INDEX TO FINANCIAL STATEMENTS
                          of Federal Insurance Company
<TABLE>
<CAPTION>
<S>                                                                         <C>
Financial Statements
     Report of Independent Auditors.........................................F-1
     Balance Sheets (Statutory Basis) as of December 31, 1998 and December
     31, 1997...............................................................F-2
     Statements of Income (Statutory Basis) for Years Ended December
     31, 1998, 1997 and 1996................................................F-3
     Statements of Surplus (Statutory Basis) for Years Ended December
     31, 1998, 1997 and 1996................................................F-4
     Statements of Cash Flows (Statutory Basis) for Years Ended December
     31, 1998, 1997 and 1996    ............................................F-5
     Notes to Financial Statements..........................................F-6
</TABLE>
THE FINANCIAL STATEMENTS OF FEDERAL INSURANCE COMPANY ("FEDERAL") INCLUDED 
HEREIN HAVE BEEN PREPARED ON A STATUTORY BASIS, RATHER THAN IN ACCORDANCE
WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES BECAUSE STATE INSURANCE
DEPARTMENTS RESPONSIBLE FOR OVERSIGHT OF FEDERAL'S FINANCIAL CONDITION
REQUIRE FINANCIAL STATEMENTS TO BE PRESENTED ON A STATUTORY BASIS.  AS A 
RESULT, THE CHUBB CORPORATION DOES NOT PREPARE FINANCIAL STATEMENTS IN 
ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES FOR FEDERAL, ITS
WHOLLY OWNED SUBSIDIARY.




                                     PAGE 9
<PAGE>
                       REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Federal Insurance Company

        We have audited the accompanying statutory-basis balance sheets of 
Federal Insurance  Company  (Company) as of December 31, 1998 and 1997, and the 
related statutory-basis  statements of income, surplus to policyholders,  and 
cash flows for each of the  three  years in the  period  ended  December  31,  
1998.  These financial  statements are the  responsibility of the Company's  
management.  Our responsibility  is to express an opinion on these financial  
statements based on our audits.

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

        As described in Note 1, these financial statements have been prepared in
conformity  with  accounting  practices  prescribed  or permitted by the Indiana
Insurance  Department,  the  jurisdiction  of  domicile  of the  Company,  which
practices differ from generally accepted  accounting  principles.  The variances
from such  practices  and  generally  accepted  accounting  principles  are also
described in Note 1. The effects on the financial  statements of these variances
are not reasonably determinable but are presumed to be material.

        In our  opinion,  because of the effects of the matter  described in the
preceding  paragraph,  the financial statements referred to above do not present
fairly,  in  conformity  with  generally  accepted  accounting  principles,  the
financial position of Federal Insurance Company at December 31, 1998 and 1997 or
the results of its  operations  or its cash flows for each of the three years in
the period ended December 31, 1998.

        However,  in our opinion,  the  financial  statements  referred to above
present  fairly,  in all material  respects,  the financial  position of Federal
Insurance  Company  at  December  31,  1998  and  1997  and the  results  of its
operations  and its cash flows for each of the three  years in the period  ended
December 31,  1998,  in  conformity  with  accounting  practices  prescribed  or
permitted by the Indiana Insurance Department.

                                ERNST & YOUNG LLP




New York, New York
February 24, 1999


                                    PAGE F-1
<PAGE>
<TABLE>
<CAPTION>
                            FEDERAL INSURANCE COMPANY
                        BALANCE SHEETS - STATUTORY BASIS
                           December 31, 1998 and 1997
                 (dollars in thousands except per share amounts)


<S>                                                                 <C>                <C>    


                                                                          1998                1997
                                                                    -----------------  --------------------
ADMITTED ASSETS

Invested Assets:
  Cash and Short Term Investments, at Amortized Cost                     $   408,664           $   719,375
  Tax Exempt Bonds, at Amortized Cost                                      5,901,710             5,221,481
  Taxable Bonds, at Amortized Cost                                         1,852,756             1,922,965
  Equity Securities, at Market                                               495,285               465,563
  Investments in U.S. Property & Casualty Subsidiaries                     1,083,050             1,042,295
  Investments in Other Unconsolidated Subsidiaries                           220,550               220,182
  Receivable for Securities                                                   10,157                29,838
  Other Invested Assets                                                      252,850               237,340
                                                                    -----------------  --------------------
    Total Cash and Invested Assets (Note 2)                               10,225,022             9,859,039

Premiums Receivable                                                          589,650               625,601
Interest and Dividends Due and Accrued                                       138,990               126,395
Reinsurance Recoverable on Paid Losses                                       100,011                49,763
Equities and Deposits in Pools and Associations                               79,495                66,276
Amounts Due from Associated Companies (Note 3)                               158,233                51,388
Other Assets                                                                 282,176               174,057
                                                                    -----------------  --------------------
                                                                          11,573,577            10,952,519
                                                                     
Deduct: Non-Admitted Assets                                                  186,876               127,261
                                                                    -----------------  --------------------
      Total Admitted Assets                                              $11,386,701           $10,825,258
                                                                    =================  ====================

LIABILITIES AND SURPLUS TO POLICYHOLDERS
 
        
Outstanding Losses and Loss
 Expenses (Notes 7 and 8)                                                $ 6,348,319           $ 6,065,735
Unearned Premiums                                                          1,803,792             1,683,472
Working Funds Due to Manager                                                       -               136,598
Provision for Reinsurance                                                     61,892                45,454
Accrued Expenses and Other Liabilities                                       384,480               338,883
                                                                    -----------------  --------------------
       Total Liabilities                                                   8,598,483             8,270,142
                                                                    -----------------  --------------------


Commitments and Contingent Liabilities (Notes 6 and 8)

Common Capital Stock                                                          13,987                13,987
Paid-In Surplus                                                              378,890               378,890
Unassigned Funds                                                           2,262,120             1,972,505
Unrealized Appreciation of Investments                                       133,221               189,734
                                                                    -----------------  --------------------
                                                                    -----------------  --------------------
       Total Surplus To Policyholders (Note 9)                             2,788,218             2,555,116
                                                                    -----------------  --------------------

       Total Liabilities and
                                                                    -----------------  --------------------
        Surplus to Policyholders                                         $11,386,701           $10,825,258
                                                                    =================  ====================

       Common Capital Stock:
         Shares Authorized                                                 3,499,971             3,499,971
         Shares Issued and Outstanding                                     3,496,678             3,496,678
         Par Value Per Share                                             $         4           $         4
</TABLE>
                                    PAGE F-2

<PAGE>


                            FEDERAL INSURANCE COMPANY
                     STATEMENTS OF INCOME - STATUTORY BASIS
                  Years Ended December 31, 1998, 1997 and 1996
                                 (in thousands)

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

                                                                 1998                1997                1996
                                                                 ------------------  ------------------  ------------------
Net Premiums Written                                                    $3,491,466          $3,676,579          $2,582,131

Increase in Unearned Premiums
 Net of Accrued Retrospective Premiums                                     120,320             428,188             137,785
                                                                 ------------------  ------------------  ------------------
    Premiums Earned (Note 7)                                             3,371,146           3,248,391           2,444,346
                                                                 ------------------  ------------------  ------------------

Losses and Loss Expenses (Note 7)                                        2,293,839           2,139,189           1,697,816

Underwriting Expenses                                                    1,120,183           1,120,121             790,017

Dividends to Policyholders                                                  26,139              23,089              14,581
                                                                                                         ------------------
                                                                 ------------------  ------------------  ------------------
                                                                         3,440,161           3,282,399           2,502,414
                                                                 ------------------  ------------------  ------------------
    Underwriting Loss                                                      (69,015)            (34,008)            (58,068)
                                                                 ------------------  ------------------  ------------------

Investment Income Before Expenses                                          654,947             977,002             559,686

Realized Capital Gains                                                      92,737              53,132              34,693

Investment Expenses                                                          8,495               7,540               5,325
                                                                                                         ------------------
                                                                 ------------------  ------------------  ------------------
    Investment Income                                                      739,189           1,022,594             589,054
                                                                 ------------------  ------------------  ------------------

Other Income (Loss) (including gain
 or loss on foreign exchange) (Note 6)                                     (15,863)              1,786              (9,617)
                                                                 ------------------  ------------------  ------------------
Income Before Federal and Foreign Income Tax                               654,311             990,372             521,369

Federal and Foreign Income Tax (Note 4)                                     62,188             164,440              83,186
                                                                 ------------------  ------------------  ------------------
Net Income                                                              $  592,123          $  825,932          $  438,183
                                                                 ==================  ==================  ==================
</TABLE>
                                    PAGE F-3

<PAGE>
                            FEDERAL INSURANCE COMPANY
            STATEMENTS OF SURPLUS TO POLICYHOLDERS - STATUTORY BASIS
                  Years Ended December 31, 1998, 1997 and 1996
                                 (in thousands)

<TABLE>
<CAPTION>
<S>                                                              <C>                 <C>
                                                                 1998                1997               1996
                                                                 -----------------   -----------------   ------------------


Common Stock

  Balance, Beginning and End of Year                                     $   13,987          $   13,987          $   13,987
                                                                   -----------------   -----------------  ------------------

Paid-In Surplus

  Balance, Beginning of Year                                                378,890             472,986             472,986
  Distribution of Bellemead Development
   Corporation to Parent                                                          -             (94,096)                  -
                                                                   -----------------   -----------------  ------------------
  Balance, End of Year                                                      378,890             378,890             472,986
                                                                   -----------------   -----------------  ------------------

Unassigned Funds

  Balance, Beginning of Year                                              1,972,505           1,649,830           1,347,361
  Net Income                                                                592,123             825,932             438,183
  Dividends Declared to Parent                                             (280,000)           (280,000)           (250,000)
  Decrease (Increase) in Provision
   for Reinsurance                                                          (16,438)            (12,361)              9,505
  Decrease (Increase) in Non-Admitted Assets                                (59,615)            (17,421)                 71
  Increase (Decrease) in Unassigned Funds of
   U.S. Property & Casualty Subsidiaries                                     53,562            (193,261)             89,809
  Other, Net                                                                    (17)               (214)             14,901
                                                                                       -----------------  ------------------
                                                                   -----------------   -----------------  ------------------
  Balance, End of Year                                                    2,262,120           1,972,505           1,649,830
                                                                   -----------------   -----------------  ------------------

Unrealized Appreciation of Investments

  Balance, Beginning of Year                                                189,734             326,682             433,116
  Distribution of Bellemead Development
   Corporation to Parent                                                          -            (175,664)                  -
  Change During the Year                                                    (56,513)             38,716            (106,434)
                                                                                                          ------------------
                                                                   -----------------   -----------------  ------------------
  Balance, End of Year                                                      133,221             189,734             326,682
                                                                   -----------------   -----------------  ------------------
    Total Surplus to Policyholders                                       $2,788,218          $2,555,116          $2,463,485
                                                                   =================   =================  ==================

</TABLE>


                                    PAGE F-4
<PAGE>
                            FEDERAL INSURANCE COMPANY
                   STATEMENTS OF CASH FLOWS - STATUTORY BASIS
                  Years Ended December 31, 1998, 1997 and 1996
                                 (in thousands)
<TABLE>
<CAPTION>                                                            


<S>                                                                <C>                 <C>
                                                                   1998                1997              1996
                                                                   ----------------    ----------------  ---------------
Cash From Operations

Premiums Collected Net of Reinsurance                                    $3,527,417          $3,644,597       $2,527,854
Losses and Loss Expenses Paid (net of
 salvage and subrogation)                                                 2,061,503             967,543        1,717,314
Underwriting Expenses Paid                                                1,112,444           1,079,486          787,594
Other Underwriting Income (Expenses)                                       (158,443)            (97,527)         163,458
                                                                   ----------------    ----------------  ---------------
     Cash from Underwriting                                                 195,027           1,500,041          186,404

Investment Income (net of investment expenses)                              638,633             959,457          542,767
Other Income (Expenses)                                                     (28,895)              2,275           11,223
Dividends to Policyholders Paid                                             (19,694)             (8,862)         (10,912)
Federal Income Taxes Paid                                                   (59,267)           (181,083)         (72,964)
                                                                   ----------------    ----------------  ---------------
     Net Cash from Operations                                               725,804           2,271,828          656,518
                                                                   ----------------    ----------------  ---------------

Cash From Investments

Proceeds from Investments Sold or Matured:
   Bonds                                                                  1,674,555           1,826,979        2,378,073
   Equity Securities                                                        188,319              77,626          155,359
   Other Invested Assets                                                     76,864              72,019           33,972
   Miscellaneous Proceeds                                                       607               2,894           15,801
                                                                   ----------------    ----------------  ---------------
                                                                   ----------------    ----------------  ---------------
     Total Investment Proceeds                                            1,940,345           1,979,518        2,583,205
                                                                   ----------------    ----------------  ---------------

Cost of Investments Acquired:
   Bonds                                                                  2,270,292           3,591,204        2,806,024
   Equity Securities                                                        209,449             304,742          196,520
   Other Invested Assets                                                     72,411              55,568           47,323
   Miscellaneous Applications                                                49,180                 314              389
                                                                   ----------------    ----------------  ---------------
     Total Investments Acquired                                           2,601,332           3,951,828        3,050,256
                                                                   ----------------    ----------------  ---------------
                                                                   ----------------    ----------------  ---------------
     Net Cash from Investments                                             (660,987)         (1,972,310)        (467,051)
                                                                   ----------------    ----------------  ---------------

Cash From Financing and Miscellaneous Sources

Other Cash Provided                                                             631              14,458              639
                                                                   ----------------    ----------------  ---------------

Cash Applied:
   Dividends to Stockholders Paid                                           280,000             280,000          250,000
   Other Applications                                                        96,159               2,507           11,963
                                                                   ----------------    ----------------  ---------------
     Total Cash Applied                                                     376,159             282,507          261,963
                                                                   ----------------    ----------------  ---------------
     Net Cash from Financing and
       Miscellaneous Sources                                               (375,528)           (268,049)        (261,324)
                                                                   ----------------    ----------------  ---------------

Net Change in Cash and Short Term Investments                              (310,711)             31,469          (71,857)

Cash and Short Term Investments:
     Beginning of Year                                                      719,375             687,906          759,763
                                                                   ----------------    ----------------  ---------------
     End of Year                                                         $  408,664          $  719,375       $  687,906
                                                                   ================    ================  ===============
</TABLE>

                                    PAGE F-5
<PAGE>
                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS




1.     Summary of significant accounting policies

       (a) Federal Insurance  Company  (Company) is a wholly-owned  property and
casualty insurance  subsidiary of The Chubb Corporation  (Chubb). The Company is
domiciled  in the State of Indiana and  underwrites  most forms of property  and
casualty   insurance,   principally  in  the  United   States.   The  geographic
distribution  of  business  in the United  States is broad  with a  particularly
strong market presence in the Northeast.

       The Company is a member of an affiliated group of U.S. based property and
casualty insurance companies,  including several wholly-owned subsidiaries.  For
purposes of this report,  the affiliated group of companies,  including  Federal
Insurance Company, is collectively referred to as the Companies.

       The  financial   statements  reflect  estimates  and  judgments  made  by
management  for those  transactions  that are not yet  complete or for which the
ultimate  effects cannot be precisely  determined.  Such estimates and judgments
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the reported amounts of income and expenses during the reporting period.
Actual results could differ from those estimates.

       Certain  amounts  in  the  prior  year  financial  statements  have  been
reclassified to conform with the 1998 presentation.

        These  financial  statements  have  been  prepared  in  conformity  with
accounting   practices   prescribed  or  permitted  by  the  Indiana   Insurance
Department.  Such accounting  practices vary in certain  respects from generally
accepted accounting principles (GAAP), including:

           (i) investments in bonds are reported at amortized cost and are not
               classified as held-to-maturity or available-for-sale; under GAAP,
               those bonds classified as available-for-sale are carried at
               market value,

          (ii) the costs of acquiring new business are charged to operations as
               incurred rather than being deferred and amortized over the 
               period in which the related premiums are earned,

         (iii) certain assets designated "non-admitted" are excluded,

          (iv) outstanding  losses  and loss  expenses  are  reported  net of
               amounts  recoverable  from reinsurers;  unearned  premiums are
               reported net of the unearned portion of premiums ceded,

           (v) a provision is made for statutory  liabilities with respect to
               unearned  premiums  and  losses  reinsured  with  non-admitted
               reinsurers  and for  certain  overdue  amounts  from  admitted
               reinsurers to the extent funds are not held,

                                    PAGE F-6

<PAGE>


                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

1.     Summary of significant accounting policies (Cont'd)

         (vi)     no provision is made for deferred federal income tax, and

         (vii)    investments  in  wholly-owned  U.S.  and foreign  property and
                  casualty  insurance  subsidiaries,  various other subsidiaries
                  which  are  not  material   and,  in  1996,   a   wholly-owned
                  non-property and casualty insurance subsidiary (see Note 1(f))
                  are  included  at  statutory  net  asset  value  and  are  not
                  consolidated;  dividends  declared  by such  subsidiaries  are
                  included in investment income. Net income of the U.S. property
                  and casualty insurance subsidiaries is included as a change in
                  unassigned  funds.  Net  income of the other  subsidiaries  is
                  included   as  a  change   in   unrealized   appreciation   of
                  investments.

         The effects of the foregoing variances from GAAP on the statutory basis
financial statements have not been determined, but are presumed to be material.

       (b)  Invested  assets are carried at values  prescribed  by the  National
Association of Insurance  Commissioners  (NAIC).  Short term investments,  which
have an original  maturity of one year or less,  are carried at amortized  cost.
Bonds are generally  carried at amortized cost.  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.   Equity  securities  are  carried  at  market  value.
Investments  in  unconsolidated  subsidiaries  and  other  invested  assets  are
accounted for on the equity basis.

        Realized gains and losses on the sale of  investments  are determined on
the  basis of the cost of the  specific  investments  sold and are  credited  or
charged to income. Unrealized appreciation or depreciation of equity securities,
unconsolidated  subsidiaries  and other invested assets are excluded from income
and credited or charged directly to surplus to policyholders.

       (c) Premiums are earned on a monthly pro rata basis over the terms of the
policies. Unearned premiums represent the portion of premiums written applicable
to the unexpired terms of policies in force.

       (d)  Liabilities  for  outstanding  losses and loss expenses  include the
accumulation  of  individual  case  estimates  for  claims  reported  as well as
estimates of unreported claims and claim settlement expenses,  less estimates of
anticipated  salvage and subrogation  recoveries.  Estimates are based upon past
claim  experience  modified for current  trends as well as prevailing  economic,
legal and  social  conditions.  Such  estimates  are  continually  reviewed  and
updated. Any resulting adjustments are reflected in current operating results.

                                    PAGE F-7
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


1.     Summary of significant accounting policies (Cont'd)

       (e)      The methods and assumptions used to estimate the fair value of 
                financial instruments are as follows:

        (i)    The carrying value of short term  investments  approximates  fair
               value due to the short maturities of these investments.

       (ii)    Fair  values of bonds  with  active  markets  are based on quoted
               market prices. For bonds that trade in less active markets,  fair
               values are  obtained  from  independent  pricing  services.  Fair
               values of bonds are  principally  a function of current  interest
               rates.  Care should be used in  evaluating  the  significance  of
               these  estimated  market values which can fluctuate based on such
               factors as interest rates, inflation, monetary policy and general
               economic conditions.

      (iii)    Fair values of equity securities are based on quoted market 
               prices.

        (f)    In 1997, the Company distributed its investment in Bellemead 
Development Corporation to Chubb; in connection with the  distribution, paid-in 
surplus was reduced by $94,096,000  representing the cost of the investment,  
and unrealized appreciation  of  investments  was  reduced  by  $175,664,000  
representing  the increase in the statutory net asset value of Bellemead  
Development  Corporation from  the  date of  acquisition  through  the date of 
transfer.  This  non-cash transaction has been excluded from the statement of 
cash flows.

2.  Invested assets

        (a)  The realized capital gains and losses at December 31, 1998, 1997, 
and 1996 were as follows (in thousands):
<TABLE>
<S>                                                      <C>                         <C>                 <C>
                                                         1998                        1997                1996
                                                         ----                        ----                ----

Gross realized capital gains                             $106,328                     $68,320             $65,229
Gross realized capital losses                              13,591                      15,188              30,536
                                                         --------                     -------             -------
                                                         $ 92,737                     $53,132             $34,693
                                                         ========                     =======             =======

</TABLE>

       (b)  The  cost  of  equity  securities,   investments  in  unconsolidated
subsidiaries  and other  invested  assets at December  31, 1998 and 1997 were as
follows (in thousands):
<TABLE>
<S>                                                      <C>                         <C>
                                                         1998                        1997
                                                         ----                        ----

Equity Securities                                        $462,750                    $410,001
Unconsolidated Subsidiaries                               181,681                     173,362
Other Invested Assets                                     219,656                     191,791

</TABLE>

                                    PAGE F-8
<PAGE>
                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


2.  Invested assets (Cont'd)

      (c) The components of unrealized  appreciation  of investments at December
31, 1998 and 1997 were as follows (in thousands):
<TABLE>  
<S>                                                      <C>                          <C>
                                                         1998                         1997
                                                         ----                         ----

Gross Unrealized Appreciation                            $239,814                     $256,947
Gross Unrealized Depreciation                             106,593                       67,213
                                                         --------                     --------
                                                         $133,221                     $189,734
                                                         ========                     ========
</TABLE>

     (d) The amortized cost and estimated  market value of bonds were as follows
(in thousands):
<TABLE>
December 31, 1998
<S>                                           <C>                 <C>               <C>              <C>
                                                                  Gross             Gross            Estimated
                                              Amortized Cost      Unrealized        Unrealized       Market
                                                                  Gains             Losses           Value

Tax Exempt Bonds                              $5,901,710          $373,873             $ 1,754       $6,273,829
Taxable U.S. Government Bonds                    159,767             2,780                   -          162,547
Taxable Corporate Bonds                          778,730            32,583                 804          810,509
Taxable Foreign Bonds                            179,552            11,450               1,510          189,492
Mortgage-Backed Securities                       734,707             7,606              15,290          727,023
                                              ----------          --------             -------         -------
  Total Bonds                                 $7,754,466          $428,292             $19,358       $8,163,400
                                              ==========          ========             =======       ==========

</TABLE>
December 31, 1997
<TABLE>
<S>                                           <C>                 <C>               <C>              <C>
                                                                  Gross             Gross           Estimated
                                              Amortized Cost      Unrealized        Unrealized      Market
                                                                  Gains             Losses          Value

Tax Exempt Bonds                              $5,221,481          $326,053              $  148      $5,547,386
Taxable U.S. Government Bonds                    286,812             4,470                  97         291,185
Taxable Corporate Bonds                          589,826            21,129               1,998         608,957
Taxable Foreign Bonds                            150,320             5,524               1,864         153,980
Mortgage-Backed Securities                       896,007            22,843               1,510         917,340
                                              ----------          --------             -------        --------
  Total Bonds                                 $7,144,446          $380,019              $5,617      $7,518,848
                                              ==========          ========              ======      ==========
</TABLE>
                                    PAGE F-9
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


2.  Invested assets (Cont'd)

        (e) The amortized  cost and estimated  market value of bonds at December
31, 1998 by contractual maturity were as follows (in thousands):
<TABLE>
<S>                                                            <C>                         <C>  
                                                               Amortized                   Market
                                                               Cost                        Value

Due in One Year or Less                                        $  238,938                  $  240,814
Due after One Year through Five Years                           1,038,941                   1,079,466
Due after Five Years through Ten Years                          2,516,845                   2,694,400
Due after Ten Years                                             3,225,035                   3,421,697
Mortgage-Backed Securities                                        734,707                     727,023
  Total Bonds                                                  $7,754,466                  $8,163,400
                                                               ==========                  ==========
</TABLE>
        Actual  maturities  could  differ from  contractual  maturities  because
borrowers may have the right to call or prepay obligations.

3.  Related party transactions

        During 1997 and 1996, Chubb & Son Inc. (C&S), a subsidiary of Chubb, had
agreements  with the Companies  pursuant to which the Companies  participated in
the U.S.  insurance  business written through C&S. C&S arranged for the exchange
of reinsurance between the Companies (See Note 8).

         The terms of the  agreements  included that C&S be  reimbursed  for all
expenses  incurred  on behalf  of the  Companies.  Such  expenses  are  included
primarily in underwriting expenses.

         On  December  31,  1997,  the  agreements  with  C&S  were  terminated.
Effective  January  1, 1998,  new  agreements  were  entered  into  substituting
Federal, through its Chubb & Son division, in place of C&S.

         Investment income includes dividends from subsidiaries of $146,000,000,
$507,370,000 and $177,225,000 in 1998, 1997, and 1996, respectively.

                                   PAGE F-10
<PAGE>
                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

4.  Federal and foreign income tax

        The  Company  is  a  member  of  an  affiliated   group  which  files  a
consolidated  federal  income tax  return.  Intercompany  tax  transactions  and
allocations are governed by an  intercompany  tax allocation  agreement  between
Chubb and the  Companies.  Under the written  agreement,  which is in accordance
with Section 1552(a)(1) of the Internal Revenue Code, each of the companies with
taxable  income is allocated a current tax  provision  based on the ratio of its
taxable  income to the total taxable  income of those  companies  having taxable
income.

        The  provision  for  federal  and  foreign  income  tax gives  effect to
differences  between income for statutory reporting purposes and taxable income.
The principal  differences  are (i) interest income on tax exempt bonds and (ii)
the  accelerated  recognition  of taxable  income  through  the  discounting  of
outstanding  losses and loss  expenses  and the  reduction  of unearned  premium
reserves for tax purposes.

5.      Employee benefits

        The employees of the Companies are afforded  benefits  under  retirement
and  other  postretirement   benefit  programs.   The  Company  contributes  its
proportionate share towards the cost of these programs.

        The Company participates in a non-contributory,  defined benefit pension
and  retirement  plan  covering  employees  of the  Companies.  The benefits are
generally  based on an  employee's  years of service  and  average  compensation
during the last five years of employment.

        Vested  benefits  are fully  funded.  The  employers'  policy is to make
annual  contributions that meet the minimum funding requirements of the Employee
Retirement Income Security Act of 1974. Each participating  affiliate is charged
for its allocable share of such contributions.

        No pension expense was allocated to the Company in 1998 and 1997.  
Pension expense allocated to the Company in 1996 was $4,077,000.

        As of January 1, 1998,  the most recent  actuarial  valuation  date, the
plan's total accumulated benefit obligation was $287,025,000 based on an assumed
interest rate of 7.5%, including vested benefits of $271,252,000; the fair value
of plan assets was $470,642,000.

                                   PAGE F-11

<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

5.      Employee benefits (cont'd)

        In  addition  to  pension   benefits,   retired   employees   and  their
beneficiaries and covered dependents are provided other postretirement benefits,
principally health care and life insurance. Substantially all U.S. employees may
become  eligible for these benefits upon retirement if they meet minimum age and
years of service requirements.

        The Company does not fund these  benefits in advance.  Benefits are paid
as covered expenses are incurred. Health care coverage is contributory.  Retiree
contributions  vary based upon a retiree's  age,  type of coverage  and years of
service with the Company. Life insurance coverage is non-contributory.

        The Company  accrues its  proportionate  share of the  expected  cost of
providing postretirement benefits to retirees and other fully eligible or vested
plan participants and their beneficiaries and covered dependents.  The Companies
elected to amortize the transition  obligation,  which represents their unfunded
and unrecognized accumulated  postretirement benefit obligation as of January 1,
1993, over 20 years. The unamortized  transition obligation of the Companies was
$29,947,000  and  $32,086,000 at December 31, 1998 and 1997,  respectively.  Net
postretirement  benefit  costs  include the expected  cost of such  benefits for
newly eligible or vested employees, interest cost, gains and losses arising from
differences in actuarial  assumptions and actual  experience and amortization of
the transition  obligation.  Net  postretirement  benefit costs allocated to the
Company for the years ended  December 31, 1998,  1997 and 1996 were  $7,188,000,
$5,447,000 and $5,254,000,  respectively.  The Company's portion of the unfunded
postretirement  benefit liability  included in other liabilities at December 31,
1998 and 1997 was $22,177,000 and $18,366,000, respectively.

        The estimated  amount of the  postretirement  benefit  obligation of the
Companies  for active  nonvested  employees as of December 31, 1998 and 1997 was
$50,586,000 and $53,950,000, respectively.

        The weighted  average  discount rate used in  determining  the actuarial
present value of the accumulated  postretirement  benefit obligation at December
31, 1998 and 1997 was 7.25% and 7.5%,  respectively.  At December 31, 1998,  the
weighted  average  health care cost trend rate used to measure  the  accumulated
postretirement  cost for medical  benefits  was 9.9% for 1999 and was assumed to
decrease  gradually  to  6.0%  for the  year  2005  and  remain  at  that  level
thereafter.

                                   PAGE F-12
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

6.  Restructuring charge

        During the fourth quarter of 1997, the Companies began an activity value
analysis process to identify and eliminate  low-value  activities and to improve
operational  efficiency  in order to reduce  expenses and redirect  resources to
those current activities and new initiatives that have the greatest potential to
contribute to future results.  Implementation began in the first quarter of 1998
and is  substantially  completed.  In the first  quarter  of 1998,  the  Company
recorded a restructuring  charge of $14,623,000 related to the implementation of
the cost control initiative.

7.  Leases

        The Companies  occupy office  facilities  under lease  agreements  which
expire at various  dates  through  2019;  such leases are  generally  renewed or
replaced by other  leases.  In addition,  the Companies  lease data  processing,
office and transportation  equipment.  Leases are the obligation of the Company.
The Company  contributes its  proportionate  share of the rental cost under such
leases.

        Most leases contain renewal options for increments ranging from three to
five  years;  certain  lease  agreements  provide  for rent  increases  based on
price-level factors. All leases are operating leases.

        At December 31, 1998,  future  minimum  rental  payments  required under
non-cancelable operating leases were as follows (in thousands):

<TABLE>
<CAPTION>
Years ending December 31:

        <S>                                         <C>               <C>   
        1999                                                          $ 67,987
        2000                                                            65,765
        2001                                                            59,767
        2002                                                            53,558
        2003                                                            47,957
        After 2003                                   325,865
                                                    --------

                                                                      $620,899

</TABLE>

                                   PAGE F-13
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


8.  Reinsurance

        The  Company   participates  in  pooling  arrangements  with  affiliated
insurers  whereby these companies  assume and cede  reinsurance with each other.
These  arrangements  vary as a function of the line of business  and location of
the risk. A  substantial  amount of the  reinsurance  of the Company is effected
under these pooling  arrangements.  Effective January 1, 1997, the Company's pro
rata participation in the pooled property and casualty business increased.

        In the  ordinary  course of  business,  the  Company  assumes  and cedes
reinsurance with other insurance  companies and is a member of various pools and
associations.  Reinsurance  is  ceded  to  provide  greater  diversification  of
business  and  minimize  the maximum net loss  potential  arising  from large or
concentrated  risks.  A large  portion  of the  reinsurance  is  effected  under
contracts  known as treaties and in some  instances by negotiation on individual
risks.  Certain of these arrangements  consist of excess of loss and catastrophe
contracts which protect against losses over stipulated  amounts arising from any
one occurrence or event. Ceded reinsurance  contracts do not relieve the Company
of its primary obligation to the policyholders.

        The  effect of  reinsurance  on  premiums  earned  for the  years  ended
December 31, 1998, 1997 and 1996 was as follows (in thousands):
<TABLE>
                  <S>                     <C>                     <C>                       <C>                                

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

                  Direct                  $ 2,975,310             $ 2,932,452               $ 2,868,065
                  Assumed                   1,504,786                   1,436,560                 1,158,882
                  Ceded                    (1,108,950)             (1,120,621)               (1,582,601)
                                          -----------             -----------               ----------- 

                    Net                   $ 3,371,146             $ 3,248,391               $ 2,444,346
                                          ===========             ===========               ===========
</TABLE>
        For many years, a portion of the U. S. insurance business written by the
Company was  reinsured on a quota share basis with a  subsidiary  of Royal & Sun
Alliance  Insurance  Group  plc.  Effective  January 1,  1997,  the  reinsurance
agreement with Royal & Sun Alliance was terminated.  Ceded reinsurance  premiums
earned in 1996 included $266,796,000 from such reinsurance.

        Reinsurance  recoveries  which have been  deducted  from losses and loss
expenses were  $920,522,000,  $711,805,000 and  $1,048,760,000 in 1998, 1997 and
1996, respectively.

9.  Outstanding losses and loss expenses

        The process of  establishing  loss  reserves is a complex and  imprecise
science that reflects significant judgmental factors. This is true because claim
settlements  to be made in the future  will be  impacted  by  changing  rates of
inflation and other  economic  conditions,  changing  legislative,  judicial and
social environments and changes in the Company's claim handling  procedures.  In
many liability cases,  significant  periods of time, ranging up to several years
or more,  may elapse between the occurrence of an insured loss, the reporting of
the loss and the settlement of the loss.

                                   PAGE F-14
<PAGE>
                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


9.  Outstanding losses and loss expenses (cont'd)

        Judicial decisions and legislative actions continue to broaden liability
and policy  definitions  and to increase  the severity of claim  payments.  As a
result of this and other societal and economic  developments,  the uncertainties
inherent in  estimating  ultimate  claim  costs on the basis of past  experience
continue to further complicate the already complex loss reserving process.

        The  uncertainties  relating  to  asbestos  and  toxic  waste  claims on
insurance  policies written many years ago are exacerbated by inconsistent court
decisions and judicial and legislative  interpretations of coverage that in some
cases have tended to erode the clear and express  intent of such policies and in
other cases have  expanded  theories of  liability.  The  industry is engaged in
extensive  litigation  over  these  coverage  and  liability  issues and is thus
confronted  with a  continuing  uncertainty  in its  efforts to  quantify  these
exposures.

        In 1993, Pacific Indemnity Company (Pacific  Indemnity),  a wholly-owned
property and casualty insurance subsidiary of the Company, entered into a global
settlement  agreement  with  Continental  Casualty  Company (a subsidiary of CNA
Financial  Corporation),  Fibreboard  Corporation,  and  attorneys  representing
claimants  against  Fibreboard  for all future  asbestos-related  bodily  injury
claims against  Fibreboard.  This agreement is subject to final  appellate court
approval.  The  settlement  relates to an insurance  policy issued to Fibreboard
Corporation  by  Pacific  Indemnity.  The  Pacific  Indemnity  policy  was  100%
reinsured  by the  Company.  Pursuant  to the  global  settlement  agreement,  a
$1,525,000,000  trust fund will be established  to pay future claims,  which are
claims that were not filed in court  before  August 27, 1993.  The  Company,  as
reinsurer of the Pacific Indemnity policy,  will contribute  $538,172,000 to the
trust fund and  Continental  Casualty will contribute the remaining  amount.  In
December 1993, upon execution of the global  settlement  agreement,  the Company
and Continental  Casualty paid their  respective  shares into an escrow account.
The  Company's  share is included in  short-term  investments.  Upon final court
approval of the settlement, the amount in the escrow account, including interest
earned  thereon,  will be transferred to the trust fund. All of the parties have
agreed to use their  best  efforts to seek final  court  approval  of the global
settlement agreement.

        Pacific Indemnity and Continental  Casualty reached a separate agreement
in 1993 for the handling of all asbestos-related bodily injury claims pending on
August 26, 1993  against  Fibreboard.  As reinsurer  of Pacific  Indemnity,  the
Company's obligation under this agreement with respect to such pending claims is
approximately  $635,000,000,  all of which has been paid. The agreement  further
provides that the total  responsibility  of Pacific  Indemnity  and  Continental
Casualty  with  respect to pending  and future  asbestos-related  bodily  injury
claims against  Fibreboard  will be shared on an approximate  35% and 65% basis,
respectively.

                                   PAGE F-15
<PAGE>
                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


9.  Outstanding losses and loss expenses (Cont'd)

        At the same time, Pacific Indemnity, Continental Casualty and Fibreboard
entered  into  a   trilateral   agreement  to  settle  all  present  and  future
asbestos-related  bodily injury claims  resulting from  insurance  policies that
were, or may have been, issued to Fibreboard by the two insurers. The trilateral
agreement  will be triggered if the global  settlement  agreement is  ultimately
disapproved.  The Company's obligation, as reinsurer of Pacific Indemnity, under
the trilateral  agreement is therefore  similar to, and not duplicative of, that
under those agreements described above.

        The trilateral  agreement  reaffirms portions of an agreement reached in
March 1992 between Pacific Indemnity and Fibreboard.  Among other matters,  that
1992  agreement  eliminates  any Pacific  Indemnity  liability to Fibreboard for
asbestos-related property damage claims.

        In July 1995, the United States  District Court of the Eastern  District
of Texas approved the global settlement agreement and the trilateral  agreement.
The  judgments  approving  these  agreements  were appealed to the United States
Court of Appeals for the Fifth  Circuit.  In July 1996,  the Fifth Circuit Court
affirmed the 1995 judgments of the District  Court.  The objectors to the global
settlement  agreement appealed to the United States Supreme Court. In June 1997,
the  Supreme  Court set aside the  ruling by the Fifth  Circuit  Court  that had
approved the global settlement  agreement and ordered the Fifth Circuit Court to
reconsider its approval. In January 1998, the Fifth Circuit Court again affirmed
the global settlement agreement.  In April 1998, the objectors to the settlement
petitioned the Supreme Court to review the decision.  In December 1998, argument
was held before the Supreme  Court on the  objectors'  challenge.  A decision is
expected during 1999.

        The trilateral agreement was never appealed to the United States Supreme
Court and is final.  As a  result,  management  continues  to  believe  that the
uncertainty of the Company's exposure,  as reinsurer of Pacific Indemnity,  with
respect to  asbestos-related  bodily injury claims  against  Fibreboard has been
eliminated.

        Since 1993,  a California  Court of Appeal has agreed,  in response to a
request by Pacific Indemnity,  Continental Casualty and Fibreboard, to delay its
decisions  regarding   asbestos-related   insurance  coverage  issues  that  are
currently  before  it and  involve  the  three  parties  exclusively,  while the
approval of the global settlement is pending in court.  Continental Casualty and
Pacific  Indemnity  have  dismissed  disputes  against each other which involved
Fibreboard and were in litigation.

        The Company has additional  potential  asbestos  exposure,  primarily on
insureds for which excess  liability  coverages were written.  Such exposure has
increased  due to the erosion of much of the  underlying  limits.  The number of
claims  against  such  insureds  and the value of such claims have  increased in
recent years due in part to the non-viability of other defendants.

                                   PAGE F-16
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


9.  Outstanding losses and loss expenses (Cont'd)

        The  remaining  asbestos  exposures  are mostly  peripheral  defendants,
including a mix of  manufacturers  and  distributors  of certain  products  that
contain asbestos as well as premises owners. Generally, these insureds are named
defendants on a regional rather than a nationwide basis. Notices of new asbestos
claims and new  exposures  on  existing  claims  continue to be received as more
peripheral  parties are drawn into  litigation  to replace the now defunct mines
and bankrupt manufacturers.

        Hazardous waste sites are another significant potential exposure.  Under
the  federal  "Superfund"  law and  similar  state  statutes,  when  potentially
responsible parties (PRPs) fail to handle the clean-up, regulators have the work
done and then attempt to establish  legal  liability  against the PRPs. The PRPs
disposed of toxic materials at a waste dump site or transported the materials to
the site.  Insurance  policies  issued to PRPs  were not  intended  to cover the
clean-up  costs of  pollution  and, in many  cases,  did not intend to cover the
pollution   itself.   As  the  costs  of  environmental   clean-up  have  become
substantial, PRPs and others have increasingly filed claims with their insurance
carriers.  Litigation against insurers extends to issues of liability,  coverage
and other policy provisions.  There is great uncertainty  involved in estimating
the Company's liabilities related to these claims. First, the liabilities of the
claimants are extremely  difficult to estimate.  At any given clean-up site, the
allocation of  remediation  costs among  governmental  authorities  and the PRPs
varies greatly.  Second,  different courts have addressed liability and coverage
issues regarding pollution claims and have reached  inconsistent  conclusions in
their interpretation of several issues. These significant  uncertainties are not
likely to be resolved in the near future.

        Uncertainties  also remain as to the Superfund  law itself.  Superfund's
taxing  authority  expired on December 31, 1995. It is currently not possible to
predict the  direction  that any  reforms  may take,  when they may occur or the
effect that any changes may have on the insurance industry.

        Reserves for asbestos  and toxic waste claims  cannot be estimated  with
traditional loss reserving techniques that rely on historical accident year loss
development  factors.  Case  reserves and expense  reserves for costs of related
litigation have been established where sufficient information has been developed
to  indicate  the  involvement  of a specific  insurance  policy.  In  addition,
incurred but not reported  reserves have been  established  to cover  additional
exposures on both known and unasserted  claims.  These reserves are  continually
reviewed and updated.

                                   PAGE F-17
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

9.      Outstanding losses and loss expenses (Cont'd)

        A  reconciliation  of the beginning and ending liability for outstanding
losses and loss expenses, net of reinsurance  recoverable,  and a reconciliation
of the net  liability  to the  corresponding  liability  on a gross  basis is as
follows (in thousands):
<TABLE>
<S>                                                       <C>                     <C>                      <C>        

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

Gross liability, beginning of year                        $8,644,186              $8,020,224               $7,896,430
Reinsurance recoverable,
  beginning of year                                        2,578,451               3,126,676                2,992,274
                                                          ----------              ----------               ----------
Net liability, beginning of year                           6,065,735               4,893,548                4,904,156
                                                          ----------              ----------               ----------

Net incurred claims and claim
  expenses related to:
    Current year                                           2,403,351               2,167,893                1,678,276
    Prior years                                             (109,512)                (28,704)                  19,540
                                                          ----------              ----------               ----------
                                                           2,293,839               2,139,189                1,697,816
                                                          ----------              ----------               ----------

Net payments for claims and
  claim expenses related to:
    Current year                                             765,500                 640,581                  489,074
    Prior years                                            1,245,755                 326,421                1,219,350
                                                          ----------              ----------               ----------
                                                           2,011,255                 967,002                1,708,424
                                                          ----------              ----------               ----------
Net liability, end of year                                 6,348,319               6,065,735                4,893,548

Reinsurance recoverable,
  end of year                                              2,750,484               2,578,451                3,126,676
                                                          ----------              ----------               ----------

Gross liability, end of year                              $9,098,803              $8,644,186               $8,020,224
                                                          ==========              ==========               ==========
</TABLE>

                                   PAGE F-18
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS

9.      Outstanding losses and loss expenses (Cont'd)

        A reconciliation of the beginning and ending gross and net liability for
outstanding  losses and loss expenses related to asbestos and toxic waste claims
is as follows (in thousands):
<TABLE>
<S>                                                       <C>                     <C>                      <C>
                                                          1998                    1997                     1996
                                                          ----                    ----                     ----

Gross of Reinsurance:

Liability, beginning of year                              $1,172,751              $1,086,500               $1,437,764
Incurred losses and loss adjustment
  expenses                                                   103,251                 159,562                  219,231
Calendar year payments for losses
  and loss adjustment expenses                               119,264                  73,311                  570,495
                                                          ----------              ----------               ----------

Liability, end of year                                    $1,156,738              $1,172,751               $1,086,500
                                                          ==========              ==========               ==========


Net of reinsurance:

Liability, beginning of year                              $1,036,393              $  908,189               $1,289,883
Incurred losses and loss adjustment
  expenses                                                    87,909                 127,837                  153,614
Calendar year payments for losses
  and loss adjustment expenses                                98,426                    (367)                 535,308
                                                          ----------              ----------               ----------

Liability, end of year                                    $1,025,876              $1,036,393               $  908,189
                                                          ==========              ==========               ==========
</TABLE>
        During 1998, the Company  experienced  overall favorable  development of
$109,512,000 on outstanding losses and loss expenses, including unallocated loss
adjustment expenses, established as of the previous year-end. This compares with
favorable  development  of $28,704,000  in 1997 and  unfavorable  development of
$19,540,000  in 1996.  Such  development  was reflected in operating  results in
these  respective  years.  Each of the past three years benefited from favorable
claim severity trends for certain liability  classes;  this was offset each year
in varying  degrees by incurred  losses  relating  to  asbestos  and toxic waste
claims.

        Management believes that the aggregate outstanding loss and loss expense
reserves of the Company at December  31, 1998 were  adequate to cover claims for
losses  which  had  occurred,  including  both  those  known and those yet to be
reported.  In establishing such reserves,  management  considers facts currently
known and the present state of the law and coverage litigation.  However,  given
the  expansion of coverage and liability by the courts and the  legislatures  in
the  past  and the  possibilities  of  similar  interpretations  in the  future,
particularly  as they relate to asbestos and toxic waste claims,  as well as the
uncertainty in determining what scientific  standards will be deemed  acceptable
for  measuring  hazardous  waste site  clean-up,  additional  increases  in loss
reserves may emerge which would adversely affect results in future periods.  The
amount cannot reasonably be estimated at the present time.

                                   PAGE F-19
<PAGE>

                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS


10.  Dividend restrictions

        Indiana  Insurance  laws  restrict  the  Company  as to  the  amount  of
shareholder  dividends it may pay without prior approval.  The  restrictions are
generally based on net investment income and on statutory surplus.  Dividends in
excess of such  thresholds  are  considered  "extraordinary"  and require  prior
approval.  The  maximum  dividend  distribution  that may be made by the Company
during 1999 without prior approval is $592,123,000.

11.  Year 2000 Readiness Disclosure (Unaudited)

         The Year 2000 issue  relates to the  inability  of certain  information
technology  (IT) systems and  applications  as well as non-IT  systems,  such as
equipment  with imbedded  chips and  microprocessors,  to properly  process data
containing  dates  beginning  with the year 2000.  The issue exists because many
systems used two digits  rather than four to define the  applicable  year.  Such
systems may  recognize the date "00" as the year 1900 rather than the year 2000.
This could result in a system failure or miscalculations  causing disruptions of
normal business activities or other unforeseen problems.

      The Company has  performed an inventory  and  assessment  of its mainframe
systems to determine  which must be retired,  renovated or rewritten as a result
of Year 2000 issues. As of December 31, 1998, remediation and testing procedures
were  completed  on 95% of the  Company's  mainframe IT systems,  including  all
mission  critical  systems except one.  Management  expects the  remediation and
testing of all remaining systems to be completed by June 1999.

         The Company has also  completed an inventory and  assessment of all its
personal  computers,  servers  and  other  non-mainframe  computers.  Management
expects that all such computers and related  software will be Year 2000 ready by
the third  quarter of 1999.  The Company has also  assessed its non-IT  systems.
Management  believes that the failure of any of these systems would have minimal
impact on the Company's operations.

         The  Company  has  initiated  contact  with third  parties  that it has
interaction with regarding their plans for Year 2000 readiness.  The information
obtained  will be used to develop  business  contingency  plans to  address  any
mission critical  operations that may be adversely impacted by the noncompliance
of a third party with whom the Company interacts.

         The Company has identified those third parties that are critical to its
operations and is assessing risks with respect to the potential  failure of such
parties to be Year 2000 ready.  However,  the Company does not have control over
these third parties and management is unable to determine whether all such third
parties  will  address  the Year  2000  issue  successfully.  Management  cannot
determine the effect on the Company's future operating results of the failure of
third parties to be Year 2000 ready.

                                   PAGE F-20
<PAGE>


                            FEDERAL INSURANCE COMPANY

                          NOTES TO FINANCIAL STATEMENTS




11.     Year 2000 Readiness Disclosure (Unaudited)(Cont'd)

         The Company's Year 2000 plans have been developed with the intention of
minimizing  the need for actual  implementation  of  contingency  activities.  A
substantial  portion of 1999 will be used to monitor systems already  remediated
for  Year  2000  for  any  unidentified   problems  and  to  perform  additional
remediation and testing as necessary.  Additionally,  management is studying the
development of contingency plans to continue business in the unlikely event
that one of the Company's critical systems fails.

      Management  believes that the Company is taking the necessary  measures to
address  Year 2000 issues that may arise and that its  internal  systems will be
compliant.  Notwithstanding  such efforts,  significant Year 2000 problems could
arise.  Given  the  uncertain  nature  of Year  2000  problems  that may  arise,
management  cannot  determine at this time whether the consequences of Year 2000
related problems will have a material impact on the Company's financial position
or results of operations.

         An additional  concern is the potential  future impact of the Year 2000
issue on insurance  coverages  written by the Company.  The Year 2000 issue is a
risk for some of the Company's  insureds and needs to be  considered  during the
underwriting  process  similar to any other risk to which its  customers  may be
exposed.  It is  possible  that Year 2000  related  losses may emerge that would
adversely  affect the Company's  operating  results in future  periods.  At this
time, in the absence of any significant  claims  experience,  management  cannot
determine the nature and extent of any losses,  the availability of coverage for
such losses or the likelihood of significant claims.

                                   PAGE F-21