --            --
Incurred claims and CAE, net of reinsurance,
  for:
  Current year...............................  116,357,433   206,636,150   196,260,939
  Prior years................................   (1,696,688)    8,274,823     1,134,739
                                               -----------   -----------   -----------
       Total incurred........................  114,660,745   214,910,973   197,395,678
                                               -----------   -----------   -----------
Paid claims and CAE, net of reinsurance, for:
  Current year...............................   89,952,807   144,056,413   153,758,124
  Prior years................................   29,999,535    57,576,823    35,853,956
                                               -----------   -----------   -----------
       Total paid............................  119,952,342   201,633,236   189,612,080
                                               -----------   -----------   -----------
Balance at end of year.......................  $74,395,205   $56,186,802   $42,909,065
                                               ===========   ===========   ===========
</TABLE>
 
     The foregoing indicates that a $1,696,688 redundancy in the 1997 reserves
emerged in 1998, and that a $8,274,823 deficiency emerged in 1997. The
deficiency in the 1996 reserves resulted from substantial losses developing on
insurance plans issued in 1995, and higher utilization than anticipated.
 
I. REINSURANCE ARRANGEMENTS
 
  UNITED BENEFIT LIFE INSURANCE COMPANY
 
     Effective August 1, 1998, Central entered into a reinsurance treaty with
United Benefit Life Insurance Company ("UBL"), a life and accident and health
insurer in Texas. Under the terms of the treaty, Central agreed to assume 100%
of UBL's book of business, until such time as profits earned by Central on the
assumed block reach a contractual threshold, which approximates $20,000,000 of
pretax income. Upon achieving this threshold, the quota share percentage is
reduced from 100% to 80%, until a second threshold, which approximates
$16,000,000 in pretax income, is achieved. Upon achieving the second threshold,
the quota share percentage is further reduced from 80% to 50%. Central paid to
UBL a $20,000,000 ceding allowance in connection with this transaction. In
addition, Central entered into an agency arrangement with respect to the
marketing of UBL policies with Insurance Advisors of America, Inc. ("IAA"), a
subsidiary of United Benefit Managed Care Corporation and an affiliate of UBL,
in exchange for a $7,000,000 note receivable. Central recorded a full valuation
allowance against such note receivable at December 31, 1998.
 
     Reserve liabilities assumed by Central under the UBL agreement on August 1,
1998 exceeded the cash transferred to Central by UBL as reimbursement for this
assumption by $3,000,000, which is reflected in a note receivable. Subsequent to
August 1, 1998, the balance of the note receivable was increased to $7,367,556
as a result of adverse developments in the assumed policy liabilities, net of
amounts ceded to Hannover, and net of an allowance for uncollectability. The
note receivable is secured by the outstanding common stock and assets of UBL,
which assets include real estate, bonds and reinsurance receivables from an
unrelated party, and commissions due to IAA. Effective March 17, 1999, the
Company and UBL executed an agreement for Central to assume ownership of UBL in
satisfaction of the note receivable. The Company anticipates that such
transaction will be completed during the second quarter of 1999.
 
                                       41
<PAGE>   23
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     In connection with the UBL reinsurance treaty, Central ceded to Hannover
80% of the book of business assumed from UBL. This treaty provided Central an
initial ceding allowance of $20,000,000, which is being accounted for as a
deferred reinsurance gain in the accompanying consolidated financial statements,
and will be amortized into income over the duration of the underlying block of
business.
 
  CENTRAL RESERVE LIFE INSURANCE COMPANY
 
     In December 1997, Central entered into a retroactive reinsurance treaty
(the "1997 Treaty") with Hannover. The quota share treaty was effective January
1, 1997, and covered certain group accident and health policies in force and
written during 1997. Under the provisions of the 1997 Treaty, Central cedes 50%
of the premiums of the eligible policies, and in return receives reimbursement
for 50% of the claims paid, plus a commission and expense allowance. In
connection with the 1997 Treaty, Central transferred $24,550,000 of reserves to
Hannover, and received an initial ceding allowance of $10,000,000, resulting in
a net cash transfer of $14,550,000 to Hannover. The initial ceding allowance is
reported as a deferred reinsurance gain, in the accompanying consolidated
financial statements.
 
     In the ordinary course of business, Central maintains other reinsurance
arrangements with other insurers. These arrangements are designed to limit the
maximum amount of exposure that Central retains on a given policy. For ordinary
and group life claims, Central's maximum retention is $50,000, with no retention
maintained over age 70. Maximum retention on substandard risks is $10,000. For
accident and health claims, maximum retention on individual claims is $500,000.
 
     The following table summarizes the net impact of reinsurance arrangements
on benefits, claims, losses and settlement expenses, commissions, and other
operating expenses:
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31
                                         --------------------------------------------
                                             1998            1997            1996
                                         ------------    ------------    ------------
<S>                                      <C>             <C>             <C>
Benefits, claims, losses and settlement
  expenses.............................  $217,747,183    $211,194,654    $204,446,897
Reinsurance recoverable................  (101,688,508)       (418,288)       (769,665)
                                         ------------    ------------    ------------
                                         $116,058,675    $210,776,366    $203,677,232
                                         ============    ============    ============
Underwriting, acquisition and insurance
  expenses:
  Commissions..........................  $ 36,853,066    $ 35,525,295    $ 35,654,815
  Salaries and benefits................    15,717,718      18,112,730      16,855,141
  Taxes, licenses and fees.............     6,448,343       6,366,798       6,136,793
  Other operating expense..............    22,450,200      14,758,817      13,770,924
  Reinsurance expenses.................    13,773,476              --              --
  Reinsurance allowances...............   (40,874,688)             --              --
                                         ------------    ------------    ------------
                                         $ 54,368,115    $ 74,763,640    $ 72,417,673
                                         ============    ============    ============
</TABLE>
 
     Central remains obligated for amounts ceded in the event that the
reinsurers do not meet their obligations.
 
     Other reinsurance arrangements in conjunction with other business
combinations are described in Note D.
 
                                       42
<PAGE>   24
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
J. COMMITMENTS AND CONTINGENCIES
 
     The Company is involved in litigation and may become involved in potential
litigation arising in the ordinary course of business. In the opinion of
management, the effects, if any, of such litigation are not expected to be
material to the Company's consolidated financial condition.
 
     On December 16, 1997, Central issued to the Company a $14,000,000 surplus
note with interest on the unpaid balance payable quarterly at a fixed rate of
8 1/2%. Central reported the $14,000,000 as surplus rather than a liability in
accordance with statutory accounting practices. In June 1998, the Company
converted the surplus note into a capital contribution to Central.
 
     The Company executed a mortgage note payable in December 1990 for
$9,000,000 bearing interest at 9 1/2% per annum for 10 years. The Company
received $8,500,000 of the funds in December 1990 and the remaining $500,000 in
December 1991. The mortgage note is collateralized by the home office building
and by an assignment of the tenant lease for the building. The Company has been
required to make monthly payments, since January 1991, based on a 30 year
amortization schedule, of $75,677 for 10 years. After five years, the Company
has the right to prepay the loan with a 3% prepayment fee. Principal payments
due in the next three years, assuming no prepayments, are $126,572 in 1999,
$139,134 in 2000, and $8,018,178 on January 1, 2001.
 
     At December 31, 1998, the Company maintained a $15,000,000 line of credit
arrangement with a major commercial bank for short-term borrowings. There was no
amount outstanding on the line of credit at December 31, 1998. Effective
February 17, 1999, this line of credit was replaced with a $10,000,000 line of
credit with a syndicate of major commercial banks.
 
K. STOCK-BASED COMPENSATION
 
     On March 5, 1983, the Company adopted an Incentive Stock Option Plan (the
"1983 Plan"). The 1983 Plan, which expired in May 1993, provided that key
full-time employees of the Company and its subsidiaries were eligible for
participation. The following table summarizes data regarding the 1983 Plan.
 
<TABLE>
<CAPTION>
                                                           1998        1997          1996
                                                         --------    ---------    -----------
<S>                                                      <C>         <C>          <C>
Number of shares subject to options:
  Outstanding at beginning of year.....................    65,845      302,740        322,770
  Expired/canceled.....................................   (65,845)    (186,895)            --
  Exercised............................................        --      (50,000)       (20,030)
                                                         --------    ---------    -----------
Outstanding at end of year.............................        --       65,845        302,740
                                                         ========    =========    ===========
Price range of options exercised.......................  $    N/A    $    2.83    $2.83-$6.75
</TABLE>
 
     In 1998, pursuant to various individual employment agreements with certain
key officers, and pursuant to the 1998 Key Employee Share Incentive Plan, the
Company granted common stock options to certain employees. Such grants generally
vest over three years, and expire ten years from the date of the grant. Also in
1998, pursuant to an employment contract, the Company provided an award of
common shares to a key employee. The number of shares awarded is contingent upon
the weighted average fair value of the common shares over specified periods, but
is based on a fixed dollar amount. The award vests on July 1, 2001, and
management currently estimates that 395,669 shares will be issued at that date,
based upon the fair value of the Company's shares at December 31, 1998.
 
                                       43
<PAGE>   25
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     A summary of the Company's stock option activity, and the related
information for the years ended December 31, 1998 is as follows:
 
<TABLE>
<CAPTION>
                                                                   WEIGHTED-
                                                                    AVERAGE
                                                                   EXERCISE
                                                        OPTIONS      PRICE
                                                       ---------   ---------
<S>                                                    <C>         <C>
Outstanding at January 1, 1998.......................         --        --
Options granted, with exercise prices:
  Greater than fair value at grant date..............    700,000     $8.36
  Equal to fair value at grant date..................    315,000      6.59
  Less than fair value at grant date.................     50,000      5.50
                                                       ---------     -----
Outstanding at December 31, 1998.....................  1,065,000     $7.70
                                                       =========     =====
Exercisable at December 31, 1998.....................    240,000     $7.54
                                                       =========     =====
</TABLE>
 
     Exercise prices for options outstanding at December 31, 1998 ranged from
$5.50 to $10.50. While some options have no expiration date, management
estimates the remaining average contractual life of options awarded is 5 years.
 
     In 1998, the Company recognized $866,000 in compensation expense related to
stock-based compensation.
 
     As required by FASB Statement No. 123, Accounting for Stock-Based
Compensation,the Company has estimated the pro forma impact on net income and
earnings per share of stock-based compensation under the fair value method,
using the Black-Scholes option valuation model.
 
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
 
     Significant underlying assumptions made are summarized as follows:
 
<TABLE>
<S>                                                   <C>
Risk-free rate of return..........................       4.54%
Dividend yield....................................          0%
Volatility factor.................................      0.592
Expected life of award............................    5 years
</TABLE>
 
     Based on the methodology and assumptions delineated above, the weighted
average fair value of options granted in 1998, at grant date, was $3.23 per
share. The pro forma impact would be to increase the net loss by $785,540 and
increase the net loss per share by $0.10 for the year ended December 31, 1998.
 
L. PREFERRED SHARES
 
     The Company has authorized 2,000,000, $.001 par value Non-Voting Preferred
Shares. The Company has never issued any Non-Voting Preferred Shares, however,
the Board of Directors is authorized at any time to provide for the issuance of,
such shares in one or more series, and to determine the designations,
preferences, limitations and other rights of the shares issued, including but
not limited to the dividend rate,
 
                                       44
<PAGE>   26
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
liquidation preference, redemption rights and price, sinking fund requirements,
conversion rights and restrictions on the issuance of such shares. Holders of
Non-Voting Preferred Shares shall have no voting rights except as required by
law.
 
M. STATUTORY FINANCIAL INFORMATION
 
     The Company's insurance subsidiaries, Central and PALHIC, are required to
file Annual Statements with state insurance regulatory authorities to whose
jurisdiction those entities are subject. These Annual Statements are prepared on
an accounting basis prescribed or permitted by the domiciliary state insurance
department, which differs from GAAP. Prescribed accounting practices include a
variety of publications of the National Association of Insurance Commissioners
("NAIC"), as well as state laws, regulations and general and administrative
rules. Permitted statutory accounting practices encompass all accounting
practices not prescribed.
 
     The statutory capital and surplus of Central at December 31, 1998, 1997,
and 1996, as reported in the Annual Statement filed with regulatory authorities,
was $30,418,544, $24,650,804, and $16,595,497, respectively, and the statutory
net loss for each of the three years ended December 31, 1998 was $21,162,850,
$21,616,489, and $9,321,633, respectively.
 
     The statutory capital and surplus of PALHIC as reported in its Annual
Statement filed with regulatory authorities at December 31, 1998 was $5,392,945.
 
     At December 31, 1998, total statutory capital and surplus of Central and
PALHIC are approximately $27,900,000 and $3,900,000 in excess of minimum
regulatory requirements, respectively.
 
     Central and PALHIC are subject to certain Risk-Based Capital ("RBC")
requirements as specified by the NAIC. The RBC model serves as a benchmark for
the regulation of life and accident and health insurance companies by state
insurance regulators. At December 31, 1998, both Central and PALHIC exceeded the
minimum RBC requirements.
 
     The amount of dividends which Central and PALHIC can pay is subject to
certain regulatory restrictions. In 1999, Central can pay approximately
$1,056,000 in dividends without the prior approval by the Ohio Insurance
Commissioner. In 1999, PALHIC cannot pay any dividends without the prior
approval of the Pennsylvania Insurance Commissioner as a result of its statutory
unassigned deficit at December 31, 1998.
 
N. LOSS PER SHARE
 
     The following table sets forth the computation of basic and diluted loss
per share:
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31
                                                    ------------------------------------------
                                                       1998            1997           1996
                                                    -----------    ------------    -----------
<S>                                                 <C>            <C>             <C>
Net loss..........................................  $(3,835,659)   $(20,956,356)   $(9,288,365)
Weighted-average number of common shares
  outstanding.....................................    7,845,172       4,182,672      4,052,314
                                                    -----------    ------------    -----------
Basic and diluted loss per share..................  $     (0.49)   $      (5.01)   $     (2.29)
                                                    ===========    ============    ===========
</TABLE>
 
     In 1998, 1997 and 1996, there were no differences between basic and diluted
loss per share because the Company reported net losses in those years, and the
exercise of potential shares would therefore have been antidilutive.
 
                                       45
<PAGE>   27
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
O. EMPLOYEE BENEFIT PLAN
 
     Effective January 1, 1998, the Company's noncontributory pension plan was
converted into a defined contribution 401(k) savings plan (the "Plan").
Employees become eligible to participate in the Plan after six months of
service. Based on the provisions of the Plan, participants may contribute up to
10% of their pretax annual compensation. The Plan provides for an 100% employer
matching contribution only for that portion of participant contributions made to
a fund which holds principally the Company's Shares, up to $1,000 annually. In
1998, total matching contributions expensed by the Company were approximately
$52,000.
 
     Prior to January 1, 1998, the Plan operated as a noncontributory pension
plan, covering substantially all employees who had competed six months of
service. Vesting in accordance with the Plan began after two years of service,
with full vesting after seven years. Total contributions made under the Plan
were $1,308,000 in 1997 and $1,214,000 in 1996.
 
P. OPERATING SEGMENTS
 
     The Company has identified three distinct operating segments based upon
product types, as follows: group life and health, life insurance and annuities,
and corporate and other.
 
     Products included in the group life and health segment include short-term
major medical insurance products and comprehensive major medical plans. Group
life policies are included in this segment because such policies are issued only
in conjunction with health insurance policies, and the costs of administering
those policies are incidental to the administration of the related health
policies.
 
     Products included in the life and annuity segment include term insurance,
single premium deferred annuities, flexible premium deferred annuities, and
single premium immediate annuities. These products are not marketed aggressively
by the Company, and are underwritten as an accommodation product. Such products
are segregated from the group life and health segment based upon significant
differences in the sales and administration of such policies, including the
underwriting and claims adjudication process.
 
     The corporate and other segment encompasses all other activities of the
organization, including interest income and expense of the parent company.
 
                                       46
<PAGE>   28
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     Revenues from each segment are primarily generated from premiums charged to
external policyholders and interest earned on cash and investments, and are
summarized in the following tables:
 
<TABLE>
<CAPTION>
                                                      1998            1997            1996
                                                  ------------    ------------    ------------
<S>                                               <C>             <C>             <C>
Group Life and Health
  Revenues:
     Net Premiums...............................  $160,201,806    $258,170,130    $257,495,315
     Investment income..........................     5,817,656       5,021,692       5,014,262
     Other income...............................     1,696,690              --              --
                                                  ------------    ------------    ------------
                                                   167,716,152    $263,191,822     262,509,577
                                                  ============    ============    ============
  Expenses:
     Benefits and claims........................   114,181,891     208,933,873     202,074,527
     Other operating expenses...................    52,762,598      73,589,360      70,960,571
                                                  ------------    ------------    ------------
                                                   166,944,489     282,523,233     273,035,098
                                                  ============    ============    ============
  Segment profit (loss) before federal income
     taxes......................................  $    771,663    $(19,331,411)   $(10,525,521)
                                                  ============    ============    ============
 
Life and Annuity
  Revenues:
     Net premiums...............................  $    583,091    $    689,177    $    680,022
     Investment income..........................     1,362,251       1,459,718       1,506,162
                                                  ------------    ------------    ------------
                                                     1,945,342       2,148,895       2,186,184
                                                  ============    ============    ============
  Expenses:
     Benefits and claims........................     1,876,784       1,842,493       1,602,705
     Other operating expenses...................       366,505         551,986         767,474
                                                  ------------    ------------    ------------
                                                     2,243,289       2,394,479       2,370,179
                                                  ============    ============    ============
  Segment profit (loss) before federal income
     taxes......................................  $   (297,947)   $   (245,584)   $   (183,995)
                                                  ============    ============    ============
 
Corporate and Other
  Revenues:
     Investment income..........................  $    485,130    $    192,605    $    189,834
                                                  ============    ============    ============
  Expenses:
     Interest and financing expenses............     1,841,334       1,078,198         812,833
     Other operating expenses...................     1,886,283         626,299         801,435
                                                  ------------    ------------    ------------
                                                     3,727,617       1,704,497       1,614,268
                                                  ============    ============    ============
     Segment profit (loss) before federal income
       taxes....................................  $ (3,242,487)   $ (1,511,892)   $ (1,424,434)
                                                  ============    ============    ============
</TABLE>
 
     The Company does not separately allocate investment or other identifiable
assets by industry segment, nor are income tax (benefits) expenses allocated by
industry segment. The Company also expanded the detail of its disclosures for
1998, 1997 and 1996, which included certain reclassifications.
 
Q. FAIR VALUES OF FINANCIAL INSTRUMENTS
 
     Fair values of financial instruments are based upon quoted market prices,
where available, or on values obtained from independent pricing services. In
cases where quoted market prices are not available, fair value is based on
estimates using present value or other valuation techniques. These techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. Although fair value estimates are calculated
using assumptions that management believes are appropriate, changes in
assumptions could cause these estimates to vary materially. In that regard, the
derived fair value estimates
 
                                       47
<PAGE>   29
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
cannot be substantiated by comparison to independent markets and, in many cases,
could not be realized in the immediate settlement of the instruments.
 
     The tax ramifications of the related unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered in the
estimates.
 
     The following methods and assumptions were used by the Company in
estimating its fair value disclosures:
 
          INVESTMENT SECURITIES -- Fair value for fixed maturity securities is
     based on quoted market prices, where available. For fixed maturity
     securities not actively traded, fair value is estimated using values
     obtained from independent pricing services.
 
          CASH, CASH EQUIVALENTS, PREMIUMS RECEIVABLE, NOTE RECEIVABLE,
     REINSURANCE RECEIVABLE, AND POLICY LOANS -- The carrying amounts reported
     in the consolidated balance sheets for these instruments approximate their
     fair value.
 
          ANNUITY CONTRACTS -- The fair value for the annuity reserves included
     in the liability for future policy benefit, losses and claims is the amount
     payable on demand.
 
          OTHER POLICYHOLDERS' FUNDS -- The carrying amount reported in the
     consolidated balance sheets for these instruments approximate their fair
     value.
 
          MORTGAGE NOTE PAYABLE, NOTE PAYABLE AND REINSURANCE PAYABLE -- The
     carrying amount reported in the consolidated balance sheets for the
     mortgage note payable and note payable approximates their fair value.
 
     Carrying amounts and estimated fair values of financial instruments at
December 31 are summarized as follows:
 
<TABLE>
<CAPTION>
                                                   1998                          1997
                                        --------------------------    --------------------------
                                         CARRYING       ESTIMATED      CARRYING       ESTIMATED
                                          AMOUNT       FAIR VALUE       AMOUNT       FAIR VALUE
                                        -----------    -----------    -----------    -----------
<S>                                     <C>            <C>            <C>            <C>
ASSETS
Investments:
  Fixed maturities held to maturity...  $ 8,899,659    $ 9,017,950    $11,898,627    $11,882,268
  Fixed maturities available for
     sale.............................   80,832,097     80,832,097     67,961,886     67,961,886
  Policy loans........................       94,432         94,432         96,211         96,211
Cash and cash equivalents.............   19,376,380     19,376,380     11,533,821     11,533,821
Premiums receivable...................    2,203,690      2,203,690      2,098,243      2,098,243
Reinsurance receivable................   41,417,031     41,417,031     26,215,765     26,215,765
Note receivable.......................    7,367,556      7,367,556             --             --
LIABILITIES
Annuity reserve.......................  $18,224,007    $18,083,915    $21,736,606    $21,454,000
Other policyholders' funds............    8,845,829      8,845,829      7,565,341      7,565,341
Mortgage note payable.................    8,283,884      8,283,884      8,399,028      8,399,028
Note payable..........................           --             --     20,000,000     20,000,000
</TABLE>
 
R. CONCENTRATIONS OF CREDIT RISK
 
     Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of fixed maturity investments,
cash, cash equivalents and reinsurance receivable.
 
                                       48
<PAGE>   30
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
 
                        DECEMBER 31, 1998, 1997 AND 1996
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
     The Company maintains cash and short-term investments with various
financial institutions, and the Company performs periodic evaluations of the
relative credit standings of those financial institutions.
 
     Substantially all of the Company's reinsurance recoverable is due from a
single reinsurer, Hannover. At December 31, 1998, Hannover maintains an "A"
rating from the A.M. Best Company. The Company performs periodic evaluation of
this reinsurer's credit standing.
 
S. QUARTERLY RESULTS OF OPERATIONS -- (UNAUDITED)
 
     The following is a summary of quarterly results of operations for the years
ended December 31, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                        FIRST         SECOND          THIRD         FOURTH
                                     -----------    -----------    -----------    -----------
<S>                                  <C>            <C>            <C>            <C>
1998:
  Revenues.........................  $$38,104,509   $40,256,756    $45,412,071    $46,373,288
  Benefits and claims..............   30,642,992(a)  31,289,280(a)  30,081,923     24,044,480
  Commissions and general
     expenses......................    9,819,628(a)  12,022,271(a)  14,927,038     20,087,783(b)
  Net (loss) income................   (2,358,111)    (3,054,795)       403,110      1,174,137
  Basic (loss) earnings per
     share(c)......................         (.56)          (.73)           .04            .10
  Diluted (loss) earnings per
     share(c)......................         (.56)          (.73)           .03            .09
1997:
  Revenues.........................  $68,849,774    $66,511,467    $64,473,579    $65,698,502
  Benefits and claims..............   53,204,489     51,696,958     50,496,272     55,378,647
  Commissions and general
     expenses......................   17,948,310     19,033,608     18,124,136     20,739,789
  Net loss.........................   (1,828,025)    (3,548,099)    (4,431,494)   (11,148,738)
  Basic loss per share.............         (.44)          (.85)         (1.06)         (2.66)
  Diluted loss per share...........         (.44)          (.85)         (1.06)         (2.66)
</TABLE>
 
---------------
 
(a) In 1998, the Company reclassified certain items from commissions and general
    expenses to benefits and claims related to the first and second quarters.
    There was no effect on earnings (loss) or the per share amounts resulting
    from these reclassifications.
 
(b) Includes $3,700,000 related to policy administration fees expensed to
    Hannover in 1998.
 
(c) The sum of basic and diluted income (loss) per share by quarter does not
    agree with the amounts reported on the statement of operations due to the
    issuance of 7,300,000 Company Common Shares in July 1998.
 
                                       49
<PAGE>   31
 
                                                                     SCHEDULE II
 
                       CERES GROUP, INC. AND SUBSIDIARIES
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
                        CERES GROUP, INC. (PARENT ONLY)
                                 BALANCE SHEETS
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31
                                                              -------------------------
                                                                 1998          1997
                                                              -----------   -----------
<S>                                                           <C>           <C>
ASSETS
Investments in subsidiaries*................................  $25,344,127   $ 5,006,254
Property and equipment......................................    9,076,024     9,525,416
Cash and cash equivalents...................................   11,174,736       821,054
Surplus note receivable*....................................           --    14,000,000
Other.......................................................      734,014       626,585
                                                              -----------   -----------
                                                              $46,328,901   $29,979,309
                                                              ===========   ===========
 
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
  Accounts payable..........................................  $ 2,209,303   $    68,439
  Note payable..............................................           --    20,000,000
  Mortgage note payable.....................................    8,283,884     8,399,028
                                                              -----------   -----------
                                                               10,493,187    28,467,467
                                                              ===========   ===========
 
Shareholders' equity:
  Common stock..............................................       11,495     2,097,586
  Paid-in capital...........................................   43,883,357     4,122,319
  Retained earnings (deficit)...............................   (9,154,986)   (5,319,327)
  Accumulated other comprehensive income....................    1,095,848       611,264
                                                              -----------   -----------
                                                               35,835,714     1,511,842
                                                              -----------   -----------
                                                              $46,328,901   $29,979,309
                                                              ===========   ===========
</TABLE>
 
---------------
 
*Eliminated in consolidation.
 
                 See accompanying independent auditors' report.
 
                                       50
<PAGE>   32
 
                                                                     SCHEDULE II
 
                       CERES GROUP, INC. AND SUBSIDIARIES
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
                        CERES GROUP, INC. (PARENT ONLY)
                            STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31
                                                    -----------------------------------------
                                                       1998           1997           1996
                                                    -----------   ------------   ------------
<S>                                                 <C>           <C>            <C>
REVENUES
  Dividend from subsidiaries*.....................  $        --   $         --   $  1,500,000
  Inter-company fees*.............................      930,000      1,310,000      1,210,000
  Other investment income.........................      293,344             --             --
                                                    -----------   ------------   ------------
                                                      1,223,344      1,310,000      2,710,000
 
EXPENSES
Operating expenses................................    3,712,293      1,690,205      1,314,012
                                                    -----------   ------------   ------------
(Loss) income before equity in earnings of subsid-
  iaries..........................................   (2,488,949)      (380,205)     1,395,988
Equity in losses of subsidiaries (net of
  dividends)......................................   (1,134,710)   (20,576,151)   (10,684,353)
                                                    -----------   ------------   ------------
     Net loss.....................................  $(3,835,659)  $(20,956,356)  $ (9,288,365)
                                                    ===========   ============   ============
</TABLE>
 
---------------
 
*Eliminated in consolidation.
 
                 See accompanying independent auditors' report.
 
                                       51
<PAGE>   33
 
                                                                     SCHEDULE II
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
                        CERES GROUP, INC. (PARENT ONLY)
 
                            STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31
                                                    -----------------------------------------
                                                        1998           1997          1996
                                                    ------------   ------------   -----------
<S>                                                 <C>            <C>            <C>
Operating activities
Net (loss) income before equity in subsidiaries...  $ (2,488,949)  $   (380,205)  $ 1,395,988
  Change in accounts payable......................     2,140,864          9,703        41,498
  Depreciation....................................       449,392        449,392       444,052
  Change in other assets..........................      (107,428)      (166,525)     (221,953)
                                                    ------------   ------------   -----------
Net cash (used in) provided by operating
  activities......................................        (6,121)       (87,635)    1,659,585
 
Investing activities
  Surplus note receivable*........................    14,000,000    (14,000,000)           --
  Contribution to subsidiary surplus*.............   (21,200,000)    (5,000,000)           --
  Purchase of property and equipment..............            --       (267,000)     (208,375)
                                                    ------------   ------------   -----------
Net cash used in investing activities.............    (7,200,000)   (19,267,000)     (208,375)
 
Financing activities
  Proceeds from note payable......................            --     25,200,000            --
  Repayment of note payable.......................   (20,000,000)    (5,200,000)           --
  Dividends paid..................................            --             --    (2,104,708)
  Issuance of common stock........................    37,674,947        141,500       582,715
  Decrease in mortgage payable....................      (115,144)      (104,748)      (95,291)
                                                    ------------   ------------   -----------
Net cash provided by (used in) financing
  activities......................................    17,559,803     20,036,752    (1,617,284)
                                                    ------------   ------------   -----------
Net increase (decrease) in cash...................    10,353,682        682,117      (166,074)
Cash and cash equivalents at beginning of year....       821,054        138,937       305,011
                                                    ------------   ------------   -----------
Cash and cash equivalents at end of year..........  $ 11,174,736   $    821,054   $   138,937
                                                    ============   ============   ===========
</TABLE>
 
---------------
 
*Eliminated in consolidation.
 
                 See accompanying independent auditors' report.
 
                                       52
<PAGE>   34
 
                                                                    SCHEDULE III
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                       SUPPLEMENTAL INSURANCE INFORMATION
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                   FUTURE         OTHER                                       BENEFITS
                                                   POLICY         POLICY                                       CLAIMS
                                   DEFERRED       BENEFITS        CLAIMS                         NET         LOSSES AND
                                 ACQUISITION       LOSSES      AND BENEFITS     PREMIUM       INVESTMENT     SETTLEMENT
                                    COSTS        AND CLAIMS      PAYABLE        REVENUE         INCOME        EXPENSES
------------------------------------------------------------------------------------------------------------------------
<S>                              <C>            <C>            <C>            <C>            <C>            <C>
 
Year ended December 31, 1998
  Group life and health........   $3,400,000    $ 2,418,631    $74,310,205    $160,201,806    $5,646,805    $114,181,891
  Life insurance and
    annuities..................      278,301     20,299,231         85,000        583,091      1,322,245      1,876,784
  Corporate and other..........      131,436             --             --             --        485,130             --
                                  ----------    -----------    -----------    ------------    ----------    ------------
        Total..................   $3,809,737    $22,717,862    $74,395,205    $160,784,897    $7,454,180    $116,058,675
                                  ==========    ===========    ===========    ============    ==========    ============
 
Year ended December 31, 1997
  Group life and health........   $       --    $   788,438    $56,128,420    $258,170,130    $4,875,214    $208,933,873
  Life insurance and
    annuities..................      325,572     23,760,693         58,382        689,177      1,459,718      1,842,493
  Corporate and other..........           --        354,366             --             --        192,605             --
                                  ----------    -----------    -----------    ------------    ----------    ------------
        Total..................   $  325,572    $24,903,497    $56,186,802    $258,859,307     6,527,537    210,776,366
                                  ==========    ===========    ===========    ============    ==========    ============
 
Year ended December 31, 1996
  Group life and health........   $       --    $ 8,025,093    $42,889,233    $257,495,315    $5,014,262    $202,074,527
  Life insurance and
    annuities..................      321,567     25,388,607         19,832        680,022      1,506,163      1,602,705
  Corporate and other..........           --        328,119             --             --        180,316             --
                                  ----------    -----------    -----------    ------------    ----------    ------------
        Total..................   $  321,567    $33,741,819    $42,909,065    $258,175,337     6,700,741    203,677,232
                                  ==========    ===========    ===========    ============    ==========    ============
 
<CAPTION>
 
                                 AMORTIZATION
                                 OF DEFERRED
                                 ACQUISITION     OPERATING
                                     COST         EXPENSES
-------------------------------
<S>                              <C>            <C>
Year ended December 31, 1998
  Group life and health........    $600,000     $52,162,598
  Life insurance and
    annuities..................      47,271         319,234
  Corporate and other..........          --       1,886,283
                                   --------     -----------
        Total..................    $647,271     $54,368,115
                                   ========     ===========
Year ended December 31, 1997
  Group life and health........    $     --     $73,589,360
  Life insurance and
    annuities..................       4,005         547,981
  Corporate and other..........          --       1,704,497
                                   --------     -----------
        Total..................    $  4,005     $75,841,838
                                   ========     ===========
Year ended December 31, 1996
  Group life and health........    $     --     $70,960,571
  Life insurance and
    annuities..................     111,807         655,667
  Corporate and other..........          --       1,614,268
                                   --------     -----------
        Total..................    $111,807     $73,230,506
                                   ========     ===========
</TABLE>
 
                 See accompanying independent auditors' report.
 
                                       53
<PAGE>   35
 
                                                                     SCHEDULE IV
 
                       CERES GROUP, INC. AND SUBSIDIARIES
 
                                  REINSURANCE
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                                                            PERCENTAGE
                                                               CEDED TO     ASSUMED FROM                    OF AMOUNT
                                                GROSS           OTHER          OTHER            NET         ASSUMED TO
                                                AMOUNT        COMPANIES      COMPANIES         AMOUNT          NET
------------------------------------------
<S>                                         <C>              <C>            <C>            <C>              <C>
 
Year ended December 31, 1998
  Life insurance in force.................  $1,239,853,000   $ 88,477,000   $        --    $1,151,376,000
                                            ==============   ============   ===========    ==============      ====
 
Premiums
  Life insurance..........................  $    6,816,641   $    200,451   $        --    $    6,616,190
  Accident and health insurance...........     258,051,545    149,805,223    45,922,385       154,168,707        30%
                                            --------------   ------------   -----------    --------------      ----
                                            $  264,868,186   $150,005,674   $45,922,385    $  160,784,897        29%
                                            ==============   ============   ===========    ==============      ====
 
Year ended December 31, 1997
  Life insurance in force.................  $1,192,280,000   $ 95,249,000   $        --    $1,097,031,000
                                            ==============   ============   ===========    ==============      ====
 
Premiums
  Life insurance..........................  $    7,003,747   $    166,034   $        --    $    6,837,713
  Accident and health insurance...........     255,157,596      3,136,002            --       252,021,594
                                            --------------   ------------   -----------    --------------      ----
                                            $  262,161,343   $  3,302,036   $        --    $  258,859,307
                                            ==============   ============   ===========    ==============      ====
 
Year ended December 31, 1996
  Life insurance in force.................  $1,293,673,000   $ 80,895,000   $        --    $1,212,778,000
                                            ==============   ============   ===========    ==============      ====
 
Premiums
  Life insurance..........................  $    7,829,103   $    113,910   $        --    $    7,715,193
  Accident and health insurance...........     252,246,994      1,786,850            --       250,460,144
                                            --------------   ------------   -----------    --------------      ----
                                            $  260,076,097   $  1,900,760   $        --    $  258,175,337
                                            ==============   ============   ===========    ==============      ====
</TABLE>
 
                 See accompanying independent auditors' report.
 
                                       54