SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

              /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 1998

                                       OR

              / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                 For the transition period from ______ to ______

                        Commission File Number 001-13135

                                 HSB GROUP, INC.
             (Exact name of registrant as specified in its charter)

                             Connecticut 06-1475343
                (State or other jurisdiction of (I.R.S. Employer
               incorporation or organization) Identification No.)

                                  P.O. Box 5024
                                One State Street
                        Hartford, Connecticut 06102-5024
               (Address of principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (860) 722-1866

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


                                           Name of each exchange
Title of each class                        on which registered
-------------------                        --------------------
Common stock, without par value            New York Stock Exchange, Inc.
Rights to Purchase Depositary Receipts     New York Stock Exchange, Inc.

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

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

Yes...X...,  No.......

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

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant as of February 16, 1999 was $1,005,363,488.

Number  of  shares  of  common  stock  outstanding  as  of  February  16,  1999:
28,948,775.

Documents Incorporated by Reference:

Portions of the Proxy  Statement  dated March 5, 1999 for the Annual  Meeting of
Shareholders  to be held April 20, 1999 are  incorporated  by reference in Parts
III and IV herein.



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                                     PART I

Item 1.  Business.

A.     GENERAL DEVELOPMENT OF BUSINESS

     HSB  Group,  Inc.  (together  with  its  subsidiaries  referred  to as  the
"Company"  or "HSB"  hereinafter)  was  formed  under  the laws of the  State of
Connecticut  in 1997 to serve as the  holding  company  for The  Hartford  Steam
Boiler  Inspection  and Insurance  Company  (HSBIIC) and its  subsidiaries.  The
Hartford  Steam Boiler  Inspection  and  Insurance  Company was  chartered as an
insurance company by the Connecticut legislature in 1866.

    The Company's operations are divided into four reportable operating segments
- Commercial insurance, Global Special Risk insurance,  Engineering Services and
Investments. The most significant business of the Company is providing insurance
against losses from accidents to boilers,  pressure vessels,  and a wide variety
of mechanical and electrical  machinery and equipment along with a high level of
inspection and engineering  services aimed at loss  prevention.  Earned premiums
for the Company's  insurance  segments in the aggregate  were $396.1 million for
1998, which accounted for approximately 68.4 percent of the Company's  revenues.
See Note 10 to the Consolidated  Financial  Statements located in Item 8 of Part
II herein for  information on the Company's net written and net earned  premiums
over the last three years.

     The Company  conducts its business in Canada  through its  subsidiary,  The
Boiler Inspection and Insurance  Company of Canada.  Insurance for risks located
in  countries  other  than the  United  States  and  Canada  is  written  by HSB
Engineering Insurance Limited (HSB EIL). In December 1994, the Company purchased
the remaining 50% interest in HSB EIL's parent  company,  Engineering  Insurance
Group (EIG) from General Reinsurance Corporation.

     Effective  July 1, 1998,  HSBIIC  completed an  acquisition of the monoline
boiler and machinery  business and the ASME inspection  services,  which certify
boiler  and  pressure  vessel  compliance  with the codes and  standards  of the
American Society of Mechanical  Engineers,  of the Kemper  Insurance  Companies.
Kemper and HSBIIC also completed an agreement for HSBIIC to reinsure  boiler and
machinery coverage included as part of Kemper's commercial package policies.

     On January 6, 1998,  HSBIIC sold its 23.5 percent share in Industrial  Risk
Insurers (IRI) to Employers  Reinsurance  Corporation  (ERC), one of the world's
largest  reinsurance  companies,  in  accordance  with  a  previously  announced
purchase and sale agreement between ERC and IRI's twenty-three  member insurers.
IRI is a voluntary, unincorporated joint underwriting association which provides
property  insurance for the class of business known as "highly  protected risks"
(HPR) -- larger manufacturing,  processing,  and industrial businesses that have
invested in  protection  against  loss through the use of  sprinklers  and other
means.  Contemporaneous  with the close of the sale, IRI was reconstituted  with
ERC (with a 99.5 percent share) and HSBIIC (with a .5 percent share) as the sole
members.  HSBIIC writes the business for the  reconstituted  IRI 

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(which has been  renamed  HSB  Industrial  Risk  Insurers)  using its  insurance
licenses and provides  certain  other  management  and  technical  services.  In
addition,  through  various  reinsurance  agreements  with ERC and  IRI,  HSBIIC
transferred  its  manufacturing  book of  business to IRI and retains 85% of the
equipment  breakdown  insurance and 15% of the property insurance of the HSB/IRI
combined portfolio.  See "Participation in HSB Industrial Risk Insurers" on page
xx for additional information.

     To support the Company's  expanded role with HSB IRI, on December 31, 1997,
a  business  trust  formed  by HSB sold  $300  million  of  20-year,  7  percent
Convertible  Capital  Securities  in a private  placement  to ERC, of which $250
million was  contributed  by the Company to HSBIIC.  The capital  securities are
convertible into HSB common stock, at any time, subject to regulatory  approval.
See Note 13 to the Consolidated  Financial  Statements located in Item 8 of Part
II herein for more information on this transaction.

     The Company also offers  professional  scientific and technical  consulting
services  for  industry  and  government  on  a  world-wide  basis  through  its
Engineering Department and its engineering subsidiaries. In 1998 net engineering
services  revenues were $93.5 million,  which accounted for  approximately  16.1
percent of the Company's revenues.

     On January 2, 1998, the Company  exercised its option to put its 40 percent
share in Radian  International  LLC (Radian LLC) to The Dow Chemical Company for
approximately  $129 million,  net of expenses.  Radian LLC was formed in January
1996  as a  joint  venture  with  Dow  to  provide  environmental,  engineering,
information  technology,  remediation and strategic chemical management services
to industries and  governments  world-wide.  In connection with the formation of
the new company, the Company contributed  substantially all of the assets of its
wholly-owned subsidiary, Radian Corporation to Radian LLC. The results of Radian
LLC were classified as discontinued  operations  following  ratification in July
1997 by the Board of Directors of management's decision to exercise its put. The
Company's share of Radian LLC's losses  incurred  subsequent to such decision of
approximately  $6.6 million after-tax was deferred until the closing of the sale
on January 2, 1998, at which time an estimated  after-tax gain of $30.3 million,
net of  deferred  losses,  was  realized.  In 1996 and prior to July  1997,  the
Company's  share of the  joint  venture's  results  were  recorded  as equity in
Radian.

     Recently  the  Company  has  been  focusing  on   identifying   acquisition
candidates in the niche  engineering  management  consulting  service  business,
primarily  in  process  industries,  in order to grow the  engineering  services
segment of its  business.  The Company does not  currently  anticipate  that any
single  acquisition  within  the next  twelve  months  will be  material  to the
operations  or financial  position of the Company.  In April 1998,  HSB acquired
Solomon  Associates,  Inc. (SAI) based in Dallas,  Texas.  SAI is an engineering
management  consulting firm that provides comparative  performance  benchmarking
consulting to the refining,  petro-chemical and power generation industries. SAI
establishes  efficiency  and  productivity  benchmarks  for  80  percent  of the
world-wide  petroleum refining  industry.  During 1997 the Company completed the
acquisition of Haughton Engineering Services Limited of England. Haughton offers
a wide  range of  inspection  services  in the  United  Kingdom  to help  ensure
compliance  with  regulatory  codes.  During 1997 the 

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Company also acquired a 51 percent interest in Integrated  Process  Technologies
LLC,  a  provider  of  cost  control  strategies  and  management  services  for
businesses with geographically distributed locations.

     The  Company  is a  multi-national  company  operating  primarily  in North
American, European, and Asian markets. Currently, the Company's principal market
for its insurance and engineering  services is the United States.  However,  the
Company  does  desire  to  become a  stronger  competitor  in the  international
machinery  breakdown  insurance and related  engineering  services markets as it
believes that there is significant  opportunity for profitable  growth overseas.
In 1998 the revenues and pre-tax income  associated with  operations  outside of
the United States were approximately 15.2 percent and 3.3 percent, respectively.
Identifiable  assets associated with operations outside of the United States are
approximately 17.5 percent of the consolidated  amount. See Note 1 and Note 5 to
the Consolidated  Financial  Statements  located in Item 8 of Part II herein for
more financial data based on geographic location and business segments.


B.     PRODUCTS AND SERVICES

Insurance

     Equipment  breakdown  insurance  provides  for the  indemnification  of the
policyholder  for financial  loss  resulting  from  destruction  or damage to an
insured boiler,  pressure vessel, or other item of machinery or equipment caused
by an accident.  This  financial  loss can include the cost to repair or replace
the damaged equipment (property damage), and product spoilage,  lost profits and
expenses  to  avert  lost  profits  (business  interruption)  stemming  from  an
accident.

     The  Company   distinguishes  itself  from  other  insurance  suppliers  by
providing  a  high  level  of  loss  prevention,   failure  analysis  and  other
engineering  services with the insurance  product.  This heavy  emphasis on loss
prevention  historically has had the dual effect of increasing  underwriting and
inspection expenses, while reducing loss and loss adjustment expenses.

     An important  ancillary benefit for the policyholder is that the inspection
performed by the  Company's  inspector on a boiler,  pressure  vessel,  or other
piece of equipment,  as part of the insurance  process,  is normally accepted by
state and other  regulatory  jurisdictions  for  their  certification  purposes.
Without  a  certificate  of  inspection  by the  insurance  carrier  or  another
inspection agency, policyholders cannot legally operate many types of equipment.

     The  Company  also  writes  all risk  property  insurance  for  risks  with
significant  machinery  and  equipment  exposures,   in  addition  to  its  more
traditional  boiler and  machinery  products.  The all risk line is  marketed to
customers with equipment and machinery  exposures,  such as electric  utilities,
where  sophisticated  engineering  services are important to loss prevention and
control.  These  customers are offered  technical  services such as computerized
evaluations  of fire  protection  systems in  addition to fire  inspections  and
boiler and  

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machinery  inspections.  The Company also writes all risk coverage  specifically
tailored for data processing systems.

Engineering Services

     HSBIIC's Engineering Services division provides quality assurance services,
training  for  nondestructive  testing,  inspections  to code  standards  of the
American  Society of Mechanical  Engineers (ASME) and other  organizations,  ISO
certification  and  registration  services  and  other  specialized  consulting,
condition monitoring, benchmarking and inspection services related to the design
and applications of boilers, pressure vessels, and many other types of equipment
for domestic and foreign equipment manufacturers and their customers.  HSBIIC is
the  largest  Authorized  Inspection  Agency for ASME  codes in the  world.  The
Engineering  Services  division  also  offers  a  wide  array  of  training  and
educational  services  related  to  these  areas,  and in  addition  focuses  on
researching and developing potential new products and services,  and new markets
for current services.

    Aside from  HSBIIC,  the  Company's  engineering  subsidiaries  include  HSB
Reliability  Technologies  Corp. (HSB RT), HSB Professional  Loss Control,  Inc.
(HSB PLC), Solomon Associates,  Inc. (SAI) and HSB Haughton Engineering Services
Limited  (Haughton).  HSB  RT  maintains  an  extensive  database  on  equipment
maintenance  and  reliability  and provides  preventive  maintenance  consulting
services  and  programs  to a wide  range of  businesses  and  industries.  Such
services and programs are designed to increase  production,  reduce maintenance,
energy and spare parts inventory  costs, and extend equipment life. HSB PLC is a
fire  protection   consulting  and  engineering   firm.  Its  services   include
inspections,  hazards analysis and risk  assessment,  engineering  design,  code
consulting,  research and testing, and training.  SAI, Haughton,  and Integrated
Process  Technologies,  in which the  Company  holds a  majority  interest,  are
described on pages 3-4.

C.     COMPETITION

Insurance

     The Company is the largest writer of equipment breakdown insurance in North
America and is establishing a significant presence in the engineering  insurance
market outside of North America.  Based on net premiums  written reported in the
1998 edition of Best's Aggregates and Averages,  the Company has approximately a
40 percent  market share and no other single  company has more than a 10 percent
market share of the domestic equipment breakdown market.  Members of the Factory
Mutual  System,  an  affiliated  group of  insurers  which are in the process of
completing a merger, have a market share of approximately 18 percent.

     In general,  the  insurance  market is  influenced  by the total  insurance
capacity  available  based on  policyholder  surplus.  Over the last few  years,
global  capacity to accept  risk has grown as new  insurers  enter the  property
casualty  market and new  financial  products  have been  designed to securitize
catastrophe  risks.  In  addition  to  available  capacity,  competition  

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in the equipment breakdown insurance market is based on price and service to the
insured.  Service includes maintaining customer  relationships,  engineering and
loss  prevention  activities,  and claims  settlement.  The  Company  prices its
product  competitively in the marketplace,  but primarily competes by offering a
high level of service, not by offering the lowest-priced product.

     Competition in the equipment  breakdown  insurance  market,  as well as the
property/casualty market in general, has intensified in recent years as a result
of  continuing  restructuring  and  consolidation  in  the  insurance  industry.
However,  because the Company  primarily  underwrites risks which require unique
engineering  expertise and jurisdictionally  mandated  inspections,  the Company
believes that its products and services will continue to be competitive.

Engineering Services

     The Company provides a wide range of engineering, consulting and inspection
services as  described  on page 5. For most of these  services  it has  numerous
competitors,  some of whom are much larger and have greater financial  resources
than the Company.

     Competition  in these  areas is based on price  and on the  qualifications,
experience  and  availability  of the  individuals  who  perform  the work.  The
Company's force of inspectors,  engineers,  and technicians is spread throughout
the world.  Ongoing  training  programs  ensure that the  Company's  inspectors,
engineers,  and technicians  are kept  up-to-date on the latest  engineering and
technical developments.

D.     MARKETING

Insurance

     The Company's various functional operations are aligned to focus on its two
principal  customer  groups,  commercial  risks and global  special  risks.  The
Company  believes that this  organizational  structure  allows it to service its
customers more  effectively  and  efficiently  and at the same time to be a more
aggressive and flexible competitor.

     Currently, the Company's principal market for its insurance business is the
United  States.  In 1998,  87.4 percent of its net written  premiums  related to
risks located in the United States. Of the direct premiums written in the United
States in 1998 (gross premiums less return premiums and cancellations, excluding
reinsurance  assumed  and  before  deducting  reinsurance  ceded),  less than 10
percent was written in any one state. With the exception of California, Florida,
New York,  Pennsylvania and Texas, no state accounted for more than 5 percent of
such premiums.

     The Company has contracts with independent  insurance agencies in all fifty
states, the District of Columbia,  Puerto Rico and Canada. These agencies market
the  Company's  direct  insurance to its small and medium  commercial  accounts.
Personal contact with these 

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independent  insurance agents is accomplished  through the Company's field sales
force which  operates out of various  branch  offices  across the country and in
Canada. It is the Company's policy in appointing agents to be selective, seeking
to  maintain  and   strengthen  its  existing   relationships   and  to  develop
relationships with new agents whom the Company believes will become a continuing
source of  profitable  business.  The  Company  periodically  reviews its agency
contracts and selectively  reduces them in order to retain only those agents who
consistently produce certain minimum levels of business for the Company.

     Large, engineering-intensive U.S. and international accounts, most of which
comprise the Global Special Risk segment, are primarily marketed and serviced by
account teams comprised of underwriting, marketing, engineering and claims staff
who have specialized knowledge of particular customer industries. U.S. customers
are serviced  primarily by HSBIIC and HSB  Industrial  Risk  Insurers.  Canadian
customers are serviced by The Boiler Inspection and Insurance Company of Canada.
Overseas customers are serviced by HSB Engineering  Insurance Limited,  based in
London, with additional offices in Hong Kong,  Malaysia,  Australia,  Miami, New
York, Spain, Korea and South Africa.

     Additionally,  the  Company  markets  its  insurance  products  through the
distribution channels of the companies which it reinsures.

    HSB Industrial Risk Insurers markets its products  primarily through a small
number of large international brokerage firms. A portion of the Company's Global
Special Risk business is also produced through these brokers.

     Recently  there has been  significant  consolidation  in the  international
brokerage  business,  including  the  merger of Marsh & McLennan  and  Johnson &
Higgins during 1997, and the subsequent  merger with Sedgwick  Group.  For 1998,
approximately 35 percent of the Company's gross written premium generated by its
Global Special Risk business  which  includes HSB  Industrial  Risk Insurers was
produced  by J&H Marsh &  McLennan  and  Sedgwick  Group and 11.35  percent  was
produced by Aon Corporation.

     No other  insured  or  broker  accounts  for more  than 10  percent  of the
consolidated total revenues of the Company.

Engineering Services

     The  Company's  engineering  services  are  marketed  in a variety of ways.
Customized services related to loss prevention,  failure analysis, and equipment
testing are generally  sold in conjunction  with the insurance  contract but are
also available separately. Most other engineering services are marketed on a bid
or proposal basis. While such business is usually price sensitive,  the exacting
standards  and  requirements  set by  industry  and  government  for most of the
services offered by the Company tend to diminish that effect.

     Engineering  services  are  marketed  and  serviced  primarily by personnel
located in the Company's various domestic and international offices.

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     While the primary market for engineering services continues to be the U.S.,
the Company has been focusing on expanding its international business, primarily
in Europe,  the Pacific Rim and certain countries in South America as demand for
engineering  services is  expected to grow at a faster rate in these  developing
regions than in the U.S.

     No engineering  services  customer accounts for more than 10 percent of the
Company's consolidated total revenues.

E.     REGULATION

Insurance

     The Company's  domestic insurance  subsidiaries'  operations are subject to
regulation  throughout  the United  States.  Various  aspects  of the  insurance
operations are regulated,  including the type and amount of business that can be
written, the price that can be charged for particular forms of coverage,  policy
forms,  trade and claim settlement  practices,  reserve  requirements and agency
appointments.  Regulations  also  extend to the form and  content  of  financial
statements filed with such regulatory authorities, the type and concentration of
permitted  investments  for insurers,  and the extent and nature of transactions
between  members of a holding  company  system,  including  dividends  involving
insurers.  In general,  such  transactions must be on fair and reasonable terms,
and in some cases, prior regulatory approval is required.

     The nature and extent of regulations pertaining to the business the Company
writes  outside  of the U.S.  varies  considerably.  Regulations  cover  various
financial and  operational  areas,  including such matters as amount and type of
reserves,  currency,  policy  language,  repatriation  of assets and  compulsory
cessions of reinsurance.

     The  National  Association  of Insurance  Commissioners  (NAIC) has adopted
risk-based  capital  (RBC)  requirements  applicable  to property  and  casualty
insurers.  The RBC formula establishes a required statutory surplus level for an
insurer  based  on the  risks  inherent  in its  overall  operations  which  are
identified  as  underwriting   risk,   invested  asset  risk,  credit  risk  and
off-balance  sheet risk. The law provides for regulatory  responses ranging from
requiring a plan of corrective  action to placing the insurer  under  regulatory
control for insurers whose surplus is below the prescribed RBC target.  HSBIIC's
adjusted  capital  significantly  exceeded the authorized  control level RBC for
1998.

     NAIC Insurance Regulatory  Information System (IRIS) ratios are part of the
solvency  impairment  early warning  system of the NAIC.  They consist of twelve
categories of financial data with defined acceptable ranges for each.  Companies
with ratios outside of the  acceptable  ranges are selected for closer review by
regulators. HSBIIC's IRIS ratios were within acceptable ranges for 1998.

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     The Company's insurance subsidiaries' operations are subject to examination
by  insurance  regulators  at regular  intervals.  The most  recently  concluded
insurance  examination  for HSBIIC was conducted for the year ended December 31,
1994 by the Connecticut Insurance  Department,  the HSBIIC's domestic regulator.
No material  findings were included in the final report of the examination.  The
years  1995-1998 are currently under  examination by the  Connecticut  Insurance
Department.  Similar  regulatory  procedures govern the Company's other U.S. and
foreign insurance subsidiaries.

     Insurance  guaranty fund laws exist in all states which subject insurers to
assessments  up to  prescribed  limits  for  certain  obligations  of  insolvent
insurers to their  policyholders  and  claimants.  The Company is  permitted  to
recover a portion of these  assessments  through  premium tax offsets and policy
surcharges.

     See Note 6 to the Consolidated  Financial  Statements  located in Item 8 of
Part II herein for additional information on statutory reporting.

     As discussed earlier,  the Company's  insureds receive,  in addition to the
insurance product,  inspections which meet state, county or municipally mandated
requirements.  In order for the Company's  inspectors to perform these  mandated
inspections,  they  must be  commissioned.  Commissioning  is  conducted  by the
National  Board of Boiler and Pressure  Vessel  Inspectors and the various state
jurisdictional  authorities.  The  majority  of  the  Company's  inspectors  are
commissioned,  and the  Company  believes  that  it has an  adequate  number  of
commissioned inspectors to conduct its business affairs.

Engineering Services

     A  portion  of  the  Company's  engineering  services  revenue  comes  from
certifying that boilers and pressure vessels are being constructed  according to
standards adopted by the American Society of Mechanical  Engineers  (ASME).  The
commission  that authorizes  inspectors to conduct  insurance  inspections  also
authorizes  them to perform ASME Code  inspections.  The Company  performs other
certification  and  inspection   services  which  are  governed  by  established
standards, such as ISO 9000.

Other

     The Company and members of its professional and technical staff are subject
to a variety of other state, local and foreign licensing and permit requirements
and other laws generally applicable to corporations and businesses.

F.     INSURANCE OPERATIONS

Policies

     Pricing for the  Company's  insurance  policies is based upon the rates the
Company has developed for use with its various products.  In many  jurisdictions
in which the Company  

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does  business,  such rates,  as well as the policy  forms  themselves,  must be
approved by the  jurisdiction's  insurance  regulator.  Rates for the  Company's
products are developed based upon estimated claim costs, expenses related to the
acquisition  and  servicing of the business,  engineering  expenses and a profit
component.

     Coverages  for  unique  risks  are  judgment-rated,   taking  into  account
deductibles,  the  condition of the insured's  equipment,  loss  prevention  and
maintenance programs of the insured, and other factors.

     Policies are normally written for a term of one year. Most of the Company's
policies  provide  coverage for property  damage and  business  interruption  to
insured  property  (including  buildings and structures  under the Company's all
risk policy) resulting from covered perils. Property insured under the Company's
equipment breakdown policies includes such equipment as steam boilers, hot water
boilers,  pressure vessels,  refrigerating and air conditioning systems, motors,
generators,  compressors,  pumps,  engines,  fans, blowers, gear sets, turbines,
transformers, electrical switch gear, data processing and business equipment and
a wide variety of production and processing equipment.

     The Company's policy with respect to the business it underwrites (exclusive
of its participation in HSB Industrial Risk Insurers) is to generally manage its
risks to probable maximum losses (PMLs) not in excess of $50 million and maximum
foreseeable  losses (MFLs) not in excess of $100 million.  The Company's current
reinsurance  program generally limits the Company's retention on any one loss to
$3 million,  with potentially higher per risk retentions  dependent on aggregate
losses   experienced  by  the  Company  during  the  reinsurance   period.   See
"Participation in HSB Industrial Risk Insurers" on page 12 below for information
on the underwriting policy of HSB Industrial Risk Insurers.

Reinsurance Assumed

     The  predominant  practice in the insurance  industry is to combine several
types of insurance  coverages into one policy  referred to as a package  policy.
The  Company  has  reinsurance  agreements  with over 100  multi-line  insurance
companies to reach the small to mid-sized  customers  that purchase such package
policies.  This business  primarily  focuses on small and  mid-sized  commercial
customers  and it offers a  significant  opportunity  for growth by the  Company
because,  based on  Company  estimates,  equipment  breakdown  coverage  is only
provided  currently  to less  than 10  percent  of the over 10  million  insured
companies and institutions in the United States.

     Under the reinsurance  agreements,  the Company's  reinsured  companies may
include equipment  breakdown exposures in their multi-peril  policies,  and such
risks will be assumed by the Company  under the terms of the  agreements.  These
plans generally  provide that the Company will assume 100 percent of each boiler
and machinery risk, subject to the capacity specified in the agreement, and will
receive the entire equipment  breakdown  premium except for a ceding  commission
which will be retained by the reinsured  company for  commissions  to agents and
brokers, premium taxes and handling expenses.

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     Although the Company  assumes the role of  reinsurer,  it continues to have
selling and underwriting  responsibilities  as well as involvement in inspecting
and claims  adjusting.  In effect,  the Company becomes the equipment  breakdown
insurance  department of the reinsured company and provides equipment  breakdown
underwriting  (that is, the  examination and evaluation of the risk based on its
engineering  judgments),  claims and engineering  services as if it were part of
that  organization.  Traditionally,  as part of the  underwriting  process,  the
Company retains the right to decline or restrict  coverage in the same manner as
it does for its own  business.  In 1996 the Company  began to write a simplified
program  (referred to as  ReSource)  under which a reinsured  company  agrees to
include  equipment  breakdown  insurance  on a  portfolio  of  accounts  meeting
specific  underwriting  guidelines and occupancy  parameters,  which the Company
agrees to reinsure for equipment breakdown losses.

     The  insurance  industry,  in general,  continues to undergo a  significant
shakeout  and  consolidation.  A  significant  amount of merger and  acquisition
activity has occurred recently and may continue in the future.  Depending on the
specific  companies  involved in these activities and other market factors,  the
level of  reinsured  business  the  Company  assumes  in the  future  under  the
arrangements described above could be impacted.

     The Company also assumes reinsurance, primarily on a facultative basis, for
certain large risks and several insurance pools.

     The written premium  generated through  reinsurance  assumed totaled $318.5
million in 1998, representing  approximately 40.0 percent of the Company's gross
written premium.

Reinsurance Ceded

     As a property carrier, the Company is subject to losses that may arise from
catastrophic  events.  The Company  participates in various  facultative,  quota
share  and  excess  of  loss  reinsurance  agreements  to  limit  its  exposure,
particularly  to  catastrophic  losses  and  high  risk  lines,  and to  provide
additional  capacity to write business.  The Company evaluates its exposures and
reinsurance  needs  annually to  implement a program that  corresponds  with the
level of exposure it is willing to retain.  Under the Company's  current  treaty
reinsurance  program,  its  maximum  retention  on any one risk is limited to $3
million,  with  potentially  higher per risk  retentions  depending on aggregate
losses  experienced by the Company during the  reinsurance  program  period.  In
addition,  the Company uses  facultative  reinsurance  on certain high  exposure
risks and has catastrophe  reinsurance for aggregate net losses greater than $15
million.

     The Company's  reinsurance  costs continue to be impacted by its prior loss
experience and business growth.  In 1998 the Company's ceded premiums  increased
by 217.1 percent  primarily due to the quota share  reinsurance  agreements with
Employers  Reinsurance   Corporation  and  HSB  Industrial  Risk  Insurers  (see
"Participation  in HSB Industrial 

                                       11
<PAGE>

Risk Insurers"  below) and changes in the Company's  reinsurance  programs which
now utilize more quota share reinsurance on certain of its books of business.

     The  Company   utilizes   well-capitalized   domestic   and   international
reinsurance  companies and syndicates for its  reinsurance  program and monitors
their  financial  condition on an ongoing  basis.  For  reinsurers  that are not
accredited  in their state of  domicile,  the Company  requires  collateral  for
reinsurance  recoverable  from such  carriers.  In the  unlikely  event that the
Company's  reinsurers  are unable to meet their  obligations,  the Company would
continue  to have  primary  liability  to  policyholders  for  losses  incurred.
Uncollectible  reinsurance  recoverables  have not had,  and are not expected by
management to have in the future,  a material adverse effect on the consolidated
results of operations or financial  position of the Company.  The Company is not
party to any contracts  that do not comply with the risk transfer  provisions of
SFAS 113  "Accounting  and  Reporting  for  Reinsurance  of  Short-Duration  and
Long-Duration Contracts".

     For  additional  information  on  reinsurance,  see  Notes 10 and 11 to the
Consolidated Financial Statements located in Item 8 of Part II herein.

Pools and Joint Underwriting Associations

     With the exception of HSB  Industrial  Risk Insurers as described on page 2
and discussed below, the Company does not participate to any significant  degree
in voluntary  reinsurance pools of other insurance companies because the Company
generally  chooses to insure only those risks which it has  inspected or has the
right to  inspect.  The  Company is required  to  participate  in certain  joint
underwriting  associations  which provide  insurance for  particular  classes of
insureds when insurance in the voluntary market is unavailable.

Participation in HSB Industrial Risk Insurers

     HSB  Industrial  Risk  Insurers (HSB IRI) is an  unincorporated,  voluntary
joint underwriting association that provides property insurance for the class of
business known as "highly protected risks" for larger manufacturing,  processing
and industrial businesses which have invested in protection against loss through
the use of sprinklers and other means. As a result of the  reconstitution of HSB
IRI effective January 1, 1998 (see "A. GENERAL  DEVELOPMENT OF BUSINESS" above),
HSBIIC  writes  the  insurance  for HSB IRI using  its  insurance  licenses  and
provides  certain  other  services.  In addition,  through  various  quota share
reinsurance  agreements  with  Employers  Reinsurance  Corporation  and HSB IRI,
HSBIIC  transferred its manufacturing book of business to HSB IRI and retains 85
percent of the  equipment  breakdown  insurance  and 15 percent of the  property
insurance of the combined insurance portfolio.

     From  December  1,  1996  until the  close of the sale of its  interest  in
Industrial Risk Insurers to ERC, HSBIIC's  membership interest was 23.5 percent.
In  1996  and  1995  its  membership  share  was  14  percent  and  .5  percent,
respectively.  The Company increased its share  significantly over this two-year
period  because  it  believed  that  participation  in the  IRI  represented  an
opportunity to 

                                       12
<PAGE>

apply the Company's  underwriting,  engineering and reinsurance  skill sets to a
large block of business and to potentially  provide a quick  turnaround of IRI's
underwriting  results with only a limited  capital outlay of Company funds.  The
Company's increased share enabled the Company to have a more significant role in
helping  IRI be an  effective  and  profitable  provider of  essential  property
insurance and loss prevention  services to larger risks. The new agreements with
ERC and HSB IRI continue this  opportunity to utilize the Company's skills while
at the same time reducing its exposure to the more volatile property business.

     The  agreements  with ERC are of indefinite  duration and are terminable in
the event of the insolvency or loss of accredited  reinsurer or licensed insurer
status of ERC or HSBIIC,  or a material  breach  which has not been cured within
the time frame specified in the agreements, or by mutual consent of the parties.
In addition,  ERC has an option to purchase HSBIIC's interest in the business in
the event of a 50 percent or more change in control of HSB.  Net earned  premium
attributable  to the agreements  with ERC and HSB IRI, prior to the placement of
reinsurance by the Company for its own account,  was 15 percent of the Company's
total consolidated  revenues for 1998. Ceding commissions,  which are netted out
of expenses, were 10 percent of consolidated revenues for 1998.

         HSB  IRI's  underwriting  policy is to  manage  its  risks to  probable
maximum losses (PML) not to exceed $150 million and maximum  foreseeable  losses
(MFL) not to exceed $400 million.  The equipment  breakdown PMLs and MFLs within
the overall  property  coverage  underwritten by HSB IRI do not generally exceed
$50 million  and $100  million,  respectively.  HSBIIC's  primary  participation
effective  January 1, 1998 as described  above is attributable to the 85 percent
share of the equipment  breakdown  insurance  written  through HSB IRI. Based on
HSBIIC's  current  participation  in  HSB  IRI's  business,  were  an  equipment
breakdown MFL to take place, the Company's  proportionate  share, net of HSB IRI
and HSBIIC reinsurance, would be no more than $3 million.

Claims and Claim Adjustment

     Essentially  all claims  under the  Company's  policies  of  insurance  are
handled by the  Company's  own claims  handlers.  Management  believes  that the
Company's  handlers  are  better  able  to  make  the  connection  between  loss
prevention and loss control.  The Company employs claims handlers in its various
offices  throughout the country,  Canada and the U.K. Claims  handlers,  in many
cases, are assigned to particular  customer groups in order to apply specialized
industry  knowledge to the adjustment of claims.  Policies  underwritten  by the
Company  pursuant  to the  agreements  with  Employers  Reinsurance  Corporation
relating  to the  business  of HSB IRI  described  under  "Participation  in HSB
Industrial  Risk  Insurers" on page 12 are adjusted by Company and HSB IRI staff
claims handlers as determined by the Company in accordance with such agreements.

     Claims  and  adjustment  expense  reserves  comprise  one  of  the  largest
liabilities of the Company.  Reserves are  established  to reflect  estimates of
total losses and loss  adjustment  expenses  that will  ultimately be paid under
direct  and  assumed  insurance  contracts.  Loss  reserves  include  claims and
adjustment  expenses on claims that have been reported but not 

                                       13
<PAGE>

settled and those that have been  incurred  but not yet  reported.  Loss reserve
estimates  reflect such  variables as past loss  experience  and  inflation.  In
addition,  due to the  nature  of much  of the  coverages,  complex  engineering
judgments are involved.  Subjective  judgments are an integral  component of the
loss reserving process, due to the nature of the variables involved.  Previously
established loss reserves are regularly adjusted as loss experience develops and
new  information  becomes  available.   Adjustments  to  previously  established
reserves are  reflected in the  financial  statements in the period in which the
estimates are changed.

     The normal  turnaround time in paying small claims is less than six months.
The vast  majority  of claims  are  settled  within one year and very few remain
unsettled  two years after the loss occurs.  This pattern is somewhat  skewed in
terms of claim  dollars (as noted in the schedule on pages 17 - 18) as it is the
larger   claims   that  often   take   longer  to   adjust.   Compared   to  the
property/casualty industry as a whole, the Company has a very "short-tail".  The
Company's  claims  expenses  are  based on  estimates  of the  current  costs of
replacing  productive   capacity.   The  Company  does  not  employ  discounting
techniques in establishing liabilities for claims and claim adjustment expenses.

     For those relatively few claims involving litigation, the Company uses both
its in-house law department and outside counsel, depending on the issues, costs,
and staffing requirements.

    The following  table provides a  reconciliation  of the beginning and ending
reserves  for net  claims  and claim  adjustment  expenses  for the years  ended
December 31, 1998, 1997 and 1996.

                       RECONCILIATION OF NET LIABILITY FOR
                      CLAIMS AND CLAIM ADJUSTMENT EXPENSES


                                                  1998       1997     1996
                                               ---------- ---------- ----------
                                                        (in millions)
Net liability for claims and
 adjustment expenses at January 1,               $190.8     $177.8   $145.5

Plus:
 Provision for claims and adjustment
  expenses occurring in the current year          164.0      209.5    214.2

 Increase (decrease) in estimated claims and        
  adjustment expenses arising in prior years       10.9        8.4     (9.8)
                                                --------------------------------
                                                  
Total incurred claims and adjustment expenses     174.9      217.9    204.4
                                                --------------------------------

Less:
 Payment for claims arising in:
  Current year                                     84.2       82.3     91.4
 Prior years                                      111.8      122.6     80.7
                                                --------------------------------
                                                  
Total payments                                    196.0      204.9    172.1
                                                --------------------------------

Net liability for claims and adjustment          
expenses at December 31,                         $169.7     $190.8   $177.8
                                                --------------------------------

                                       14
<PAGE>


     The 1998 loss ratio was 44.2  percent  compared  to 44.4  percent  and 45.6
percent for 1997 and 1996, respectively. Results for the 1998 year were impacted
by severe ice storms that affected 30 percent of Canada in January, as well as a
few significant losses in the Company's  international business. The 1.2 percent
decrease in loss ratio in 1997 was primarily the result of fewer weather-related
losses. Adverse development in 1998 and 1997 added 2.8 and 1.7 percentage points
to the  respective  loss ratio.  Positive  development  in 1996 reduced the loss
ratio by 2.2 percentage points.

     The  following  table shows a  reconciliation  of the net  liability to the
gross  liability for claims and claim  adjustment  expenses based on reinsurance
recoverable on unpaid losses.

               RECONCILIATION OF NET LIABILITY TO GROSS LIABILITY
                    FOR CLAIMS AND CLAIM ADJUSTMENT EXPENSES

                                                 1998      1997        1996
                                               ---------------------------------
                                                         (in millions)

Net liability for claims and
 adjustment expenses at December 31,           $169.7     $190.8     $177.8

Reinsurance recoverable on unpaid claims
 and adjustment expenses                        380.6       85.9      125.1
                                            ------------------------------------

Gross liability for claims and
 adjustment expenses at December 31,           $550.3     $276.7     $302.9
                                            ====================================




                                       15
<PAGE>




                RECONCILIATION OF GROSS LIABILITY FOR CLAIMS AND
                            CLAIM ADJUSTMENT EXPENSES

                                                     1998     1997      1996
--------------------------------------------------------------------------------
                                                           (in millions)
Gross liability for claims and 
 claim adjustment expenses at January 1,           $276.7     $302.9    $190.9

Plus:
 Provision for claims and claim adjustment 
  expenses occurring in the current year            564.8      263.3     313.3

 Increase in estimated claims and claim 
  adjustment expenses arising in prior years         46.9       (0.2)     16.1
                                                -------------------------------
 Total incurred claims and claim 
  adjustment expenses                              $611.7     $263.1    $329.4
                                                -------------------------------

Less:
Payment for claims arising in:
 Current year                                       141.0       90.6     103.3
 Prior years                                        197.1      198.7     114.1
                                                -------------------------------

 Total payments                                    $338.1     $289.3    $217.4
                                                -------------------------------

Gross liability for claims and claim 
adjustment expenses at December 31,                $550.3     $276.7    $302.9
--------------------------------------------------------------------------------

     The claim and claim expense  reserve  runoff table on the  following  pages
shows the amounts of the net  liability for 1988 through 1998 and the amounts of
the gross  liability for 1993 through 1998. The ten-year  development  table for
gross  liabilities  is being  constructed  progressively,  with 1993 as the base
year.  Within the tables for net and gross  liabilities,  each column  shows the
reserve  established at each calendar  year-end as well as cumulative totals for
claims payments and re-estimated liabilities for both that accident year and all
previous  years that  combined  make up that year-end  reserve.  The  redundancy
(deficiency) shown on a gross and net basis is a cumulative number for that year
and all previous years.

     The net  deficiencies  in  1990,  1991 and 1992  were  attributable  to the
settlement of certain large losses for which the Company initially determined it
would not have  liability,  the settlement of some  outstanding  claims for more
than was originally  anticipated,  unusually late notice of loss provided by the
insured for several large losses,  and reserves  established for losses on which
the coverage was being contested.

     The  redundancy  shown  for  1988  was  attributed  to  the  difficulty  in
estimating claims due to inflationary impacts and business  interruption,  which
became a larger component of 

                                       16
<PAGE>

claims.  The claim reserves  established  in 1988 have been  favorably  settled,
adjusted  or  closed  based on the  results  of  claim  audits,  technical  loss
analysis,  subrogation,   settlement  with  property  carriers  and  the  latest
available  information.  The net impact of those  favorable  settlements  was to
decrease  claims expenses as reported by $10.2 million in 1990 and $28.0 million
in 1989.



<PAGE>


             RECONCILIATION OF BEGINNING AND ENDING CLAIMS RESERVES
                   AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES)
                                  (in millions)

                         Net Reserves
<TABLE>
<CAPTION>
YEAR ENDED               1988      1989     1990     1991      1992      1993      1994       1995      1996       1997       1998
----------               ----      ----     ----     ----      ----      ----      ----       ----      ----       ----       ----
<S>                     <C>       <C>      <C>      <C>       <C>       <C>       <C>        <C>       <C>        <C>        <C>

Net Liability for 
 Unpaid Claims and       
 Claim Adjustment 
 Expenses               $157.4    $139.6   $115.7   $111.4    $132.8    $171.3    $161.3     $145.5    $177.8     $190.8     $169.7

Cumulative Amount Paid 
 as of:
End of Year                -         -        -        -         -         -         -          -         -          -          -
One Year Later            78.8      85.6     86.7     91.2      99.7      108.8    111.7       80.6     122.6      111.8        -
Two Years Later           92.1     104.2    109.7    115.5     134.0      152.1    126.9       99.8     146.3        -          -
Three Years Later         95.5     110.3    120.6    127.0     154.4      153.4    134.5      112.1       -          -          -
Four Years Later          95.4     112.5    127.6    137.7     151.1      157.8    144.1        -         -          -          -
Five Years Later          93.6     118.9    132.7    135.7     151.6      166.1      -          -         -          -          -
Six Years Later          100.5     123.0    131.4    135.7     160.0       -         -          -         -          -          -
Seven Years Later        101.5     121.4    130.9    136.7       -         -         -          -         -          -          -
Eight Years Later        100.1     120.8    131.6      -         -         -         -          -         -          -          -
Nine Years Later         100.2     121.5      -        -         -         -         -          -         -          -          -
Ten Years Later          100.4       -        -        -         -         -         -          -         -          -          -

Net Liability 
 Reestimated as of:
End of Year              157.4     139.6    115.7    111.4     132.8     171.3     161.3      145.5     177.8      190.8      169.7
One Year Later           129.4     129.4    135.4    137.5     159.7     172.7     163.9      135.7     186.2      201.7        -
Two Years Later          108.7     127.4    138.0    139.7     166.6     173.9     157.3      128.8     187.5        -          -
Three Years Later        106.8     127.8    136.9    141.1     165.2     170.6     154.2      131.2       -          -          -
Four Years Later         103.0     125.0    137.9    142.0     163.0     169.2     155.3        -         -          -          -
Five Years Later         102.3     125.8    135.7    141.4     161.5     168.0       -          -                    -          -
Six Years Later          104.0     125.5    136.0    141.3     163.4       -         -          -         -          -          -
Seven Years Later        103.8     125.8    135.8    139.6       -         -         -          -         -          -          -
Eight Years Later        104.2     125.5    134.5      -         -         -         -          -         -          -          -
Nine Years Later         104.7     124.2      -        -         -         -         -          -         -          -          -
Ten Years Later          103.0       -        -        -         -         -         -          -         -          -          -

Cumulative Redundancy
(Deficiency)              54.3     15.4    (18.7)   (28.3)    (30.6)       3.4    6.1       14.3      (9.6)     (10.9)          -
</TABLE>


The above  table and the  following  table  include  information  related to the
Company's  participation  in HSB IRI.  For  1998,  incurred  claims  and  claims
adjustment expenses include $14.4 million related to the Company's participation
in HSB IRI effective  January 1, 1998 plus  development  of $.4 relating to 1997
and prior  accident  years.  For 1997,  incurred  claims and  claims  adjustment
expenses   include  $31.6  million   related  to  the  Company's   23.5  percent
participation  in IRI  effective  December  1,  1996 plus  development  of ($1.3
million) relating to prior accident years. For 1996,  incurred claims and claims
adjustment  expenses  include $23.2 million  related to the Company's 14 percent
participation  in IRI  effective  December  1, 1995,  plus  development  of ($.4
million)  relating to prior accident years.  The Company carried net reserves in
the amounts of $20.6,  $22.2, and $11.6 million related to its  participation in
HSB  IRI at  December  31,  1998  and in IRI at  December  31,  1997  and  1996,
respectively.



                                       17
<PAGE>




                                                               Gross Reserves
<TABLE>
<CAPTION>
YEAR ENDED                                                         1993       1994       1995        1996       1997         1998
----------                                                         ----       ----       ----        ----       ----         ----
<S>                                                              <C>        <C>        <C>         <C>        <C>          <C>

Gross Liability for
 Unpaid Claims and Claim
 Adjustment Expenses                                             $214.4     $199.4     $190.9      $302.9     $276.7       $550.3

Cumulative Amount Paid as of:
End of Year                                                         -          -          -           -          -            -
One Year Later                                                    144.2      135.2      108.9       198.8      197.1          -
Two Years Later                                                   189.9      164.1      158.0       284.2        -            -
Three Years Later                                                 200.2      201.1      212.4         -          -            -
Four Years Later                                                  229.8      251.7        -           -          -            -
Five Years Later                                                  277.0        -          -           -          -            -
Gross Liability Reestimated as of:
End of year                                                       214.4      199.4      190.9       302.9      276.7        550.3
One Year Later                                                    224.3      212.0      205.5       302.7      323.5          -
Two Years Later                                                   227.0      228.3      194.6       339.8        -            -
Three Years Later                                                 243.4      226.8      234.6         -          -            -
Four Years Later                                                  245.0      264.8        -           -          -            -
Five Years Later                                                  281.4        -          -           -          -            -
Cumulative Redundancy
(Deficiency)                                                      (67.0)     (65.3)     (43.7)      (36.9)     (46.9)         -

</TABLE>

The adverse  development  primarily resulted from the decision rendered under an
arbitration  proceeding  for a claim  occurring in 1992 and from adverse  claims
experience  in  international  operations  primarily  occurring in accident year
1997.

G.     INVESTMENTS

     Income from the Company's investment portfolio contributes significantly to
earnings.  Each year there is a significant  net inflow of cash from  insurance,
engineering  services and investment  operations  into the Company's  investment
portfolio.  In addition,  cash flow is affected by the normal  maturity of fixed
income  investments,  financing  activities  and the purchase and sale of equity
securities.

<TABLE>
<CAPTION>
                                                     (in millions)
                                            1998      1997       1996      1995       1994
                                          -------- -----------------------------------------
<S>                                       <C>       <C>        <C>        <C>       <C>    

Net Investment Income                     $ 64.2    $ 36.8     $ 32.3     $ 28.9    $  26.2
Realized Investment Gains                   25.4      14.1       12.1        2.8        8.7
                                          -------- --------- -------------------------------

    Income from Investment Operations     $ 89.6    $ 50.9     $ 44.4     $ 31.7    $  34.9


Net Unrealized Gains                      $113.1    $ 95.3     $ 81.4     $ 65.4    $  16.5

Statutory Surplus  (HSBIIC)               $612.6    $550.8     $292.4     $280.6     $238.0
</TABLE>
 
     The  Company's  strategy  continues  to be to maximize  total return on the
investment  portfolio  through  investment  income  and  capital   appreciation.
Investment  strategies  for any given year are  developed  based on many factors
including  operational  results,  tax  implications,   regulatory  requirements,
interest  rates,   dividends  to  stockholders   and  market   conditions.   The
fluctuations  in income from  investment  operations from 1994 through 1997 were
largely driven by the amount of realized gains  generated in each of such years.
In 1994 the stock market  experienced a significant  decline which impacted both
the Company's  realized and unrealized  gains. In 1995 the Company curtailed its
realized gains in order to 

                                       18
<PAGE>

take advantage of a strongly  performing market and to build statutory  surplus.
In 1996  the  Company  continued  to  build  statutory  surplus,  however,  high
valuations  towards  the end of the year  caused the  Company to realize  gains.
Realized investment gains increased in 1997 over 1996 as the Company managed its
portfolio   to  respond  to  changing   market   conditions   and  tax  planning
opportunities,  and as a  result  of  calls  of  fixed  income  and  convertible
securities.  Realized  investment gains in 1998 were  significantly  impacted by
call  premiums  on fixed  income  instruments  and sales of certain  convertible
securities and common stocks in response to market conditions.

     Net investment income reached its lowest level during 1994 as a result of a
lower average investment portfolio as holdings were liquidated to pay dividends,
repay debt, and purchase fixed assets and treasury  stock.  The increase in 1995
resulted from the full consolidation of EIG, Co. offset by a lower interest rate
environment.  Net  investment  income  increased  11.8 percent in 1996 due to an
increased  level  of  investable  assets  and to a  lesser  extent  by  dividend
increases on the Company's common stock  investments.  Net investment income for
1997 increased 13.9 percent  compared to 1996. The increase is  attributable  to
calls of high yielding  preferred stocks early in the year the proceeds of which
were  invested in fully taxable  securities,  and more  investable  funds as the
Company invested the proceeds from its capital  securities  issued in the second
half of 1997. In 1998 net investment  income increased  significantly due to the
investment of the capital securities proceeds and from the January 1998 sales of
the Company's interests in IRI and Radian International LLC.

     The significant  increase in statutory  surplus of HSBIIC for 1997 resulted
from a  contribution  to capital of $250 million of the $300 million in proceeds
received by the Company from the sale of its convertible  capital  securities to
Employers Reinsurance  Corporation on December 31, 1997. The increase in surplus
for 1998 resulted  from the January 1998 sales of HSBIIC's  interests in IRI and
Radian International LLC.

     The Company's  investment  portfolio  consists of  high-grade  domestic and
foreign  investments.  Excluding short-term  investments,  HSB's investments are
primarily  comprised of publicly traded,  highly liquid  securities.  Investment
strategies  for any given year are  developed  based on many  factors  including
operational results, tax implications,  regulatory requirements, interest rates,
dividends to shareholders and market conditions.

    In December 1996,  HSBIIC entered into three "zero cost collar" contracts to
mitigate the effects of market risk on its U.S.  common stock  portfolio  (which
for management purposes included certain convertible preferreds).  In the fourth
quarter of 1997, HSBIIC settled all of its outstanding  contracts which required
HSBIIC to pay its  counterparty  $30.7 million in foregone  appreciation  on its
portfolio.  In 1997, the Company's  U.S.  common stock  portfolio  experienced a
total return of $57 million (which included price  appreciation of approximately
$54 million) since December 31, 1996, and had a price movement  correlation with
the S&P 500 Index well in excess of 80 percent.

                                       19
<PAGE>

     At December 31,  1998,  the Company had  approximately  53.6 percent of its
invested  assets in fixed  maturities  as compared  to 38.1  percent at year-end
1997. In the period 1991-1996 the Company  gradually  reduced its investments in
common stocks as part of its overall capital  management  strategy.  At year-end
1998, the carrying value of the equity  securities  portfolio  represented  40.6
percent of invested  assets  compared to 49.7 percent at year-end  1997. The 9.1
percent  decrease is primarily  attributable to a substantial  increase in fixed
income  assets  as total  equity  securities  actually  increased  by over  $100
million.

     The Company  does not engage in  cash-flow  underwriting;  it seeks to have
underwriting  profit  each  year.  None  of the  Company's  claim  reserves  are
discounted as most claims settle, on average,  within one year.  Therefore,  the
Company  does not use  duration  measurements  in  managing  its  interest  rate
exposure.  Instead,  the Company manages its portfolio by laddering a portion of
its invested assets such that the average estimated  maturity of these assets is
generally  maintained  between 5-10 years.  This technique  provides the Company
with a  predictable  cash  flow  each  year and  enables  it to  respond  to the
previously  discussed  parameters  that  impact  its  investment  strategy.   In
addition,   the  Company   manages  a  portion  of  its  invested  assets  on  a
long-term/segmented   basis  to  provide  interest  coverage  on  the  servicing
requirements of its convertible capital securities.

     See "Investment  Operations" in the Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations located in Item 7 and
Note 7 to  Consolidated  Financial  Statements  in Item 8 of Part II herein  for
additional information.

     The following  table  summarizes  the  investment  results of the Company's
investment portfolio:

                                                         
                                         Annualized Rate        Investment  
                       Net Invest-        of Return (2)      Gains (Losses) (3)
       Cash and       ment Income     ------------------------------------------
       Invested          Less         Before     After
      Assets, Less     Interest       Income     Income             Change in
      Borrowed Money   Expense (1)    Taxes      Taxes   Realized   Unrealized
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
               (in millions)                                 (in millions)
1998    $1,048.7        $63.4         6.6%**     5.1%**   $25.4      $17.8
1997       629.2*        35.5         6.1        5.1       14.1       13.9
1996       572.6         31.7         6.0        5.4       12.1       16.0

* Does not include $300 million in proceeds from the sale of convertible capital
securities on December 31, 1997.

**For the calculation of Annualized Rate of Return,  "Cash and Invested  Assets,
Less Borrowed  Money"  includes the $300 million in proceeds in the beginning of
the year.

(1) Net investment income excludes  realized  investment gains and is reduced by
investment expenses, but is before the deduction for income taxes.

                                       20
<PAGE>

(2) The rates of return on  investments  shown  above  have been  determined  in
accordance  with rules  prescribed  by the  National  Association  of  Insurance
Commissioners. These rates have been determined by the following formula:

                                  2I
                                 ----  
                               A + B - I

I is equal to net investment income, before taxes, earned on investment assets.

A+B is equal to the sum of the beginning and end of the year amounts shown under
"Cash and Invested Assets,  Less Borrowed Money".  The after tax rates of return
are computed in the same manner,  but net investment income is reduced by income
taxes.

(3) Realized and unrealized investment gains (losses) are before income taxes.


H.     EMPLOYEES

     At year-end 1998, the Company, including its wholly-owned subsidiaries, had
2,447 full and part-time employees.  Management believes that its relations with
its employees are satisfactory.

I.     FORWARD-LOOKING STATEMENTS

     For a summary of factors that may  materially  affect the Company's  future
business,  see  "Forward-Looking  Statements"  in  Management's  Discussion  and
Analysis of Consolidated  Financial  Condition and Results of Operations in Item
7.

Item 2.  Properties.

     The  Hartford  Steam  Boiler   Inspection  and  Insurance   Company  leases
approximately  221,516  square  feet for its home  office at One  State  Street,
Hartford,  Connecticut  under a long-term  capital  lease with One State  Street
Limited Partnership. In addition to its home office facility, the Company leases
facilities for its branch offices and subsidiaries  throughout the United States
and  Canada,  and in a small  number of other  foreign  locations.  The  Company
considers the office facilities and other operating resources to be suitable and
adequate for its current and anticipated level of operations.

     See Notes 8 and 9 to Consolidated Financial Statements located in Item 8 of
Part II herein for additional information.

                                       21
<PAGE>

Item 3.  Legal Proceedings.

     HSBIIC is currently  involved in a  claim-related  dispute  concerning  the
extent to which a certain  explosion  event is  insured  under  the  boiler  and
machinery  coverage  of HSBIIC or under  coverages  of other  insurers.  A final
decision  in an  arbitration  proceeding  on this  matter has  concluded  with a
decision  requiring HSBIIC to pay $22 million of the amount that was in dispute.
The $22 million,  less HSBIIC's retention of $3 million,  which was reserved for
in prior  years,  is fully  reinsured.  In response  to the ruling,  the Company
increased  both its gross reserves and  reinsurance  recoverable by $19 million,
resulting in no impact to net income.  HSBIIC has filed a motion in  Connecticut
Superior  Court to  confirm  the  arbitration  award.  The other  insurers  have
contested  the  award.  In the  event  the  award is not  confirmed,  subsequent
proceedings  could  result in  additional  amounts on the order of $100  million
potentially becoming recoverable from HSBIIC's reinsurers.

     The obligations of HSBIIC's  reinsurers with respect to this litigation are
not in dispute. Therefore,  management believes that any adverse outcome in this
case will not have a material  effect on either the  results  of  operations  or
financial  condition  of the  Company.  HSBIIC's  reinsurance  contracts  do not
require HSBIIC to reimburse its reinsurers  for any loss such  reinsurers  might
incur  should  this  case  not  be  decided  in  HSBIIC's  favor.  Nevertheless,
reinsurers  often  quote  rates for future  coverages  based upon their or other
reinsurers' experience on a particular account. Therefore, in the event HSBIIC's
reinsurers pay significant  sums pursuant to the litigation  described above, it
is likely HSBIIC's reinsurance rates would increase in future periods.  However,
given the insured capacity that exists in reinsurance markets worldwide, coupled
with  HSBIIC's   ability  to  negotiate  a  redesign  or  restructuring  of  its
reinsurance program, it does not necessarily mean that such an increase would be
material.

     HSBIIC was involved in another litigation  regarding an explosion event and
the extent of HSBIIC's coverage in that matter. The 7th Circuit Court of Appeals
recently  ruled in  HSBIIC's  favor and  remanded  the case for a judgment of no
liability to be entered for HSBIIC.

     The  Company  is also  involved  in  various  other  legal  proceedings  as
defendant or co-defendant that have arisen in the normal course of its business.
In the judgment of management, after consultation with counsel, it is improbable
that any  liabilities  which may arise from such litigation will have a material
adverse  impact on the results of operations  or the  financial  position of the
Company.

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

     None.

                                       22
<PAGE>

Item 4(a).  Executive Officers of the Registrant.

     All executive officers are elected by the Board of Directors to hold office
until the next Annual Meeting of Shareholders.  An officer may be removed at any
time by the Board of Directors.

    On June 24,  1997,  all of the  outstanding  shares of  common  stock of The
Hartford Steam Boiler Inspection and Insurance Company were exchanged for shares
of common stock of the Company.  The service listed for each  executive  officer
listed below includes their service with Hartford Steam Boiler.

Gordon W. Kreh, 51, Chairman since 9/98 and Chief Executive  Officer,  President
and  Director  since  4/94;  President  and  Director  9/93 - 4/94;  Senior Vice
President - Marketing 4/92 - 9/93; President - Engineering Insurance Group 10/89
- 4/92; Vice President 11/84 - 10/89; Assistant Vice President 4/81 - 11/84.

Saul L. Basch, 52, Senior Vice President,  Treasurer and Chief Financial Officer
since 10/95;  Partner,  Coopers & Lybrand L.L.P.  9/73 - 10/95, most recently as
Partner-in-Charge of Coopers & Lybrand's New York Insurance Industry Practice.

Michael L. Downs,  49, Senior Vice  President - Global Special Risks since 2/94;
Managing  Director - Engineering  Insurance  Co., Ltd. 1/91 - 2/94;  Second Vice
President 7/87 - 1/91; Assistant Vice President 2/85 - 7/87; Assistant Secretary
4/80 - 2/85.

John J.  Kelley,  53,  Senior  Vice  President  -  Commercial  Risks - Strategic
Development  since  2/94;  Corporate  Secretary  and  Special  Assistant  to the
President 5/87 - 2/94;  Assistant  Vice  President and Special  Assistant to the
President 9/83 - 5/87; Assistant Vice President 9/79 - 9/83; Assistant Secretary
4/77 - 9/79.

William A. Kerr,  61,  Senior Vice  President  -  Engineering  since 9/95;  Vice
President and General Manager,  Pratt & Whitney Turbo Power and Marine Division,
United  Technologies  Corporation  8/95 - 9/95;  Vice  President of  Aftermarket
Operations,  Pratt  &  Whitney  4/92  -  8/95;  Vice  President  of  Development
Operations and Materials Engineering, Pratt & Whitney 1989-4/92.

Normand Mercier, 53, Senior Vice President - Commercial Risks - Operations since
9/98; Senior Vice President, HSBIIC since 4/98; President, The Boiler Inspection
and Insurance Company 1/90-4/98.

R. Kevin Price,  52, Senior Vice President and Corporate  Secretary  since 2/94;
Second Vice President 4/89 - 2/94; Assistant Vice President 1/84 - 4/89.

William Stockdale,  53, Senior Vice President since 9/95;  Managing Director and
Chief Executive Officer of HSB Engineering  Insurance Ltd., London,  since 9/94;
Director of 

                                       23
<PAGE>

Engineering,  Engineering  Insurance  Co.,  Ltd.  9/92-9/94;  Managing  Director
Scottish Power PLC, Glasgow, Scotland 1/89 - 8/92.

Robert C. Walker,  55, Senior Vice  President-Claims  and General  Counsel since
1/95; Senior Vice President - Claims 3/94 - 1/95;  Associate General Counsel and
head of  Corporate  Litigation  Department  of United  Technologies  Corporation
5/89-3/94.


                                     PART II

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

     The Company's  common stock is traded on the New York Stock  Exchange under
the symbol HSB.  As of  February  16,  1999,  the  Company had 5,034  holders of
record.

     Dividends  paid by The  Hartford  Steam  Boiler  Inspection  and  Insurance
Company,  HSB  Group's  principal  subsidiary,  are  limited by state  insurance
regulations.  Approval from the Connecticut  Insurance  Commissioner is required
for dividend  distributions  within a twelve-month period which would exceed the
greater of (i) 10 percent of an insurer's  statutory  surplus or (ii) net income
calculated  as of the  December  31st last  preceding.  Regulatory  approval was
required  for  the  payment  of  1998  dividends  but is not  anticipated  to be
necessary for 1999  dividends  since  approximately  $200.2  million of HSBIIC's
statutory surplus is available for distribution to HSB Group, Inc. without prior
regulatory approval.

     Quarterly  dividends declared for the 1998 and 1997 fiscal years,  adjusted
for the May 22, 1998 three-for-two stock split, were as follows:

          First        Second        Third        Fourth      Year
1998      $.40         $.40          $.42         $.42        $1.64
1997      $.38         $.38          $.40         $.40        $1.56

     Quarterly  market prices for the Company's  common stock,  adjusted for the
May 22, 1998 three-for-two  stock split, were as follows for the two most recent
years:

                 First         Second      Third        Fourth         Year
1998 High        $44.92        $53.50      $57.63       $42.00        $57.63
1998 Low         $36.45        $43.17      $40.38       $36.00        $36.00

1997 High        $31.50        $35.92      $37.67       $37.08        $37.67
1997 Low         $29.83        $29.58      $35.08       $33.67        $29.58


                                       24
<PAGE>

Item 6.  Selected Financial Data.

     The  following  selected  consolidated  financial  data  should  be read in
conjunction  with the  consolidated  financial  statements  and  notes  included
elsewhere herein.

(in millions, except per share amounts)(1)(2)
<TABLE>
<CAPTION>

                                              1998            1997            1996             1995             1994
------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>           <C>             <C>                 <C>               <C>    
Summary of Consolidated Statements of
   Operations
   Revenues:
     Gross earned premiums                  $   770.5     $  609.3        $   556.5           $455.0            $381.7
     Ceded premiums                             374.4        118.1            107.9             65.9              45.1
                                          -------------- --------------- --------------- ----------------- ----------------
     Insurance premiums                     $   396.1     $  491.2        $   448.6           $389.1            $336.6
     Engineering services                        93.5         61.3             55.8             49.9              48.0
     Income from investment operations           89.6         50.9             44.4             31.7              34.9
                                          -------------- --------------- --------------- ----------------- ----------------
            Total revenues(3)               $   579.2     $  603.4        $   548.8           $470.7            $419.5
                                          -------------- --------------- --------------- ----------------- ----------------
   Income from continuing operations        $   104.1     $   66.3        $    54.6           $ 52.7            $ 44.5
   Income from continuing operations        
     per common share-basic                 $     3.55    $    2.21       $     1.81          $  1.72           $  1.45
   Income from continuing operations        
     per common share-assuming dilution     $     3.35    $    2.20       $     1.81          $  1.72           $  1.45
   Dividends paid per common share          $     1.62    $    1.54       $     1.52          $  1.48           $  1.43
  ------------------------------------------------------------------------------------------------------------------------
Summary of Consolidated Statements of
   Financial Position
   Total assets                             $ 2,144.0     $1,537.2        $ 1,112.3           $951.9            $877.8
   Long-term borrowings and capital         
     lease obligations                      $    53.0     $   53.0        $    53.0           $ 53.4            $ 28.4
   Convertible redeemable preferred         
     stock                                  $    --       $   --          $    20.0           $ --              $ --
   Company obligated mandatorily            
     redeemable capital securities          $   408.9     $  408.9        $    --             $ --              $ --
   Shareholders' equity:
     Common                                 $   419.3     $  345.3        $   345.6           $341.1            $299.5
     Per common share                       $    14.53    $   11.75       $    11.50          $ 11.21           $  9.78
     Return on average equity                    35.2%(5)     19.1%            15.6%            19.5%             16.9%
   Stock price per share:
     High                                   $    57.63    $   37.67       $    34.83          $ 33.50           $ 35.58
     Low                                    $    36.00    $   29.58       $    28.58          $ 26.50           $ 24.08
     Close                                  $    41.06    $   36.80       $    30.92          $ 33.33           $ 26.58
     Common shares outstanding at end            
       of year (4)                               28.9         29.4             30.0             30.5              30.6
  ------------------------------------------------------------------------------------------------------------------------
Insurance
   Operating gain                           $    41.2     $   39.8        $    21.8           $ 34.2            $ 20.7
   Loss ratio                                    44.2%        44.4%            45.6%            39.8%             42.5%
   Expense ratio                                 45.2%        47.3%            49.1%            50.9%             50.5%
                                          -------------- --------------- --------------- ----------------- ----------------
   Combined ratio                                89.4%        91.7%            94.7%            90.7%             93.0%(6)
 ------------------------------------------------------------------------------------------------------------------------
Engineering Services
   Operating gain                           $     7.3     $    4.3        $     7.3           $  6.7            $  4.3
       Engineering services margin                7.8%         7.1%            13.2%            13.3%              9.0%
------------------------------------------------------------------------------------------------------------------------
Investments
   Net investment income                    $    64.2     $   36.8        $    32.3           $ 28.9            $ 26.2
   Realized investment gains                     25.4         14.1             12.1              2.8               8.7
                                          -------------- --------------- --------------- ----------------- ----------------
     Income from investment operations      $    89.6     $   50.9        $    44.4           $ 31.7            $ 34.9
------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1)Prior year information has been restated to reflect Radian LLC as a 
   discontinued operation.
(2)All per share and share data has been restated to reflect stock splits.
(3)Excludes revenues from investments accounted for under the equity method.
(4)Reflects the repurchase of approximately 1.2, 1.5, 0.4, 0.2 and 0.2 million 
   shares in 1998, 1997, 1996, 1995 and 1994, respectively.
(5)Includes gain on sale of IRI and discontinued operations of Radian.
(6)Excludes charge for Proposition 103.


                                       25
<PAGE>

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

(dollar amounts in millions, except per share amounts)

                        Summary of Results of Operations

Consolidated Overview

For the years ended December 31,     1998           1997             1996
--------------------------------------------------------------------------------
Revenues:
Gross earned premiums               $770.5         $609.3           $556.5
Ceded premiums                       374.4          118.1            107.9
                                 -----------------------------------------------
Insurance premiums                  $396.1         $491.2           $448.6
Engineering services                  93.5           61.3             55.8
Net investment income                 64.2           36.8             32.3
Realized investment gains             25.4           14.1             12.1
                                 -----------------------------------------------
Total revenues                      $579.2         $603.4           $548.8
Gain on sale of IRI                 $ 36.6         $ --             $ --
Income from continuing
   operations                       $104.1         $ 66.3           $ 54.6
Discontinued operations               30.3           --               (1.2)
Net income                          $134.4         $ 66.3           $ 53.4
Earnings per share*:
   Income from continuing
      operations:
      Basic                         $  3.55        $  2.21          $  1.81
      Assuming dilution             $  3.35        $  2.20          $  1.81
   Net income:
      Basic                         $  4.59        $  2.21          $  1.77
      Assuming dilution             $  4.21        $  2.20          $  1.77
--------------------------------------------------------------------------------


* Prior years restated to reflect 1998 stock split.


The table above  presents  consolidated  results of HSB Group,  Inc. (HSB or the
Company).

     Net income for 1998 included  after-tax gains on the sale of HSB's interest
in Industrial Risk Insurers (IRI) of $23.8 million and Radian  International LLC
(Radian LLC) of $30.3 million. The Radian LLC gain is net of after-tax operating
losses of $6.6 million that were  deferred in 1997 when the decision was made to
exercise HSB's option to put the Company's  interest to The Dow Chemical Company
(Dow).  As  a  result,  HSB's  interest  in  Radian  LLC  was  classified  as  a
discontinued operation in 1997. The Company's after-tax earnings,  excluding the
after-tax  gains on sales of IRI and Radian LLC,  increased 20.9 percent in 1998
compared with 1997 due to increased  underwriting profits,  improved engineering
results and higher net realized gains.

     Net income and income  from  continuing  operations  per common  share on a
diluted basis  increased  24.2 percent and 21.4 percent,  respectively,  in 1997
from  1996 due to  significantly  higher  underwriting  gains  in the  Company's
insurance operations.

     On January 2, 1998, the Company  exercised its option to put its 40 percent
share in Radian LLC to Dow, for  approximately  $129  million,  net of expenses.
Radian  LLC was formed in January  1996 as a joint  venture  with Dow to provide
environmental,  engineering,  information technology,  remediation and strategic
chemical  management  services  to  industries  and  governments  worldwide.  In
connection  with the  formation  of the new  company,  the  Company  contributed
substantially  all  of  the  assets  of  its  wholly  owned  subsidiary,  Radian
Corporation  to Radian  LLC.  The  results  of  Radian  LLC were  classified  as
discontinued  operations  following  ratification in July 1997 by HSB's Board of
Directors of  management's  decision to exercise its 

                                       26
<PAGE>

put. The after-tax  gain of $30.3 million  recognized in 1998 is net of deferred
losses  previously noted. In 1996 and prior to July 1997, the Company's share of
the joint venture's results was recorded as equity in Radian.

     On January 6, 1998,  the  Company  sold its  interest  in IRI to  Employers
Reinsurance Corporation (ERC) in accordance with a previously announced purchase
and sale  agreement  between ERC and IRI's  twenty-three  member  insurers.  The
Hartford Steam Boiler  Inspection and Insurance  Company (HSBIIC) received gross
proceeds of $49.1  million,  prior to  transaction  costs,  for its 23.5 percent
share in IRI.  The gain on the sale of IRI was $36.6  million  pre-tax and $23.8
million  after-tax.  Because the sale was  structured  in part as a  reinsurance
transaction,  a portion of  HSBIIC's  gross  proceeds  was  utilized to reinsure
in-force policies with ERC.

     IRI is an unincorporated,  voluntary joint  underwriting  association which
provides property  insurance for the class of business known as Highly Protected
Risks (HPR) for larger  manufacturing,  processing  and  industrial  businesses,
which have invested in protection against loss through the use of sprinklers and
other means.  IRI primarily  writes policies on a syndicate basis that specifies
to the  insured  the  percentage  share of risk  accepted  by each member of the
association.  Each member  company,  therefore,  operates as a direct insurer or
reinsurer on such policies and participates in the premiums and losses generated
thereunder in proportion to its membership interest.  In 1997 and 1996, HSBIIC's
membership shares were 23.5 and 14 percent  respectively;  in 1995 and prior the
shares were 0.5 percent.

     In essence,  IRI  facilitates  the  proportional  sharing of risk under one
policy where each member is  essentially  considered to be the direct writer for
reporting, premium tax and other regulatory purposes. Liability on such policies
is several and not joint, and therefore,  members are not responsible for policy
liabilities of the other  members.  An increased  participation  does not expose
HSBIIC to the effect of adverse loss development on claims incurred prior to the
effective date of the increase;  conversely a decrease in participation does not
release HSBIIC from the effect of adverse development.

     Contemporaneous  with the close of the sale, IRI was reconstituted with ERC
(with a 99.5 percent  share) and HSBIIC  (with a 0.5 percent  share) as the sole
members.  The new  association  has been renamed HSB  Industrial  Risk Insurers.
HSBIIC writes the business for HSB Industrial  Risk Insurers using its insurance
licenses and provides certain other services. In addition, through various quota
share reinsurance  agreements with ERC and HSB Industrial Risk Insurers,  HSBIIC
transferred its  manufacturing  book of business to HSB Industrial Risk Insurers
and retains 85 percent of the  equipment  breakdown  insurance and 15 percent of
the property insurance of the combined insurance portfolio.  This arrangement is
the largest  contributing  factor in the growth of both gross earned premium and
ceded premium. As a result, the unearned insurance premiums,  reinsurance assets
and the ceded reinsurance  payables reflected in the Consolidated  Statements of
Financial  Position  have  increased   significantly.   The  agreements  are  of
indefinite  duration,  but ERC has an option to purchase  HSB's  interest in the
business in the event of a 50 percent or more change in control of HSB.

     In  contemplation  of HSB's  expanded role, on December 31, 1997 a business
trust formed by HSB sold $300 million of 20 year, 7 percent  Convertible Capital
Securities in a private placement to ERC. The Convertible Capital Securities are
convertible into shares of HSB common stock, at any time,  subject to regulatory
approval, at a conversion price of $56.67 per share, restated to reflect the May
22, 1998  three-for-two  stock split (formerly a conversion  price of $85.00 per
share).  $250 million of the proceeds were contributed to HSBIIC and $50 million
was retained by HSB (see note 13).

     Total  revenues  declined 4.0 percent in 1998 and grew 9.9 percent in 1997.
Gross  earned  premiums  grew  26.4  percent  in 1998.  Much of this  growth  is
attributable  to HSB Industrial  Risk Insurers and growth in our commercial book
of business,  as well as through the acquisition of the Kemper book noted in the
Other Developments section of this MD&A.

                                       27
<PAGE>

     The  combined  ratio for the Company  improved to 89.4 percent in 1998 from
91.7 percent in 1997. In 1996 the combined ratio was 94.7 percent.

     Engineering services revenue increased 52.6 percent in 1998 and 9.9 percent
in 1997. The growth in 1998 was primarily due to acquisitions  made late in 1997
and in 1998 as well as growth in certain core businesses.

     Net  investment  income  grew 73.9  percent  in 1998  primarily  due to the
investment  of  proceeds  from the sales of IRI and Radian  LLC and the  capital
securities issued in the second half of 1997.

     The  effective  tax  rates on  income  from  continuing  operations  before
distributions  on capital  securities for 1998 was 29.6 percent compared to 26.8
percent and 25.1 percent for 1997 and 1996. Tax rate  fluctuations  occur as the
levels of  underwriting  and  engineering  services  results and realized  gains
change  the  mix of  pre-tax  income  between  fully  taxable  earnings  and tax
preferred  earnings  that can be obtained by investing  in certain  instruments.
Various tax credits  (primarily  foreign tax credits)  also impact the effective
rate. The Company continues to manage its use of tax advantageous investments to
maximize after-tax earnings.


Recent Accounting Developments

     In June 1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
Statement  of  Financial   Accounting   Standard  (SFAS)  No.  130,   "Reporting
Comprehensive  Income," which requires items that comprise  comprehensive income
be reported in a financial  statement  display with the same prominence as other
financial  statements.  This includes the  presentation  of items such as market
value  adjustments  of  securities,  foreign  currency  translation  and certain
adjustments made for benefit plans.  This statement was implemented in the first
quarter of 1998.

     Also in June of 1997,  the FASB  issued SFAS No.  131,  "Disclosures  about
Segments of an Enterprise  and Related  Information."  This  statement  requires
companies to report  financial  and  descriptive  information  about  reportable
operating segments. It includes disclosure requirements relating to products and
services,  geographic areas and major customers.  This statement was implemented
at year-end 1998 and caused the Company to redefine its reportable segments (see
note 5).

     In June 1998,  the FASB  issued SFAS No. 133,  "Accounting  for  Derivative
Instruments and Hedging Activities." This statement  establishes  accounting and
reporting  standards for derivative  instruments,  including certain  derivative
instruments embedded in other contracts, and for hedging activities. It requires
that all  derivatives  be  recognized  as either  assets or  liabilities  in the
statement of financial  position and that such  instruments  be measured at fair
value. In addition, all hedging relationships must be designated, reassessed and
documented  pursuant  to the  provisions  of SFAS No.  133.  This  statement  is
effective  for  fiscal  years   beginning  after  June  15,  1999.  The  Company
anticipates  that the adoption of the provisions of SFAS No. 133 will not have a
material impact on results of operations, financial condition or cash flows.

     In December  1997,  the  Accounting  Standards  Executive  Committee of the
American Institute of Certified Public  Accountants  (AcSEC) issued Statement of
Position  (SOP)  97-3,  "Accounting  by  Insurance  and  Other  Enterprises  for
Insurance-Related   Assessments."  This  statement  provides  guidance  for  the
recording  of a  liability  for  insurance-related  assessments.  The  statement
requires that a liability be recorded when all of the following  conditions have
been met: an  assessment  has been imposed or it is probable  that an assessment
will be imposed;  the event  obligating  an entity to pay an imposed or probable
assessment has occurred on or before the date of the financial  statements;  and
the amount of the  assessment  can be reasonably  estimated.  This  statement is
effective  for fiscal years  beginning  after  December  15,  1998.  The Company
anticipates  that the  adoption  of the  provisions  of SOP 97-3 will not have a
material impact on results of operations, financial condition or cash flows.

     In March 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of Computer
Software  Developed or Obtained for Internal Use." This statement  specifies the
types of costs  that  must be  capitalized  and  amortized  over the  software's
expected useful life and the types of costs which must be immediately 

                                       28
<PAGE>

recognized  as  expense.  For  purposes  of this SOP,  internal-use  software is
software acquired,  internally developed or modified solely to meet the entity's
internal  needs for which no  substantive  plan exists or is being  developed to
market  the  software   externally   during  the   software's   development   or
modification.   Certain   internal  and  external   costs  incurred  to  develop
internal-use   computer   software  that  relate  to  system  design,   software
configuration  and  interfaces,  coding,  testing and  installation  to hardware
should  generally be  capitalized.  This statement is effective for fiscal years
beginning after December 15, 1998. The Company's current policy is to capitalize
such costs and therefore  anticipates that the adoption of the provisions of SOP
98-1  will not have a  material  impact  on  results  of  operations,  financial
condition or cash flows.

     In April 1998,  AcSEC issued SOP 98-5,  "Reporting on the Costs of Start-Up
Activities."  This  statement  requires  the costs of  start-up  activities  and
organization  costs be expensed as incurred.  Start-up costs are defined broadly
as those one-time  activities  related to opening a new facility,  introducing a
new  product or service,  conducting  business  in a new  territory,  conducting
business  with a new class of customer,  initiating a new process in an existing
facility,  or commencing some new operation.  Start-up costs include  activities
related to organizing a new entity (commonly referred to as organization costs).
This SOP applies to development stage entities as well as established  entities.
This statement is effective for fiscal years  beginning  after December 15, 1998
and initial application should be reported as a cumulative effect of a change in
accounting  principle.  The Company does not expect the  application of SOP 98-5
will have a material  impact on results of  operations,  financial  condition or
cash flows.

     In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance  Contracts That Do Not Transfer  Insurance  Risk." The
SOP identifies  several methods of deposit  accounting and provides  guidance on
the  application  of  each  method.  This  statement  classifies  insurance  and
reinsurance  contracts for which the deposit  method is appropriate as contracts
that (i) transfer only  significant  timing risk, (ii) transfer only significant
underwriting  risk, (iii) transfer neither  significant  timing nor underwriting
risk, and (iv) have an  indeterminate  risk. This SOP is effective for financial
statements  for fiscal  years  beginning  after June 15,  1999.  Restatement  of
previously issued financial statements is not permitted. The effect of initially
adopting  SOP 98-7  should be  reported  as a  cumulative  effect of a change in
accounting principle.  Currently the Company is not party to any contracts which
do not comply with the risk transfer provisions of SFAS No. 113, "Accounting and
Reporting for Reinsurance of Short-Duration  and Long-Duration  Contracts," and,
therefore,  does not  anticipate  the  adoption of SOP 98-7 will have a material
impact on results of operations, financial condition or cash flows.



Other Developments

     At a special  meeting  of HSBIIC on June 23,  1997,  shareholders  voted to
approve a proposal  which  enabled the formation of a new holding  company,  HSB
Group, Inc. Shareholders of HSBIIC's common and convertible redeemable preferred
stock  became  holders of HSB Group,  Inc.  common  and  convertible  redeemable
preferred  stock,  respectively,  through  a  share  exchange  approved  by  the
shareholders.   Certificates   representing   HSBIIC's  common  and  convertible
redeemable  preferred stock automatically  represent the corresponding shares of
HSB Group, Inc. common and convertible  redeemable  preferred stock. The holding
company  was  formed  in  order  to  achieve  greater  operating  and  financial
flexibility  in connection  with certain  investments,  business  operations and
financing activities.

     On April 21, 1998, the Board of Directors  approved a  three-for-two  stock
split for shares held of record on May 1, 1998. Additional shares resulting from
the split were  distributed  on May 22, 1998. In  accordance  with SFAS No. 128,
"Earnings per Share," all earnings per share presentations have been adjusted to
reflect the impact of the stock  split,  including  retroactive  restatement  of
prior periods.

     In April 1998, HSB acquired Solomon Associates, Inc. (SAI) based in Dallas,
Texas.  SAI  is  an  engineering   management   consulting  firm  that  provides
comparative performance  benchmarking consulting to the refining,  petrochemical
and power  generation  industries.  SAI establishes  efficiency and productivity

                                       29
<PAGE>

benchmarks for 80 percent of the worldwide  petroleum  refining  industry.  This
acquisition  expands  HSB's  engineering   management  consulting  services  and
benchmarking capability.

     HSBIIC  completed  an  acquisition  of the  monoline  boiler and  machinery
business of Kemper Insurance Companies (Kemper), effective July 1, 1998. The two
companies  also  completed  an  arrangement  for HSBIIC to  reinsure  boiler and
machinery coverage written as part of Kemper's commercial package policies.

     On July 1, 1998, HSB purchased  Kemper's ASME inspection  services business
that  certifies  boiler  and  pressure  vessel  compliance  with the  codes  and
standards of the American Society of Mechanical Engineers.



Insurance Operations

                                     
For the years ended December 31,    1998        1997          1996
------------------------------ ----------------------------------------------

Gross earned premiums               $770.5       $609.3       $556.5
Ceded premiums                       374.4        118.1        107.9
                               ----------------------------------------------

Insurance premiums                  $396.1       $491.2       $448.6

Claims and adjustment
   expenses                          174.9        217.9        204.4
Underwriting, acquisition
   and other expenses                180.0        233.5        222.4
                               ----------------------------------------------

Underwriting gain                   $ 41.2       $ 39.8       $ 21.8

Loss ratio                            44.2%        44.4%        45.6%
Expense ratio                         45.2%        47.3%        49.1%
Combined ratio                        89.4%        91.7%        94.7%
------------------------------ ----------------------------------------------


     Insurance  operations  include  the  underwriting  results of  HSBIIC,  HSB
Engineering Insurance Limited (EIL), The Boiler Inspection and Insurance Company
of Canada (BI&I), The Allen Insurance  Company,  Ltd., The Hartford Steam Boiler
Inspection  and  Insurance  Company of  Connecticut,  The Hartford  Steam Boiler
Inspection  and  Insurance  Company of Texas and HSBIIC's  participation  in HSB
Industrial Risk Insurers and various other pools.

     Gross earned  premiums in 1998  increased  26.4 percent over 1997.  Much of
this growth is attributable to HSB Industrial Risk Insurers  ($155.4 million) as
well as the addition of the Kemper  portfolio  to our  commercial  business.  In
1997,  gross  earned  premiums  increased  9.5 percent as a result of IRI ($23.2
million) and growth in both the domestic and global markets.

     Domestically,  exclusive  of HSB  Industrial  Risk  Insurers,  gross earned
premiums remained flat in 1998 and increased  approximately 3.5 percent in 1997.
This  performance  resulted from the  combination of growth in written  premiums
from our  client  companies  in 1998,  1997 and  1996,  and a  reduction  in our
domestic special risk premiums. In addition,  the 1998 acquisition of the Kemper
direct boiler and  machinery  book and  reinsurance  of the boiler and machinery
component of their package policies have provided  premium growth.  Gross earned
premiums  representing  coverage  outside the U.S.,  exclusive of HSB Industrial
Risk  Insurers,  increased 5.4 percent to $133.5  million from $126.7 million in
1997. In 1997, gross earned premiums increased 15.5 percent from 1996.

     The  insurance  industry,  in  general,  continues  to undergo  significant
restructuring and consolidation.  Considerable  merger and acquisition  activity
has  occurred  recently  and more is possible in the  future.  Depending  on the
specific  companies  involved in these activities and other market factors,  the
level of reinsured business the Company assumes in the future could be impacted.
HSB is  positioned  to benefit from 

                                       30
<PAGE>

these  changes  over  the  long  term  due to its  strong  market  position  and
reinsurance relationships with more than 100 multi-line carriers; while over the
shorter term, there is both opportunity and challenge.

     The increase in ceded  premiums of 217.1  percent in 1998 was primarily due
to the quota  share  reinsurance  agreements  with ERC and HSB  Industrial  Risk
Insurers,  as previously  discussed,  and changes in the  Company's  reinsurance
programs which now utilize more quota share  reinsurance on certain of our books
of  business.  We  anticipate  these  new  reinsurance  contracts  and  the  HSB
Industrial Risk Insurers  arrangement will continue to result in growth in gross
earned premiums but lower growth in net earned premiums.  The Company  continues
to seek  opportunities  for growth,  particularly  in those  countries where the
infrastructure  development is moving to the private  sector.  At the same time,
softening of the pricing in this market has  occurred  globally as the number of
insurers offering capacity has expanded.  The Company will not write business at
rates that would lessen its ability to maintain underwriting profit.

     The Company participates in various facultative,  quota share and excess of
loss reinsurance agreements to limit its exposure,  particularly to catastrophic
losses  and  high  risk  lines,  and to  provide  additional  capacity  to write
business.  The Company evaluates its exposures and reinsurance needs annually to
implement a program that corresponds with the level of exposure it is willing to
retain.  Because  the  Company has primary  responsibility  to its  insureds,  a
careful  evaluation  of the  financial  strength  of those  reinsurers  it cedes
business to is performed. HSB's reinsurance costs continue to be impacted by its
prior loss experience and business growth.

                                

For the years ended December 31,    1998          1997             1996
------------------------------------------------------------------------
Provision for claims and
   adjustment expenses
   occurring in the
   current year                    $164.0        $209.5           $214.2
Increase (decrease) in
   estimated claims and
   adjustment expenses
   arising in prior years*           10.9           8.4             (9.8)
                                   --------------------------------------
Total incurred claims and
   adjustment expenses             $174.9        $217.9           $204.4

Loss ratio                           44.2%         44.4%            45.6%
-------------------------------------------------------------------------

* Includes approximately $5.0, $3.3 and $4.9 million of subrogation  recoveries,
respectively.

     The loss ratio decreased 0.2 percentage  points in 1998 from 1997.  Current
year results were impacted by severe ice storms that affected over 30 percent of
Canada  in  January,   as  well  as  a  few  significant  losses  in  our  other
international  business.  The loss ratio decreased 1.2 percentage points in 1997
as  compared  to 1996  primarily  as a result of fewer  weather-related  losses.
Adverse  development in 1998 and 1997 added 2.8 and 1.7 percentage points to the
respective  loss ratio.  Positive  development in 1996 reduced the loss ratio by
2.2 percentage points. The components of claims and adjustment expenses,  net of
reinsurance, are displayed above.

     Gross  claims  and  adjustment  expenses  were  $611.7  million  in 1998 as
compared to $263.1 million in 1997. The increase in gross claims was largely due
to the Company's role as direct writer of HSB Industrial Risk Insurers' policies
and include  approximately  $154  million  from  Hurricane  Georges on exposures
written by HSB Industrial  Risk Insurers.  On a net basis the impact on HSB from
such  hurricane  losses  after  cessions to HSB  Industrial  Risk  Insurers  and
reinsurance recoveries was $1.9 million.

     Claims  and  adjustment  expense  reserves  comprise  one  of  the  largest
liabilities  on the Company's  Consolidated  Statements  of Financial  Position.
Reserves are established to reflect the Company's  estimates of total losses and
loss  adjustment  expenses that will ultimately be paid under direct and assumed
insurance  contracts.  Loss reserves  include claims and adjustment  expenses on
claims  that have been  reported  but not 

                                       31
<PAGE>

yet  settled  and those  that have been  incurred  but not yet  reported  to the
Company.  The  length of time that  reserves  are  carried  on the  Consolidated
Statements  of  Financial  Position  is  a  function  of  the  pay-out  patterns
associated  with the types of  coverage  involved.  The  majority  of claims the
Company incurs are  short-tailed  in nature,  relative to the  property/casualty
industry as a whole,  meaning they  generally  settle  shortly  after claims are
reported.  The Company's loss reserve  estimates  reflect such variables as past
loss  experience  and inflation.  In addition,  due to the nature of much of the
Company's  types  of  coverage,  complex  engineering  judgments  are  involved.
Previously  established loss reserves are regularly  adjusted as loss experience
develops  and new  information  becomes  available.  Adjustments  to  previously
established  reserves are reflected in the financial statements in the period in
which  the  estimates  are  changed.  The  Company  does not  discount  its loss
reserves.

The expense  ratio  improved to 45.2  percent in 1998 from 47.3 percent in 1997.
The new quota share reinsurance  agreements and the HSB Industrial Risk Insurers
arrangement with ERC, both of which result in ceding  commissions to HSBIIC have
positively impacted our expense ratio by approximately 11.0 percentage points. A
portion  of  such  ceding  commission  is  intended  to  reimburse  HSB  for the
additional  costs of  managing  HSB  Industrial  Risk  Insurers  and  offset the
reduction in net earned premiums. The rate of decline in the expense ratio since
1996 may not continue in 1999 and beyond.

The  following  information  summarizes  key  financial  results  by  reportable
insurance segment:

For the years ended December 31,    1998         1997            1996
-------------------------------- ------------ ------------- -----------------
Commercial:
   Net earned premiums             $306.3       $269.0          $253.1
   Net income                        14.8         13.4            11.8
   Income taxes                       4.6          6.1             6.9
Global Special Risks:
   Net earned premiums             $ 83.6       $217.1          $187.7
   Net income (loss)                  9.8         10.7            (3.0)
   Income taxes (benefit)             7.7          6.2            (1.3)
-------------------------------- ------------ ------------- -----------------

The  Commercial  business  has  shown  strong  revenue  growth  year  over  year
notwithstanding  significant  price competition as HSB continues to focus on its
client company  strategy.  Net earned  premiums in the  commercial  segment rose
$37.3 million in 1998 due primarily to strong growth in client company  billings
and  integration  of  the  Kemper  portfolio.   Domestic  operations  posted  an
underwriting  gain  that  was  partially  offset  by  a  difficult  claims  year
internationally,  particularly  due to severe ice storms that  affected  over 30
percent of Canada. The high tax benefit recognized on Canadian losses caused the
effective tax rate decline from 1997.

Global  Special  Risks net  earned  premiums  declined  $133.5  million  in 1998
primarily due to the increased use of reinsurance and the  arrangement  with HSB
Industrial  Risk  Insurers.  The business does not set revenue goals as such but
rather  continues  to  seek to  increase  underwriting  profits.  As part of the
arrangement  with HSB Industrial  Risk Insurers,  HSB writes all direct policies
for HSB Industrial  Risk Insurers and then cedes back these risks 100 percent to
HSB Industrial Risk Insurers. HSB then reinsures ERC's 99.5 percent share of the
business  resulting in the  assumption of 85 percent of the equipment  breakdown
business and 15 percent of the property  business.  In 1998,  the  international
businesses have been impacted by adverse claims  experience as compared to 1997.
In 1996, claims  experience was positive.  In 1998, income taxes as a percentage
of net income increased as a result of a decreased use of foreign tax credits.

HSBIIC is currently involved in a claim-related dispute concerning the extent to
which a certain  explosion  event is  insured  under the  boiler  and  machinery
coverage of HSBIIC or under coverages of other insurers.  A final decision in an
arbitration  proceeding on this matter has concluded  with a decision  requiring
HSBIIC to pay $22 million of the amount that was in  dispute.  The $22  million,
less HSBIIC's retention of $3 million, which was reserved for in prior years, is
fully reinsured. In response to the ruling, the Company increased both its gross
reserves and reinsurance  recoverable by $19 million,  resulting in no impact to
net income.  

                                       32
<PAGE>

HSBIIC  has  filed a  motion  in  Connecticut  Superior  Court  to  confirm  the
arbitration  award.The other insurers have contested the award. In the event the
award is not  confirmed,  subsequent  proceedings  could  result  in  additional
amounts  on the order of $100  million  potentially  becoming  recoverable  from
HSBIIC's reinsurers.

The  obligations of HSBIIC's  reinsurers with respect to this litigation are not
in dispute. Therefore, management believes that any adverse outcome in this case
will not have a material effect on either the results of operations or financial
condition of the Company.  HSBIIC's reinsurance  contracts do not require HSBIIC
to reimburse its reinsurers for any loss such reinsurers might incur should this
case not be decided in  HSBIIC's  favor.  Nevertheless,  reinsurers  often quote
rates for future coverages based upon their or other reinsurers' experience on a
particular account.  Therefore, in the event HSBIIC's reinsurers pay significant
sums  pursuant  to  the  litigation  described  above,  it  is  likely  HSBIIC's
reinsurance rates would increase in future periods.  However,  given the insured
capacity that exists in  reinsurance  markets  worldwide,  coupled with HSBIIC's
ability to negotiate a redesign or restructuring of its reinsurance  program, it
does not necessarily mean that such an increase would be material.

HSBIIC was involved in another  litigation  regarding an explosion event and the
extent of HSBIIC's  coverage in that  matter.  The 7th Circuit  Court of Appeals
recently  ruled in  HSBIIC's  favor and  remanded  the case for a judgment of no
liability to be entered for HSBIIC.

The Company is also involved in various other legal  proceedings as defendant or
co-defendant  that have  arisen in the  normal  course of its  business.  In the
judgment of management,  after consultation with counsel,  it is improbable that
any  liabilities  which may  arise  from such  litigation  will have a  material
adverse  impact on the results of operations  or the  financial  position of the
Company.


Engineering Services Operations

For the years ended December 31,         1998       1997            1996
------------------------------------- ---------- ----------- ------------------
Engineering services revenues           $93.5      $61.3           $55.8
Engineering services expenses            86.2       57.0            48.5
                                      ---------- ----------- ------------------
Operating gain                          $ 7.3      $ 4.3           $ 7.3
Operating margin                          7.8%       7.1%           13.2%
------------------------------------- ---------- ----------- ------------------

Engineering  services  operations  include  the results of  HSBIIC's,  EIL's and
BI&I's  engineering   services,   HSB  Reliability   Technologies  (HSBRT),  HSB
Professional Loss Control, HSB International,  SAI and the Company's interest in
Integrated Process Technologies, LLC.

Engineering  services revenues increased 52.6 percent in comparison to 1997. The
growth in revenues is  primarily  due to  increases  generated  by HSBRT,  EIL's
acquisition of Haughton's  engineering in the last quarter of 1997, the addition
of SAI in  April  1998,  as well as  revenues  generated  by some  recent  small
acquisitions.  Engineering  services  revenues  in 1997  increased  9.8  percent
primarily  attributable to increased sales of $3.2 million at HSBRT, offset by a
modest decline in revenues from our engineering operations based in Asia.

The  Company  continues  to  focus on  identifying  and  evaluating  acquisition
candidates in the niche  engineering  management  consulting  service  business,
primarily  in  process  industries,   in  order  to  expand  or  complement  its
engineering service capabilities.

Margins  increased 0.7  percentage  points in 1998 as a result of improved field
service staff utilization and cost  efficiencies,  which were offset somewhat by
the start-up costs of integrating recent acquisitions.  Margins declined in 1997
as the Company decreased the staff utilization  domestically in order to develop
new growth opportunities. The Company continues to maintain staff levels in Asia
at somewhat lower than historical  productivity levels, as the Company continues
to have confidence in its long-term growth prospects in the region.


                                       33
<PAGE>


Investment Operations

                                           
For the years ended December 31,       1998            1997              1996
--------------------------------------------------------------------------------
Net investment income               $   64.2          $ 36.8            $ 32.3
Realized investment gains               25.4            14.1              12.1
                                  ----------------------------------------------

Income from investment
   operations                       $   89.6          $ 50.9            $ 44.4
Total cash and invested
   assets, at fair value            $1,094.8          $996.7            $600.9

Unrealized gains, pre-tax           $  113.1          $ 95.3            $ 81.4
--------------------------------------------------------------------------------

The Company's  investment  strategy  continues to be to maximize total return on
the investment  portfolio through  investment  income and capital  appreciation.
Investment  strategies  for any given year are  developed  based on many factors
including  operational  results,  tax  implications,   regulatory  requirements,
interest rates, dividends to stockholders and market conditions.  The investment
portfolio  includes a wide variety of high quality  equity  securities  and both
domestic and foreign fixed  maturities.  The Company continues to manage its use
of tax advantageous  investments to maximize after-tax investment earnings.  The
Company does not engage in cash flow underwriting; it seeks to have underwriting
profit each year.

None of the Company's  claim reserves are  discounted as most claims settle,  on
average,  within  one  year.  Therefore,  the  Company  does  not  use  duration
measurements  in managing its interest rate exposure.  Instead,  HSB manages its
portfolio by laddering a portion of its invested  assets such that the effective
average estimated maturity of these assets is generally  maintained between 5-10
years.  This  technique  provides the Company with a predictable  cash flow each
year that  enables it to respond to the  previously  discussed  parameters  that
impact its investment  strategy.  In addition,  the Company manages a portion of
its invested assets on a long-term/segmented  basis to provide interest coverage
on the servicing requirements of its convertible capital securities.

Net investment  income for 1998 increased $27.4 million  compared to 1997 due to
the investment of proceeds from capital securities issued during the second half
of 1997. In addition, proceeds from the January 1998 sales of HSB's interests in
IRI and Radian LLC significantly increased investable funds. Realized investment
gains were  significantly  impacted  in 1998 by call  premiums  on fixed  income
investments  and sales of certain  convertible  securities  and common stocks in
response to market conditions.

In 1997  realized  gains were reduced by $30.7  million to reflect the estimated
fair value of three  "zero cost  collar  contracts"  entered  into at the end of
1996. These collars were closed out by year-end 1997. Net investment  income for
1997  increased  $4.5 million in comparison to 1996 as the Company  invested the
proceeds from its July 1997 Capital Securities offerings.  Net investment income
was  impacted  early in 1997 by calls of high  yielding  preferred  stocks.  Net
investment income increases in 1997 also reflected more investable funds,  which
were invested  during a period of declining rates in comparison to our portfolio
averages,  and a modest  change in the mix of the  portfolio  from tax preferred
investments  to more taxable  investments  with higher pre-tax  yields.  In 1997
higher  interest  costs  resulted  from a  larger  amount  of  commercial  paper
outstanding.

On December 19, 1996,  HSBIIC entered into three "zero cost collar contracts" to
mitigate the effects of market risk on its U.S. common stock  portfolio  (which,
for management purposes, included certain convertible preferreds). Each contract
had a notional  value of $50 million and maturity  dates  ranging from  November
1997 to January 1998. The contracts were European  style,  which means they only
settled upon maturity. The contracts,  which were entered into when the Standard
& Poor's 500 Index (S&P 500 Index) was 744.3, allowed HSBIIC to recover from the
counterparty if the index was below 695.2 at the time of maturity,  and required
HSBIIC to reimburse the  counterparty if the index was above a range of 811.3 to
818.7 at the time of maturity.

                                       34
<PAGE>

In the fourth quarter of 1997,  HSBIIC settled all of its outstanding  contracts
that  required  HSBIIC  to  pay  its  counterparty  $30.7  million  in  foregone
appreciation  on its  portfolio.  In  1997,  the  Company's  U.S.  common  stock
portfolio  experienced  a total  return of $57  million  (which  included  price
appreciation of approximately $54 million) and had a price movement  correlation
with the S&P 500 Index well in excess of 80 percent.

Through its U.K. subsidiary, EIL, the Company writes business in Malaysia and up
through  December  31, 1997 was  required to maintain  approximately  50 million
ringgit  denominated  investments ($12.8 million) on deposit in that country. At
December  31,  1998 the  Company's  deposits  in that  currency  was 29  million
ringgit,  which  equated  to $7.7  million.  Due to the recent  fluctuations  of
currencies  in  southeast  Asia,  realized  investment  gains  increased by $0.1
million in 1998 and were reduced by $7.4 million during 1997.

HSB's  investment  portfolio  continues  to consist of high grade  domestic  and
foreign  investments.  Excluding short-term  investments,  HSB's investments are
primarily comprised of publicly traded, highly liquid securities.  At the end of
1998,  HSB's fixed maturities  portfolio  comprised 53.6 percent of the value of
the invested  assets.  The credit quality of HSB's bond  investments at December
31, 1998,  averaged an A rating.  HSB's  portfolio does not include any bonds in
default as to either principal or interest. Bonds held at December 31, 1998, had
a fair  value of $357.9  million.  Redeemable  preferred  stocks  averaged a BBB
rating.  Declining yields  available on new fixed maturities  relative to higher
yields  on  maturing  investments  over the past few years  have also  moderated
investment income growth.

The carrying value of the equity securities  portfolio  represented 40.6 percent
of the  investments  at December  31,  1998.  This  included  $110.8  million of
unrealized investment gains, which had a net increase of $18.3 million from 1997
as a result of strong  performance  of certain S&P 500 "large cap"  stocks.  HSB
also  recorded  $20.4  million of  dividends  and $20.7  million of net  pre-tax
realized gains from this portfolio in 1998. The Company's largest single holding
accounted  for less  than 1  percent  of  total  consolidated  assets.  Realized
investment  gains  increased  in 1998 over  1997 (and in 1997 over  1996) as HSB
managed its portfolio to respond to changing market  conditions and tax planning
opportunities.



Market Risk

Market risk generally  encompasses systemic risks or risks associated with macro
factors  relating to economic losses due to adverse changes in the fair value of
a financial instrument.  Market risk relates to the variability of market prices
and/or cash flows associated with changes in interest rates,  securities prices,
market indices,  yield curves or currency  exchange rates and is inherent to all
financial  instruments.  The Company's  investment strategy is to maximize total
return  on the  investment  portfolio  through  investment  income  and  capital
appreciation  and  is  based  on  such  factors  as  operational   results,  tax
implications,    regulatory   requirements,   interest   rates,   dividends   to
stockholders,   servicing   requirements   of  capital   securities  and  market
conditions.

The focus of this  disclosure is on one element of market risk - price risk. For
the  Company,  price risk relates to changes in the level of prices of financial
instruments due to changes in interest rates,  equity prices or foreign exchange
rates.  The primary price risk  exposures of the Company relate to interest rate
and equity price risk.

For purposes of this  disclosure  market risk  sensitive  instruments  are to be
categorized as  instruments  entered into for trading  purposes and  instruments
entered  into for  purposes  other than  trading.  The Company does not hold any
financial  instruments entered into for trading purposes and, therefore,  market
risk  sensitive  instruments  are  classified  as held for  purposes  other than
trading.



Interest Rate Risk

Interest  rate risk is the major price risk facing the  Company's  fixed  income
portfolio.  Such  exposure  can subject  the  Company to economic  losses due to
changes  in the level or  volatility  of  interest  rates.  Bond  prices  change
inversely  with the direction of interest  rates.  Generally,  as interest rates
rise prices for fixed 

                                       35
<PAGE>

income  instruments will fall. As rates decline the inverse is true. The Company
attempts to mitigate  this risk by investing in high quality  issues using a buy
and hold approach.


Equity Market Risk


Equity market risk is defined as the chance that market  influences  will affect
the expected  returns of all equities.  Returns are  influenced  not only by the
fundamental attributes of investment  securities,  but by the price movements of
the general marketplace.  Much of this depends on the sensitivity to the overall
market of the individual issue. The Company attempts to reduce this risk through
diversification and a focus on high quality, blue chip investments.


Foreign Exchange Risk


Foreign  exchange  risk  arises  from the  possibility  that  changes in foreign
currency   exchange  rates  will   adversely   impact  the  value  of  financial
instruments.  The Company has foreign  exchange  exposure  when it buys or sells
foreign currencies or financial  instruments  denominated in a foreign currency.
The  Company's  foreign  transactions  are  primarily  denominated  in  Canadian
dollars.



Sensitivity Analysis


The following  analysis  illustrates  the sensitivity of the market value of the
Company's financial  instruments to selected changes in market rates and prices.
The range of changes selected reflects the Company's view of reasonably possible
market movements over a one-year period. The range of values selected should not
be interpreted as the Company's  prediction of future market events,  but rather
an illustration of the impact of such events.

The  analysis  assumes  that the  composition  of the  Company's  interest  rate
sensitive assets and liabilities existing at the beginning of the period remains
constant  over the period  being  measured  and also  assumes  that a particular
change  in  interest  rates  is  reflected  uniformly  across  the  yield  curve
regardless of the time to maturity. Also, the interest rates on certain types of
assets and  liabilities  may fluctuate in advance of changes in market  interest
rates,  while  interest  rates on other  types may lag behind  changes in market
rates.  Accordingly,  the analysis may not be indicative  of, is not intended to
provide  and does not  provide a precise  forecast  of the  effect of changes of
market interest rates on the Company's income or stockholders' equity.  Further,
the  computations  do not contemplate any actions the Company would undertake in
response to changes in interest rates.

The  sensitivity  analysis  assumes an  instantaneous  shift in market  interest
rates,  with scenarios of interest  rates  increasing and decreasing 100 and 150
basis  points from their  levels at December  31, 1998 with all other  variables
held constant.  The analysis assumes the yield to worst  methodology.  A 100 and
150 basis point increase in the market  interest rates would result in a pre-tax
decrease in the net  financial  instrument  position of $38.2  million and $55.1
million,  respectively.  Similarly, a 100 and 150 basis point decrease in market
interest  rates  would  result  in a  pre-tax  increase  in  the  net  financial
instrument position of $38.2 million and $55.1 million, respectively.

The  Company's  long term  debt of $25.1  million  as of  December  31,  1998 is
denominated  in U.S.  dollars.  The  Company's  long term  debt and  convertible
capital  securities  have been  issued  at fixed  rates,  and as such,  interest
expense would not be impacted by interest rate shifts. The impact of 100 and 150
basis point increases in interest rates on the fixed rate debt would result in a
decrease  in the  market  value of the debt by $0.3  million  and $0.5  million,
respectively.  The effect on the convertible  capital securities is estimated to
be $14.7 million and $21.7 million and is calculated  without  giving any effect
to the  relationship of the conversion  price to the current market price of HSB
Group,  Inc.  common stock.  The impact of 100 and 150 basis point  increases in
interest  rates on the  variable  rate  capital  securities  would  result in an
additional   

                                       36
<PAGE>

charge to pre-tax  income of $1.1 million and $1.6  million,  respectively,  per
year.  A 100 and 150 basis  point  decrease in  interest  rates  would  increase
pre-tax income by $1.1 million and $1.6 million, respectively, per year.

Equity  price risk was  measured  assuming  an  instantaneous  10 percent and 25
percent change in the S&P 500 Index from its level at December 31, 1998 with all
other  variables  held constant.  The Company's  equity  holdings  (comprised of
common  stocks and  non-redeemable  preferreds)  were  assumed to be 100 percent
correlated  to this index.  A 10 percent and 25 percent  increase or decrease in
the S&P 500 Index would result in a $24.9 million and $62.4 million  increase or
decrease, respectively in the net financial instrument position.

The sensitivity analysis also assumes an instantaneous 10 percent and 20 percent
change in the foreign currency  exchange rates versus the U.S. dollar from their
levels at December 31, 1998 with all other variables held constant. A 10 percent
and 20 percent  strengthening  of the U.S.  dollar  would result in decreases of
$6.4 million and $12.4 million,  respectively,  in the net financial  instrument
position.  Weakening of the U.S. dollar versus all other currencies would result
in like increases in the net financial instrument position.

The following  table  reflects the estimated  effects on the market value of the
Company's  financial  instruments  due to an increase  in interest  rates of 100
basis  points,  a 10 percent  decline in the S&P 500 Index,  and a decline of 10
percent in foreign currency exchange rates.



Held For Other Than Trading Purposes

                                 Market      Interest    Currency      Equity
 At December 31, 1998            Value       Rate Risk      Risk        Risk
--------------------------------------------------------------------------------
Fixed maturity securities      $  577.1      $(27.1)       $(2.1)     $  --
Equity securities                 437.1       (10.2)        (1.9)      (24.9)
Short term investments             62.3        (0.9)        (2.4)        --
                               --------      --------      -------    --------
   Total all securities        $1,076.5      $(38.2)       $(6.4)     $(24.9)

The following  table  reflects the estimated  effects on the market value of the
Company's  financial  instruments  due to an increase  in interest  rates of 150
basis  points,  a 25 percent  decline in the S&P 500 Index,  and a decline of 20
percent in foreign currency exchange rates.


                                       37
<PAGE>

Held For Other Than Trading Purposes

                                  Market     Interest     Currency     Equity 
At December 31, 1998              Value     Rate Risk      Risk        Risk
--------------------------------------------------------------------------------

Fixed maturity securities      $   577.1    $(39.4)      $ (4.2)     $  --
Equity securities                  437.1     (14.4)        (3.7)       (62.4)
Short-term investments              62.3      (1.3)        (4.5)        --
                              --------------------------------------------------

   Total all securities         $1,076.5    $(55.1)      $(12.4)      $(62.4)
--------------------------------------------------------------------------------


Statement of Comprehensive Income

In  addition  to the impact of HSB's  results of  operations,  the  Consolidated
Statements of  Comprehensive  Income  displays the effects of price movements on
HSB's  invested  assets.  As a result of the market  corrections  and subsequent
rebounds,  1998 cumulative holding gains, net of taxes,  increased $28.1 million
as compared to the increase in 1997 of $21.3 million and $16.7 million in 1996.



Liquidity and Capital Resources

At December 31,                                   1998             1997
---------------------------------------------- ---------------- --------------

Total assets                                    $2,144.0         $1,537.2
Short-term investments                              62.3            131.3
Cash and cash equivalents                           18.3            293.2
Short-term borrowings                               21.0             42.4
Capital securities of subsidiary Trust I           108.9            108.9
Capital securities of subsidiary Trust II          300.0            300.0
Common shareholders' equity                        419.3            345.3
---------------------------------------------- ---------------- --------------

Liquidity refers to the Company's  ability to generate  sufficient funds to meet
the cash requirements of its business operations. HSB is a holding company whose
principal  subsidiary is HSBIIC. HSB relies on investment  income,  primarily in
the form of  dividends  from  HSBIIC,  in order to meet its short and  long-term
liquidity  requirements  including  the  service  requirements  for its  capital
securities.  The  Company  receives  a  regular  inflow  of cash  from  maturing
investments,  engineering  services  and  insurance  operations.  The mix of the
investment  portfolio is managed to respond to expected  claim pay-out  patterns
and the service  requirements  of the  Company's  capital  securities.  HSB also
maintains a highly liquid  short-term  portfolio to provide for  immediate  cash
needs and since the issuance of the $110 million of Global Floating Rate Capital
Securities  in July  1997,  which are  discussed  below,  to offset a portion of
interest rate risk relating to such  securities.  The Company's cash equivalents
and short-term  portfolio at December 31, 1997 reflects the temporary investment
of the proceeds from the $300 million Convertible  Capital Securities  discussed
below.

On July 15, 1997, HSB sold $110 million of 30 year Global  Floating Rate Capital
Securities  (Capital  Securities)  in a private  placement.  The  securities are
generally  non-callable for ten years, but may be called earlier by HSB upon the
occurrence of certain tax events  including loss of deductibility of interest on
the  securities.  The securities  were issued through HSB Capital I (Trust I), a
Delaware business trust created by HSB, at a floating rate equal to 90 day LIBOR
plus 0.91  percent.  The current  coupon is 6.3 percent.  Holders of the Capital
Securities   will  be  entitled   to  receive   preferential   cumulative   cash
distributions  accumulating  from  the date of  original  issuance  and  payable
quarterly in arrears. HSB has the right to defer payment of distributions on the
securities  at any  time or from  time to time  for a period  not  exceeding  20
consecutive  quarterly  periods with respect to each deferral period.  During an
extension   period,   interest  will  continue  to  accrue  and  the  amount  of
distributions  to which  holders of the Capital  Securities  are  entitled  will
accumulate, and the Company will be prohibited from paying any cash dividends on
its common stock. The 

                                       38
<PAGE>

Company  has  irrevocably  and  unconditionally  guaranteed  all  of  Trust  I's
obligations  under the Capital  Securities.  The Company has used or may use the
proceeds for general corporate purposes,  including the repurchase of HSB common
stock;  funding  investments  in,  or  extensions  of  credit  to  subsidiaries;
repayment of maturing  debt; and financing  possible  future  acquisitions.  HSB
subsequently  filed a  registration  statement  covering  securities  with terms
identical in all material respects and offered to exchange registered securities
for the original Capital Securities.  The exchange was completed on December 11,
1997. The floating rate Capital Securities are currently rated BBB by Standard &
Poor's and BBB+ by Duff & Phelps credit rating agencies.

On December 31, 1997, HSB Group,  Inc. sold $300 million of 20 year  Convertible
Capital  Securities  in a private  placement  to ERC.  The  Convertible  Capital
Securities are callable by the Company at its option (i) at any time after seven
years;  (ii)  upon the  occurrence  of  certain  tax  events  including  loss of
deductibility  of the  interest on the  securities;  (iii) in the event that HSB
vetoes a prospective purchaser of the Convertible Capital Securities; or (iv) in
the event of a change in control of ERC. The Convertible  Capital Securities are
mandatorily  redeemable on December 31, 2017,  and are  redeemable at par plus a
redemption premium, at the option of ERC, in the event of a change in control of
HSB within five years following issuance of the securities.

The  Convertible  Capital  Securities are  convertible,  in whole or in part, at
ERC's option at any time,  subject to  regulatory  approval,  into shares of HSB
common stock at a conversion  price of $56.67,  subject to  adjustment.  HSB has
provided certain  registration rights to ERC in connection with the common stock
into which the  Convertible  Capital  Securities are  convertible  pursuant to a
Registration  Rights Agreement dated December 31, 1997. Were ERC to exercise its
conversion  rights in total,  it would hold at  December  31,  1998,  on a fully
diluted  basis,  approximately  15.5 percent of HSB's common stock.  Pursuant to
certain provisions  contained in the Purchase Agreement dated December 31, 1997,
ERC has agreed to certain  "standstill"  arrangements which for a period of five
years will preclude ERC from  purchasing  any common stock of HSB, other than by
exercise of its  conversion  rights,  and will limit its ability to take certain
other actions with respect to HSB during that period.

The  securities  were  issued  through  HSB  Capital  II (Trust  II), a Delaware
business trust created by HSB, at a 7 percent coupon, payable semi-annually. The
Convertible  Capital  Securities  rank pari  passu with the  Capital  Securities
issued July 1997. Holders of the Convertible Capital Securities will be entitled
to receive preferential cumulative cash distributions accumulating from the date
of original issuance and payable  semi-annually in arrears. HSB has the right to
defer  payment  of  interest  at any time or from time to time for a period  not
exceeding 10  consecutive  semi-annual  periods  with  respect to each  deferral
period.  During an extension  period,  interest  will continue to accrue and the
amount of distributions to which holders of the Convertible  Capital  Securities
are entitled will  accumulate,  and HSB will be prohibited  from paying any cash
dividends  on  its  common  stock.  HSB  has  irrevocably  and   unconditionally
guaranteed  all  of  Trust  II's  obligations  under  the  Convertible   Capital
Securities.

Cash  provided  from  operations  was $55.6  million in 1998  compared  to $26.1
million for 1997. Insurance operations cash flows (excluding HSB Industrial Risk
Insurers) were impacted by a decline in net claims paid of 2.9 percent  compared
to the same period in 1997 while  premiums  collected were 6.2 percent higher in
1998.  Payments to reinsurers  for ceded  premiums  increased  approximately  72
percent in the current  year.  HSBIIC's  participation  in HSB  Industrial  Risk
Insurers  impacted  components  of the  Consolidated  Statements  of Cash Flows,
including a positive impact of $35.3 million and $1.5 million for 1998 and 1997,
respectively, to cash provided from operations.

Capital resources consist of shareholders'  equity,  capital securities and debt
outstanding, and represent those funds deployed, or available to be deployed, to
support business  operations.  Common  shareholders' equity of $419.3 million at
December 31, 1998 increased  $74.0 million since December 31, 1997. The increase
reflects net income of $134.4 million and an increase in unrealized  gains,  net
of tax, of $11.0 million, offset by dividends of $47.9 million and $22.2 million
net share  repurchases.  On October 30,  1997,  the sole  holder 

                                       39
<PAGE>

of convertible  redeemable  preferred  stock converted those shares into 597,609
shares of common stock, restated to reflect the May 22, 1998 three-for-two stock
split  (formerly  398,406  shares)  adding $20  million to common  shareholders'
equity.

Pursuant to the share  repurchase  authorization  approved by the Board,  during
1998,  HSB  repurchased  approximately  1.2  million  shares  at a cost of $47.7
million.  At December 31, 1997, treasury stock of $85.9 million was reclassified
to retained  earnings and additional  paid-in capital to reflect the elimination
of the concept of treasury shares in accordance  with the  Connecticut  Business
Corporation Act which became effective January 1, 1997. On January 25, 1999, the
Board renewed the  authorization  to repurchase up to 3 million shares of common
stock.

At December 31, 1998,  HSBIIC had  significant  short-term  borrowing  capacity.
HSBIIC is currently  authorized to issue up to $75 million of commercial  paper.
Commercial paper outstanding at December 31, 1998 and 1997 was $20.0 million and
$42.3 million, respectively. In 1998, Standard & Poor's and Duff & Phelps credit
rating services reaffirmed their highest ratings for the commercial paper.

The  Company  writes  business in European  markets  primarily  through its U.K.
subsidiary,  EIL. The adoption of a common  currency (the euro) by eleven of the
fifteen  member  countries  of the  European  Union on  January  1,  1999 is not
expected to result in a  substantial  change in the  business  or a  significant
increase in costs in the short term. In part,  this is due to the fact that much
of the business is U.S.  dollar  denominated.  The U.K. is not a first wave euro
country and as such the primary impact will be in Spain and the Irish  Republic.
Over time, if the U.K. adopts the euro as its currency,  there may be more of an
impact,  however,  the number of  affected  transactions  are such that a manual
backup system is practicable.  The Company will continue to monitor developments
and assess impacts on markets, pricing and reporting.



Year 2000

Year 2000 Plan and State of Readiness

In 1996, the Company began a  comprehensive  effort to assess and address issues
affecting the Company,  which related to the inability of computer equipment and
embedded computer chips to distinguish  between the year 1900 and the year 2000.
As has been well publicized, many computer systems and date controlled equipment
may cease to function or may  function in a different  manner when the year 2000
arrives because they are programmed to recognize only the last two digits of the
year.

As a part of this effort, the Company established a Year 2000 Program to address
four key areas: (i) applications software, primarily consisting of the Company's
policy management,  claims,  financial  recording and reporting,  human resource
systems, and engineering databases and systems;  (ii)  infrastructures,  such as
mainframe and corporate servers,  workstations and networking components;  (iii)
embedded  technology in facilities in which the Company  conducts its operations
and in testing equipment used by the Company's  engineering  staff; and (iv) key
business  partners  and  suppliers.  In  addition,  the  Company  is  evaluating
potential  coverage  exposures  arising  out of the Year 2000 and its  impact on
insured  equipment.  The Company's  Year 2000 Program  consists of six partially
overlapping  stages for the key areas listed above: (i) assessment and analysis;
(ii) development, renovation and replacement; (iii) implementation; (iv) testing
and  certification;  (v) contingency  planning;  and (vi) audit and review.  The
Company is using members of its internal information technology staff as well as
external  consultants  and  programmers to complete  various tasks in connection
with its Year 2000 Program and is currently on schedule.

The Company has  completed  the  assessment  and  analysis  phase for its policy
management,  claims, and financial  recording and reporting,  and human resource
systems and engineering databases and systems. The Company has largely completed
the development,  renovation,  replacement and implementation  phases for 

                                       40
<PAGE>

all of these  applications  as of December 31, 1998 with the  exception of human
resource and certain  non-critical  financial  reporting and engineering systems
which are expected to be compliant by mid-1999.

The Company has  completed  the  assessment  and analysis  phase with respect to
infrastructure  items.  The  mainframe  is Year 2000  compliant  and the Company
expects to complete the migration to Year 2000 compliant  servers and supporting
hardware and software by September 1999.  Replacement of the various  components
of non-compliant  workstations  and peripheral  equipment also is expected to be
completed by  September  1999.  Many of the  third-party  software  applications
utilized  by the  Company  in its  desktop  environment  are  already  Year 2000
compliant.  The Company  expects to complete the  installation of such compliant
programs on virtually all of its workstations during the first half of 1999.

In the area of  embedded  chip  technology,  the  Company's  principal  exposure
relates to the  prevalence of such  technology in office  buildings in which the
Company  leases space for conducting  its business  operations.  The Company has
sent  questionnaires to the leasing vendors for all of its principal  facilities
with respect to Year 2000  readiness  and has received  assurances  of readiness
from most of its vendors.

The  Company is  currently  in the process of  identifying  and  contacting  key
suppliers of services and business  partners,  such as client companies,  agents
and brokers,  with whom the Company has significant  business  relations and who
may either  electronically  provide to, or receive  from,  the  Company  certain
financial and other  information.  The Company expects to compile the assessment
of the  potential  impact on the  Company  of such  parties'  Year 2000 state of
readiness  and  remediation  plans by the end of the first  quarter  of 1999 and
conduct renovations and/or replacement and compliance testing, as appropriate.

The Company is relying upon Year 2000 readiness statements of other entities and
has not independently verified the accuracy of such statements.



Costs

It is currently  estimated that the Company's  aggregate  spending in connection
with  the  Year  2000  Program  will be in the  range  of $26  million  of which
approximately $19.7 million has been expended through December 31, 1998. Certain
of these costs are being  expensed  as they are  incurred  and are being  funded
through operating cash flow. The Company has expensed $5.1 million, $1.5 million
and $0.2 million in 1998,  1997 and 1996,  respectively.  It is  estimated  that
expenditures  of $5.2  million  for  1999  will be  expensed  as  incurred.  The
remainder  of the $26  million  estimate  relates  to systems  that the  Company
anticipated replacing in the normal course of information technology development
but the timetable for which was  accelerated in  contemplation  of the Year 2000
event.   Costs  of  replacement  and  renovation  of  information   systems  and
infrastructure that would have occurred in the normal course of business without
the advent of the Year 2000 event are excluded from these  amounts.  The current
estimate also does not include any costs associated with the  implementation  of
contingency plans that are in the process of being developed.

The Company does not expect the costs  relating to its Year 2000 Program to have
a  material  effect  on  its  results  of  operations,  liquidity  or  financial
condition.  However,  the  Year  2000  Program  is an  ongoing  process  and the
estimated costs, as well as the estimated completion dates for various phases of
the program, are subject to change.



Risks

The failure of one or more critical  software  applications or components of the
Company's  infrastructure  to be Year  2000  compliant  could  cause a  material
disruption in the normal business  operations of the Company.  Such  disruptions
could include the inability to process  policies,  register and collect premiums
and  engineering  receivables,   process  claims  or  schedule  inspections  and
engineering services. Due to the difficulty in estimating the scope and duration
of such  failures,  the Company is unable to  determine at this time whether the
consequences  of such  failures  will have a  material  impact on the  Company's
results  of  

                                       41
<PAGE>

operations,   liquidity,   or  financial  condition.   Moreover,  the  Company's
operations  are  interdependent  with  systems of business  partners and service
providers,  such as financial institutions,  communication service providers and
utilities,  over which the Company has no control. The failure of one or more of
such business partners or service providers to be Year 2000 compliant could have
a material  adverse impact on the Company.  However,  the Company  believes that
with the  implementation  of its Year 2000 Program as  scheduled,  including the
contingency  plans  discussed  below,  the risk of material  disruptions  to its
normal business operations should be significantly reduced.

As an  insurance  company,  the Company  maintains a  significant  portfolio  of
investments in cash, short-term fixed income, and equity securities. Inasmuch as
the advent of the Year 2000 may cause events, business interruptions and altered
economic facts and circumstances,  the value of the Company's investments may be
affected  favorably or  unfavorably.  The Company is selectively  monitoring the
Year 2000  compliant  status of the corporate  issuers of the  securities in its
investment  portfolio  primarily through reviewing public disclosure  documents.
State government and municipal bonds held by the Company are general obligations
and/or are  credit-enhanced and therefore the Company does not perceive there to
be a  significant  credit risk with these  securities in the absence of a severe
Year  2000  disruption  affecting  governments  and  businesses  generally.   An
immaterial  portion of the Company's  portfolio is invested in non-public issues
where public  disclosure  documents are  unavailable.  Due to the  difficulty in
estimating  the scope and  duration  of such  events,  the  Company is unable to
determine at this time whether the consequences of such developments will have a
material  impact on the Company's  investment  portfolio and  therefore,  on the
Company's results of operations, liquidity or financial condition.



Contingency Plans

As a component of the Year 2000 Program, the Company is concurrently  developing
contingency  plans  intended to mitigate  the  possible  disruption  of business
operations  arising out of the Year 2000 event. These plans will be continuously
refined during 1999 as the Company completes  compliance testing on its internal
applications  software  and  infrastructure  and further  assesses the Year 2000
readiness  status  of its  business  partners.  Contingency  plans  may  include
securing  back-up  power  for the  Company's  data  center,  manual  processing,
short-term  fixes to non-compliant  programs or business partner  interfaces and
modifying the Company's asset selection criteria for its investment activities.



Insurance Coverage Issues

The Company continues to evaluate the potential  coverage  exposures arising out
of the Year 2000 event and its  impact on insured  equipment.  The  Company  has
filed with the various  jurisdictions an endorsement to its equipment  breakdown
forms which reiterates that coverage is not provided for the inherent  inability
of computers and computerized  equipment to properly recognize a particular date
or time, such as the year 2000. The endorsement is being included in policies in
all states that have approved the endorsement.  In the four  jurisdictions  that
have not approved the endorsement,  a notice  reiterating the Company's coverage
intent with respect to Year 2000 exposures is being sent to  policyholders.  The
Company  has  recently  filed a similar  endorsement  for use with its  all-risk
policy and expects to receive  approvals  consistent with those received for its
equipment breakdown endorsement. Many of the insurers that the Company reinsures
for  equipment  breakdown  coverage are issuing  similar  endorsements  to their
policies. The Company is conducting an on-going  communications program with its
client company insurers and agents to disseminate to the ultimate  policyholders
its Year 2000 loss control suggestions and policy coverage position.

Quantification of the Company's exposure to Year 2000 losses and loss adjustment
expenses  are not  reasonably  estimable at this time as  applicable  policy and
reinsurance  contract  wordings  have not been legally  tested in the context of
such losses.

                                       42
<PAGE>


Forward-Looking Statements

Certain statements contained in this report are forward-looking and are based on
management's  current  expectations.  Actual results may differ  materially from
such  expectations  depending on the outcome of certain  factors  described with
such forward-looking statements and other factors including: significant natural
disasters  and severe  weather  conditions;  changes in  interest  rates and the
performance  of the financial  markets;  changes in the  availability,  cost and
collectibility of reinsurance; changes in domestic and foreign laws, regulations
and taxes; the entry of new or stronger  competitors and the  intensification of
pricing  competition;  the loss of current  customers or the inability to obtain
new customers;  changes in the coverage  terms selected by insurance  customers,
including  higher  deductibles and lower limits;  the adequacy of loss reserves;
changes in asset  valuations;  consolidation  and restructuring in the insurance
industry;   changes  in  the  Company's   participation  in  joint  underwriting
associations,  and in  particular  its  arrangement  with  HSB  Industrial  Risk
Insurers; changes in the demand and customer base for engineering and inspection
services  offered by the Company,  whether  resulting from changes in the law or
otherwise, and other general market conditions.


Item 7A.  Quantitative and Qualitative Disclosures about Market Risk.

See "Market  Risk" in  Management's  Discussion  and  Analysis  of  Consolidated
Financial Condition and Results of Operations in Item 7.


Item 8.  Financial Statements and Supplementary Data.

                          INDEX TO FINANCIAL STATEMENTS
                        AND FINANCIAL STATEMENT SCHEDULES

                                                                  Page No.

Report of Independent Accountants                                   45          

Financial Statements

     Consolidated Statements of Operations
       for the years ended December 31, 1998,
       1997 and 1996.                                               46          

     Consolidated Statements of Comprehensive Income
       for the years ended December 31, 1998,
       1997 and 1996.                                               47 

     Consolidated Statements of Financial
       Position - December 31, 1998 and 1997.                       48

     Consolidated Statements of Cash Flows
       for the years ended December 31, 1998,
       1997 and 1996.                                               49 

                                       43
<PAGE>


     Consolidated Statements of Changes in
       Shareholders' Equity for the years ended
       December 31, 1998, 1997 and 1996.                            50

Notes to Consolidated Financial Statements                          51 

Schedule  I -  Summary of Investments-
                 Other than Investments in Related Parties          79

Schedule II - Condensed Financial Information of
                 HSB Group, Inc.                                 80-82

Schedule III - Supplementary Insurance Information                  83

Schedule  IV - Reinsurance                                          84

Schedule V - Valuation and Qualifying Accounts                      85

Schedule VI - Supplemental Information Concerning
                 Property-Casualty Insurance Operations             86

Schedules  other than the ones listed above are omitted for the reason that they
are not required or are not  applicable or the required  information is shown in
the financial statements or notes thereto.


                                       44
<PAGE>


REPORT OF INDEPENDENT ACCOUNTANTS



To the Shareholders and Board of Directors of HSB Group, Inc.:


In  our  opinion,  the  consolidated  financial  statements  and  the  financial
statement  schedules of HSB Group, Inc. and its subsidiaries listed in Item 8 of
this Form 10-K  present  fairly,  in all  material  respects,  the  consolidated
financial  position of HSB Group, Inc. and its subsidiaries at December 31, 1998
and 1997, and the consolidated  results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted  accounting  principles.  These  consolidated  financial
statements   are  the   responsibility   of  the   Company's   management;   our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements  based on our audits.  We conducted our audits of these  consolidated
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.





/s/ PricewaterhouseCoopers LLP

January 26, 1999


                                       45
<PAGE>

Financial Statements

                      Consolidated Statements of Operations

For the years ended December 31, (in millions, except per share amounts)



                                             1998          1997          1996
--------------------------------------------------------------------------------
Revenues:

  Gross earned premiums                    $770.5         $609.3        $556.5
  Ceded premiums                            374.4          118.1         107.9
                                            ------------------------------------
  Insurance premiums                        396.1          491.2         448.6
  Engineering services                       93.5           61.3          55.8
  Net investment income                      64.2           36.8          32.3
  Realized investment gains                  25.4           14.1          12.1
                                            ------------------------------------
     Total revenues                         579.2          603.4         548.8
                                            ------------------------------------

Expenses:
  Claims and adjustment                     174.9          217.9         204.4
  Policy acquisition                         66.3           90.7          86.0
  Underwriting and inspection               113.7          142.8         136.4
  Engineering services                       86.2           57.0          48.5
  Interest                                    0.8            1.3           0.6
                                            ------------------------------------
     Total expenses                         441.9          509.7         475.9
                                            ------------------------------------
Gain on sale of IRI                          36.6           --            --

Income from continuing operations 
    before income taxes and 
    distributions on capital 
    securities                              173.9           93.7          72.9
    
Income taxes (benefit):
  Current                                    45.0           23.8          24.7
  Deferred                                    6.4            1.3          (6.4)
                                            ------------------------------------
     Total income taxes                      51.4           25.1          18.3
                                            ------------------------------------

  Distributions on capital 
    securities of subsidiary 
    trusts, net of income 
    taxes of $9.9; $1.2; and $-              18.4            2.3           --
                                            ------------------------------------
Income from continuing operations           104.1           66.3          54.6
                                            ------------------------------------

Discontinued operations:

  Loss from operations, net of income       
    tax benefits of $3.2; $0.1; $0.4         (6.6)          --            (1.2)
  Gain on disposal, net of income taxes 
    of $23.7; $-; and $-                     36.9           --              --
                                            ------------------------------------
     Total discontinued operations           30.3           --            (1.2)
                                            ------------------------------------
Net income                                 $134.4         $ 66.3        $ 53.4
                                            ------------------------------------

Earnings (loss) per common share-basic:
  Income from continuing operations        $  3.55        $  2.21       $  1.81
  Discontinued operations                     1.04          --            (0.04)
                                            ------------------------------------
  Net income                               $  4.59        $  2.21       $  1.77
                                            ------------------------------------
                                             29.3           29.5          30.3
Average common shares outstanding
Earnings (loss) per common 
  share-assuming dilution:
   Income from continuing operations       $  3.35        $  2.20       $  1.81
   Discontinued operations                    0.86            --          (0.04)
                                            ------------------------------------
   Net income                              $  4.21        $  2.20       $  1.77
                                            ------------------------------------
Average common shares outstanding and        
  common stock equivalents                   35.2           30.2          30.3


The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.


                                       46
<PAGE>

Consolidated Statements of Comprehensive Income

For the years ended December 31, (in millions)

<TABLE>
<CAPTION>

                                                  1998             1997              1996
----------------------------------------------------------------------------------------------------
<S>                                              <C>               <C>              <C>    
Net Income:                                      $134.4            $66.3            $53.4
Other comprehensive income, net of tax:
  Unrealized gains on securities:
    Unrealized holding gains arising                  
     during the period, net of income    
     taxes of $16.6; $15.7; and $11.6              28.1             21.3             16.7
                  
    Add: reclassification adjustments 
       for gains included in net income           (16.0)           (13.5)            (7.7)
                                                ----------------- ---------------- -----------------
        Total unrealized gains on securities       12.1              7.8              9.0
       
  Minimum pension liability adjustments,
     net of income taxes                           (0.1)            (0.3)            (0.1)

  Foreign currency translation adjustments,
     net of income taxes                           (1.1)            (0.8)            (0.1)
                                                ----------------- ---------------- -----------------
  Other comprehensive income                       10.9              6.7              8.8
                                                ----------------- ---------------- -----------------
  Comprehensive income                           $145.3            $73.0            $62.2

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

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.


                                       47
<PAGE>

Consolidated Statements of Financial Position

At December 31, (in millions, except per share amounts)

                                                    1998               1997
------------------------------------------------------------------- ------------
Assets:
  Cash and cash equivalents                       $   18.3           $  293.2
  Short-term investments, at cost                     62.3              131.3
  Fixed maturities, at fair value 
   (cost-$568.5; $241.1)                             577.1              248.4
  Equity securities, at fair value 
   (cost-$326.3; $231.3)                             437.1              323.8
                                               ---------------------------------
   Total cash and invested assets                  1,094.8              996.7
  Reinsurance assets                                 630.4              124.5
  Insurance premiums receivable                      146.7              138.0
  Engineering services receivable                     26.1               12.2
  Fixed assets                                        54.9               36.4
  Prepaid acquisition costs                           46.6               42.5
  Capital lease                                       14.6               15.3
  Investment in Radian                                 0.0               83.4
  Other assets                                       129.9               88.2
                                               ---------------------------------
   Total assets                                   $2,144.0           $1,537.2
                                               ---------------------------------

Liabilities:
  Unearned insurance premiums                     $  477.9           $  287.3
  Claims and adjustment expenses                     550.3              276.7
  Short-term borrowings                               21.0               42.4
  Long-term borrowings                                25.1               25.1
  Capital lease                                       27.9               27.9
  Deferred income taxes                               42.7               31.5
  Dividends and distributions 
   on capital securities                              23.2               13.3
  Ceded reinsurance payable                           64.1                3.9
  Other liabilities                                   83.6               74.9
                                               ---------------------------------
   Total liabilities                               1,315.8              783.0
                                               ---------------------------------
Company obligated mandatorily  
   redeemable capital securities of
   subsidiary Trust I holding solely
   junior  subordinated deferrable 
   interest debentures of the
   Company, net of unamortized 
   discount of $1.1 in 1998 and 1997                 108.9              108.9
Company obligated mandatorily redeemable 
   convertible capital securities 
   of subsidiary Trust II holding solely
   junior subordinated deferrable interest
   debentures of the Company                         300.0              300.0
Shareholders' equity:
  Common stock (stated value; shares 
   authorized 50.0;shares issued and
    outstanding 28.9; 29.4)                           10.0               10.0
  Additional paid-in capital                          33.5               31.6
  Accumulated other comprehensive income              66.8               55.9
  Retained earnings                                  311.2              248.8
  Benefit plans                                       (2.2)              (1.0)
                                               ---------------------------------
   Total shareholders' equity                        419.3              345.3
                                               ---------------------------------
   Total                                          $2,144.0           $1,537.2
                                               ---------------------------------
  Common shareholders' equity 
   per common share                               $   14.53          $   11.75

1997 amounts restated to reflect 1998 stock split.                              
------------------------------------------------------------------- ------------

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                       48
<PAGE>


Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>

For the years ended December 31, (in millions)
                                                                 1998                 1997                1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                  <C>                 <C>    
Operating activities:
Net income                                                       $134.4               $ 66.3              $ 53.4
Adjustments to reconcile net income to
  cash provided by operating activities:
  Depreciation and amortization                                    15.9                  9.5                10.6
  Deferred income taxes (benefit)                                   6.4                  1.3               (10.0)
  Realized investment gains, including market
   adjustments for derivative instruments                         (25.4)               (14.1)              (12.1)
  Distributions on capital securities                              28.3                  3.5                --
  Gain from disposition of Radian, net of income taxes            (30.3)                --                  --
  Gain from disposition of IRI, net of income taxes               (23.8)                --                  --
  Change in balances, net of effects from 
   purchases and sales of subsidiaries:
   Insurance premiums receivable                                   (8.7)               (31.6)              (19.2)
   Engineering services receivable                                (11.2)                (0.5)               (2.7)
   Prepaid acquisition costs                                       (4.1)                (4.9)               (6.5)
   Reinsurance assets                                            (505.9)                38.4              (103.4)
   Unearned insurance premiums                                    190.6                 19.7                54.4
   Ceded reinsurance payable                                       60.2                 (1.5)                1.9
   Claims and adjustment expenses                                 273.6                (26.2)              112.0
   Investment in Radian                                            --                   (3.7)               12.9
   Other                                                          (44.4)               (30.1)                1.6
                                                            ----------------------------------------------------------
     Cash provided by operating activities                         55.6                 26.1                92.9
                                                            ----------------------------------------------------------
Investing activities:
Fixed asset additions, net                                        (20.8)               (10.4)               (1.7)
Investments:
   (Sale) purchase of short-term investments, net                  69.0                (78.7)              (16.1)
   Purchase of fixed maturities                                  (423.5)               (60.6)              (89.0)
   Proceeds from sale of fixed maturities                          66.5                 27.9                93.1
   Redemption of fixed maturities                                  30.8                 14.4                11.5
   Purchase of equity securities                                 (326.7)              (252.9)             (149.3)
   Proceeds from sale of equity securities                        251.8                254.1               131.2
   Proceeds from disposition of Radian                            128.9                 --                  --
   Proceeds from disposition of IRI                                49.1                 --                  --
   Purchase of Solomon Associates, Inc., 
    net of cash acquired                                           (2.1)                --                  --
   Purchase of Kemper books of business                           (27.5)                --                  --
   Settlement of collar contracts                                  --                  (30.7)               --
   Cash transferred to investment in Radian                        --                   --                  (0.7)
                                                            ----------------------------------------------------------
     Cash used in investment activities                          (204.5)              (136.9)              (21.0)
                                                            ----------------------------------------------------------
Financing activities:
Proceeds from Company obligated mandatorily redeemable
  capital securities of subsidiary Trust I                         --                  108.9                --
Proceeds from Company obligated mandatorily redeemable
  convertible capital securities of subsidiary Trust II            --                  300.0                --
(Decrease) increase in short-term borrowings                      (21.4)                39.1               (10.2)
Repayment of long-term debt                                        --                   --                  (0.5)
Dividends and distribution on capital securities                  (66.2)               (46.7)              (46.1)
Reacquisition of stock                                            (47.7)               (54.0)              (13.0)
Exercise of stock options                                           9.3                  7.0                 1.1
                                                            ----------------------------------------------------------
   Cash (used in) provided by financing activities               (126.0)               354.3               (68.7)
                                                            ----------------------------------------------------------
   Net (decrease) increase in cash and cash equivalents          (274.9)               243.5                 3.2
   Cash and cash equivalents at beginning of period               293.2                 49.7                46.5
                                                            ----------------------------------------------------------
   Cash and cash equivalents at end of period                    $ 18.3               $293.2              $ 49.7
                                                            ----------------------------------------------------------
Interest paid                                                    $  2.5               $  3.2              $  2.3
Federal income tax paid                                          $ 52.4               $ 33.8              $ 25.7
</TABLE>

Non-cash investing and financing activities:
Issuance of HSB convertible  preferred stock in exchange for EIG, Co.  preferred
stock in 1996;  conversion  into HSB common  stock in 1997;  and issuance of HSB
common stock in connection with the acquisition of Solomon  Associates,  Inc. in
1998 (see note 3).

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.

                                       49
<PAGE>

Consolidated Statements of Changes in Shareholders' Equity

<TABLE>
<CAPTION>

For the years ended December 31, (in millions)

                                         Total          Common     Additional  Accumulated    Retained       Treasury    Benefit
                                         Shareholders'  Stock      Paid-in     Other          Earnings       Stock        Plans
                                         Equity                    Capital     Comprehensive
                                                                               Income
---------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>            <C>        <C>         <C>           <C>          <C>          <C>
Balances at December 31, 1995              $341.1         $10.0      $33.9       $40.4         $305.1       $(47.7)      $(0.6)
--------------------------------------------------------------------------------------------------------------------------------

Net income                                   53.4          --          --          --            53.4          --          --
Dividends declared                          (45.9)         --          --          --           (45.9)         --          --
Change in accumulated other
   comprehensive income,
   net of tax                                 8.8          --          --          8.8            --           --          --
Benefit plans                                 0.1          --          --          --             --           0.2        (0.1)
Purchase of treasury stock                  (13.0)         --          --          --             --         (13.0)        --
Exercise of stock options                     1.1          --          0.1         --             --           1.0         --
Reclassification of treasury stock            --           --         (2.0)        --           (57.5)        59.5         --
--------------------------------------------------------------------------------------------------------------------------------

Balances at December 31, 1996              $345.6         $10.0      $32.0       $49.2         $255.1       $  0.0       $(0.7)
--------------------------------------------------------------------------------------------------------------------------------

Net income                                   66.3          --          --          --            66.3          --          --
Dividends declared                          (47.0)         --          --          --           (47.0)         --          --
Change in accumulated other
   comprehensive income,
   net of tax                                 6.7          --          --          6.7            --           --          --
Benefit plans                                (0.3)         --          --          --             --           --         (0.3)
Reacquisition of stock                      (54.0)         --         (1.8)        --           (52.2)         --          --
Conversion of redeemable preferred stock     20.0          --          0.7         --            19.3          --          --
Exercise of stock options                     7.0          --          0.5         --             6.5          --          --
Issuance of reacquired stock, net of          1.0          --          0.2         --             0.8          --          --
   forfeitures
--------------------------------------------------------------------------------------------------------------------------------

Balances at December 31, 1997              $345.3         $10.0      $31.6       $55.9         $248.8       $  0.0       $(1.0)
--------------------------------------------------------------------------------------------------------------------------------

Net income                                  134.4          --          --          --           134.4         --           --
Dividends declared                          (47.9)         --          --          --           (47.9)        --           --
Change in accumulated other
   comprehensive income,
   net of tax                                10.9          --          --         10.9            --          --           --
Benefit plans                                (1.2)         --          --          --             --          --          (1.2)
Reacquisition of stock                      (47.7)         --         (5.0)        --           (42.7)        --           --
Exercise of stock options                     9.3          --          1.8         --             7.5         --           --
Issuance of reacquired stock, net of         16.2          --          5.1         --            11.1         --           --
   forfeitures
--------------------------------------------------------------------------------------------------------------------------------

Balances at December 31, 1998              $419.3         $10.0      $33.5       $66.8         $311.2       $  0.0       $(2.2)
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.


                                       50
<PAGE>

Notes to Consolidated Financial Statements
(in millions, except per share amounts)


1. Accounting Policies


Consolidation

The accompanying  financial statements present the consolidated  accounts of HSB
Group,  Inc.  and its  subsidiaries  (collectively,  HSB or the Company) and are
prepared in accordance with generally  accepted  accounting  principles  (GAAP).
Significant  intercompany  transactions  and balances  have been  eliminated  in
consolidation.  The preparation of financial  statements in accordance with GAAP
requires  the use of  estimates in  reporting  certain  assets and  liabilities.
Actual results could differ from those  estimates.  Certain amounts for 1997 and
1996 have been reclassified to conform with the 1998 presentation.



Insurance

Insurance premium revenues are net of reinsurance ceded and are generally earned
on a pro rata basis over the  contract  period.  The portion of gross  insurance
premiums  not earned at the end of the period is recorded as unearned  insurance
premiums on the Consolidated Statements of Financial Position.

Prepaid acquisition costs, consisting principally of commissions,  premium taxes
and  certain  underwriting  expenses  are  amortized  as the  related  insurance
premiums are earned. Unearned ceded commissions arising from certain reinsurance
transactions  are netted in prepaid  acquisition  costs.  All other  acquisition
costs are charged to operations as incurred.

Liabilities  for  claims and  adjustment  expenses  for  boiler  and  machinery,
property  and  other  coverages  represent  estimated  reserves  on  claims  and
adjustment  expenses  reported  but not yet  settled  and the cost of claims and
adjustment  expenses  incurred  but not yet  reported.  Reserves  for claims and
adjustment  expenses are undiscounted and are gross of amounts  recoverable from
reinsurers.   Reserves  are  reduced  for  estimated   amounts  of  salvage  and
subrogation  and  deductibles  from  customers.  HSB  records  subrogation  when
recoverability  is probable,  such as when a judgment is returned,  liability is
admitted to or  settlement  is  reached.  The length of time that  reserves  for
claims and  adjustment  expenses are carried on the  Consolidated  Statements of
Financial  Position is a function of the pay-out  patterns  associated  with the
types of coverages involved. Estimates for these reserves reflect such variables
as past loss experience,  changes in judicial interpretation of legal liability,
policy coverage and inflation.  The  establishment  of such reserves  frequently
requires  complex  engineering  judgments.  Due to the  nature of the  variables
involved  in  the  reserving  process,  subjective  judgments  are  an  integral
component.   Previously  estimated  reserves  are  regularly  adjusted  as  loss
experience  develops and new information  becomes available.  Since reserves are
based  on  estimates,  the  ultimate  liability  may be more or less  than  such
reserves.  The  effects of changes in  estimated  reserves  are  included in the
results of operations in the period in which the estimates are changed (see note
11).

Reinsurance  assets  represent  amounts due from  reinsurers for paid and unpaid
claims,  paid and unpaid loss  adjustment  expenses and the unearned  portion of
premiums ceded through reinsurance agreements.



Engineering Services

HSB recognizes the majority of its engineering  services revenues as the service
is provided.  Costs on such  contracts  are included in  operations as incurred.
Provisions  are made for  losses on  contracts  at the time such  losses  become
known.


                                       51
<PAGE>

Investments

Cash and cash  equivalents  include cash on hand and  short-term  highly  liquid
investments with maturities of three months or less. Short-term investments have
a maturity  of one year or less and are  carried at cost,  which  together  with
accrued interest  thereon,  approximates  fair value.  Fixed maturities  include
bonds, notes and redeemable  preferred stocks.  Equity securities include common
and non-redeemable  preferred stocks. All fixed maturities and equity securities
are classified as available for sale. Accordingly, these investments are carried
at estimated  fair value.  Estimated  fair values of  securities  classified  as
available for sale are based  principally upon quoted market prices.  Unrealized
gains and losses on  investments  classified  as available  for sale and foreign
exchange gains and losses on certain investments in foreign operations where the
U.S.  dollar is not the  functional  currency  are included net of income tax in
shareholders' equity.

Investment income is net of investment  expenses.  Realized investment gains and
losses are  determined on the basis of costs related to those  investments  sold
and are recorded on the trade date. Also,  included in realized investment gains
and  losses  are  losses  arising  from  declines  in the  realizable  value  of
investments considered to be other than temporary.

The carrying  values of short-term  investments,  investment  income accrued and
securities transactions in the course of settlement approximate their fair value
because  of the  relatively  short  period of time  between  origination  of the
instruments and their expected realization.

Financial  instruments which qualify for hedge accounting are recorded at market
with gains and losses  reflected  in  shareholders'  equity.  To the extent such
instruments  do not qualify for hedge  accounting,  related gains and losses are
reflected in results of operations.



Income Taxes

Deferred  tax assets  and  liabilities  are  generally  determined  based on the
difference  between  financial  statement  and tax bases for certain  assets and
liabilities  using tax rates in effect for the year in which the differences are
expected to reverse.  Deferred tax assets are allowed if future  realization  is
more  likely  than not.  Deferred  income  taxes  are  provided  for  unrealized
appreciation/depreciation  on fixed maturities and equity  securities  available
for  sale,  prepaid  acquisition  costs,  loss  reserve  discounting,   unearned
premiums, certain employee benefit costs and other items which are the result of
temporary  differences  in the  treatment  of such  items for tax and  financial
statement purposes (see note 12).



Fixed Assets

Fixed assets include real and personal property and certain eligible capitalized
system  development  costs.  Fixed  assets are carried at cost less  accumulated
depreciation  and  amortization.  Depreciation and amortization is calculated on
the basis of estimated useful lives using straight-line and accelerated methods.
Upon  retirement  or  replacement,  any gain or loss is  included  in results of
operations.


Goodwill and Other Intangible Assets

Goodwill  represents  the cost of acquiring a business which is in excess of the
fair value of its net assets. Goodwill is generally amortized over 7 to 15 years
and other intangible assets over their estimated useful lives.  These assets are
included in other assets on the  Consolidated  Statements of Financial  Position
and  amounted  to $57.7  and  $20.7  million  at  December  31,  1998 and  1997,
respectively.  HSB evaluates the reliability of goodwill based upon  projections
of undiscounted cash flows.


2. Changes in Accounting Principles

In June 1998, the Financial  Accounting  Standards Board (FASB) issued Statement
of Financial  Accounting  Standard  (SFAS) No. 133,  "Accounting  for Derivative
Instruments and Hedging Activities." This statement  establishes  

                                       52
<PAGE>

accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts,  and for hedging activities.
It requires that all  derivatives  be recognized as either assets or liabilities
in the statement of financial  position and that such instruments be measured at
fair  value.  In  addition,   all  hedging  relationships  must  be  designated,
reassessed  and  documented  pursuant to the  provisions  of SFAS No. 133.  This
statement  is  effective  for fiscal years  beginning  after June 15, 1999.  The
Company anticipates that the adoption of the provisions of SFAS No. 133 will not
have a material  impact on results of  operations,  financial  condition or cash
flows.

In December 1997, the Accounting  Standards  Executive Committee of the American
Institute of Certified Public  Accountants  (AcSEC) issued Statement of Position
(SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments."  This statement provides guidance for the recording of a liability
for insurance related  assessments.  The statement  requires that a liability be
recorded when all of the following  conditions  have been met: an assessment has
been imposed or it is probable  that an  assessment  will be imposed;  the event
obligating an entity to pay an imposed or probable assessment has occurred on or
before the date of the financial  statements;  and the amount of the  assessment
can be  reasonably  estimated.  This  statement  is  effective  for fiscal years
beginning after December 15, 1998. The Company  anticipates that the adoption of
the  provisions  of SOP 97-3  will not have a  material  impact  on  results  of
operations, financial condition or cash flows.

In March  1998,  AcSEC  issued SOP 98-1,  "Accounting  for the Costs of Computer
Software  Developed or Obtained for Internal Use." This statement  specifies the
types of costs  that  must be  capitalized  and  amortized  over the  software's
expected useful life and the types of costs which must be immediately recognized
as  expense.  For  purposes  of this  SOP,  internal-use  software  is  software
acquired,  internally developed or modified solely to meet the entity's internal
needs for which no substantive  plan exists or is being  developed to market the
software externally during the software's  development or modification.  Certain
internal and external costs incurred to develop  internal-use  computer software
that relate to system design,  software  configuration  and interfaces,  coding,
testing and  installation  to hardware  should  generally be  capitalized.  This
statement is effective for fiscal years  beginning  after December 15, 1998. The
Company's  current policy is to capitalize such costs and therefore  anticipates
that the adoption of the provisions of SOP 98-1 will not have a material  impact
on results of operations, financial condition or cash flows.

In April  1998,  AcSEC  issued  SOP 98-5,  "Reporting  on the Costs of  Start-Up
Activities."  This  statement  requires  the costs of  start-up  activities  and
organization  costs to be  expensed  as  incurred.  Start-up  costs are  defined
broadly  as  those  one-time  activities  related  to  opening  a new  facility,
introducing a new product or service,  conducting  business in a new  territory,
conducting business with a new class of customer, initiating a new process in an
existing  facility,  or commencing  some new  operation.  Start-up costs include
activities  related  to  organizing  a  new  entity  (commonly  referred  to  as
organization  costs).  This SOP applies to development stage entities as well as
established  entities.  This  statement is effective for fiscal years  beginning
after  December  15,  1998 and  initial  application  should  be  reported  as a
cumulative  effect of a change in  accounting  principle.  The Company  does not
expect the  application  of SOP 98-5 will have a  material  impact on results of
operations, financial condition or cash flows.

In October 1998,  AcSEC issued SOP 98-7,  "Deposit  Accounting:  Accounting  for
Insurance and Reinsurance  Contracts That Do Not Transfer  Insurance  Risk." The
SOP identifies  several methods of deposit  accounting and provides  guidance on
the  application  of  each  method.  This  statement  classifies  insurance  and
reinsurance  contracts for which the deposit  method is appropriate as contracts
that (i) transfer only  significant  timing risk; (ii) transfer only significant
underwriting  risk; (iii) transfer neither  significant  timing nor underwriting
risk; and (iv) have an  indeterminate  risk. This SOP is effective for financial
statements  for fiscal  years  beginning  after June 15,  1999.  Restatement  of
previously issued financial statements is not permitted. The effect of initially
adopting  SOP 98-7  should be  reported  as a  cumulative  effect of a change in
accounting principle.  Currently the Company is not party to any contracts which
do not comply with the risk transfer provisions of SFAS No.113,  "Accounting and
Reporting for Reinsurance of Short-Duration  and Long-Duration  Contracts," and,
therefore,  does not  anticipate  the  adoption  of this  statement  will have a
material impact on results of operations, financial condition or cash flows.

                                       53
<PAGE>


3. Corporate Activity

Acquisitions / Divestitures

Industrial Risk Insurers

On January 6, 1998, The Hartford Steam Boiler  Inspection and Insurance  Company
(HSBIIC)  sold its 23.5  percent  share in  Industrial  Risk  Insurers  (IRI) to
Employers Reinsurance  Corporation (ERC), one of the world's largest reinsurance
companies, in accordance with a previously announced purchase and sale agreement
between ERC and IRI's twenty-three member insurers.  The gain on the sale of IRI
was $36.6  million  pre-tax and $23.8  million  after-tax.  IRI is a  voluntary,
unincorporated joint underwriting association, which provides property insurance
for the class of  business  known as  "highly  protected  risks"  (HPR) - larger
manufacturing,  processing,  and  industrial  businesses  which have invested in
protection  against loss through the use of sprinklers  and other means.  HSBIIC
received gross proceeds of $49.1 million,  prior to transaction  costs,  for its
23.5  percent  share  in IRI.  Because  the  sale  was  structured  in part as a
reinsurance  transaction,  a portion of HSBIIC's  gross proceeds was utilized to
reinsure in-force policies with ERC.

Contemporaneous with the close of the sale, IRI was reconstituted with ERC (with
a 99.5 percent share) and HSBIIC (with a 0.5 percent share) as the sole members.
The new association has been renamed HSB Industrial Risk Insurers. HSBIIC writes
the business for HSB Industrial  Risk Insurers using its insurance  licenses and
provides certain other management and technical services.  In addition,  through
various quota share  reinsurance  agreements  with ERC and HSB  Industrial  Risk
Insurers,   HSBIIC  transferred  its  manufacturing  book  of  business  to  HSB
Industrial  Risk  Insurers  and  retains 85 percent of the  equipment  breakdown
insurance  and 15 percent of the property  insurance  of the combined  insurance
portfolio.

To support HSB's expanded role, on December 31, 1997, a business trust formed by
HSB sold $300 million of 20 year  Convertible  Capital  Securities  in a private
placement to ERC.  These  capital  securities  are  convertible  into HSB common
stock, at any time,  subject to regulatory  approval,  at a conversion  price of
$56.67,  restated to reflect the May 22,1998  three-for-two  stock  split.  $250
million of the proceeds  were  contributed  by HSB to HSBIIC and $50 million was
retained at HSB (see note 13).


Radian

On January 2, 1998,  HSBIIC  exercised its option to put its 40 percent share in
Radian  International  LLC (Radian LLC) to The Dow Chemical  Company (Dow),  for
approximately  $129 million,  net of expenses.  Radian LLC was formed in January
1996  as a  joint  venture  with  Dow  to  provide  environmental,  engineering,
information  technology,  remediation and strategic chemical management services
to industries and governments worldwide. In connection with the formation of the
new company, HSBIIC contributed  substantially all of the assets and liabilities
of its wholly owned subsidiary,  Radian Corporation at historical cost to Radian
LLC.  No gain was  recognized  on the  transfer.  The results of Radian LLC were
classified as discontinued  operations following ratification on July 28,1997 by
HSB's Board of  Directors  of  management's  decision to exercise  its put.  The
Company's share of Radian LLC's losses  incurred  subsequent to such decision of
approximately $6.6 million after-tax was deferred and recognized at the time the
gain was recognized in 1998. This  transaction  resulted in an after-tax gain of
approximately  $36.9 million which was recorded in the first quarter of 1998. In
1996 and prior to June 1997, the Company's share of the joint venture's  results
were recorded as equity in Radian.


                                       54
<PAGE>

Summarized financial data for Radian follows:


                                      1997              1996
------------------------------- ------------------ ----------------

Assets                              $159.7             $156.3
Liabilities                           88.4               62.1
Revenues                             288.0              229.6
Expenses                             314.0              233.6
------------------------------- ------------------ ----------------


Presented at 100 percent - HSBIIC's  interest in Radian during these periods was
40 percent.



EIG

In  December  1994,  HSBIIC  acquired  the  remaining  50  percent  interest  in
Engineering  Insurance  Group (EIG),  a partnership  which was jointly formed by
HSBIIC and General Reinsurance Corporation (Gen Re) in 1988. The partnership was
the parent of  Engineering  Insurance  Company  Limited,  a London based insurer
formed in 1989 principally to offer machinery breakdown coverage to business and
industry outside the United States and Canada. Coincident with the December 1994
acquisition,   the  partnership  was  incorporated  with  HSBIIC  acquiring  all
outstanding  common  shares  and Gen Re  acquiring  preferred  shares of the new
company,  EIG, Co.  HSBIIC had the option to request Gen Re to exchange the EIG,
Co. preferred stock for HSBIIC convertible redeemable preferred stock at the end
of 1996.  This option was  exercised  on  December  30,  1996  resulting  in the
issuance of 2,000 shares of HSBIIC  convertible  redeemable  preferred stock. On
October 30, 1997,  these  shares were  converted  into 597,609  shares of common
stock of HSB,  restated  to reflect the May  22,1998  three-for-two  stock split
discussed in Other Activities below (formerly 398,406 shares).



Kemper

HSBIIC completed an acquisition of the monoline boiler and machinery business of
Kemper  Insurance  Companies  (Kemper) and  Kemper's  ASME  inspection  services
business that certifies boiler and pressure vessel compliance with the codes and
standards of the American  Society of Mechanical  Engineers,  effective  July 1,
1998.  The two  companies  also  completed an  agreement  for HSBIIC to reinsure
boiler and machinery coverage as part of Kemper's commercial package policies.



Solomon Associates, Inc.

In April 1998,  HSB acquired  Solomon  Associates,  Inc.  (SAI) based in Dallas,
Texas.  SAI  is  an  engineering   management   consulting  firm  that  provides
comparative performance benchmarking consulting to the refining,  petro-chemical
and power  generation  industries.  SAI establishes  efficiency and productivity
benchmarks for 80 percent of the worldwide petroleum refining industry.



Other Activities

Holding Company Formation

At a special meeting of HSBIIC on June 23, 1997, shareholders voted to approve a
proposal which enabled the formation of a new holding company,  HSB Group,  Inc.
Shareholders of HSBIIC's common stock and convertible redeemable preferred stock
automatically  became holders of HSB Group,  Inc.  common stock and  convertible
redeemable preferred stock,  respectively,  through a share exchange approved by
the  shareholders.  Certificates  

                                       55
<PAGE>

representing   HSBIIC's  common  and  convertible   redeemable  preferred  stock
automatically  represent the corresponding  shares of HSB Group, Inc. common and
convertible  redeemable preferred stock. HSBIIC remains the principal subsidiary
of HSB.



Stock Split

On April 21, 1998, the Board of Directors  approved a three-for-two  stock split
for  shares  held of record on May 1,  1998.  Additional  shares of HSB's  stock
resulting from the split were  distributed  on May 22, 1998. In accordance  with
SFAS  No.  128  "Earnings  per  Share"(see  note  4),  all  earnings  per  share
presentations  have been  adjusted  to reflect  the  impact of the stock  split,
including  retroactive  restatement  of prior  periods.  Shares  have  also been
restated for comparative purposes.



Capital Securities

On July 15, 1997, HSB sold $110 million of 30 year Global  Floating Rate Capital
Securities in a private placement. On December 31, 1997, HSB issued $300 million
of 20 year fixed rate Convertible  Capital Securities to ERC, a subsidiary of GE
Capital Services (see note 13).



4. Earnings per Share

Pursuant to the  provisions  of SFAS No. 128,  all EPS  presentations  have been
adjusted to reflect the impact of the stock split (see note 3). Previously,  the
Company  reported  basic EPS from  continuing  operations of $3.32 and $2.71 per
share and assuming dilution EPS of $3.29 and $2.71 per share for the years ended
1997 and 1996, respectively.


The following table presents a  reconciliation  of the numerator and denominator
of the  calculation  of  basic  and  diluted  EPS  for  income  from  continuing
operations:




                                         1998            1997          1996
--------------------------------------------------------------------------------
Income from continuing operations       $104.1          $66.3         $54.6
Dividends on preferred shares              --            (1.1)          --
                                     -------------------------------------------
Income applicable to common stock        104.1           65.2          54.6
Convertible preferred stock                --             1.1           --
After-tax distributions on
  convertible capital securities(1)       13.7            --            --
                                     -------------------------------------------
Adjusted for diluted computation        $117.8          $66.3         $54.6
--------------------------------------------------------------------------------
Weighted average common shares 
 outstanding(2)                           29.3           29.5          30.3
Convertible capital securities             5.3            --            --
Convertible preferred stock                --             0.5           --
Stock options(3)                           0.6            0.2           --
                                     -------------------------------------------
Adjusted for diluted computation          35.2           30.2          30.3
--------------------------------------------------------------------------------
From continuing operations:
Earnings per share-basic (4)            $  3.55          $2.21         $1.81
Earnings per share-assuming
 dilution                               $  3.35          $2.20         $1.81
--------------------------------------------------------------------------------


(1)See note 13.

(2)Average  shares  reflect the  repurchase  of  approximately  1.2, 1.5 and 0.4
million in 1998, 1997 and 1996, respectively.


(3)Includes  the dilutive  effect of stock options  computed  using the treasury
stock method and shares issuable under deferred stock awards (see note 15).


(4)Represents  income  applicable  to common stock  divided by  weighted-average
common shares outstanding.

                                       56
<PAGE>



5. Segment Information

In 1998,  HSB  implemented  the provisions of SFAS No. 131,  "Disclosures  about
Segments of an  Enterprise  and Related  Information."  This  standard  requires
companies to report  financial  and  descriptive  information  about  reportable
operating  segments  utilizing  the  management  approach to defining  operating
segments. It includes disclosure requirements relating to products and services,
geographic  areas and major  customers.  The  adoption  of SFAS No.  131 did not
affect consolidated results of operations,  financial position or cash flows but
did affect the disclosure of segment information.

The prior year's  segment  information  has been  restated to present HSB's four
reportable  segments - Commercial  insurance,  Global  Special  Risk  insurance,
Engineering services and Investments.  HSB is a multi-national company operating
primarily in North American,  European and Asian markets. Through its Commercial
segment operations, HSB provides risk modification services, equipment breakdown
insurance  and loss  recovery  services  to  commercial  businesses.  The Global
Special  Risk  operating  segment  focuses  on the needs of  equipment-intensive
industries by offering all-risk coverage with customized  engineering consulting
and risk management.  HSB's Engineering  services operations offers professional
scientific  and technical  consulting for industry and government on a worldwide
basis. The Company's  investment assets are managed by its Investment  operating
segment.

The  accounting  policies of the  segments  are the same as those  described  in
"Accounting  Policies"  (see note 1), except for certain  benefit  charges which
comprise the Corporate  Account.  HSB evaluates the  performance of its segments
and allocates  resources to them based on net income (loss).  Segment assets are
not  included  in this  evaluation  process.  Interest  income and  expense  are
included in the results of Investment operations.

HSB's foreign operations (primarily insurance) are widely dispersed such that no
country or logical  aggregation  of countries in a  geographic  area  comprise a
significant  concentration  with  respect  to either  revenues  or  identifiable
assets.  Export  sales from HSB's  domestic  operations  are  minimal due to the
existence  of the  Company's  foreign  subsidiaries  which are  responsible  for
virtually all of the Company's foreign sales.

The  following  presents  financial  data of the  Company  based  on  geographic
location:


For the years ended December 31,            1998          1997           1996
--------------------------------------------------------------------------------
Revenues from continuing operations:
U.S.                                     $  491.0      $  483.1     $   437.4
Non-U.S.                                     88.2         120.3         111.4
                                        -------------- ------------- -----------
Total                                    $  579.2      $  603.4     $   548.8

Income from continuing operations 
before taxes and distributions    
on capital securities:
U.S.                                     $  168.2      $   78.4    $     52.9
Non-U.S.                                      5.7          15.3          20.0
                                        ----------------------------------------
Total                                    $  173.9      $   93.7    $     72.9
--------------------------------------------------------------------------------

At December 31,                            1998           1997           1996
--------------------------------------------------------------------------------
Identifiable assets:
U.S.                                     $1,769.2      $1,244.7     $   854.3
Non-U.S.                                    374.8         292.5         258.0
                                        ----------------------------------------
Total                                    $2,144.0      $1,537.2      $1,112.3
--------------------------------------------------------------------------------

                                       57
<PAGE>

The  following  presents  revenue and net income from the  Company's  reportable
segments and reconciles these amounts to the corresponding consolidated totals:

For the years ended December 31,         1998           1997            1996
--------------------------------------------------------------------------------
Revenues from continuing operations:
  Insurance premiums:
   Commercial                           $306.3         $269.0          $253.1
   Global Special Risks                   83.6          217.1           187.7
  Engineering services                    93.5           61.3            55.8
  Net investment income 
   and realized investment
    gains                                 89.6           50.9            44.4
                                     -------------------------------------------
   Total revenues from 
    reportable segments                  573.0          598.3           541.0
   Other segments                          6.2            5.1             7.8
                                     -------------------------------------------
   Total revenues                       $579.2         $603.4          $548.8
Net income (loss):
  Commercial                            $ 14.8         $ 13.4          $ 11.8
  Global Special Risks                     9.8           10.7            (3.0)
  Engineering services                     4.6            3.0             4.0
  Investments                             65.1           37.7            36.3
                                     -------------------------------------------
   Total net income from 
     reportable segments                  94.3           64.8            49.1
  Other segments                          (0.3)          (1.3)            0.4
  Corporate account                        4.7            5.1             5.1
  Distributions on 
   capital securities                    (18.4)          (2.3)             --
  Discontinued operations                 30.3            --             (1.2)
  Gain on sale of IRI, net of 
    income taxes                          23.8            --               --
                                     -------------------------------------------
   Net income                           $134.4         $ 66.3          $ 53.4
--------------------------------------------------------------------------------

Specified  items included in the measure of net income for  reportable  segments
are as follows:

For the years ended December 31,         1998             1997           1996
--------------------------------------------------------------------------------
Depreciation and amortization 
  expense:
  Commercial                          $    7.3       $    3.4       $    5.2
  Global Special Risks                     2.2            3.2            2.3
  Engineering services                     5.9            2.7            3.0
  Investments                              0.3            --             --
Income tax expense (benefit):
  Commercial                               4.6            6.1            6.9
  Global Special Risks                     7.7            6.2           (1.3)
  Engineering services                     1.6            0.1            2.0
  Investments                             22.5           10.3            7.0
--------------------------------------------------------------------------------


                                       58
<PAGE>

6. Statutory Financial Information

HSBIIC is a Connecticut domiciled insurance company which is licensed to conduct
business in all 50 states,  the District of  Columbia,  Puerto Rico and the U.S.
Virgin Islands. The annual statements for state insurance regulatory authorities
are currently  prepared using accounting methods prescribed or permitted by such
authorities  (statutory  basis) and are not consolidated.  Statutory  Accounting
Practices (SAP) also differ in certain other respects from GAAP. With respect to
HSBIIC,  these differences are primarily comprised of the accounting for prepaid
acquisition costs, deferred income taxes, fixed maturity investments,  valuation
of certain non-insurance affiliates and employee benefit plans. At year-end 1998
and 1997,  policyholders'  surplus  on a  statutory  basis was $612.6 and $550.8
million, respectively. Statutory net income, adjusted to include the earnings of
all HSBIIC domestic  insurance  subsidiaries for 1998, 1997 and 1996 was $202.5,
$42.9 and $32.1 million, respectively.

HSBIIC  and  its  insurance   subsidiaries  are  currently  subject  to  various
regulations that limit the maximum amount of dividends  ultimately  available to
HSBIIC's  parent  company   without  prior  approval  of  insurance   regulatory
authorities.  Under SAP,  approximately  $200.2 million of statutory  surplus is
available for  distribution to HSB Group,  Inc. in 1999 without prior regulatory
approval.

In 1998, the National Association of Insurance  Commissioners (NAIC) adopted the
Codification of Statutory Accounting Principles guidance, which will replace the
current  Accounting  Practices  and  Procedures  manual  as the  NAIC's  primary
guidance on statutory accounting.  The NAIC is now considering amendments to the
Codification guidance that would be effective upon implementation.  The NAIC has
recommended  an effective date of January 1, 2001. The Company has not estimated
the potential effect of the Codification  guidance if adopted by the Connecticut
Insurance Department.


                                       59
<PAGE>

7. Investments

For the years ended December 31,                1998         1997        1996
--------------------------------------------------------------------------------
Income from Investment Operations:
Net investment income:
   Short-term interest                         $  8.7      $  6.7      $  4.8
   Fixed maturities:
    Taxable interest                             31.9         9.6         9.8
    Tax exempt interest                           2.5         2.1         1.8
    Redeemable preferred dividends                5.9         7.2         7.9
   Equity securities:
    Common dividends                              6.4         4.7         4.6
    Non-redeemable preferred 
     dividends                                   14.0         8.3         5.9
   Other                                          0.2         2.1         1.0
                                            ------------------------------------
     Total investment income                     69.6        40.7        35.8
     Investment expenses                         (5.4)       (3.9)       (3.5)
                                            ------------------------------------
       Net investment income                    $64.2       $36.8       $32.3
Realized investment gains (losses):
   Fixed maturities:
    Bonds:
     Gains                                     $  2.1      $  0.5      $  2.0
     Losses                                      (0.2)       (0.3)       (0.2)
                                            ------------------------------------
       Net gains                                  1.9         0.2         1.8
    Redeemable preferred stocks:
     Gains                                        2.3         0.4         0.3
     Losses                                      (0.1)       (0.3)       (1.5)
                                            ------------------------------------
       Net gains (losses)                         2.2         0.1        (1.2)
   Equity securities:
   Common stocks:
     Gains                                       20.5        48.1        14.6
     Losses                                      (7.0)       (5.1)       (3.3)
                                            ------------------------------------
       Net gains                                 13.5        43.0        11.3
   Non-redeemable preferred stocks:
     Gains                                       10.3         7.7         4.2
     Losses                                      (3.1)       (0.2)       (4.0)
                                            ------------------------------------
       Net gains                                  7.2         7.5         0.2
   Foreign exchange gains (losses)                0.3        (7.4)        --
   Collar contracts losses                        --        (30.7)        --
   Other gains                                    0.3         1.4         --
                                            ------------------------------------
       Realized investment gains                $25.4       $14.1       $12.1
--------------------------------------------------------------------------------

There  were  no  material  declines  in  the  realizable  value  of  investments
considered  to be other than  temporary for 1998 and 1997.  Realized  investment
gains and  losses for 1996  included  $0.8  million of losses on  non-redeemable
preferred  stock arising from declines in the  realizable  value of  investments
considered to be other than temporary.


                                       60
<PAGE>
                                     
At December 31,                      1998             1997              1996
---------------------------------------------- ----------------- ---------------

Unrealized Investment Gains,
 Net of Tax
Fixed maturities:
   Gains                            $13.0           $  7.9            $  6.1
   Losses                            (4.4)            (0.6)             (1.6)
                               --------------- ----------------- ---------------
     Net gains                        8.6              7.3               4.5
Equity securities:
   Gains                            122.9             94.3              82.0
   Losses                           (12.1)            (1.8)             (2.2)
                               --------------- ----------------- ---------------
     Net gains                      110.8             92.5              79.8
Foreign exchange losses              (6.3)            (4.5)             (2.9)
                               --------------- ----------------- ---------------
     Total unrealized          
      investment gains              113.1             95.3              81.4    
Income taxes                        (42.3)           (35.5)            (28.6)
                               --------------- ----------------- ---------------
     Unrealized investment     
       gains, net of tax            $70.8            $59.8             $52.8
---------------------------------------------- ----------------- ---------------


Fixed Maturities

The amortized cost,  estimated fair values (based principally upon quoted market
prices) and gross  unrealized  gains and losses of fixed  maturities at December
31, were as follows:

<TABLE>
<CAPTION>
 
                                                                 1998
-----------------------------------------------------------------------------------------------
                                      Amortized      Estimated         Gross       Gross
Category                                Cost          Fair          Unrealized   Unrealized
                                                      Value            Gains       Losses
--------------------------------- -------------------------------------------------------------
<S>                                    <C>          <C>              <C>           <C>    
Redeemable preferred stocks            $215.5       $219.2           $ 5.0         $1.3
States and municipalities                47.4         49.3             2.1          0.2
Foreign governments                      21.0         21.3             0.4          0.1
Corporate and other                     284.6        287.3             5.5          2.8
                                  -------------------------------------------------------------
   Total fixed maturities              $568.5       $577.1           $13.0         $4.4
</TABLE>


<TABLE>
<CAPTION>

                                                                  1997
-----------------------------------------------------------------------------------------------
Category                            Amortized       Estimated         Gross        Gross
                                     Cost             Fair          Unrealized   Unrealized
                                                      Value           Gains       Losses
--------------------------------------------------------------------------------------------------
<S>                                    <C>          <C>               <C>          <C> 
Redeemable preferred stocks            $131.2       $135.4            $4.7         $0.5
States and municipalities                37.6         39.7             2.2          0.1
Foreign governments                      33.1         33.5             0.4          --
Corporate and other                      39.2         39.8             0.6          --
                                ------------------------------------------------------------------

   Total fixed maturities              $241.1       $248.4            $7.9         $0.6
---------------------------------------------------------------------------------------------------
</TABLE>


                                       61
<PAGE>

The amortized cost and estimated fair value of fixed  maturities at December 31,
by contractual  years-to-maturity  is as follows  (actual  maturities may differ
from  contractual  maturities  because  borrowers  may have the  right to prepay
obligations):



                                                      1998
--------------------------------------------------------------------------------

Maturity                                 Amortized             Estimated
                                            Cost               Fair Value
--------------------------------------------------------------------------------

One year or less                          $ 18.8               $ 18.9
Over one year through five years            93.3                 96.4
Over five years through ten years           47.3                 48.9
Over ten years                             409.1                412.9
                                    --------------------------------------------

Total fixed maturities                    $568.5               $577.1
--------------------------------------------------------------------------------


Equity Securities

The cost,  estimated fair values (based  principally  upon quoted market prices)
and gross unrealized gains and losses of equity  securities at December 31, were
as follows:
                                                      1998
--------------------------------------------------------------------------------
                                            Estimated    Gross         Gross
                                              Fair      Unrealized   Unrealized
                                 Cost        Value       Gains         Losses
--------------------------------------------------------------------------------

Common stocks                   $141.3        $249.3     $112.3     $     4.3
Non-redeemable 
  preferred stocks               185.0         187.8       10.6           7.8
                             --------------------------------------- -----------

   Total equity securities      $326.3        $437.1     $122.9      $   12.1
-------------------------------------------------------------------- -----------



                                                      1997
--------------------------------------------------------------------------------
                                            Estimated     Gross        Gross
                                               Fair     Unrealized   Unrealized
                                 Cost         Value       Gains        Losses
--------------------------------------------------------------------------------

Common stocks                   $ 97.5        $179.0     $ 82.2      $    0.7
Non-redeemable 
  preferred stocks               133.8         144.8       12.1           1.1
                                 -----------------------------------------------

   Total equity securities      $231.3        $323.8     $ 94.3      $    1.8
--------------------------------------------------------------------------------

On December 19, 1996,  HSBIIC entered into three "zero cost collar contracts" to
mitigate the effects of market risk on its U. S. common stock portfolio  (which,
for management purposes, included certain convertible preferreds). Each contract
had a notional  value of $50 million and maturity  dates  ranging from  November
1997 to January 1998.  The  contracts,  which were entered into when the S&P 500
Index was 744.3,  allowed HSBIIC to recover from the  counterparty  if the index
was below 695.2 at the time of maturity,  and required  HSBIIC to reimburse  the
counterparty  if the  index  was  above a range of 811.3 to 818.7 at the time of
maturity.  In the fourth quarter of 1997,  HSBIIC settled all of its outstanding
contracts  resulting in realized  losses of $30.7  million for the year,  all of
which were offset by and  represented  portfolio  appreciation  and returns that
were  realized.  During the year ended  December 31, 1997,  the  Company's  U.S.
common stock  portfolio  had  experienced  a total return of $57 million  (which
includes  price  appreciation  of  approximately  $54  million)  and had a price
movement correlation with the S&P 500 Index well in excess of 80 percent.

                                       62
<PAGE>

The collar  subjected the Company to market and  counterparty  credit risk.  The
Company  managed this exposure by  frequently  modeling the effects of potential
future  price  movements on the value of the collar and HSB's  portfolio  and by
entering into contracts with internationally  recognized financial institutions,
which  were  expected  to  perform  under  the  terms  of the  contract,  and by
evaluating  the credit  worthiness of such  institutions  by taking into account
credit ratings and other factors.



8. Fixed Assets

Fixed assets are summarized as follows:


At December 31,                               1998                  1997
-----------------------------------------------------------------------------

Land and buildings                           $ 5.1                 $ 5.0
Furniture, equipment,            
   leasehold improvements, 
   and other                                  68.0                  57.1
Systems development costs                     23.9                   6.6
                                       --------------------------------------

                                              97.0                  68.7

Less: accumulated depreciation 
  and amortization                           (42.1)                (32.3)
                                       --------------------------------------

   Total fixed assets                        $54.9                 $36.4
-----------------------------------------------------------------------------

Property  and  equipment  are stated at cost.  Depreciation  expense is computed
using  straight-line and accelerated  methods over the estimated useful lives of
31.5  years  for  buildings  and 3 to 10  years  for  equipment  and  furniture.
Leasehold  improvements  are  amortized  over the shorter of the assets'  useful
lives or their remaining contractual lease terms.

The Company has a policy of  capitalizing  certain  systems  development  costs.
Systems  development  costs are amortized over estimated useful lives of 3 to 10
years. In 1998,  approximately $6.5 million of systems development costs relates
to the allocation of purchase price for SAI.

In 1996, the Company began a  comprehensive  effort to assess and address issues
relating to the ability of its policy processing and other  operational  systems
to properly recognize calendar dates beginning in the year 2000. As part of this
effort,  the  Company  established  a Year 2000  Program to address the areas of
applications  software,  infrastructures,  embedded  technology and key business
partners and suppliers.  It is currently  estimated that the Company's aggregate
spending in  connection  with the Year 2000  Program will be in the range of $26
million.  Certain of these costs are being expensed as incurred. The Company has
expensed $5.1 million for 1998, $1.5 million for 1997 and $0.2 million for 1996.
It is estimated that  expenditures  of $5.2 million for 1999 will be expensed as
incurred.  The remainder of the $26 million  estimate is related to systems that
the Company anticipated replacing in the normal course of information technology
development, however, the timetable was accelerated in contemplation of the Year
2000 event.  The costs  associated  with  replacement  of such systems are being
capitalized in accordance with the Company's existing capitalization policy.



9. Leases

The  Company  leases  its home  office  facility  at One  State  Street  under a
long-term   capital  lease  with  the  One  State  Street  Limited   Partnership
(Partnership).  The lease  obligation  of $26.1  million was recorded at July 1,
1983 at an  interest  rate of 15  percent.  An asset of $26.1  million  was also
recorded  in 1983.  Accumulated  amortization  on the  asset was $11.6 and $10.8
million at December 31, 1998 and 1997, respectively.  Terms of the lease require
annual  payments of  approximately  $4 million a year through June 30, 2018.  In
addition,  the  Company is  required  to pay over the lease 

                                       63
<PAGE>

term a proportional share of the facility's  variable operating  expenses.  This
amounted to approximately  $2.9, $2.6 and $2.8 million for the years ended 1998,
1997 and 1996, respectively.

The Company owns the One State Street land and leases it to the Partnership. The
Company  receives a base rent for the land and a  participation  in the net cash
flow of the  Partnership.  If the facility is sold,  the Company will receive 50
percent or more of the sales proceeds in excess of the mortgages,  all operating
expenses  and  costs of sale and the  rental  obligations  pursuant  to the land
lease.  Under certain  circumstances,  the Company has the right to purchase the
facility.

In addition to its home office  facility,  the  Company  leases  facilities  and
certain  equipment which are accounted for as operating  leases.  Lease expenses
amounted to $10.2, $8.4 and $5.7 million in 1998, 1997 and 1996, respectively.


At December 31, 1998,  future minimum  rental  commitments  under  noncancelable
leases accounted for as operating leases with initial or remaining terms of more
than one year were as follows:


               1999                        $ 6.4

               2000                          4.6

               2001                          3.1

               2002                          2.5

               2003                          1.9

               2004 and thereafter           2.6
                                             ---
                 Total                     $21.1


10. Reinsurance

The components of net written and net earned insurance premiums were as follows:




For the years ended December          
31,                               1998               1997            1996
--------------------------------------------------------------------------------
Written premiums:
   Direct                       $ 478.2            $ 361.4         $ 338.6
   Assumed                        318.5              257.1           232.6
   Ceded                         (444.1)            (120.0)         (116.8)
                              --------------------------------------------------
    Net written premiums        $ 352.6            $ 498.5         $ 454.4

Earned premiums:
   Direct                       $ 408.8            $ 370.1         $ 343.4
   Assumed                        361.7              239.2           213.1
   Ceded                         (374.4)            (118.1)         (107.9)
                              --------------------------------------------------
    Insurance premiums          $ 396.1            $ 491.2         $ 448.6
--------------------------------------------------------------------------------

In 1998 HSBIIC  became the direct  writer for business  written on behalf of HSB
Industrial  Risk  Insurers.  This  business is ceded to that entity and HSBIIC's
share of the  equipment  breakdown  and  property  business  is assumed  back in
accordance with the reinsurance  agreements in place with ERC (see note 3). This
has  resulted  in  growth in gross and ceded  premiums,  claims  and  adjustment
expenses.

                                       64
<PAGE>

The Company writes direct  business,  which in 1998 includes HSB Industrial Risk
Insurers  business,  through  agencies and  brokerage  firms.  In addition,  the
Company assumes boiler and machinery exposures from over 100 insurance companies
and several  insurance pools.  Under the reinsurance  agreements,  the Company's
reinsured   companies  may  include  equipment   breakdown  exposures  in  their
multi-peril  policies,  and such risks will be assumed by the Company  under the
terms of the agreement. These agreements generally provide that the Company will
assume 100 percent of each boiler and  machinery  risk,  subject to the capacity
specified  in the  agreement,  and will receive the entire  equipment  breakdown
premium except for a ceding commission,  which will be retained by the reinsured
company  for  commissions  to agents and  brokers,  premium  taxes and  handling
expenses.

Although the Company assumes the role of reinsurer, it continues to have selling
and  underwriting  responsibilities  as well as  involvement  in inspecting  and
claims  adjusting.  In effect,  the  Company  becomes  the  equipment  breakdown
insurance  department  of the  reinsured  company  and  provides  all  equipment
breakdown  underwriting  (that is, the  examination  and  evaluation of the risk
based on its engineering  judgments),  claims and engineering  services as if it
were  part  of that  organization.  Traditionally,  as part of the  underwriting
process,  the Company  retains the right to decline or restrict  coverage in the
same manner as it does for its own business. In 1996, the Company began to write
a simplified  program  (referred to as ReSource) under which a reinsured company
agrees to  include  equipment  breakdown  insurance  on an entire  portfolio  of
accounts  meeting  specific  underwriting  guidelines and occupancy  parameters,
which the Company agrees to reinsure for equipment breakdown losses.

The insurance industry,  in general, is undergoing a shakeout and consolidation.
A significant  amount of merger and acquisition  activity has occurred  recently
and may continue in the future.  Depending on the specific companies involved in
these activities and other market factors,  the level of reinsured  business the
Company assumes in the future could be impacted.

Recently there has been significant consolidation in the international brokerage
business,  including the merger of Marsh & McLennan and Johnson & Higgins during
1997, and the subsequent merger with Sedgwick Group. For 1998,  approximately 35
percent of the Company's gross written  premium  generated by its Global Special
Risk  business,  which includes HSB  Industrial  Risk Insurers,  was produced by
J&HMarsh & McLennan and Sedgwick Group.

As a property  insurer,  the  Company  is subject to losses  that may arise from
catastrophic  events.  The Company  participates in various  facultative,  quota
share  and  excess  of  loss  reinsurance  agreements  to  limit  its  exposure,
particularly to catastrophic losses, and to provide additional capacity to write
business.  In the unlikely event that ceded  reinsurers are unable to meet their
obligations,   the  Company  would   continue  to  have  primary   liability  to
policyholders for losses incurred.  Reinsurance recoverable on unpaid claims and
the  unearned  portion of ceded  reinsurance  premiums  are  reported as assets,
rather than netted against the related  liability  accounts.  The Company is not
party to any contracts which do not comply with the risk transfer  provisions of
SFAS No. 113,  "Accounting and Reporting for Reinsurance of  Short-Duration  and
Long-Duration  Contracts." The Company recorded $436.4, $45.2 and $113.9 million
of reinsurance  recoveries as a reduction of its claims and adjustment  expenses
for the years ended December 31, 1998, 1997 and 1996, respectively.  Reinsurance
recoverable on paid claims and adjustment expenses was $14.6 and $8.0 million at
December 31, 1998 and 1997, respectively.


                                       65
<PAGE>

11. Reconciliation of Liability for Claims and Adjustment Expenses

The  following  tables  provide  reconciliations  of the  beginning  and  ending
reserves for claims and  adjustment  expenses on both a gross  liability and net
(of reinsurance) liability basis:

Reconciliation of Gross Liability for Claims and Adjustment Expenses

                                           1998         1997         1996
--------------------------------------------------------------------------------
Gross liability for claims and 
   adjustment expenses at                 
   January 1,                             $276.7       $302.9         $190.9
Plus:
   Provision for claims and 
     adjustment expenses occurring 
     in the current year                   564.8        263.3          313.3
   Increase (decrease) in estimated 
     claims and adjustment expenses 
     arising in prior years(1)              46.9         (0.2)          16.1
                                       -----------------------------------------

Total incurred claims and 
  adjustment expenses                     $611.7       $263.1         $329.4
                                       -----------------------------------------
Less:
   Payment for claims arising in:
     Current year                          141.0         90.6          103.3
     Prior years                           197.1        198.7          114.1
                                       -----------------------------------------
        Total payments                    $338.1       $289.3         $217.4
                                       -----------------------------------------
Gross liability for claims and         
  adjustment expenses at December 31,     $550.3       $276.7         $302.9
--------------------------------------------------------------------------------


Reconciliation of Net Liability for Claims and Adjustment Expenses

                                            1998           1997          1996
--------------------------------------------------------------------------------
Net liability for claims and           
  adjustment expenses at January 1,        $190.8        $177.8         $145.5
Plus:
   Provision for claims and 
     adjustment expenses occurring 
     in the current year                    164.0         209.5          214.2
   Increase (decrease) in estimated 
    claims and adjustment expenses  
     arising in prior years                  10.9           8.4           (9.8)
                                       -----------------------------------------
        Total incurred claims and 
          adjustment expenses              $174.9        $217.9         $204.4
                                       -----------------------------------------
Less:
   Payment for claims arising in:
      Current year                           84.2          82.3           91.4
      Prior years                           111.8         122.6           80.7
                                       -----------------------------------------
         Total payments                    $196.0        $204.9         $172.1
                                       -----------------------------------------
Net liability for claims and           
   adjustment expenses at December 31,     $169.7        $190.8         $177.8
--------------------------------------------------------------------------------


(1)The 1998  increase  primarily  resulted from the decision  rendered  under an
arbitration   proceeding   and  adverse  claims   experience  in   international
operations.

                                       66
<PAGE>


1998, 1997 and 1996 claims and adjustment expenses incurred have been reduced by
subrogation   recoveries  of   approximately   $5.0,   $3.3  and  $4.9  million,
respectively.

A  reconciliation  of the net  liability to the gross  liability  for claims and
adjustment expenses is as follows:




                                              1998         1997         1996
At December 31,
--------------------------------------------------------------------------------
Net liability for claims and            
  adjustment expenses at December 31,        $169.7       $190.8      $177.8
Reinsurance recoverable on unpaid       
   claims and adjustment expenses             380.6         85.9       125.1
                                        ----------------------------------------
Gross liability for claims and          
   adjustment expenses at December 31,       $550.3       $276.7      $302.9
--------------------------------------------------------------------------------

The Company utilizes  well-capitalized  domestic and  international  reinsurance
companies  and  syndicates  for  its  reinsurance  program  and  monitors  their
financial  condition on an ongoing basis. For reinsurers that are not accredited
in their state of domicile,  the Company  requires  collateral  for  reinsurance
recoverable from such carriers.  Uncollectible reinsurance recoverables have not
had,  and are not  expected  by  management  to have in the  future,  a material
adverse effect on the consolidated  results of operations or financial  position
of the Company.

The following table displays information  concerning the primary participants in
the Company's current reinsurance program as of December 31, 1998.



Reinsurer                             Ceded                
                                     Written       Reinsurance      1998 A.M.
                                     Premium         Asset        Best's Rating
--------------------------------------------------------------------------------

Employers Reinsurance Corporation*    $167.7        $ 248.6    A++(Superior)
General Reinsurance Corporation       $ 44.7        $  66.0    A++(Superior)
Gerling-Konzern Globale               $  9.6        $  13.3    n/a
Hartford Fire Insurance Company       $  9.3        $  13.4    A+   (Superior)
American Re-Insurance Company         $  8.7        $  13.2    A++(Superior)
NAC Reinsurance Corporation           $  8.3        $  12.8    A+   (Superior)

* net of business assumed by HSB from ERC

As of December  31,  1998 no other  reinsurance  asset of the  Company  from any
single reinsurer exceeded 3.0 percent of shareholders'  equity.  Certain Lloyd's
syndicates  participate in the excess of loss reinsurance program,  primarily in
the excess  layers.  The  highest  aggregate  percentage  participation  of such
syndicates, at 31.9 percent, is in the $50 million excess of $100 million layer.
No individual  syndicate has more than 6.8 percent  participation  in any of the
excess layers. In addition,  certain syndicates  participate in two of our quota
share treaties,  aggregating 7.9 percent  participation  in one and 13.5 percent
participation in another. Lloyd's participation in our catastrophe cover is 77.3
percent  with no  individual  syndicate  retaining  more than 5.3  percent.  The
Company's reinsurance asset in the aggregate from all Lloyd's syndicates is less
than 8.0 percent of  shareholders'  equity at  December  31,  1998.  Lloyd's has
historically  participated  more heavily in the higher treaty layers,  including
those years relating to the arbitration and litigation cases discussed below.

HSBIIC is currently involved in a claim-related dispute concerning the extent to
which a certain  explosion  event is  insured  under the  boiler  and  machinery
coverage of HSBIIC or under coverages of other insurers.  A final decision in an

                                       67
<PAGE>

arbitration  proceeding on this matter has concluded  with a decision  requiring
HSBIIC to pay $22 million of the amount that was in  dispute.  The $22  million,
less HSBIIC's retention of $3 million, which was reserved for in prior years, is
fully reinsured. In response to the ruling, the Company increased both its gross
reserves and reinsurance  recoverable by $19 million,  resulting in no impact to
net income.  HSBIIC has filed a motion in Connecticut  Superior Court to confirm
the arbitration award. The other insurers have contested the award. In the event
the award is not confirmed,  subsequent  proceedings  could result in additional
amounts  on the order of $100  million  potentially  becoming  recoverable  from
HSBIIC's reinsurers.

The  obligations of HSBIIC's  reinsurers with respect to this litigation are not
in dispute. Therefore, management believes that any adverse outcome in this case
will not have a material effect on either the results of operations or financial
condition of the Company.  HSBIIC's reinsurance  contracts do not require HSBIIC
to reimburse its reinsurers for any loss such reinsurers might incur should this
case not be decided in  HSBIIC's  favor.  Nevertheless,  reinsurers  often quote
rates for future coverages based upon their or other reinsurers' experience on a
particular account.  Therefore, in the event HSBIIC's reinsurers pay significant
sums  pursuant  to  the  litigation  described  above,  it  is  likely  HSBIIC's
reinsurance rates would increase in future periods.  However,  given the insured
capacity that exists in  reinsurance  markets  worldwide,  coupled with HSBIIC's
ability to negotiate a redesign or restructuring of its reinsurance  program, it
does not necessarily mean that such an increase would be material.

HSBIIC was involved in another  litigation  regarding an explosion event and the
extent of HSBIIC's  coverage in that  matter.  The 7th Circuit  Court of Appeals
recently  ruled in  HSBIIC's  favor and  remanded  the case for a judgment of no
liability to be entered for HSBIIC.

The Company is also involved in various other legal  proceedings as defendant or
co-defendant  that have  arisen in the  normal  course of its  business.  In the
judgment of management,  after consultation with counsel,  it is improbable that
any  liabilities  which may  arise  from such  litigation  will have a  material
adverse  impact on the results of operations  or the  financial  position of the
Company.



12. Income Taxes

Tax Provision

A reconciliation of income taxes (benefit) at U.S. statutory rates to the income
taxes (benefit) as reported is as follows:

<TABLE>
<CAPTION>

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

                                                % of                   % of                    % of
                                               Pre-tax                Pre-tax                Pre-tax
                                     Amount    Income       Amount     Income      Amount     Income
-----------------------------------------------------------------------------------------------------------
<S>                                  <C>        <C>          <C>         <C>        <C>         <C>
 Income from continuing operations
   before income taxes and
   distributions on capital
   securities                        $173.9     100%         $93.7       100%       $72.9       100%
                                    ------------------------------------------------------------------------

Tax at statutory rates               $ 60.9      35%         $32.8        35%       $25.5        35%
Income taxed at foreign rates          (0.6)     --            1.0         1          0.5         1
Dividends received deduction           (4.3)     (2)          (4.9)       (5)        (4.5)       (6)
Tax exempt interest                    (0.9)     (1)          (0.8)       (1)        (0.6)       (1)
Tax credits and others                 (3.7)     (2)          (3.0)       (3)        (2.6)       (4)
                                    ------------------------------------------------------------------------
Total income taxes and effective     
   tax rate                          $ 51.4      30%         $25.1        27%       $18.3        25%
------------------------------------------------------------------------------------------------------------
</TABLE>

                                       68
<PAGE>


Income taxes (benefit) consisted of the following:

                                      1998              1997           1996
--------------------------------------------------------------------------------
Current provision:
   U.S.                               $45.3            $16.8          $17.3
   Foreign                             (0.3)             7.0            7.4
                                ------------------------------------------------
     Total current provision           45.0             23.8           24.7
                                ------------------------------------------------
Deferred provision:
   U.S.                                 6.2              1.1           (6.0)
   Foreign                              0.2              0.2           (0.4)
                                ------------------------------------------------
    Total deferred provision            6.4              1.3           (6.4)
                                ------------------------------------------------
Total income taxes                    $51.4            $25.1          $18.3
--------------------------------------------------------------------------------



Deferred Income Taxes

Deferred  income  taxes  reflect  the net tax  effect of  temporary  differences
between the carrying  amounts of assets and liabilities for financial  reporting
purposes  and the  amounts  used for  income  tax  purposes.  Components  of the
Company's  deferred tax  liabilities and assets as of December 31, 1998 and 1997
are as follows:


                                          1998                 1997
------------------------------------ -------------------- ----------------------

Deferred tax liabilities:
   Prepaid acquisition costs              $(17.1)              $(13.2)
   Accelerated depreciation                 (0.5)                (0.3)
   Pension asset                           (14.4)               (13.3)
   Unrealized investment gains             (42.3)               (35.5)
   Other                                   (14.0)               (12.5)
                                     -------------------- ----------------------

    Total deferred tax liabilities         (88.3)               (74.8)
                                     -------------------- ----------------------

Deferred tax assets:
   Benefit plans                             9.2                  9.0
   Capital lease                             4.7                  4.4
   Unearned insurance premiums              12.1                 15.0
   Loss reserve discounting                  3.3                  5.9
   Other                                    16.3                  9.0
                                     -------------------- ----------------------

    Total deferred tax assets               45.6                 43.3
                                     -------------------- ----------------------

     Net deferred tax liabilities         $(42.7)              $(31.5)
------------------------------------ -------------------- ----------------------


Other Information

U.S. federal tax return examinations have been completed for years through 1995.
The Company believes  adequate  provisions for income tax have been recorded for
all years.


                                       69
<PAGE>


13. Capital Structure

HSB's capital structure is as follows at December 31:


                                                              1998       1997
--------------------------------------------------------------------------------

Short-term borrowings                                        $  21.0    $  42.4
Long-term borrowings *                                       $  25.1    $  25.1
Company obligated mandatorily redeemable
   capital securities of subsidiary Trust I holding
   solely junior subordinated deferrable interest
   debenture of the Company                                   $108.9     $108.9
Company obligated mandatorily redeemable convertible
   capital securities of subsidiary Trust II holding
   solely junior subordinated deferrable interest
   debenture of the Company                                   $300.0     $300.0
Common shareholders' equity                                   $419.3     $345.3
--------------------------------------------------------------------------------

*excludes capital lease (see note 9).


Short-term and Long-term Borrowings

HSBIIC has a commercial  paper  program with a limit of $75 million.  Commercial
paper  outstanding  at December  31, 1998 and 1997 was $20.0 and $42.3  million,
respectively. Commercial paper outstanding at year end 1998 matures on or before
April 20, 1999.  Long-term  debt includes  $25.1 million of senior notes due May
15, 2000 at an interest rate of 6.83 percent.  Current market value is estimated
to be $26.2 million.



Capital Securities

On July 15, 1997, HSB sold $110 million of 30 year Global  Floating Rate Capital
Securities  (Capital  Securities)  in a private  placement.  The  securities are
generally  non-callable  for ten years but may be called earlier by HSB upon the
occurrence of certain tax events  including loss of deductibility of interest on
the  securities.  The securities  were issued through HSB Capital I (Trust I), a
Delaware business trust created by HSB, at a floating rate tied to 90 day LIBOR.
The  current  coupon  is  approximately  6.3  percent.  Holders  of the  Capital
Securities   will  be  entitled   to  receive   preferential   cumulative   cash
distributions  accumulating  from  the date of  original  issuance  and  payable
quarterly in arrears. HSB has the right to defer payment of distributions on the
securities  at any  time or from  time to time  for a period  not  exceeding  20
consecutive  quarterly  periods with respect to each deferral period.  During an
extension   period,   interest  will  continue  to  accrue  and  the  amount  of
distributions  to which  holders of the Capital  Securities  are  entitled  will
accumulate,  and HSB will be  prohibited  from paying any cash  dividends on its
common stock.  HSB has irrevocably and  unconditionally  guaranteed all of Trust
I's obligations  under the Capital  Securities.  The Company has used or may use
the proceeds for general  corporate  purposes,  including the  repurchase of HSB
common stock;  funding investments in, or extensions of credit to, subsidiaries;
repayment of maturing  debt; and financing  possible  future  acquisitions.  HSB
subsequently  filed a  registration  statement  covering  securities  with terms
identical in all material respects and offered to exchange registered securities
for the original Capital Securities.  The exchange was completed on December 11,
1997.

On December  31,  1997,  HSB sold $300  million of 20 year  Convertible  Capital
Securities in a private placement to ERC. The Convertible Capital Securities are
callable by the Company at its option (i) at any time after  seven  years;  (ii)
upon the occurrence of certain tax events including loss of deductibility of the
interest  on the  securities;  (iii)  in the  

                                       70
<PAGE>

event that the Company vetoes a prospective purchaser of the Convertible Capital
Securities;  or (iv) in the event of a change in control of ERC. The Convertible
Capital  Securities  are  mandatorily  redeemable on December 31, 2017,  and are
redeemable at par plus a redemption  premium, at the option of ERC, in the event
of a change in control of the Company  within five years  following  issuance of
the securities.

The  Convertible  Capital  Securities are  convertible,  in whole or in part, at
ERC's option at any time, subject to regulatory approval, into shares of Company
common stock at a conversion price of $56.67 per share,  restated to reflect the
May 22,1998 three-for-two stock split (formerly a conversion price of $85.00 per
share) (see note 3),  subject to  adjustment.  The Company has provided  certain
registration  rights to ERC in  connection  with the common stock into which the
Convertible Capital Securities are convertible pursuant to a Registration Rights
Agreement dated December 31, 1997. Were ERC to exercise its conversion rights in
total,  it would hold, on a fully diluted basis,  approximately  15.5 percent of
the Company's  common  stock.  Pursuant to certain  provisions  contained in the
Purchase   Agreement  dated  December  31,  1997,  ERC  has  agreed  to  certain
"standstill"  arrangements,  which for a period of five years will  preclude ERC
from  purchasing any common stock of the Company,  other than by exercise of its
conversion rights, and will limit its ability to take certain other actions with
respect to the Company during that period.

The  securities  were  issued  through  HSB  Capital  II (Trust  II), a Delaware
business  trust  created  by HSB Group,  Inc.,  at a 7 percent  coupon,  payable
semi-annually.  The  Convertible  Capital  Securities  rank pari  passu with the
capital  securities  issued  July  1997.  Holders  of  the  Convertible  Capital
Securities   will  be  entitled   to  receive   preferential   cumulative   cash
distributions  accumulating  from  the date of  original  issuance  and  payable
semi-annually in arrears.  HSB has the right to defer payment of interest at any
time or from time to time for a period not exceeding 10 consecutive  semi-annual
periods  with  respect to each  deferral  period.  During an  extension  period,
interest  will  continue  to accrue  and the  amount of  distributions  to which
holders of the Convertible Capital Securities are entitled will accumulate,  and
HSB will be prohibited  from paying any cash dividends on its common stock.  HSB
has irrevocably  and  unconditionally  guaranteed all of Trust II's  obligations
under the Convertible Capital Securities.

The estimated fair value of the Capital Securities issued by Trust I is equal to
their carrying value. The estimated fair value of the Capital  Securities issued
by Trust II is $311.1 million and is calculated without giving any effect to the
relationship  of the conversion  price to the current market price of HSB Group,
Inc. common stock.



Common Shareholders' Equity
The Connecticut  Business  Corporation Act, which became effective on January 1,
1997, eliminated the concept of treasury shares. Therefore, shares reacquired by
the Company  constitute  authorized  but  unissued  shares.  As a result of this
change in law,  the  Company  eliminated  the  caption  Treasury  Stock from its
balance sheet and  reclassified  the amounts to additional  paid-in  capital and
retained  earnings.  These  amounts were $112.8 and $85.9 million as of December
31, 1998 and 1997,  respectively.  The  reclassifications  were  distributed  as
follows:
                                   
At December 31,                    1998             1997
-------------------------------------------------------------

Additional paid-in capital        $  5.5           $ 2.8
Retained earnings                  107.3            83.1
                              -------------------------------

   Total                          $112.8           $85.9
-------------------------------------------------------------

2,000 shares of HSBIIC's  convertible  redeemable preferred stock held by Gen Re
were converted  into 597,609 shares of HSB common stock on October  30,1997 at a
price of $33.47 per share,  restated to reflect  the May 22, 1998  three-for-two
stock split (formerly 398,406 shares at $50.20 per share)(see note 3).

                                       71
<PAGE>


The components of accumulated other  comprehensive  income (net of taxes) are as
follows:

<TABLE>
<CAPTION>

-----------------------------------------------------------------------------------------------
                                      Total         
                                    Accumulated      Unrealized      Minimum      
                                       Other            Gains        Pension     Foreign  
                                   Comprehensive         On         Liability    Exchange
                                      Income         Securities    Adjustment     Losses             
-----------------------------------------------------------------------------------------------
<S>                                  <C>                 <C>           <C>          <C>    
Balances at December 31, 1996        $49.2               $54.6         $(3.6)       $(1.8)
Current period change                  6.7                 7.8          (0.3)        (0.8)
-----------------------------------------------------------------------------------------------
Balances at December 31, 1997        $55.9               $62.4         $(3.9)       $(2.6)
Current period change                 10.9                12.1          (0.1)        (1.1)
-----------------------------------------------------------------------------------------------
Balances at December 31, 1998        $66.8               $74.5         $(4.0)       $(3.7)
-----------------------------------------------------------------------------------------------
</TABLE>

14. Pension and Other Benefit Programs

In February  1998,  the FASB issued SFAS No. 132  "Employer's  Disclosure  about
Pension and Other  Postretirement  Benefits" which  standardizes  the disclosure
requirements for pensions and other postretirement  benefits.  While it does not
change the measurement or recognition of the plans,  it does require  additional
information on changes in the benefit  obligation and fair value of plan assets.
The statement is effective for fiscal years  beginning  after  December 15, 1997
and requires restatement of prior periods.  Pursuant to the requirements of this
statement,  the Company has  combined  the  pension and  postretirement  benefit
disclosures  and restated 1997 and 1996  disclosures  to conform to current year
presentation.

HSB maintains various types of pension and postretirement medical plans covering
employees  of the  Company  and  certain  subsidiaries.  The  pension  plans are
non-contributory  and benefits are based upon an employee's years of service and
final average pay based upon the highest three out of five years. Vesting occurs
after five years of service in compliance  with the provisions of the Tax Reform
Act of 1986.

Under  the  terms of the HSB  Group,  Inc.  Thrift  Incentive  Plan,  a  defined
contribution  plan, covered employees are allowed to contribute up to 15 percent
of their pay, on a pre-tax basis,  limited by the maximum allowed under Internal
Revenue  Service  regulations.  The Company makes a matching  contribution of 50
percent of employee contributions up to 6 percent of compensation. Total expense
for the plan  was  $2.1,  $1.7  and  $1.8  million  for  1998,  1997  and  1996,
respectively.

The Company makes available health care and life insurance  benefits for retired
employees  of  the  Company  and  certain   subsidiaries.   The  Company   makes
contributions  to the plans as claims are incurred.  Retirees'  contributions to
these plans  vary,  based upon  retiree's  age,  years of service  and  coverage
elected.  The Company  periodically  amends the plans changing the  contribution
rate of retirees and amounts of coverage.

                                       72
<PAGE>

The following chart summarizes the balance sheet impact,  as well as the benefit
obligations, assets, funded status and rate assumptions associated with the U.S.
pension and postretirement medical benefit plans:

<TABLE>
<CAPTION>

                                                      Pension Benefits                      Other Benefits
--------------------------------------------------------------------------------------------------------------------------
                                                   1998              1997                1998              1997
--------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>               <C>                 <C>               <C>    
Change in benefit obligation:
   Benefit obligation at beginning of year         $156.0            $140.0              $ 29.9            $ 26.7
   Service cost                                       5.3               4.1                 0.3               0.3
   Interest cost                                     11.9              10.7                 1.9               2.1
   Net benefit payments                             (10.3)             (9.2)               (1.9)             (1.9)
   Liability loss (gain)                              0.7               2.5                (2.7)              1.8
   Assumption changes                                 9.6               7.9                 1.2               0.9
   Acquisitions                                       4.2               --                  --                --
   Amendments                                         2.8               --                  --                --
                                              ----------------------------------------------------------------------------

   Benefit obligation at end of year               $180.2            $156.0              $ 28.7            $ 29.9

Change in plan assets:
   Fair value of plan assets at beginning          $213.0            $178.0              $  --             $  --
    of year
   Actual return on plan assets                      40.8              42.4                 --                --
   Acquisitions                                       3.5               --                  --                --
   Employer contributions                             0.4               --                  1.5               1.5
   Participants' contributions                       --                 --                  0.4               0.4
   Benefits paid                                     (8.6)             (7.4)               (1.9)             (1.9)
                                              ----------------------------------------------------------------------------

   Fair value of plan assets at end of             $249.1            $213.0              $  --             $  --
   year

Funded status:
   Funded status at end of year                    $ 68.9            $ 57.0              $(28.7)           $(29.9)
   Unrecognized actuarial (loss) gain               (25.6)            (13.2)                4.0               5.5
   Unrecognized transition amount                    (4.7)             (6.5)                --                --
   Unrecognized prior service cost                    4.2               2.6                 --                --
                                              ----------------------------------------------------------------------------

   Net amount recognized                           $ 42.8            $ 39.9              $(24.7)           $(24.4)

Amounts recognized in the consolidated
statements of financial position consist of:
   Prepaid benefit cost                            $ 34.6            $  31.7             $  --             $ --
   Accrued benefit liability                          --                --                (24.7)            (24.4)
   Intangible asset                                   2.0               2.2                --                --
   Accumulated other comprehensive income             6.2               6.0                --                --
                                              ----------------------------------------------------------------------------

   Net amount recognized                           $ 42.8            $ 39.9              $(24.7)           $(24.4)

Weighted-average assumptions at December 31:
   Discount rate                                      6.75%             7.25%               6.75%             7.25%
   Long-term rate of return on assets                10.00%            10.00%               n/a               n/a
   Rate of increase in future                         4.25%             4.50%               n/a               n/a
     compensation levels
   Current year health care cost trend                n/a               n/a                 6.00%             7.00%
   rate
   Ultimate health care cost trend rate               n/a               n/a                 4.25%             4.50%
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

For measurement purposes,  the annual rate of increase in the per capita cost of
covered health care benefits range from 6 percent in 1998  decreasing  gradually
to 4.25 percent by the year 2001 and remaining level thereafter.

                                       73
<PAGE>

Assets available for pension plan benefits include approximately $24.2 and $20.9
million of Company stock at December 31, 1998 and 1997, respectively.

The following chart  summarizes the cost components  associated with the pension
and postretirement medical benefit plans:

<TABLE>
<CAPTION>


                                                        Pension Benefits                          Other Benefits
------------------------------------------------------------------------------------------------------------------------------
For the years ended December 31,               1998           1997          1996          1998         1997        1996
------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>          <C>             <C>          <C>        <C>
Components of net periodic benefit
   (credit) cost:
   Service cost                               $  5.3         $ 4.1        $  3.6          $0.3         $0.3       $0.3
   Interest cost                                11.9          10.7          10.2           1.9          2.1        2.0
   Expected return on plan assets              (18.5)        (16.8)        (15.3)          --           --         --
   Amortization of transition amount            (1.9)         (1.8)         (1.8)          --           --         --
   Amortization of prior service cost            0.8           0.5           0.5           --           --         --
   Recognized actuarial loss                     1.0           0.5           0.5           --           0.1        --
                                         ------------------------------------------------------------------------------------
   Net periodic benefit (credit) cost         $ (1.4)        $(2.8)       $ (2.3)         $2.2         $2.5       $2.3
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>

The projected benefit obligation,  accumulated benefit obligation and fair value
of plan assets for the pension  plan with  accumulated  benefit  obligations  in
excess of plan assets were $36.6,  $29.7 and $3.2 million,  respectively,  as of
December 31, 1998 and $27.9 million,  $23.8 million and $0, respectively,  as of
December 31, 1997.

The Company's  acquisition of SAI in April 1998, resulted in the increase of the
pension  benefit  obligation  by $4.2  million and  pension  plan assets by $3.5
million.

Assumed  health care cost trend rates have a  significant  effect on the amounts
reported for the health care plan. A one percentage-point  change in the assumed
health care cost trend rates would have the following effects:


                                      1% Point                1% Point
                                      Increase                   Decrease
--------------------------------------------------------------------------------

Effect on total of service and 
  interest cost components             $0.1                       $(0.1)
Effect on postretirement 
  benefit obligation                    1.3                        (1.2)


15. Stock Compensation Plans

HSB has a Stock Option Plan under which key employees may be granted  restricted
stock and stock options.

HSB's Long-Term  Incentive Plan grants senior  management awards contingent upon
achievement of specified performance  objectives over a three year period, which
may be paid out in cash or shares  of  common  stock  (which  may be  restricted
shares).  The number of shares subject to issuance under this plan cannot exceed
375,000.

HSB's  restricted  stock is an award of  common  shares  that may not be sold or
transferred during the restriction  period,  usually three years under the Stock
Option Plan and five years under the Long-Term  Incentive Plan, from the date on
which the award is granted.  During the restriction  period, the employee is the
registered  owner,  receives  dividends  and may  vote  the  restricted  shares.
Compensation  expense is based on the market value of the Company's common stock
at the date of grant  and is  recognized  over the  period  of the  restriction.
Compensation  expense for this benefit was $1.0 million in 1998 and $0.6 million
in 1997 and 1996. The unamortized  compensation  expense related to this plan is
included in benefit plans as a component of shareholders'  equity. These amounts
were $2.2 and $1.0 million in 1998 and 1997,  respectively.  

                                       74
<PAGE>

A summary of grants follows (1997 and 1996 numbers have been adjusted to reflect
the April 1998 stock split - see note 3):


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


Restricted shares awarded        54,434           30,594            19,875

Weighted-average fair value 
  of shares on grant date        $39.86           $31.93            $32.57
--------------------------------------------------------------------------------


A stock  option  award under the HSB's Stock Option Plan allows for the purchase
of HSB  common  stock at no less  than the  market  price on the date of  grant.
Options granted to date are exercisable no earlier than one year after the grant
date and expire no more than ten years from the date of grant.

A summary of the status of HSB's stock options as of December 31, 1998, 1997 and
1996 and changes during the years ended on those dates is presented  below (1997
and 1996 numbers have been  adjusted to reflect the April 1998 stock split - see
note 3):

<TABLE>
<CAPTION>

                                              1998                           1997                           1996

------------------------------------------------------------------------------------------------------------------------------
                                                  Weighted-                        Weighted-                     Weighted-
                                                   Average                          Average                       Average
                                                   Exercise                         Exercise                      Exercise
                                   Shares          Price          Shares            Price         Shares            Price
------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>              <C>          <C>                  <C>        <C>                <C>
Outstanding at beginning of       
   year                           2,227,125        $32.03       1,979,475            $32.44     1,950,000          $33.91
   Granted                          814,500         39.34         558,750             32.55       591,000           33.21
   Exercised                       (279,450)        34.21        (235,500)            31.12       (36,375)          30.84
   Forfeited                        (31,950)        37.81         (75,600)            33.49      (525,150)          38.86
                                 ---------------------------------------------------------------------------------------------

Outstanding at end of year        2,730,225         33.92       2,227,125             32.03     1,979,475           32.44
                                 ---------------------------------------------------------------------------------------------

Options exercisable at year-end   1,923,225        $31.65       1,681,875            $32.51     1,424,475          $32.15

Weighted-average fair value of                    
   options granted during the
   year                                            $ 4.68                            $ 4.24                        $ 4.70
-------------------------------- ---------------------------------------------------------------------------------------------
</TABLE>

The following table summarizes information about stock options outstanding as of
December 31, 1998:

<TABLE>
<CAPTION>

                          Options Outstanding                         Options Exercisable

-------------------------------------------------------------------------------------------------
                                  Weighted-                            
                                   Average        Weighted-                       Weighted-
Range of                          Remaining       Average                         Average 
Exercise           Number         Contractual     Exercise         Number         Exercise   
 Prices          Outstanding        Life           Price         Exercisable       Price   
-------------------------------------------------------------------------------------------------
<S>               <C>                 <C>           <C>           <C>               <C>    

$27-$30.99        1,103,250           6.08          $29.97        1,103,250         $29.97
$31-$34.99          689,700           6.08          $33.25          689,700         $33.25
$35-$38.99          787,275           7.74          $38.51          130,275         $37.41
$39-$42.99          150,000           9.14          $42.02            --               --
                  ----------                                      ---------
                  2,730,225                                       1,923,225
-------------------------------------------------------------------------------------------------
</TABLE>

                                       75
<PAGE>

SFAS No. 123,  "Accounting for Stock Based  Compensation"  was issued in October
1995 for  implementation by year-end 1996. SFAS No. 123 allows the use of a fair
value based method of accounting  for an employee stock option or similar equity
instruments  or the  intrinsic  value  based  method  prescribed  by  Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" with
pro forma  disclosures of net income and earnings per share as if the fair value
based method of accounting had been applied. The Company has elected to continue
using the  intrinsic  value based method.  Had the Company  elected to recognize
compensation  cost using the fair value based  method,  compensation  would have
been measured at date of grant and recognized over the service period. Pro forma
net income and  earnings  per share would have been  imputed as follows for 1998
and 1997:


                                                               1998      1997
--------------------------------------------------------------------------------
Net Income                                     As reported    $ 134.4    $ 66.3
                                               Pro forma        131.4      64.5
Earnings per common share-basic                As reported    $  4.59    $ 2.21
                                               Pro forma         4.49      2.15
Earnings per common share-assuming dilution    As reported    $  4.21    $ 2.20
                                               Pro forma         4.12      2.13

These pro forma  disclosure  amounts  derived by the use of SFAS No. 123 are not
indicative of future amounts.  SFAS No. 123 is not applicable to options granted
prior to 1995, and additional options may be granted in future years.

The fair value of each option grant was estimated on the date of grant using the
Black-Scholes  option-pricing model with the following  assumptions for 1998 and
1997,  respectively:  risk-free  interest  rates of 4.9  percent in 1998 and 6.3
percent in 1997;  dividend yield of 4.7 percent in 1998 and 5.0 percent in 1997;
expected  lives of 6 years;  and  volatility  of 15.7  percent  in 1998 and 15.8
percent in 1997.



16. Stock Purchase Rights

On  September  21, 1998,  the Board of Directors  approved the adoption of a new
shareholder  rights  plan to replace the plan that was set to expire on November
28,  1998.  Pursuant  to the new plan,  which is  substantially  similar  to the
expiring plan,  the Board declared a dividend of one right for each  outstanding
share of common stock to shareholders of record on November 28, 1998.

The rights  will  separate  from the common  stock and become  exercisable  if a
person or group  acquires  ownership  of 15 percent  or more of the  outstanding
common stock of the Company or  commences a tender or exchange  offer to acquire
15 percent or more of the outstanding shares.

Each right entitles a holder to purchase one  two-hundredth of a share of Series
A Junior  Participating  Preferred Stock, without par value at an exercise price
of $162.00 per share,  subject to adjustment.  If an acquirer obtains 15 percent
or more of the Company's common stock and the Board of Directors determines that
such acquisition is not in the best interest of the shareholders,  the rights of
shareholders  other than the acquiror will entitle the holder to purchase common
shares of the Company (or, under certain circumstances, of the acquiror) at a 50
percent discount. Under the plan ERC will not be deemed an acquiror in the event
of the  conversion of the  Convertible  Capital  Securities it holds into common
stock of the Company unless it acquires 1 percent or more additional shares.

The rights  expire on  November  28, 2008 and may be redeemed by the Company for
$0.01  per  right  any time  until  the  tenth  business  day  following  public
announcement that a 15 percent position has been acquired.

                                       76
<PAGE>

17. Consolidated Quarterly Data (unaudited)

<TABLE>
<CAPTION>
                                            First           Second           Third             Fourth             
1998                                       Quarter         Quarter          Quarter           Quarter            Year
------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>             <C>             <C>               <C>               <C>    
Gross earned premiums                       $179.7          $175.7          $212.5            $202.6            $770.5
Ceded premiums                                80.3            85.3           113.0              95.8             374.4
                                        --------------------------------------------------------------------------------------
Insurance premiums                          $ 99.4          $ 90.4          $ 99.5            $106.8            $396.1
Engineering services                          19.7            22.7            25.3              25.8              93.5
Net investment income                         15.2            15.9            15.5              17.6              64.2
Realized investment gains                      3.2             7.3             7.9               7.0              25.4
                                        --------------------------------------------------------------------------------------
   Total revenues                           $137.5          $136.3          $148.2            $157.2            $579.2
                                        --------------------------------------------------------------------------------------
Income from continuing operations          
   before income taxes and
   distributions on capital securities      $ 69.6          $ 34.8          $ 36.1            $ 33.4            $173.9
Income taxes                                  22.5             9.3             9.3              10.3              51.4
Distributions on capital securities            
   of subsidiary trust, net of income
   tax                                         4.5             4.7             4.6               4.6              18.4
                                        --------------------------------------------------------------------------------------
Income from continuing operations           $ 42.6          $ 20.8          $ 22.2            $ 18.5            $104.1
Discontinued operations:
   Loss from operations, net of             
     income tax benefits                    $ (6.6)         $  --           $  --             $  --             $ (6.6)
   Gain on disposal, net of income            
     taxes                                    36.9             --              --                --               36.9
                                        --------------------------------------------------------------------------------------
Total discontinued operations               $ 30.3          $  --           $  --             $  --             $ 30.3
                                        --------------------------------------------------------------------------------------
Net income                                  $ 72.9          $ 20.8          $ 22.2            $ 18.5            $134.4
                                        --------------------------------------------------------------------------------------
Earnings per common share-basic:
   Income from continuing operations        $  1.45         $  0.71         $  0.75           $  0.64           $  3.55
   Discontinued operations                     1.04            --              --                 --               1.04
                                        --------------------------------------------------------------------------------------
           Net income                       $  2.49         $  0.71         $  0.75           $  0.64           $  4.59
                                        --------------------------------------------------------------------------------------
Earnings per common share-
  assuming dilution:
   Income from continuing operations        $  1.31         $  0.68         $  0.72           $  0.63           $  3.35
   Discontinued operations                     0.86            --               --                --               0.86
                                        --------------------------------------------------------------------------------------
Net income                                  $  2.17         $  0.68         $  0.72           $  0.63           $  4.21
                                        --------------------------------------------------------------------------------------
Dividends declared per common share         $  0.40         $  0.40         $  0.42           $  0.42           $  1.64
                                        --------------------------------------------------------------------------------------
Common stock price ranges:
   High                                     $ 44.92         $ 53.50         $ 57.63           $ 42.00           $ 57.63
   Low                                      $ 36.45         $ 43.17         $ 40.38           $ 36.00           $ 36.00
   Close                                    $ 44.92         $ 53.50         $ 40.38           $ 41.06           $ 41.06
Shareholders at December 31,                                                                                   5,045
------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       77
<PAGE>

<TABLE>
<CAPTION>

                                           First           Second            Third             Fourth            Year
1997                                      Quarter         Quarter           Quarter           Quarter
----------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>              <C>               <C>               <C>               <C>    

Gross earned premiums                     $155.8           $149.2            $151.6            $152.7            $609.3
Ceded premiums                              33.5             32.0              30.3              22.3             118.1
                                        ------------------------------------------------------------------------------------
Insurance premiums                        $122.3           $117.2            $121.3            $130.4            $491.2
Engineering services                        14.7             15.0              15.5              16.1              61.3
Net investment income                        8.0              8.8               9.1              10.9              36.8
Realized investment gains                    0.5              3.4               2.3               7.9              14.1
                                        ------------------------------------------------------------------------------------
   Total revenues                         $145.5           $144.4            $148.2            $165.3            $603.4
                                        ------------------------------------------------------------------------------------
Income from continuing operations        
 before income taxes and distributions
 on capital securities                    $ 21.4           $ 22.1            $ 21.5            $ 28.7            $ 93.7
Income taxes                                 5.5              5.7               5.3               8.6              25.1
Distributions on capital securities        
   of subsidiary trust, net of income
   tax                                       --              --                 1.0               1.3               2.3
                                        ------------------------------------------------------------------------------------
Income from continuing operations         $ 15.9           $ 16.4            $ 15.2            $ 18.8            $ 66.3
Discontinued operations:
   Loss from operations, net of         
     income tax benefits                  $  --            $ --              $ --              $  --             $  --
   Gain on disposal, net of income          
     taxes                                   --              --                --                 --                --
                                        ------------------------------------------------------------------------------------
     Total discontinued operations        $  --            $ --              $ --              $  --             $  --
                                        ------------------------------------------------------------------------------------
Net income                                $ 15.9           $ 16.4            $ 15.2            $ 18.8            $ 66.3
                                        ------------------------------------------------------------------------------------
Earnings per common share-basic:
   Income from continuing operations      $  0.52          $  0.54           $  0.51           $  0.65           $  2.21
   Discontinued operations                   --               --                --                --                --
                                        ------------------------------------------------------------------------------------
   Net income                             $  0.52          $  0.54           $  0.51           $  0.65           $  2.21
                                        ------------------------------------------------------------------------------------
Earnings per common share-assuming 
   dilution:
   Income from continuing operations      $  0.52          $  0.53           $  0.51           $  0.64           $  2.20
   Discontinued operations                   --               --                 --                 --              --
                                        ------------------------------------------------------------------------------------
   Net income                             $  0.52          $  0.53           $  0.51           $  0.64           $  2.20
                                        ------------------------------------------------------------------------------------
Dividends declared per common share       $  0.38          $  0.38           $  0.40           $  0.40           $  1.56
                                        ------------------------------------------------------------------------------------
Common stock price ranges:
   High                                   $ 31.50          $ 35.92           $ 37.67           $ 37.08            $37.67
   Low                                    $ 29.83          $ 29.58           $ 35.08           $ 33.67            $29.58
   Close                                  $ 29.83          $ 35.58           $ 37.13           $ 36.80            $36.80
Shareholders at December 31,                                                                                    5,221
----------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       78
<PAGE>

                                          Schedule I
                                        HSB Group, Inc.
          Summary of Investments - Other Than Investments in Related Parties
                                        (in millions)
<TABLE>
<CAPTION>


                  Column A                   Column B    Column C     Column D     Column E     Column F     Column G
----------------------------------------------------------------------------------------------------------------------------
                                                               1998                                   1997
                                             -------------------------------------------------------------------------------
                                                                         Amount                                 Amount
                                                                         Shown                                  Shown
                                                                         In The                                 In The
                                                            Market      Balance                    Market       Balance
             Type of Investment               Cost          Value        Sheet         Cost         Value        Sheet
----------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>       <C>          <C>            <C>          <C>          <C>
Fixed Maturities:
   Bonds:
      U.S. Government and Government            
        Agencies and Authorities                $  0.0    $    0.0     $    0.0       $  0.0       $  0.0       $  0.0
      States, Municipalities and Political        
        Subdivisions                              47.4        49.3         49.3         37.6         39.7         39.7
      Foreign Governments                         21.0        21.3         21.3         33.1         33.5         33.5
      Public Utilities                             0.0         0.0          0.0          0.0          0.0          0.0
      Convertibles and Bonds with Warrants         
        Attached                                   0.0         0.0          0.0          0.0          0.0          0.0
      All Other Bonds                            273.5       276.2        276.2         28.1         28.7         28.7
   Certificates of Deposit                         0.0         0.0          0.0          0.0          0.0          0.0
   Mortgage Receivable                            11.1        11.1         11.1         11.1         11.1         11.1
   Redeemable Preferred Stocks                   215.5       219.2        219.2        131.2        135.4        135.4
                                             -------------------------------------------------------------------------------
         Total Fixed Maturities                 $568.5    $  577.1     $  577.1       $241.1       $248.4       $248.4

Equity Securities:
   Common Stocks:
      Public Utilities                            16.6        19.1         19.1         16.3         19.8         19.8
      Banks and Insurance                         39.9        48.7         48.7         13.4         23.5         23.5
      Industrial and Other                        84.8       181.5        181.5         67.8        135.7        135.7
   Non-Redeemable Preferred Stocks               185.0       187.8        187.8        133.8        144.8        144.8
                                             -------------------------------------------------------------------------------
         Total Equity Securities                $326.3    $  437.1     $  437.1       $231.3       $323.8       $323.8

Short-term Investments and Cash                 $ 80.6    $   80.6     $   80.6       $424.5       $424.5       $424.5
                                             -------------------------------------------------------------------------------
         Total Investments                      $975.4    $1,094.8     $1,094.8       $896.9       $996.7       $996.7
                                             ===============================================================================
</TABLE>



                                       79
<PAGE>

                          HSB GROUP, INC. (Registrant)
        SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
                            BALANCE SHEET INFORMATION
                                  December 31,
                                  (In millions)

                                                 1998              1997
                                           -----------------------------------

Assets
Cash                                           $  0.1            $  0.7
Short-term investments, at cost                   2.1              60.5
Investment in subsidiaries                      780.2             657.0
Fixed maturities, at fair value 
  (cost-$47.9; $11.7)                            47.2              11.8
Equity securities, at fair value 
  (cost-$45.2; $27.0)                            43.4              27.2
Other assets                                      2.9              23.9
                                           -----------------------------------

     Total assets                              $875.9            $781.1
                                           ===================================

Liabilities
Dividends and distributions on 
  capital securities                           $ 23.2            $ 13.3
Other liabilities                                24.5              13.6
                                           -----------------------------------

     Total liabilities                           47.7              26.9
                                           -----------------------------------

Company obligated mandatorily redeemable        
   capital securities of subsidiary 
   Trust I holding solely
   junior subordinated
   deferrable interest
   debentures of the Company, 
   net of unamortized discount 
   of $1.1 in 1998 and 1997.                    108.9             108.9

Company obligated mandatorily redeemable 
   convertible capital securities of            
   subsidiary Trust II holding solely 
   junior subordinated deferrable
   interest debentures of the Company.          300.0             300.0

Shareholders' Equity
Common stock                                     10.0              10.0
Paid in capital                                  33.5              31.6
Accumulated other comprehensive income           66.8              55.9
Retained earnings                               311.2             248.8
Benefit plans                                    (2.2)             (1.0)
                                           -----------------------------------

     Total shareholders' equity                 419.3             345.3
                                           -----------------------------------

     Total liabilities and 
      shareholders' equity                     $875.9            $781.1
                                           ===================================


These  condensed  financial  statements  should be read in conjunction  with the
consolidated  financial statements and accompanying footnotes of HSB Group, Inc.
(see pages 46 through 78).


                                       80
<PAGE>

                         
                          HSB GROUP, INC. (Registrant)
        SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
                   CONDENSED STATEMENTS OF INCOME INFORMATION
                       For the periods ended December 31,
                                  (In millions)

                                                    1998                1997*
                                                --------------------------------

Revenues:
   Net investment income                           $  6.4               $ 1.4
   Realized investment gains                          1.0                 -
                                                --------------------------------

Income before income taxes and distributions          7.4                 1.4
   on capital securities


Income taxes                                          2.5                 0.5

Distribution on capital securities of                18.4                 2.3
   subsidiary trusts, net of income taxes of
   $9.9 and $1.2.
                                                --------------------------------

Net loss - parent only                              (13.5)               (1.4)

Equity in net income of subsidiaries                147.9                35.4
                                                --------------------------------

Net income                                         $134.4               $34.0
                                                ================================

*  For the period from June 23, 1997 through December 31, 1997.

These  condensed  financial  statements  should be read in conjunction  with the
consolidated  financial statements and accompanying footnotes of HSB Group, Inc.
(see pages 46 through 78).

                                       81
<PAGE>

                          HSB GROUP, INC. (Registrant)
        SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
                 CONDENSED STATEMENTS OF CASH FLOWS INFORMATION
                       For the periods ended December 31,
                                  (In millions)

                                                         1998             1997*
                                                     ---------------------------

Operating Activities:
   Net income                                          $134.4           $ 34.0
   Undistributed earnings of subsidiaries**             (91.8)           (21.2)
   Distributions on capital securities                   28.3              3.5 
   Realized investment gains                             (1.0)              -
   Decrease (increase) in other assets                    9.2            (26.2)
   Increase in other liabilities                         22.2             10.8

                                                     ---------------------------
   Cash provided by operating activities                101.3              0.9
                                                     ---------------------------

Investing Activities:
   Sale (purchase) of short-term investments, net        58.4            (60.5)
   Purchase of fixed maturities                         (48.0)           (11.8)
   Proceeds from sale of fixed maturities                12.3              -
   Purchase of equity securities                        (26.6)           (27.0)
   Proceeds from sale of equity securities                8.7              -
   Purchase of Solomon Associates, Inc., 
    net of cash acquired                                 (2.1)             -
   Contribution to subsidiaries                           -             (279.5)

                                                     ---------------------------
   Cash provided (used) by investing activities           2.7           (378.8)
                                                     ---------------------------

Financing Activities:
   Dividends and distribution on 
    capital securities                                  (66.2)           (11.9)
   Net proceeds from issuance of company 
    obligated mandatorily                                  
     redeemable capital securities                         -             408.9
   Options exercised                                      9.3              5.5
   Reacquisition of stock                               (47.7)           (36.5)
   Other                                                  -               12.6

                                                     ---------------------------
   Cash (used) provided by financing activities        (104.6)           378.6
                                                     ---------------------------

Change in cash                                           (0.6)             0.7

Cash at beginning of period                               0.7              -

Cash at end of period                                  $  0.1           $  0.7
                                                     ===========================


*  For the period from June 23, 1997 through December 31, 1997.

** Dividends  received  from  Hartford  Steam Boiler  Inspection  and  Insurance
Company were $56.1 million and $12.8 million in 1998 and 1997 respectively.

These  condensed  financial  statements  should be read in conjunction  with the
consolidated  financial statements and accompanying footnotes of HSB Group, Inc.
(see pages 46 through 78).


                                       82
<PAGE>

<TABLE>
<CAPTION>

                                  Schedule III
                                 HSB Group, Inc.
                       Supplementary Insurance Information
                  For Years Ended December 31, 1998, 1997, 1996

   Column A      Column B*  Column C*   Column D* Column E*  Column F Column G** Column H    Column I  Column J  Column K
----------------------------------------------------------------------------------------------------------------------------

Segment            Deferred   Future      Unearned  Other      Premium   Net        Benefits,    Amortiza-  Other      Premiums
                   acquisi-   policy      premiums  policy     revenue   invest      claims,     tion of    operating  written
                    tion     benefits                claims              -ment    losses and    prepaid     expense
                    costs     and                     and                 income    settlement   policy
                              losses,               benefits                       expenses    acquisition
                              claims and            payable                                     costs
                              loss
                              expenses
<S>                     <C>       <C>         <C>        <C>    <C>        <C>       <C>          <C>     <C>        <C>

1998:
   Commercial           $-        $-          $-         $-     $306.3     $-        $124.6       $67.6    $95.6     $327.5
   Global Special       
    Risk                 -         -           -          -       83.6      -          46.6         0.9     18.1       20.3
   Other Segments        -         -           -          -        6.2      -           3.7        (2.2)     -          4.8
                   =========================================================================================================
Total                   $-        $-          $-         $-     $396.1     $-        $174.9       $66.3   $113.7     $352.6
                   =========================================================================================================

1997:
   Commercial           $-        $-          $-         $-     $269.0     $-        $103.9       $59.5    $83.2     $277.4
   Global Special        
    Risk                 -         -           -          -      217.1      -         111.4        31.0     58.3      217.3
   Other Segments        -         -           -          -        5.1      -           2.6         0.2      1.3        3.8
                   =========================================================================================================
Total                   $-        $-          $-         $-     $491.2     $-        $217.9       $90.7   $142.8     $498.5
                   =========================================================================================================

1996:
   Commercial           $-        $-          $-         $-     $253.1     $-         $98.6       $56.3    $78.1     $255.8
   Global Special        
    Risk                 -         -           -          -      187.7      -         101.9        29.5     57.0      192.2
   Other Segments        -         -           -          -        7.8      -           3.9         0.2      1.3        6.4
                   =========================================================================================================
Total                   $-        $-          $-         $-     $448.6     $-        $204.4       $86.0   $136.4     $454.4
                   =========================================================================================================

* Segment assets are not included in  management's  evaluation of and allocation
of resources to segments.

** Investment  assets are managed by and  investment  income is allocated to the
Company's Investment segment.
</TABLE>

                                       83
<PAGE>



                                                    Schedule IV
                                                  HSB Group, Inc.
                                                    Reinsurance
                                                   (in millions)
<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------
         Column A            Column B      Column C         Column D         Column E             Column F
        Insurance             Gross        Ceded to         Assumed            Net              Percentage of
         Premiums             Amount         Other         From Other         Amount               Amount
                                           Companies       Companies                           Assumed to Net
--------------------------------------------------------------------------------------------------------------------

--------------------------------------------------------------------------------------------------------------------
<S>                           <C>          <C>             <C>              <C>                    <C>    
1998                          
Property and Liability
Insurance                     $408.8       $374.4          $361.7           $396.1                 91.3%

1997                          
Property and Liability
Insurance                     $370.1       $118.1          $239.2           $491.2                 48.7%

1996                          
Property and Liability
Insurance                     $343.4       $107.9          $213.1           $448.6                 47.5%
</TABLE>


                                       84
<PAGE>



                                                  SCHEDULE V
                                                HSB Group, Inc.
                                     Valuation and Qualifying Accounts
                                                (in millions)
<TABLE>
<CAPTION>


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

               Description            Balance at     Charged to     Charged to      Deductions     Balance At End 
                                     Beginning of     Costs and   Other Accounts   Describe (a)      of Period
                                        Period        Expenses
      -------------------------------------------------------------------------------------------------------------
      <S>                                 <C>             <C>           <C>             <C>             <C>    

      1998
      Reserve for Accounts                
      Receivable                          $3.6            $0.5          $0.0            $0.2            $3.9

      1997
      Reserve for Accounts                
      Receivable                          $3.0            $0.9          $0.0            $0.3            $3.6   

      1996
      Reserve for Accounts                
      Receivable                          $3.3            $1.4          $0.0            $1.7            $3.0

</TABLE>

      (a) Engineering  Services and Insurance Premium Receivables written off as
uncollectible.



                                       85
<PAGE>


                                      Schedule VI
                                     HSB Group, Inc.
      Supplemental Information Concerning Property-Casualty Insurance Operations


                  For Years Ended December 31, 1998, 1997, 1996

<TABLE>
<CAPTION>

        Column A  Column B   Column C  Column D   Column E  Column F  Column G      Column H        Column I   Column J   Column K
                             
        ---------------------------------------------------------------------------------------------------------------------------

        Affiliati  Prepaid  Reserves   Discount,  Unearned   Earned    Net        Claims and Claim  Amortiza-  Paid        Premiums
        with       Acquisi-   for       if any,   Premium   Premium   Investment    Adjustment       tion of  Claims and    Written
        Registrant   tion    Unpaid    deducted                        Income     Expenses Incurred Prepaid    Claim
        (Consolid-   Costs   Claims      in                                          Related to        Policy     Adjustment
        ated                  and      Column C                                                     Acquisi-    Expenses
        property-             Claim                                                                tion Costs
        casualty            Adjustment
        entities)           Expenses  
        ----------------------------------------------------------------------------------------------------------------------------
                                                                                 Current   Prior 
                                                                                   Year    Year
        ----------------------------------------------------------------------------------------------------------------------------
          <S>        <C>      <C>        <C>      <C>         <C>       <C>        <C>      <C>       <C>         <C>        <C>
          
          1998       46.6     550.3      -        477.9       396.1     64.2       164.0    10.9      66.3        196.0      352.6

          1997       42.5     276.7      -        287.3       491.2     36.8       209.5     8.4      90.7        204.9      498.5

          1996       40.6     302.9      -        270.6       448.6     32.3       214.2    -9.8      86.0        172.1      454.4
 
</TABLE>


                                       86
<PAGE>


Item 9.  Changes in and Disagreements with Accountants on

         Accounting and Financial Disclosure.


     None.

                                    PART III

Item 10.  Directors and Executive Officers of the Registrant.

     "Nominees  for  Election  to the Board of  Directors  for  Three-Year  Term
Expiring in 2002" and "Members of the Board of Directors  Continuing  in Office"
on  pages  2-5  of the  Company's  Proxy  Statement  dated  March  5,  1999  are
incorporated herein by reference. Also see pages 23 -24 herein.

Item 11.  Executive Compensation.

     "Meetings and Remuneration of the Directors" on pages 5-7, "Human Resources
Committee Report on Executive Compensation" on pages 9-12, "Summary Compensation
Table" on page 13, "Stock Option and Long-Term  Incentive  Plan Tables" on pages
14-15, "Retirement Plans" on page 16, "Employment  Arrangements" on pages 16-17,
"Compensation  Committee  Interlocks and Insider  Participation" on page 17, and
"Performance  Graph" on page 18 of the Company's  Proxy Statement dated March 5,
1999 are incorporated herein by reference.

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

"Security Ownership of Certain Beneficial Owners and Management" on pages 7-9 of
the Company's  Proxy  Statement  dated March 5, 1999 is  incorporated  herein by
reference.

Item 13.  Certain Relationships and Related Transactions.

     "Compensation Committee Interlocks and Insider Participation" on page 17 of
the Company's  Proxy  Statement  dated March 5, 1999 is  incorporated  herein by
reference.

                                     PART IV

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

     (a)   The  financial  statements  and  schedules  listed  in the  Index  to
           Financial  Statements  and Financial  Statement  Schedules on page 43
           herein are filed as part of this report.

     (b) Reports on Form 8-K -

          (i)  Form 8-K dated  October 26,  1998 to report  third  quarter  1998
               results of Registrant;
        
          (ii) Form 8-K dated November 2, 1998 to report declaration of dividend
               by Registrant;

          (iii)Form 8-K dated  December  2, 1998 to report  adoption  of revised
               shareholder rights plan;

          (iv) From 8-K dated  January 25, 1999 to report  fourth  quarter  1998
               Results of Registrant; and

                                       87
<PAGE>

          (v)  Form 8-K dated January 26, 1999 to report declaration of dividend
               by Registrant.


     (c) The exhibits listed in the accompanying  Index to Exhibits are filed as
part of this report.


                                       88
<PAGE>

                                   SIGNATURES

     Pursuant to the  requirements of Section 13 of the Securities  Exchange Act
of 1934,  the  Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

HSB GROUP, INC.
       (Registrant)


By:  /s/ Gordon W. Kreh
      Gordon W. Kreh
      Chairman, President and Chief
      Executive Officer
      March 30, 1999

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated.

       (Signature)                                             (Title)

By:/s/  Gordon W. Kreh
    Gordon W. Kreh                              Chairman, President, Chief 
     March 30, 1999                             Executive Officer and Director
    

  /s/ Saul L. Basch                             Senior Vice President, Treasurer
    Saul L. Basch                               and Chief Financial Officer
    March 30, 1999                              (Principal Financial Officer and
                                                Principal Accounting Officer)

  /s/ Robert C. Walker
      Robert C. Walker                          Senior Vice President and 
      March 30, 1999                            General Counsel

(Joel B Alvord)*                                Director


(Richard H. Booth)*                             Director


(Colin G. Campbell)*                            Director


(Richard G. Dooley)*                            Director


(William B. Ellis)*                             Director

                                       89
<PAGE>


(Henrietta Holsman Fore)*                       Director


(E. James Ferland)*                             Director


(Simon W. Leathes)*                             Director
 

(Lois Dickson Rice)*                            Director




*By:  /s/ Robert C. Walker
     Robert C. Walker
     (Attorney-in-Fact)
     March 30, 1999


                                       90
<PAGE>


                                INDEX TO EXHIBITS

Exhibit
Number      Description

**(3)(i)       Certificate of Incorporation of HSB Group, Inc.,  incorporated by
               reference to Exhibit 3(i) to the  Registrant's  Form 10-K for the
               year ended December 31, 1997, File Number 001-13135.

**(3)(ii)      By-laws of HSB Group, Inc.,  incorporated by reference to Exhibit
               3(ii) to the  Registrant's  Form 10-K for the year ended December
               31, 1997, File Number 001-13135.

**(4)(i)       Rights Agreement dated as of November 28, 1998 between HSB Group,
               Inc. and  Bankboston,  N.A.,  as Rights  Agent,  incorporated  by
               reference to the Registrant's  Report on Form 8-K dated September
               21, 1998, File Number 001-13135.

**(4)(ii)      Documents related to HSB Capital I:

               (a)    Indenture   of   Registrant   relating   to   the   Junior
                      Subordinated  Debentures,  incorporated  by  reference  to
                      Exhibit 4 to  Registrant's  Quarterly  Report on Form 10-Q
                      for the quarter ended June 30, 1997, File No. 001-13135.

               (b)    First Supplemental  Indenture of Registrant,  incorporated
                      by reference to Exhibit 4 to Registrant's Quarterly Report
                      on Form 10-Q for the quarter ended June 30, 1997, File No.
                      001-13135.

               (c)    Form  of  Certificate  of  Exchange  Junior   Subordinated
                      Debentures,  incorporated  by  reference to Exhibit 4.3 to
                      Registrant's and HSB Capital I's Registration Statement on
                      Form S-4 filed with the  Commission  on October 10,  1997,
                      Registration No. 333-37581.

               (d)    Certificate  of Trust of HSB  Capital I,  incorporated  by
                      reference to Exhibit 4.4 to  Registrant's  and HSB Capital
                      I's  Registration  Statement  on Form S-4  filed  with the
                      Commission   on  October  10,   1997,   Registration   No.
                      333-37581.

               (e)    Amended and  Restated  Trust  Agreement  of HSB Capital I,
                      incorporated  by  reference  to Exhibit 4 to  Registrant's
                      Quarterly  Report on Form 10-Q for the quarter  ended June
                      30, 1997, File No. 001-13135.

               (f)    Form of  Exchange  Capital  Security  Certificate  for HSB
                      Capital I,  incorporated  by  reference  to Exhibit 4.6 to
                      Registrant's and HSB Capital I's Registration Statement on
                      Form S-4 filed with the  Commission  on October 10,  1997,
                      Registration No. 333-37581.

               (g)    Form of Exchange  Guarantee of Registrant  relating to the
                      Exchange Capital Securities,  incorporated by reference to
                      Exhibit   4.7  to   Registrant's   and  HSB   Capital  I's
                      Registration   Statement   on  Form  S-4  filed  with  the
                      Commission   on  October  10,   1997,   Registration   No.
                      333-37581.

               Documents related to HSB Capital II:

                                       91
<PAGE>

               (a)  Purchase  Agreement as of December 31, 1997 among  Employers
                    Reinsurance  Corporation,  ERC Life Reinsurance  Corporation
                    and  Registrant,  incorporated  by reference to Registrant's
                    Current  Report  on Form  8-K.  File  No.  001-13135,  filed
                    January 12, 1998 (the "January 12, 1998 8-K).

               (b)  Indenture  of  Registrant  relating to the 7.0%  Convertible
                    Subordinated Deferrable Interest Debentures Due December 31,
                    2017, incorporated by reference to the January 12, 1998 8-K.

               (c)  Form  of  Certificate  of  7.0%   Convertible   Subordinated
                    Deferrable   Interest  Debentures  due  December  31,  2017,
                    incorporated by reference to the January 12, 1998 8-K.

               (d)  Certificate  of Trust of HSB  Capital  II,  incorporated  by
                    reference to the January 12, 1998 8-K.

               (e)  Trust   Agreement  dated  as  of  December  31,  1997  among
                    Registrant,  The  First  National  Bank  of  Chicago,  First
                    Chicago Delaware Inc. and The Administrative  Trustees named
                    therein,  incorporated  by reference to the January 12, 1998
                    8-K.

               (f)  Form of Capital  Securities  Certificate  of HSB Capital II,
                    incorporated by reference to the January 12, 1998 8-K.

               (g)  Guarantee   Agreement  between   Registrant  and  The  First
                    National  Bank of  Chicago  dated as of  December  31,  1997
                    relating to HSB Capital II, incorporated by reference to the
                    January 12, 1998 8-K.

               (h)  Registration  Rights Agreement dated as of December 31, 1997
                    among   Employers   Reinsurance   Corporation,    ERC   Life
                    Reinsurance  Corporation  and  Registrant,  incorporated  by
                    reference to the January 12, 1998 8-K.

**(10)(i)      (a)  Lease Agreement  between HSBIIC and One State Street 
                    Limited Partnership; incorporated by reference to Exhibit 
                    (10)(i) to HSBIIC's Form 10. File No. 0-13300, filed 
                    March 18, 1985.

**10(ii)       (a)  Operating  Agreement for HSB-IRI  Property  Insurance
                    Business by and among Employers  Reinsurance  Corporation,
                    HSB  Industrial  Risk  Insurers,  and The  Hartford  Steam
                    Boiler Inspection and Insurance  Company,  effective as of
                    January  1, 1998,  incorporated  by  reference  to Exhibit
                    10(ii) to Registrant's  Quarterly  Report on Form 10-Q for
                    the quarter ended March 31, 1998, File Number 001-13135.

**10(ii)       (b)  Limited  Liability Company Agreement of HSB Industrial
                    Risk  Insurers,  L.L.C.,   incorporated  by  reference  to
                    Exhibit  10(ii) to the  Registrant's  Quarterly  Report on
                    From 10-Q for the quarter ended  September 30, 1998,  File
                    Number 001-13135

(10)(iii)    **(a)  Employment  Agreement dated February 3, 1997 between
                    HSBIIC  and  various   executive   officers,   assumed  by
                    Registrant;  incorporated  by reference  to HSBIIC's  Form
                    10-K for the year ended December 31, 1996,  filed with the
                    Commission  on March 31,  1997,  File No.  001-10527  (the
                    "1996 10-K").*

                                       92
<PAGE>

             **(b)  HSB Group,  Inc.  Long-Term  Incentive  Plan, as amended and
                    restated  effective  September  21,  1998,  incorporated  by
                    reference  to  Exhibit   10(iii)(c)   to  the   Registrant's
                    Quarterly   Report  on  Form  10-Q  for  the  quarter  ended
                    September 30, 1998, File Number 001-13135.*

             **(c)  HSB Group,  Inc.  Short-Term  Incentive Plan, as amended and
                    restated   effective   January  1,  1998,   incorporated  by
                    reference  to  Exhibit  10  (iii)(b)  to  the   Registrant's
                    Quarterly  Report on Form 10-Q for the  quarter  ended March
                    31, 1998, File Number 001-13135.*

             **(d)  HSB Group,  Inc.  1985 Stock  Option  Plan,  as amended  and
                    restated as of September 21, 1998, incorporated by reference
                    to Exhibit  10(iii)(a) to the Registrant's  Quarterly Report
                    on Form 10-Q for the quarter ended  September 30, 1998, File
                    Number 001-13135.*

             **(e)  HSB Group,  Inc.  1995 Stock  Option  Plan,  as amended  and
                    restated  effective  September  21,  1998,  incorporated  by
                    reference  to  Exhibit   10(iii)(d)   to  the   Registrant's
                    Quarterly   Report  on  Form  10-Q  for  the  quarter  ended
                    September 30, 1998, File Number 001-13135.*

             **(f)  Pre-Retirement   Death  Benefit  and  Supplemental   Pension
                    Agreement between HSBIIC and various executive officers,  as
                    amended and restated  effective  March 14, 1997,  assumed by
                    Registrant, incorporated by reference to the 1996 10-K. *

             **(g)  Pre-Retirement   Death  Benefit  and  Supplemental   Pension
                    Agreement  between  HSBIIC and William A. Kerr,  dated March
                    14, 1997,  assumed by Registrant,  incorporated by reference
                    to the 1996 10-K. *

             **(h)  Pre-Retirement   Death  Benefit  and  Supplemental   Pension
                    Agreement  between HSBIIC and Robert C. Walker,  dated March
                    14, 1997,  assumed by Registrant,  incorporated by reference
                    to the 1996 10-K.*

             **(i)  HSB Group,  Inc.  Directors Stock and Deferred  Compensation
                    Plan, as amended and restated effective  September 21, 1998,
                    incorporated  by  reference  to  Exhibit  10(iii)(b)  to the
                    Registrant's  Quarterly  Report on Form 10-Q for the quarter
                    ended September 30, 1998, File Number 001-13135.*

             **(j)  Description  of  certain  arrangements  not set forth in any
                    formal documents, as described on pages 5 - 6 , with respect
                    to directors' compensation, and on pages 8 -16, with respect
                    to  executive  officer's   compensation,   which  pages  are
                    incorporated  by reference to  Registrant's  Proxy Statement
                    dated and filed March 5, 1999. *

(21)           Subsidiaries of the Registrant.

(23)           Consent of experts and counsel - consent of 
               PricewaterhouseCoopers LLP.

(24)           Power of attorney.

(27)           Financial Data Schedule.
 27.1          Financial Data Schedule
 27.2          Restated Financial Data Schedule

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<PAGE>

* Management contract,  compensatory plan or arrangement required to be filed as
an exhibit pursuant to Item 14(c) of this report.

** Previously filed.

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