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, 1997

                                       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 17, 1998 was $1,179,041,668.

Number of shares of common stock outstanding as of February 17, 1998:
19,409,870.

Documents Incorporated by Reference:

Portions of the Proxy  Statement  dated March 6, 1998 for the Annual  Meeting of
Shareholders  to be held April 21, 1998 are  incorporated  by reference in Parts
III and IV herein.



                                       1
<PAGE>


                                    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  three  industry  segments  -
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  services  aimed  at  loss
prevention.  Earned  premiums for the Company's  insurance  products were $491.2
million  for  1997,  which  accounted  for  approximately  81.4  percent  of the
Company's revenues.  See Note 9 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.

     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
which 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 will write the business for the reconstituted IRI using its
insurance  licenses and will provide  certain  other  management  and  technical
services. In addition,  through various reinsurance agreements with ERC and IRI,
HSBIIC will transfer its  manufacturing  book of business to IRI and will retain
85% of the equipment  breakdown  insurance and 15% of the property  insurance of
the HSB/IRI combined portfolio.  See "Participation in Industrial Risk Insurers"
on page 12 for additional information.

     To support the  Company's  expanded  role with 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.

                                       2
<PAGE>

The capital  securities  are  convertible  into HSB common  stock,  at any time,
subject  to  regulatory  approval.  See  Note 12 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 1997 net engineering
services  revenues were $61.3 million,  which accounted for  approximately  10.2
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  $144  million.  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 by the Board of
Directors  of  management's  decision to  exercise  its put in July 1997 and the
Company's share of Radian LLC's losses  incurred  subsequent to such decision of
approximately  $10 million was deferred until the closing of the sale on January
2, 1998, at which time an estimated  after-tax gain of $30 million 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.  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 Company  also
acquired a 51 percent  interest in Integrated  Process  Technologies  LLC, which
markets  computerized  facilities  maintenance  vendor  management  systems  and
services.

     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 1997 the revenues and pre-tax income  associated with  operations  outside of
the  United   States  were   approximately   18.5  percent  and  20.9   percent,
respectively.  Identifiable  assets  associated with  operations  outside of the
United States are  approximately  19.0 percent of the consolidated  amount.  See
Note 1 and Note 4 to the Consolidated  Financial Statements located in Item 8 of
Part II herein for more financial data based on geographic location and business
segments.


                                       3
<PAGE>


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

Engineering Services
--------------------

     Separate divisions of the Company's Engineering  Department provide quality
assurance  services,  training for nondestructive  testing,  inspections to code
standards  of  the  American  Society  of  Mechanical   Engineers  (ASME),   ISO
certification  services and other specialized consulting 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. In addition, the Company's Engineering Department focuses on
researching and developing potential new products and services,  and new markets
for current services.

                                       4
<PAGE>

     The Company's engineering subsidiaries include HSB Reliability Technologies
Corp.  (HSB RT), and HSB  Professional  Loss  Control,  Inc.  (HSB PLC).  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.  HSB Haughton and Integrated  Process  Technologies  LLC, which became
affiliated  with the Company during 1997, are described  above under "A. General
Development of Business".

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 gross earned  premium,  the Company's
U.S. market share, at approximately 37 percent,  has remained fairly stable over
the past ten years.  Based on net premiums  written reported in the 1997 edition
of Best's  Aggregates  and Averages,  no other single company has more than a 10
percent market share.  Members of the Factory Mutual System, an affiliated group
of insurers, have a market share of approximately 20 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 has grown as new insurers enter the property casualty market. In
addition to available capacity, competition 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.

                                       5
<PAGE>

Engineering Services
--------------------

     The Company provides a wide range of engineering, consulting and inspection
services as  described  on page 4. 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 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 1997, 77.1 percent of its net written premiums  (exclusive of
IRI)  related  to risks  located in the United  States.  Of the direct  premiums
written in the United States in 1997 (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 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 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.  Canadian
customers are serviced by The Boiler Inspection and Insurance Company of Canada.
Overseas customers are serviced by HSB Engineering

                                       6
<PAGE>

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.

     IRI  markets  its  products  primarily  through  a small  number  of  large
international  brokerage firms. A portion of the Company's 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. For 1997, approximately 18.5 percent of the Company's gross
written  premium  generated by its special risk business and by its 23.5 percent
participation in IRI was produced by J&H Marsh & McLennan after giving effect to
the merger. Based on writings for 1997 it is anticipated that as a result of the
agreements with Employers  Reinsurance  Corporation relating to IRI as described
under  "Participation  in Industrial  Risk  Insurers"  which went into effect on
January  1,  1998,  J&H  Marsh &  McLennan  will be  responsible  for  producing
approximately 25.2 percent of the Company's gross written premium in 1998.

     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.

     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 and the Pacific Rim 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.

                                       7
<PAGE>

E.     REGULATION

Insurance
---------

     The Company's 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.

     In December  1993,  the National  Association  of  Insurance  Commissioners
(NAIC) 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
1997.

     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 1997 with the
exception of the change in surplus  ratio.  This ratio exceeded the normal range
for surplus growth because of the $250 million  contribution  to surplus made by
the  Company  with  the  proceeds  from  the $300  million  convertible  capital
securities which were sold to Employers Reinsurance  Corporation on December 31,
1997.

     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.
Similar  regulatory  procedures  govern the Company's U.S. and foreign insurance
subsidiaries.

                                       8
<PAGE>

     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 5 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.


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  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.

                                       9
<PAGE>

     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 IRI) 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
Industrial Risk Insurers" below for  information on the  underwriting  policy of
IRI.

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-size  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 5  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.

     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


                                       10
<PAGE>

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,  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 $257.1
million in 1997, representing  approximately 41.6 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.  Under the  Company's  current  treaty
reinsurance  program (and not taking into account its participation in IRI), its
retention on any one risk is generally  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.

     As a result of the  Company's  growth and global  expansion,  combined with
loss  experience  in prior years,  the Company has been  incurring  higher ceded
reinsurance  costs  in  recent  years.  In  1995  the  Company  centralized  and
consolidated its global ceded reinsurance  operations to more closely manage its
reinsurance costs. In 1994 and continuing through 1996 the Company increased its
non-IRI  retentions  by  adding  a  $5  million  aggregate   deductible  to  its
reinsurance  program to lessen the impact of higher  reinsurance  costs.  Of the
four losses in the 1994 -1995 treaty year that exceeded $3 million,  the Company
retained an additional  $1.4 million in 1994 and $1.2 million in 1995 due to the
inclusion of the $5 million annual aggregate deductible.  Reinsurance costs were
reduced approximately $2.9 million for both 1994 and 1995. In 1996 the Company's
reinsurance  ceded  costs  increased  $42  million  over 1995  which was  almost
entirely  attributable to its increased  participation in IRI. Reinsurance ceded
costs for 1997  increased  by $10  million  over 1996  because of the  Company's
increase  in  participation  in IRI in 1997  and  the  purchase  of  facultative
insurance at HSB EIL, the Company's U.K. insurance subsidiary.

                                       11
<PAGE>

   The  Company  anticipates  a greater use of quota  share  reinsurance  in the
1998-1999  treaty year  because of the  favorable  pricing in the  international
reinsurance  market  and recent  favorable  underwriting  experience  in certain
classes of the Company's business. This increased use of reinsurance will likely
result in a reduction in net earned  premiums for 1998 at the same time as gross
premiums are expected to increase as a result of the  agreements  with Employers
Reinsurance  Corporation  relating to the IRI business.  See  "Participation  in
Industrial Risk Insurers" below.

     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 generally 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  9 and 10 to the
Consolidated Financial Statements located in Item 8 of Part II herein.

Pools and Joint Underwriting Associations
-----------------------------------------

     With the exception of  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 Industrial Risk Insurers
-----------------------------------------

     Industrial Risk Insurers is an unincorporated, voluntary joint underwriting
association which 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.  IRI primarily  writes policies on a syndicate basis
which  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
essence,  the 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

                                       12
<PAGE>

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  doesn't  release  HSBIIC from the effects of adverse
development.

    On January 6, 1998,  HSBIIC and the other IRI members sold their  membership
shares to Employers Reinsurance  Corporation.  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 entered into an operating
agreement  with ERC  pursuant to which  HSBIIC will write the  business  for the
reconstituted  IRI using its insurance  licenses and will provide  certain other
technical  and  management  services.  HSBIIC,  ERC and IRI  also  entered  into
reinsurance   agreements   pursuant  to  which   HSBIIC   transferred   its  HPR
manufacturing  book of  business  to IRI and  agreed to retain 85 percent of the
equipment  breakdown  business  and 15 percent of the  property  business of the
combined insurance portfolio.

   From  December 1, 1996 until the close of the sale of its  interest in IRI 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 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 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 HSB, or a material  breach  which has not been cured within the
time frame specified in the agreements, or by mutual consent of the parties. ERC
and the Company are in discussions  which may result in ERC having the option to
buy out the  Company's  rights under the  agreements in the event of a change in
control of the Company.  Net earned premium  attributable to the agreements with
ERC and IRI,  prior to the placement of  reinsurance  by the Company for its own
account,  could  approximate  17 percent  of the  Company's  total  consolidated
revenues for 1998.  Ceding  commissions,  which are netted out of expenses,  are
estimated to be 13 percent of consolidated revenues for 1998.

     Pursuant  to the  agreements  with ERC,  HSB has the  ability to opt out of
IRI's reinsurance programs going forward. The Company anticipates  incorporating
the IRI business into its reinsurance  program after a brief transitional period
during which the Company will participate in IRI's program.

                                       13
<PAGE>

     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.  Based on HSB's 1997  participation in IRI at 23.5 percent,
had an MFL event take place, the Company's  proportionate  share, net of IRI and
HSB  reinsurance,  would have been $ 26.6 million.  The Company  maintains other
reinsurance  programs for its own account which could absorb up to 50 percent of
this amount.  The equipment  breakdown PMLs and MFLs within the overall property
coverage  underwritten  by IRI do not  generally  exceed  $50  million  and $100
million, respectively.  HSB's primary participation effective January 1, 1998 as
described  above will be  attributable  to the 85 percent share of the equipment
breakdown  insurance  written through IRI. Based on HSB's 1998  participation in
IRI's  business,  were an equipment  breakdown MFL to take place,  the Company's
proportionate  share, net of IRI and HSB  reinsurance,  would be no more than $5
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 IRI  described  under  "Participation  in Industrial
Risk Insurers"  above will be adjusted by Company and 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 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 18 - 19) 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

                                       14
<PAGE>

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, 1997, 1996 and 1995.

                       RECONCILIATION OF NET LIABILITY FOR
                      CLAIMS AND CLAIM ADJUSTMENT EXPENSES
                      ------------------------------------


                                               1997       1996        1995
                                               ----       ----        ----

                                                       (In millions)

Net liability for claims and
adjustment expenses at January 1             $  177.8  $  145.5   $  161.3
                                               ------    ------     ------

Plus:

Provision for claims and adjustment
expenses occurring in the current year          209.5     214.2      152.2

Increase (decrease) in estimated claims
and adjustment expenses arising
in prior years                                    8.4      (9.8)       2.7
                                               ------    ------     ------

Total incurred claims and
adjustment expenses                             217.9     204.4      154.9
                                               ------    ------     ------

Less:

Payment for claims arising in:
Current year                                     82.3      91.4       58.9
Prior years                                     122.6      80.7      111.8
                                               ------    ------     ------

Total payments                                  204.9     172.1      170.7
                                               ------    ------     ------


Net liability for claims and
adjustment expenses at December 31           $  190.8  $  177.8   $  145.5
                                               ======    ======     ======


                                       15
<PAGE>

     The 1997 loss ratio was 44.4  percent  compared  to 45.6  percent  and 39.8
percent for 1996 and 1995, respectively.  The 1.2 percent decrease in loss ratio
in 1997 is  primarily  the  result  of fewer  weather-related  losses.  The 1996
increase of 5.8 percentage  points as compared to 1995, was primarily the result
of the high  frequency of claims and unusually  severe winter  weather.  Adverse
development  in 1997  added  1.7  percentage  points  to the loss  ratio,  while
positive development in 1996 benefited 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
                    ----------------------------------------

                                                1997       1996         1995
                                                ----       ----         ----

                                                       (In millions)


Net liability for claims and
adjustment expenses at December 31           $  190.8   $  177.8   $  145.5

Reinsurance recoverable on unpaid claims
 and adjustment expenses                         85.9      125.1       45.4
                                               ------     ------     ------

Gross liability for claims and
adjustment expenses at December 31           $  276.7   $  302.9   $  190.9
                                               ======     ======     ======




                                       16
<PAGE>

RECONCILIATION OF GROSS LIABILITY FOR CLAIMS AND CLAIM ADJUSTMENT EXPENSES
--------------------------------------------------------------------------

                                                         1997     1996     1995
                                                         ----     ----     ----

                                                               (In millions)
Gross liability for claims and claim adjustment
expenses at January 1                                $  302.9  $  190.9 $  199.4

Plus:
Provision for claims and claim adjustment expenses
occurring in the current year                           263.3     313.3    183.3

Increase in estimated claims and claim adjustment
expenses arising in prior years                          (0.2)     16.1     12.6
                                                       ------    ------   ------

Total incurred claims and claim adjustment
expenses                                             $  263.1  $  329.4 $  195.9
                                                       ------    ------   ------

Less:
Payment for claims arising in:
Current year                                         $   90.6  $  103.3 $   65.1
Prior years                                             198.7     114.1    139.3
                                                       ------    ------   ------

Total payments                                       $  289.3  $  217.4 $  204.4
                                                       ------    ------   ------


Gross liability for claims and claim adjustment
expenses at December 31                              $  276.7  $  302.9 $  190.9
                                                       ======    ======   ======


     The claim and claim expense  reserve  runoff table on the  following  pages
shows the amounts of the net  liability for 1987 through 1997 and the amounts of
the gross  liability for 1993 through 1997. 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.

                                       17
<PAGE>

     The redundancies  shown for 1987 and 1988 were attributed to the difficulty
in  estimating  claims due to  inflationary  impacts and business  interruption,
which became a larger  component of claims.  The claim  reserves  established in
those years 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.






RECONCILIATION OF BEGINNING AND ENDING CLAIMS RESERVES
         AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES)
                        (In Millions)
<TABLE>

                         Net Reserves

YEAR ENDED                           1987    1988   1989     1990    1991      1992     1993     1994   1995*   1996*   1997*
----------                           ----    ----   ----     ----    ----      ----     ----     ----   -----   -----   -----
<S>                                 <C>     <C>     <C>     <C>      <C>      <C>     <C>       <C>     <C>    <C>      <C>

Net Liability for Unpaid
 Claims and Claim                   $147.5  $157.4  $139.6  $115.7   $111.4   $132.8   $171.3   $161.3  $145.5 $177.8   $190.8
 Adjustment Expenses

Cumulative Amount Paid as of:
End of Year                           -      -       -       -        -        -        -        -       -      -       -
One Year Later                        57.4    78.8    85.6    86.7     91.2     99.7    108.8    111.7    80.6  122.6    -
Two Years Later                       75.9    92.1   104.2   109.7    115.5    134.0    152.1    126.9    99.8  -        -
Three Years Later                     74.5    95.5   110.3   120.6    127.0    154.4    153.4    134.5   -      -        -
Four Years Later                      75.4    95.4   112.5   127.6    137.7    151.1    157.8    -       -      -        -
Five Years Later                      74.5    93.6   118.9   132.7    135.7    151.6    -        -       -      -        -
Six Years Later                       74.2   100.5   123.0   131.4    135.7    -        -        -       -      -        -
Seven Years Later                     80.4   101.5   121.4   130.9    -        -        -        -       -      -        -
Eight Years Later                     80.4   100.1   120.8   -        -        -        -        -       -      -        -
Nine Years Later                      79.6   100.2   -       -        -        -        -        -       -      -        -
Ten Years Later                       79.7   -       -       -        -        -        -        -       -      -        -

Net Liability Reestimated as of:
End of Year                          147.5   157.4   139.6   115.7    111.4    132.8    171.3    161.3   145.5  177.8    190.8
One Year Later                       131.9   129.4   129.4   135.4    137.5    159.7    172.7    163.9   135.7  186.2    -
Two Years Later                      100.4   108.7   127.4   138.0    139.7    166.6    173.9    157.3   128.8  -        -
Three Years Later                     86.0   106.8   127.8   136.9    141.1    165.2    170.6    154.2   -      -        -
Four Years Later                      83.7   103.0   125.0   137.9    142.0    163.0    169.2    -       -      -        -
Five Years Later                      80.8   102.3   125.8   135.7    141.4    161.5    -        -       -      -        -
Six Years Later                       82.0   104.0   125.5   136.0    141.3    -        -        -       -      -        -
Seven Years Later                     82.9   103.8   125.8   135.8    -        -        -        -       -      -        -
Eight Years Later                     82.6   104.2   125.5   -        -        -        -        -       -      -        -
Nine Years Later                      83.6   104.7   -       -        -        -        -        -       -      -        -
Ten Years Later                       84.1   -       -       -        -        -        -        -       -      -        -

Cumulative Redundancy
(Deficiency)                          63.4    52.7    14.1   (20.1)   (29.9)   (28.7)     2.1      7.1    16.7   (8.4)     0.00
</TABLE>

The above table includes  information related to the Company's  participation in
the IRI.


*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  clams 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 $22.2,  $11.6 and $3.2  million
related to its  participation  in IRI at December 31, 1997, 1996, and 1995 (at a
 .5 percent participation), respectively.


                                       18
<PAGE>

                                                  Gross Reserves
<TABLE>

YEAR ENDED                                                                                1993    1994    1995    1996     1997
----------                                                                                ----    ----    ----    ----     ----
<S>                                                                                      <C>     <C>     <C>      <C>      <C>
Gross Liability for
 Unpaid Claims and Claim
 Adjustment Expenses                                                                     $214.4  $199.4  $190.9   $302.9   $276.7

Cumulative Amount Paid as of:
End of Year                                                                               -       -       -        -        -
One Year Later                                                                            144.2   135.2   108.9    198.8    -
Two Years Later                                                                           189.9   164.1   158.0    -        -
Three Years Later                                                                         200.2   201.1   -        -        -
Four Years Later                                                                          229.8   -       -        -        -
Gross Liability Reestimated as of:
End of year                                                                               214.4   199.4   190.9    302.9    276.7
One Year Later                                                                            224.3   212.0   205.5    302.7    -
Two Years Later                                                                           227.0   228.3   194.6    -        -
Three Years Later                                                                         243.4   226.8   -        -        -
Four Years Later                                                                          245.0   -       -        -        -
Cumulative Redundancy
(Deficiency)                                                                              (30.6)  (27.4)   (3.7)      .2    -


</TABLE>





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, and the purchase and sale of equity securities.

                                                     (in millions)
                                          1997     1996    1995    1994    1993
                                        -------   ------  ------  ------   -----
Net Investment Income                    $ 36.8  $ 32.3  $ 28.9  $ 26.2  $ 29.3
Realized Investment Gains                  14.1    12.1     2.8     8.7    26.1
                                        ------    ------  ------  ------  ------
    Income from Investment Operations    $ 50.9  $ 44.4  $ 31.7  $ 34.9  $ 55.4


Net Unrealized Gains                     $ 95.3  $ 81.4  $ 65.4  $ 16.5  $ 59.2

Statutory Surplus  (HSBIIC)              $550.8  $292.4  $280.6  $238.0  $259.2

     The fluctuations in income from investment  operations is largely driven by
the amount of realized gains generated in any given year. 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.  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 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

                                       19
<PAGE>

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.

     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 offerings.

     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  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.  The Company's U.S.  common stock  portfolio has  experienced a total
return of $57 million (which includes price  appreciation of  approximately  $54
million) since December 31, 1996, and has had a price movement  correlation with
the S&P 500 Index well in excess of 80 percent.

     At December  31, 1997 the Company  had  approximately  38.1  percent of its
invested assets (exclusive of the short-term  investments made with the proceeds
from its sale of $300 million in convertible  capital securities on December 31,
1997) in fixed  maturities  as compared to 40 percent at year-end  1996.  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  1997  the
carrying value of the equity  securities  portfolio  represented 49.7 percent of
invested  assets  compared  to 44  percent at  year-end  1996.  The 5.7  percent
increase  is  primarily  attributable  to market  appreciation  relative  to the
overall portfolio.

     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

                                       20
<PAGE>

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 its maturities such that the average
maturity 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.

     See "Investment  Operations" in the Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations located in Item 7 and
Note 6 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)        Investment
       Cash and        ment Income  ---------------       Gains (Losses) (3)
       Invested        Less         Before  After       --------------------
       Assets, Less    Interest     Income  Income                 Change in
       Borrowed Money  Expense (1)  Taxes   Taxes      Realized    Unrealized
       ---------------------------- -----   -----       ----------------------
              (In Millions)                                 (In Millions)

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
1995        514.8       28.5         6.2     5.2           2.8         48.9

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

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

(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.



                                       21
<PAGE>



H.     EMPLOYEES

     At year-end 1997, the Company, including its wholly-owned subsidiaries, had
1,932 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  227,288  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 7 and 8 to Consolidated Financial Statements located in Item 8 of
Part II herein for additional information.

Item 3.  Legal Proceedings.
-------  ------------------

     HSBIIC is involved in three arbitration or litigation proceedings regarding
the extent to which  certain  explosion  events  are  insured  under  boiler and
machinery  policies of HSBIIC or under the all-risk property  insurance policies
issued by other companies.  Management believes HSBIIC's policies do not provide
coverage for losses  resulting from the explosion events that are the subject of
these proceedings.

    A lower court ruling in one of these cases held that an explosion did occur,
and that  HSBIIC was not liable for  losses of the  insured  resulting  from the
explosion.  In a further  action,  the court denied  HSBIIC's motion for summary
judgment on certain issues,  thus leaving HSBIIC  potentially liable for certain
unquantified  losses resulting from events prior to the explosion.  In the first
quarter of 1997,  HSBIIC and the property  insurer jointly settled the case with
the insured.  HSBIIC's ultimate share of the settlement will be determined in an
arbitration proceeding with the property carrier. HSBIIC has incurred gross loss
and loss adjustment expenses (LAE) of $40.7 million and a net loss, after taking
into  account  reinsurance  recoverables, of $6.5  million,  of which $5 million
represents  claim costs and the  remaining  $1.5  million  represents  LAE. As a
result of payments made to date, as of December 31, 1997,  HSBIIC  carried gross
loss and LAE reserves of $2.8 million and  recoverables  from reinsurers of $2.8
million.

                                       22
<PAGE>

     HSBIIC has accrued  $6.5  million  with  respect to the other two cases for
potential LAE, including legal costs to defend HSBIIC's position. One case is in
the process of pre-trial summary judgment motions and appeals; the other case is
involved in both  arbitration and litigation  proceedings.  A trial date has not
been set for either  case.  In the event that  HSBIIC is held  liable for one or
both of the  remaining  claims,  amounts  in  excess  of  HSBIIC's  net  maximum
aggregate  retention  of $8.5  million is  recoverable  from  reinsurers.  Claim
amounts  potentially  recoverable  from  reinsurers  in the event of a  possible
adverse outcome in these cases could range,  in the aggregate,  from $40 million
to $195 million.

     The obligations of HSBIIC's  reinsurers with respect to these cases are not
in dispute.  Therefore,  management  believes that any adverse outcomes in these
cases will not, in the aggregate,  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 losses such
reinsurers  might incur  should  these  cases 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  arbitration  or
litigation  proceedings 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.

     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.

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.

                                       23
<PAGE>

Gordon W. Kreh, 50, 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, 51, 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, 48, Senior Vice President - 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,  52,  Senior  Vice  President  -  Commercial  Risks 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,  60,  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.

R. Kevin Price,  51, 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,  52, Senior Vice President since 9/95;  Managing Director and
Chief Executive Officer of HSB Engineering  Insurance Ltd., London,  since 9/94;
Director of Engineering,  Engineering  Insurance Co., Ltd.  9/92-9/94;  Managing
Director Scottish Power PLC, Glasgow, Scotland 1/89 - 8/92.

Robert C. Walker,  54, 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  17,  1998,  the  Company had 5,152  holders of
record.

                                       24
<PAGE>

     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  1997  dividends  but is not  anticipated  to be
necessary  for 1998  dividends  since  approximately  $55.1  million of HSBIIC's
statutory surplus is available for distribution to HSB Group, Inc. without prior
regulatory approval.

     Quarterly  dividends  declared  for the 1997 and 1996 fiscal  years were as
follows:

            First        Second       Third        Fourth       Year
            -----        ------       -----        ------       ----
1997        $.57         $.57         $.60         $.60         $2.34
1996        $.57         $.57         $.57         $.57         $2.28


     Quarterly  market prices for the Company's common stock were as follows for
the two most recent years:

            First        Second       Third        Fourth       Year
            -----        ------       -----        ------       ----
1997 High   $47 5/8      $53 7/8      $56 11/16    $55 3/4      $56 11/16
1997 Low    $44 5/8      $44          $52 7/16     $49 13/16    $44

1996 High   $52 1/2      $50 3/4      $49          $47 1/8      $52 1/2
1996 Low    $48          $46          $43 1/4      $42 3/4      $42 3/4



                                       25
<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.

<TABLE>

(in millions, except per share amounts) (1)(2)

                                                             1997         1996       1995          1994           1993
--------------------------------------------------------------------------------------------------------------------------
Summary of Consolidated Statements of Operations
<S>                                                       <C>          <C>          <C>          <C>              <C>

   Revenues:
     Insurance premiums                                   $   491.2    $   448.6    $   389.1    $   336.6       $   349.2
     Engineering services                                      61.3         55.8         49.9         48.0            46.0
     Income from investment operations                         50.9         44.4         31.7         34.9            55.4
                                                             -------      -------      -------      -------         -------
       Total revenues (3)                                 $   603.4    $   548.8    $   470.7    $   419.5       $   450.6
                                                             -------      -------      -------      -------         -------
   Income from continuing operations                      $    66.3    $    54.6    $    52.7    $    44.5       $    11.1
   Income from continuing operations
     per common share - basic                             $     3.32   $     2.71   $     2.58   $     2.17      $     0.54
   Income from continuing operations
     per common share - diluted                           $     3.29   $     2.71   $     2.58   $     2.17      $     0.54
   Dividends paid per common share                        $     2.31   $     2.28   $     2.22   $     2.14      $     2.12
---------------------------------------------------------------------------------------------------------------------------
Summary of Consolidated Statements of Financial Position
   Total assets                                           $ 1,540.2    $ 1,116.3    $   954.1    $   877.8       $   857.6
   Long-term borrowings and capital lease obligations     $    53.0    $    53.0    $    53.4    $    28.4       $    28.4
   Convertible redeemable preferred stock                      --      $    20.0         --           --              --
   Company obligated mandatorily redeemable
     capital securities                                   $   408.9         --           --           --              --
   Shareholders' equity:
     Common                                               $   345.3    $   345.6    $   341.1    $   299.5       $   324.7
     Per common share                                     $    17.63   $    17.25   $    16.81   $    14.67      $    15.80
     Return on average equity before accounting                19.1%        15.6%        19.5%        16.9%            3.7%
     changes
   Stock price per share:
     High                                                 $    56.69   $    52.50   $    50.38   $    53.38      $    59.50
     Low                                                  $    44.00   $    42.75   $    39.25   $    36.13      $    43.25
     Close                                                $    55.19   $    46.38   $    50.00   $    39.88      $    44.50
   Common shares outstanding at end of year (4)                19.6         20.0         20.3         20.4            20.5
---------------------------------------------------------------------------------------------------------------------------
Insurance
   Operating gain (loss)                                  $    39.8    $    21.8    $    34.2    $    20.7       $   (26.4)
     Loss ratio                                                44.4%        45.6%        39.8%        42.5%           57.1%
     Expense ratio                                             47.3%        49.1%        50.9%        50.5%           50.5%
                                                             -------      -------      -------      -------         -------
     Combined ratio                                            91.7%        94.7%        90.7%        93.0%(5)       107.6%
---------------------------------------------------------------------------------------------------------------------------

Engineering Services (3)
   Operating gain                                         $     4.3    $       7.3    $     6.7    $     4.3       $     4.0
   Engineering services margin                                  7.1%          13.2%        13.3%         9.0%            8.7%
Investments
   Net investment income                                  $    36.8    $      32.3    $    28.9    $    26.2       $    29.3
   Realized investment gains                                   14.1           12.1          2.8          8.7            26.1
     Income from investment operations                    $    50.9    $      44.4    $    31.7    $    34.9       $    55.4
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Prior year information has been restated to reflect Radian International LLC
as a discontinued operation.
(2) All per 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  1.0 in 1997, 0.3 in 1996, 0.1 in
1995, 0.1 in 1994, 0.2 in 1993.
(5) Excludes charge for Proposition 103.



                                       26
<PAGE>



Item 7.   Management's Discussion and Analysis of 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,         1997            1996           1995
------------------------------------------------------------------------------
Revenues:
   Insurance premiums                $   491.2       $   448.6       $   389.1
   Engineering services                   61.3            55.8            49.9
   Net investment income                  36.8            32.3            28.9
   Realized investment gains              14.1            12.1             2.8
                                       -------       ---------        --------
Total Revenues                       $   603.4       $   548.8       $   470.7
Income from continuing operations    $    66.3       $    54.6       $    52.7

Net income                           $    66.3       $    53.4       $    62.6

Earnings Per Share:
Income from continuing operations:
       Basic                         $     3.32      $     2.71      $     2.58
       Diluted                             3.29            2.71            2.58
   Net income:
       Basic                         $     3.32      $     2.65      $     3.07
       Diluted                             3.29            2.65            3.07
                                       -------       ----------      ---------


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

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 July 28, 1997 the HSB Board  ratified  management's  decision to
exercise its option to put its share of Radian International LLC (Radian) to The
Dow Chemical  Company (Dow) on or about January 1, 1998 for  approximately  $144
million.  Due to this  decision,  the results of Radian have been  classified as
discontinued  operations and HSB's share of losses  incurred  subsequent to this
decision of  approximately  $10 million  pre-tax have been deferred  until HSB's
share of Radian  has been  transferred  to Dow.  On  January  2, 1998 the Radian
transaction closed resulting in an estimated after-tax gain of approximately $30
million,  which includes  absorption of the deferred loss.  (See note 3). Income
from  continuing   operations  in  1996  increased  3.6  percent  from  1995  as
catastrophe  losses from

                                       27
<PAGE>

unusually severe weather conditions in our domestic insurance operations,  which
caused our  underwriting  gain to drop by $12.4 million,  were largely offset by
increased income from investment operations of $12.7 million. Net income in 1996
declined  14.7 percent from 1995 as Radian's  contribution  to pre-tax  earnings
declined by approximately  $15.7 million during 1996.  Revenue shortfalls caused
the  venture  to  reduce  its  workforce  during  the year by about 10  percent,
resulting in a charge of $3.5 million.

Consolidated  revenues  grew  9.9  percent  in 1997 and  16.6  percent  in 1996.
Insurance premiums grew 9.5 percent in 1997, with the increased participation in
Industrial  Risk Insurers (IRI) a contributing  factor as well as growth in both
the domestic and international  books of business.  Effective  December 1, 1996,
The Hartford Steam Boiler  Inspection and Insurance  Company (HSBIIC)  increased
its  participation  in IRI from 14 to 23.5 percent.  The combined  ratio for the
Company  improved to 91.7 percent in 1997 from 94.7 percent in 1996. In 1995 the
combined ratio was 90.7 percent.

Engineering  services revenue  increased 9.9 percent in 1997 and 11.8 percent in
1996.

The  effective   tax  rates  on  income  from   continuing   operations   before
distributions  on capital  securities for 1997 was 26.8 percent compared to 25.1
percent and 27.0 percent for 1996 and 1995. 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 February  1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
Statement  of  Financial  Accounting  Standards  (SFAS) No. 128,  "Earnings  per
Share".  This  statement  establishes  standards for  computing  and  presenting
earnings per share (EPS).  It replaces  the  presentation  of primary EPS with a
presentation  of basic EPS.  It also  requires  dual  presentation  of basic and
diluted  EPS on the face of the  Consolidated  Statements  of  Operations  and a
reconciliation  of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. This statement was
implemented at year end 1997. (See note 2).

In June 1997 the FASB  issued  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 will  include a  presentation  of items  such as market  value
adjustments of securities, foreign currency translation, and certain adjustments
made for benefit plans. This accounting  standard will be effective beginning in
1998 with presentation of prior periods required.

                                       28
<PAGE>

Also in June of 1997, the FASB issued 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. It includes disclosure requirements relating to products and services,
geographic  areas and major  customers.  This  statement  will be effective with
calendar year 1998,  however  application is not required for interim  financial
statements in the initial year. It is possible that this disclosure may redefine
our segment  information.  However,  the Company has not yet determined how SFAS
No. 131 will be applied.

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  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  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 December 1, 1996,  HSBIIC increased its  participation in IRI from 14 percent
to  23.5  percent.  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
which  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 1995
and prior, HSBIIC's membership share was .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  doesn't
release HSBIIC from the effects of adverse development.

On January 6, 1998,  HSBIIC 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.  HSBIIC received
gross proceeds of approximately $50 million, prior to transaction costs, for its
23.5  percent

                                       29
<PAGE>

share  in IRI.  Because  the  sale  was  structured  in  part  as a  reinsurance
transaction,  a portion of HSBIIC's  gross proceeds will be 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 .5 percent share) as the sole members.
Initially  HSBIIC will write the  business for the  reconstituted  IRI using its
insurance licenses and will provide certain other services. HSBIIC will transfer
its HPR  manufacturing  book of business to IRI and through various  reinsurance
arrangements  with  IRI/ERC  will retain 85 percent of the  equipment  breakdown
business  and 15 percent of the  property  business  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, 7 percent  Convertible Capital Securities in a
private  placement to ERC. The  Convertible  Capital  Securities are convertible
into HSB  common  stock,  at any time,  subject  to  regulatory  approval,  at a
conversion price of $85. $250 million of the proceeds were contributed to HSBIIC
and $50 million was retained by HSB. (See note 12).

Insurance Operations

For the years ended December 31,    1997         1996        1995
-------------------------------------------------------------------
Gross earned premiums            $  609.3     $  556.5     $  455.0
Ceded premiums                      118.1        107.9         65.9
                                   --------------------------------
Insurance premiums               $  491.2     $  448.6     $  389.1

Claims and adjustment
         expenses                   217.9        204.4        154.9
Underwriting, acquisition
         and other expenses         233.5        222.4        200.0
                                  ----------------------------------

Underwriting gain                $   39.8     $   21.8     $   34.2

Loss ratio                           44.4%        45.6%        39.8%
Expense ratio                        47.3%        49.1%        50.9%
Combined ratio                       91.7%        94.7%        90.7%
--------------------------------------------------------------------



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., HSB of Connecticut,  HSB of Texas and
HSBIIC's participation in IRI and various other pools.

Insurance  premiums  in 1997  increased  9.5 percent  from 1996.  This growth is
primarily attributable to the increased participation in IRI ($22.4 million) and
to growth in both the  domestic and global  markets.  The increase in 1996 was a
result of the increased  participation  in IRI ($22.6 million) as well as growth
in the global markets. It is possible

                                       30
<PAGE>

that the  reduction  in  HSBIIC's  interest  in IRI,  as a result of the sale on
January 6, 1998, may dampen growth in net insurance premiums.

Insurance premiums  representing coverage outside the U.S. increased 7.1 percent
to $93.3  million from $87.1  million in 1996 and $73.3  million  from 1995.  In
certain areas of the Company's direct domestic and international businesses, the
market is  experiencing  price  erosion.  The Company will not write business at
rates which would lessen its ability to maintain underwriting profit.  Increases
in ceded  premium of 9.5 percent in 1997 were  primarily  due to the  additional
participation  in IRI and the purchase of  facultative  reinsurance  at EIL. The
Company  continues  to see  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.

Domestically,  exclusive of IRI, premiums increased approximately $16.3 million,
or 5.0  percent  in  1997  and 3.9  percent  in  1996.  These  increases  were a
combination of growth in written  premiums from our client companies in 1997 and
1996 respectively,  and reflects the addition of new client companies, offset by
a loss  of  business  as a  result  of  industry  consolidation.  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  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 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 re-evaluates its exposures and reinsurance needs annually
to implement a program which  corresponds with the level of exposure the Company
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.  The Company's  reinsurance costs continue to be
impacted by its prior loss experience and business growth.



                                       31
<PAGE>



For the years ended December 31,                     1997     1996      1995
--------------------------------------------------------------------------------
Provision for claims and
         adjustment expenses
         occurring in the current year          $  209.5  $  214.2   $  152.2
Increase (decrease) in
         estimated claims and adjustment
         expenses arising in prior years*            8.4      (9.8)       2.7
                                                  -----------------------------
Total incurred claims and adjustment expenses   $  217.9  $  204.4   $  154.9

Loss ratio                                          44.4%     45.6%      39.8%
-------------------------------------------------------------------------------

* Includes  approximately  $3.3, $4.9 and $1.1 million  subrogation  recoveries,
respectively.

The loss ratio  decreased  1.2  percentage  points in 1997 as  compared  to 1996
primarily as a result of fewer weather-related  losses. The 1996 increase of 5.8
percentage  points as compared  to 1995,  was  primarily  the result of the high
frequency of claims and unusually severe winter weather.  Adverse development in
1997 added 1.7 percentage points to the loss ratio,  while positive  development
in 1996  benefited the loss ratio by 2.2  percentage  points.  The components of
claims and adjustment expenses, net of reinsurance, are displayed above.

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 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  coverages  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 coverages,  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 doesn't discount its loss reserves.

HSBIIC is involved in three arbitration or litigation  proceedings regarding the
extent to which certain  explosion events are insured under boiler and machinery
policies of HSBIIC or under the all-risk property  insurance  policies issued by
other companies.  Management  believes HSBIIC's policies do not provide coverage
for  losses  resulting  from  explosion  events  that are the  subject  of these
proceedings.

                                       32
<PAGE>

A lower court ruling in one of these cases held that an explosion did occur, and
that  HSBIIC  was not  liable  for  losses  of the  insured  resulting  from the
explosion.  In a further  action,  the court denied  HSBIIC's motion for summary
judgment on certain issues,  thus leaving HSBIIC  potentially liable for certain
unquantified  losses resulting from events prior to the explosion.  In the first
quarter of 1997 HSBIIC and the property  insurer  jointly  settled the case with
the insured.  HSBIIC's ultimate share of the settlement will be determined in an
arbitration  proceeding  with the property  insurer.  HSBIIC has incurred  gross
losses and loss adjustment expenses (LAE) of $40.7 million and a net loss, after
taking into  account  reinsurance  recoverables,  of $6.5  million,  of which $5
million represents claim costs and the remaining $1.5 million represents LAE. As
a result of payments  made to date, at December 31, 1997,  HSBIIC  carried gross
loss and LAE reserves of $2.8 million and  recoverables  from reinsurers of $2.8
million.

HSBIIC  has  accrued  $6.5  million  with  respect  to the  other  two cases for
potential LAE, including legal costs to defend HSBIIC's position. One case is in
the process of pre-trial summary judgment motions and appeals; the other case is
involved in both  arbitration and litigation  proceedings.  A trial date has not
been set for either  case.  In the event that  HSBIIC is held  liable for one or
both of the  remaining  claims,  amounts  in  excess  of  HSBIIC's  net  maximum
aggregate  retention  of $8.5  million is  recoverable  from  reinsurers.  Claim
amounts  potentially  recoverable  from  reinsurers  in the event of a  possible
adverse outcome in these cases could range,  in the aggregate,  from $40 million
to $195 million.

The  obligations of HSBIIC's  reinsurers  with respect to these cases are not in
dispute. Therefore, management believes that any adverse outcomes in these cases
will not,  in the  aggregate,  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 losses such reinsurers
might incur should these cases 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  arbitration  or  litigation
proceedings  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.

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.


                                       33
<PAGE>

Engineering Services Operations*

For the years ended December 31,      1997       1996        1995
------------------------------------------------------------------------------
Engineering services revenues      $  61.3     $  55.8     $  49.9
Engineering services expenses         57.0        48.5        43.2
Operating gain                     $   4.3     $   7.3     $   6.7
                                   --------------------------------
Engineering services margin            7.1%       13.2%       13.3%
------------------------------------------------------------------------------

* Excludes Radian.

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

Engineering  services revenue  increased 9.8 percent in comparison to 1996. This
was  primarily  attributable  to increased  sales of $3.2 million at HSBRT and a
modest  increase  in revenues  from our  engineering  operations  based in Asia.
Engineering  services  revenues in 1996  increased 11.8 percent in comparison to
1995.  The growth in revenues was primarily due to increases  generated by HSBRT
as their  revenues  were $4.8  million (35 percent)  higher in 1996  compared to
1995, almost entirely  attributable to increases in volume.  Margins declined in
1997 as the Company  decreased the staff  utilization  domestically  in order to
develop new growth  opportunities.  The Company is also maintaining staff levels
in Asia during the current  economic  downturn  at somewhat  lower  productivity
levels as the Company  continues  to have  confidence  in its  long-term  growth
prospects in the region.

Investment Operations

For the years ended December 31,       1997        1996       1995
-------------------------------------------------------------------------------
Net investment income               $   36.8    $   32.3    $   28.9
Realized investment gains               14.1        12.1         2.8
                                    -------------------------------------------
Income from investment
         operations                 $   50.9    $   44.4    $   31.7
Total cash and invested
         assets, at fair value      $  996.7    $  600.9    $  550.5

Unrealized gains, pre-tax           $   95.3    $   81.4    $   65.4
--------------------------------------------------------------------------------

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

                                       34
<PAGE>

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, the Company manages its portfolio by laddering its maturities
such that the average maturity 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.

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 meant they only
settled upon maturity.  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
which  required  HSBIIC  to pay  its  counterparty  $30.7  million  in  foregone
appreciation  on its portfolio.  The Company's U.S.  common stock  portfolio has
experienced a total return of $57 million (which includes price  appreciation of
approximately $54 million) since December 31, 1996, and has had a price movement
correlation with the S&P 500 Index well in excess of 80 percent.

Net  investment  income  for  1997  increased  $4.5  million  compared  to 1996.
Investable  assets  increased  in 1997  in  comparison  to  1996 as the  Company
invested the proceeds  from its capital  securities  offerings.  Net  investment
income was impacted earlier in 1997 by calls of high yielding  preferred stocks.
Net investment income increases 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.  Higher
interest costs relate to a larger amount of commercial paper outstanding.

Through its U.K. subsidiary, EIL, the Company writes business in Malaysia and is
required to maintain approximately 50 million ringgit denominated investments on
deposit in that  country.  The Company  intends to maintain its current level of
deposits in that currency,  which equated to $12.8 million at December 31, 1997.
Due to the  recent  fluctuations  of  currencies  in  southeast  Asia,  realized
investment gains were reduced by approximately $7.4 million during 1997.

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.   Invested  assets  growth  was  due  to
significant  cash  flow from

                                       35
<PAGE>

operations  during  1995 as well as the  portfolio  transfer  arising  from  the
increased  participation  in IRI during  1996.  Investment  income in the global
market also increased as these operations have shown significant growth over the
past year.

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
1997,  HSB's fixed maturities  portfolio  comprised 26.1 percent of the value of
the invested  assets.  The credit quality of HSB's bond  investments at December
31, 1997,  averaged a AA rating.  HSB's  portfolio does not include any bonds in
default as to either principal or interest. Bonds held at December 31, 1997, had
a fair value of $113 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 34 percent of
the  investments at December 31, 1997. This included $92.5 million of unrealized
investment gains, which had a net increase of $12.7 million from 1996 on a sharp
upturn in the stock market in 1997.  HSB also  recorded $13 million of dividends
and $43 million of net pre-tax  realized  gains from this portfolio in 1997. The
Company's  largest  single  holding  accounted  for less than 1 percent of total
consolidated assets.  Realized investment gains increased in 1997 over 1996 (and
in 1996 in  comparison  to 1995) as HSB  managed  its  portfolio  to  respond to
changing market conditions and tax planning opportunities.

Liquidity and Capital Resources

At December 31,                             1997            1996
-------------------------------------------------------------------------------

Total assets                            $  1,540.2      $  1,116.3
Short-term investments                       379.2            97.9
Cash                                          45.3             4.5
Short-term borrowings                         42.4             3.2
Capital securities of subsidiary
   Trust I                                   108.8            --
Capital securities of subsidiary
   Trust II                                  300.0            --
Convertible redeemable preferred
   stock                                      --              20.0
Common shareholders' equity                  345.3           345.6
--------------------------------------------------------------------------------


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

                                       36
<PAGE>

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  and
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  equivalent 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  short-term
portfolio at December 31, 1997 reflects the temporary investment of the proceeds
from the $300 million  Convertible  Capital  Securities  discussed  below. It is
unlikely  that HSB will  maintain  such high levels of  short-term  investments;
however,  given  the  current  interest  rate  environment,  HSB  is  proceeding
carefully to structure an appropriate investment portfolio.

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 .91  percent.  The  current  coupon at December  31,  1997 is 6.7  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 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
agency.

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 HSB 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

                                       37
<PAGE>

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 $85,  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,  on  a  fully  diluted  basis,
approximately 15.3 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 $26.1  million in 1997  compared  to $92.9
million for 1996.  Insurance  operations  cash flow (excluding IRI) decreased as
net claims paid increased 21.8 percent  compared to the same period in 1996, and
premiums  collected  were  1.9  percent  higher  than  last  year.  Payments  to
reinsurers for ceded premium  increased  approximately 17 percent in the current
year.  HSBIIC's  participation  in IRI impacted  components of the  Consolidated
Statements of Cash Flows for 1997,  including a positive  impact of $1.5 million
and  $2.2  million  for 1997  and  1996,  respectively,  to cash  provided  from
operations.

Capital  resources  consist  of  shareholders'  equity,  convertible  redeemable
preferred stock,  capital  securities and debt outstanding,  and represent those
funds  deployed or  available  to be deployed  to support  business  operations.
Common  shareholders'  equity of $345.3  million at December 31, 1997  decreased
$0.3 million since December 31, 1996. The decrease  reflects net income of $66.3
million year to date and an increase in unrealized

                                       38
<PAGE>

investment  gains,  net of tax,  of $7.0  million,  offset by  dividends  of $47
million and $54 million of share  repurchases.  Also,  on October 30, 1997,  the
sole holder of convertible  redeemable  preferred  stock  converted into 398,406
shares of common stock, adding $20 million to common shareholders' equity.

On January 27, 1997 the Board of Directors  renewed  HSBIIC's  authorization  to
repurchase up to one million of its common shares. At its July meeting,  the HSB
Board of Directors  increased  the  authorization  to  repurchase  shares to two
million.  Through December 31, 1997, HSB has purchased approximately one million
shares at a cost of $54  million.  On January  26,  1998 the Board of  Directors
renewed HSB's authorization to repurchase up to two million shares of its common
stock. 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.  For  comparative
purposes,  treasury stock of $59.5 million was likewise reclassified at December
1996.

At December 31, 1997,  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, 1997 and  December 31, 1996 was
$42.4  million and $3.2  million,  respectively.  In early  January,  Standard &
Poor's and Duff & Phelps credit rating services reaffirmed their highest ratings
for the commercial  paper.  HSBIIC had authorized a guaranty of up to 40 percent
of  Radian's  $40 million  credit  facility  with Dow. At December  31, 1997 the
amount guaranteed was $14.3 million.  Such guaranty  terminated upon the sale of
HSBIIC's interest in Radian to Dow on January 2, 1998.

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. The analysis
indicated  roughly 30 percent of existing code is compliant,  roughly 60 percent
is represented by legacy systems, which were scheduled to be replaced before the
end of 1998 due to current  business needs,  and the remainder will be addressed
through  modification to compliant code or  discontinuation.  The impact of year
2000  expenditures  on a stand alone basis is not clearly evident as the Company
is  replacing  legacy  applications  due to  changing  business  needs  and such
replacement applications will be year 2000 compliant.  However, the overall cost
of modification efforts and application  replacement,  which include substantial
enhancements  to business  functionality,  has been estimated at $13-$20 million
over a three year period.  Certain of the costs  related to the  replacement  of
legacy   applications  due  to  changing  business  needs  will  be  capitalized
consistent with the Company's existing capitalization policy.

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

                                       39
<PAGE>

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 IRI; 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 8.  Financial Statements and Supplementary Data.
-------  --------------------------------------------

                          INDEX TO FINANCIAL STATEMENTS
                        AND FINANCIAL STATEMENT SCHEDULES

                                                                      Page No.

Report of Independent Accountants                                         42
Financial Statements

     Consolidated Statements of Operations
     for the years ended December 31, 1997,
     1996 and 1995.                                                       43

     Consolidated Statements of Financial
     Position - December 31, 1997 and 1996.                               44

     Consolidated Statements of Cash Flows
     for the years ended December 31, 1997,
     1996 and 1995.                                                       45

     Consolidated Statements of Changes in
     Shareholders' Equity for the years ended
     December 31, 1997, 1996 and 1995.                                    46

     Notes to Consolidated Financial Statements                           47

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

                                       40
<PAGE>

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

Schedule  IV - Reinsurance                                                83

Schedule V - Valuation and Qualifying Accounts                            84

Schedule VI - Supplemental Information Concerning
                       Property-Casualty Insurance Operations             85

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.



                                       41
<PAGE>



REPORT OF INDEPENDENT ACCOUNTANTS


To the Shareholders and Board of Directors of
HSB Group, Inc., the newly formed parent of The Hartford Steam Boiler Inspection
and Insurance Company:

We  have  audited  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. These financial statements and financial statement schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and financial statement schedules based
on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the consolidated  financial position of HSB Group, Inc.
and its  subsidiaries  as of December  31, 1997 and 1996,  and the  consolidated
results of their  operations and their cash flows for each of the three years in
the period ended  December 31,  1997,  in  conformity  with  generally  accepted
accounting  principles.  In addition,  in our opinion,  the financial  statement
schedules  referred to above, when considered in relation to the basic financial
statements  taken as a whole,  present  fairly,  in all material  respects,  the
information required to be included therein.






Coopers & Lybrand L.L.P.

Hartford, Connecticut
January 26, 1998






                                       42
<PAGE>



Financial Statements

Consolidated Statements of Operations
-------------------------------------

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

<TABLE>

                                                              1997         1996        1995
--------------------------------------------------------------------------------------------
<S>                                                       <C>         <C>          <C>
Revenues:
   Insurance premiums                                     $   491.2   $   448.6    $   389.1
   Engineering services                                        61.3        55.8         49.9
   Net investment income                                       36.8        32.3         28.9
   Realized investment gains                                   14.1        12.1          2.8
                                                          ----------------------------------
         Total revenues                                       603.4       548.8        470.7
                                                          ----------------------------------

   Expenses:
   Claims and adjustment                                      217.9       204.4        154.9
   Policy acquisition                                          90.7        86.0         78.1
   Underwriting and inspection                                142.8       136.4        121.9
   Engineering services                                        57.0        48.5         43.2
   Interest                                                     1.3         0.6          0.4
                                                          ----------------------------------
         Total expenses                                       509.7       475.9        398.5
                                                          ----------------------------------

Income from continuing operations before
income taxes and distributions on capital securities           93.7        72.9         72.2

Income taxes (benefit):
   Current                                                     23.8        24.7         20.5
   Deferred                                                     1.3        (6.4)        (1.0)
                                                          ----------------------------------

      Total income taxes                                       25.1        18.3         19.5
                                                          ----------------------------------

Distributions on capital securities of subsidiary
trusts, net of income taxes of $1.2; $--; and $--               2.3         --           --
                                                          ----------------------------------

Income from continuing operations                              66.3        54.6         52.7
                                                          ----------------------------------

Discontinued operations:
Income (loss) from operations of Radian International
LLC, net of income taxes (benefit) of
($.1); ($.4); and $4.2                                          --         (1.2)         9.9
                                                          -----------------------------------

Net income                                                $    66.3   $    53.4    $    62.6
                                                          -----------------------------------

Earnings (loss) per common share - basic:
   Income from continuing operations                      $     3.32  $     2.71   $     2.58
   Discontinued operations                                      --         (0.06)        0.49
                                                          -----------------------------------
   Net income                                             $     3.32  $     2.65   $     3.07
                                                          -----------------------------------
  Average common shares outstanding                            19.7        20.2         20.4

Earnings (loss) per common share - diluted:
   Income from continuing operations                      $     3.29  $     2.71   $     2.58
   Discontinued operations                                      --         (0.06)        0.49
                                                          -----------------------------------
   Net income                                             $     3.29  $     2.65   $     3.07
                                                          -----------------------------------

Average common shares outstanding
   and common stock equivalents                                20.1        20.2         20.4
   -----------------------------------------------------------------------------------------

</TABLE>

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




                                       43
<PAGE>



<TABLE>


Consolidated Statements of Financial Position
---------------------------------------------
At December 31, (in millions, except per share amounts)

                                                                                             1997           1996
----------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>            <C>
Assets:
   Cash                                                                              $      45.3    $       4.5
   Short-term investments, at cost                                                         379.2           97.9
   Fixed maturities, at fair value
     (cost - $241.1; $231.3)                                                               248.4          235.8
   Equity securities, at fair value
     (cost - $231.3; $182.9)                                                               323.8          262.7
                                                                                      --------------------------
     Total cash and invested assets                                                        996.7          600.9
   Insurance premiums receivable                                                           138.0          106.4
   Engineering services receivable                                                          12.2           11.7
   Fixed assets                                                                             36.4           32.3
   Prepaid acquisition costs                                                                45.5           40.6
   Capital lease                                                                            15.3           16.1
   Investment in Radian                                                                     83.4           79.7
   Reinsurance assets                                                                      124.5          162.9
   Other assets                                                                             88.2           65.7
                                                                                       -------------------------
     Total assets                                                                    $   1,540.2    $   1,116.3
                                                                                       -------------------------

Liabilities:
   Unearned insurance premiums                                                       $     290.3    $     270.6
   Claims and adjustment expenses                                                          276.7          302.9
   Short-term borrowings                                                                    42.4            3.2
   Long-term borrowings                                                                     25.1           25.1
   Capital lease                                                                            27.9           27.9
   Deferred income taxes                                                                    31.5           23.7
   Dividends payable                                                                        13.3           11.4
   Other liabilities                                                                        78.8           85.9
                                                                                       -------------------------
     Total liabilities                                                                     786.0          750.7
                                                                                       -------------------------

   Convertible redeemable preferred stock -  Series B (stated and
     redemption value; shares authorized, issued and outstanding .002)                       --            20.0

   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                                                   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            --

Shareholders' equity:
   Common stock (stated value; shares authorized 50.0;
     shares issued 21.3; shares outstanding  19.6; 20.0)                                    10.0           10.0
   Additional paid-in capital                                                               31.6           32.0
   Unrealized investment gains, net of tax                                                  59.8           52.8
   Retained earnings                                                                       248.8          255.1
   Benefit plans                                                                            (4.9)          (4.3)
                                                                                     ---------------------------
     Total shareholders' equity                                                            345.3          345.6
                                                                                     ---------------------------
     Total                                                                           $   1,540.2    $   1,116.3
                                                                                     ---------------------------
   Common shareholders' equity per share                                             $      17.63   $      17.25
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
</TABLE>

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




                                       44
<PAGE>



Consolidated Statements of Cash Flows
-------------------------------------
for the years ended December 31, (in millions)
<TABLE>

                                                                1997      1996      1995
-----------------------------------------------------------------------------------------
<S>                                                         <C>       <C>       <C>
Operating activities:
Net income                                                  $   66.3  $   53.4  $   62.6
Adjustments to reconcile net income to
cash provided by operating activities:
   Depreciation and amortization                                 8.3       9.8      19.4
   Deferred income taxes (benefit)                               1.3     (10.0)     (0.6)
   Realized investment gains                                   (14.1)    (12.1)     (2.8)
 Change in:
     Insurance premiums receivable                             (31.6)    (19.2)     (4.1)
     Engineering services receivable                             (.5)     (2.7)      3.3
     Prepaid acquisition costs                                  (4.9)     (6.5)      1.4
     Investment in Radian                                       (3.7)     12.9       --
     Reinsurance assets                                         38.4    (103.4)      (.8)
     Unearned insurance premiums                                19.7      54.4      14.9
     Claims and adjustment expenses                            (26.2)    112.0      (8.5)
     Other                                                     (26.9)      4.3      10.7
                                                           ------------------------------

       Cash provided by operating activities                    26.1      92.9      95.5
                                                           ------------------------------

Investing activities:
Fixed asset additions, net                                     (10.4)     (1.7)    (16.8)
Investments:
   Purchase of short-term investments, net                    (281.4)    (24.1)      --
   Purchase of fixed maturities                                (60.6)    (89.0)   (152.1)
   Proceeds from sale of fixed maturities                       27.9      93.1      91.5
   Redemption of fixed maturities                               14.4      11.5      17.0
   Purchase of equity securities                              (252.9)   (149.3)    (95.0)
   Proceeds from sale of equity securities                     254.1     131.2     122.9
   Settlement of collar contracts                              (30.7)     --        --
   Cash transferred to investment in Radian                     --        (0.7)     --
                                                            -----------------------------
     Cash used in investment activities                       (339.6)    (29.0)    (32.5)
                                                            -----------------------------

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      --        --
Increase (decrease) in short-term borrowings                    39.1     (10.2)    (37.5)
Repayment of long-term debt                                     --        (0.5)     (0.1)
Increase in long-term debt                                      --        --        25.1
Dividends paid to shareholders                                 (46.7)    (46.1)    (45.3)
Reacquisition of stock                                         (54.0)    (13.0)     (6.3)
Repayment of employee stock ownership plan debt                 --        --        (1.7)
Exercise of stock options                                        7.0       1.1      --
                                                            -----------------------------
   Cash provided by (used in) financing activities             354.3     (68.7)    (65.8)
                                                            -----------------------------
   Net increase (decrease) in cash                              40.8      (4.8)     (2.8)
   Cash at beginning of period                                   4.5       9.3      12.1
                                                            -----------------------------
   Cash at end of period                                    $   45.3  $    4.5  $    9.3
                                                            -----------------------------

Interest paid                                               $    3.2  $    2.3  $    4.1
                                                            -----------------------------

Federal income tax paid                                     $   33.8  $   25.7  $   23.4
----------------------------------------------------------------------------------------
</TABLE>


Non-cash investing and financing activities:
Issuance of HSB convertible  preferred stock in exchange for EIG, Co.  preferred
stock in 1996, and conversion into HSB common stock in 1997. (See note 3).

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



                                       45
<PAGE>




Consolidated Statements of Changes in Shareholders' Equity
----------------------------------------------------------
For the years ended December 31, (in millions)
<TABLE>
                                                                   Net
                                     Total                         Unrealized
                                     Share-            Additional  Investment
                                     holders'  Common  Paid-in     Gains     Retained Treasury   Benefit
                                     Equity    Stock   Capital     (Losses)  Earnings Stock      Plans
--------------------------------------------------------------------------------------------------------
<S>                                <C>        <C>      <C>       <C>      <C>        <C>         <C>

Balances at December 31, 1994      $  299.5   $  10.0  $  34.0   $  13.9  $  288.1   ($ 41.9)    (4.6)
--------------------------------------------------------------------------------------------------------

Net income                             62.6       --       --        --       62.6       --        --
Dividends declared                    (45.6)      --       --        --      (45.6)      --        --
Change in unrealized
   investment gains, net of tax        30.0       --       --       30.0       --        --        --
Benefit plans                           0.4       --      (0.1)      --        --        --       0.5
Purchase of treasury stock             (6.3)      --       --        --        --       (6.3)      --
Issuance of reacquired stock,
   net of forfeitures                   0.5       --       --        --        --        0.5       --
   -----------------------------------------------------------------------------------------------------

Balances at December 31, 1995      $  341.1   $  10.0  $  33.9   $  43.9  $  305.1   ($ 47.7)  ($ 4.1)
------------------------------------------------------------------------------------------------------

Net income                             53.4       --       --        --       53.4       --        --
Dividends declared                    (45.9)      --       --        --      (45.9)      --        --
Change in unrealized
   investment gains, net of tax         8.9       --       --        8.9       --        --        --
Benefit plans                          --         --       --        --        --        0.2     (0.2)
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   $  52.8  $  255.1       --    ($ 4.3)
------------------------------------------------------------------------------------------------------

Net income                             66.3       --       --        --       66.3       --        --
Dividends declared                    (47.0)      --       --        --      (47.0)      --        --
Change in unrealized
investment gains, net of tax            7.0       --       --        7.0       --        --        --
Benefit plans                          (0.6)      --       --        --        --        --      (0.6)
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 forfeitures                   1.0       --       0.2       --        0.8       --        --
-----------------------------------------------------------------------------------------------------

Balances at December 31, 1997      $  345.3   $  10.0  $  31.6   $  59.8  $  248.8    --    ($ 4.9)
------------------------------------------------------------------------------------------------------
</TABLE>



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



                                       46
<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) (See note 3)
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 may differ from estimates. Certain amounts for 1996 and 1995 have
been reclassified to conform with the 1997 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 and premium
taxes,  are amortized as the related  insurance  premiums are earned.  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
require  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 10).

Reinsurance  assets  represents  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.


                                       47
<PAGE>


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.

Investments

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  investments 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.

Fixed Assets

Fixed assets are carried at cost less accumulated depreciation.  Depreciation 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.

                                       48
<PAGE>

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 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 $20.7  and  $12.1  million  at  December  31,  1997 and  1996,
respectively.  HSB evaluates the reliability of goodwill based upon  projections
of undiscounted cash flows.

2. Changes in Accounting Principles

In February  1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
Statement  of  Financial  Accounting  Standards  (SFAS) No. 128,  "Earnings  per
Share".  This  statement  establishes  standards for  computing  and  presenting
earnings per share (EPS).  It replaces  the  presentation  of primary EPS with a
presentation  of basic EPS.  It also  requires  dual  presentation  of basic and
diluted  EPS on the face of the  Consolidated  Statements  of  Operations  and a
reconciliation  of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS  computation.  The requirements
of this  statement  are effective for year end 1997  financial  statements  with
prior period restatement required. The effect of this standard on EPS net income
is as follows:

                              1997         1996         1995
--------------------------------------------------------------

APB No. 15 methodology
(as previously reported)      N/A        $   2.65     $   3.07
SFAS No. 128 methodology
         Basic EPS            $   3.32   $   2.65     $   3.07
         Diluted EPS          $   3.29   $   2.65     $   3.07
--------------------------------------------------------------


                                       49
<PAGE>


The  following is a  reconciliation  of the  numerator  and  denominator  of the
calculation of basic and diluted EPS for income from  continuing  operations for
the years ended 1997, 1996 and 1995:

<TABLE>


For the years ended December 31,            1997                               1996                            1995
----------------------------------------------------------------    ---------------------------     ---------------------------

                                    Income   Shares   Per-Share     Income    Shares   Per-Share    Income   Shares   Per-Share
                                    ------   ------   ---------     ------    ------   ---------    ------   ------   ---------
<S>                                 <C>       <C>       <C>         <C>        <C>       <C>        <C>       <C>      <C>

Income from continuing
  operations                        $66.3                           $53.4                           $62.6
Less: preferred stock dividends      (1.1)                            --                             --
                                    ----------------------------    ----------------------------    ---------------------------

Basic EPS:
         Income available to
         common shareholders         65.2                            53.4                            62.6
         Weighted average shares
                  outstanding                 19.7                             20.2                           20.4

                           Basic EPS                    $3.32*                           $2.65*                         $3.07*

Effect of dilutive securities:
         Convertible preferred stock  1.1      0.3                    --        --                    --       --
         Stock options                         0.1                              --                             --
                                    ---------------------------     ----------------------------     --------------------------

Diluted EPS:
         Income available to common
                  shareholders and
                  assumed
                  conversions       $66.3     20.1                  $53.4      20.2                 $62.6     20.4

                  Diluted EPS                           $3.29*                           $2.65*                         $3.07*
----------------------------------------------------------------     ---------------------------     --------------------------
-------------------------------------------------------------------------------------------------------------------------------

</TABLE>

* Computation is carried out to thousands



On December 31, 1997, HSB sold $300 million of convertible  capital  securities.
The  securities  carry a 7 percent  coupon and are  convertible  into  3,529,411
shares.  (See note 12). Due to the timing of the issuance,  the  securities  had
minimal  impact on the EPS  calculation  in 1997,  but will  affect the  diluted
calculation in 1998.

In June 1997, FASB issued 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
presentation  will include such items as market value adjustments of securities,
foreign currency  translation,  and certain  adjustments made for benefit plans,
which are currently  reported as components  of the  Consolidated  Statements of
Changes in Shareholders'  Equity.  This statement will be effective beginning in
1998 with retroactive restatement of prior periods required.

Also in June of 1997, FASB issued SFAS No. 131,  "Disclosures  about Segments of
an Enterprise  and Related  Information".  This standard  requires  companies to
report  financial

                                       50
<PAGE>

and descriptive  information about reportable  operating  segments.  It includes
disclosure requirements relating to products and services,  geographic areas and
major customers. This statement will be effective for 1998, however, application
is not required for interim  financial  statements  in the initial  year.  It is
possible that this disclosure may redefine our segment information. However, HSB
has not yet determined how SFAS No. 131 will be applied.

3. Corporate Activity

At a special  meeting of The Hartford  Steam  Boiler  Inspection  and  Insurance
Company  (HSBIIC)  on June 23,  1997,  shareholders  voted to approve a proposal
which enabled the formation of a new holding  company,  HSB Group,  Inc.  (HSB).
Shareholders  of HSBIIC's  common and  convertible  redeemable  preferred  stock
became  holders of HSB's  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  common  and
convertible  redeemable preferred stock. HSBIIC remains the principal subsidiary
of HSB.

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 398,406  shares of common
stock of HSB. (See note 12).

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 sold $300 million
of 20 year fixed rate Convertible  Capital  Securities to Employers  Reinsurance
Corporation (ERC), a subsidiary of GE Capital Services. (See note 12).

Subsequent Events

Radian

In January 1996,  HSBIIC and The Dow Chemical Company (Dow) formed a new entity,
Radian International LLC (Radian).  According to the terms of the agreement, the
ownership of Radian was initially 60 percent Dow and 40 percent HSBIIC,  via the
wholly

                                       51
<PAGE>

owned  subsidiaries  of each  company.  At the date of the  transaction,  HSBIIC
transferred virtually all of the assets and liabilities of Radian Corporation at
historical cost to Radian. No gain was recognized on the transfer.

The agreement  provided HSBIIC the option to put its share of the venture to Dow
any time during the period  from  December  31,  1997 to December  31, 1998 upon
giving appropriate  notice. On July 28, 1997 the HSB Board of Directors ratified
management's  decision to put its share of Radian to Dow on or about  January 1,
1998.  Due to this  decision,  the  results of Radian  have been  classified  as
discontinued operations.  HSB's share of Radian's losses generated subsequent to
this decision of  approximately  $10 million  pre-tax have been  deferred  until
HSB's share of Radian was sold and a gain recognized.

On  January 2, 1998 HSB  exercised  its option to put its share of Radian to Dow
for  approximately  $144 million.  This  transaction will result in an after tax
gain of approximately $30 million which will be recorded in the first quarter of
1998.

Summarized financial data for Radian follows:

                     1997*          1996*         1995
---------------------------------------------------------
Assets             $  159.7      $  156.3      $  108.6
Liabilities            88.4          62.1          37.1

Revenues              288.0         229.6         202.2
Expenses              314.0         233.6         188.1
---------------------------------------------------------


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

Industrial Risk Insurers

On January 6, 1998 HSBIIC sold its interest in Industrial Risk Insurers (IRI) to
ERC in  accordance  with a  previously  announced  purchase  and sale  agreement
between ERC and IRI's  twenty-three  member insurers.  IRI is an unincorporated,
voluntary joint underwriting association which underwrites property insurance on
highly  protected  risks.  HSBIIC received gross proceeds of  approximately  $50
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 will be 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 .5 percent share) as its sole members.
Initially  HSBIIC will write the  business for the  reconstituted  IRI using its
insurance  licenses and will provide certain other  services.  It is anticipated
that HSBIIC will transfer its domestic highly protected risk  manufacturing book
of  business  to IRI and will  retain  85  percent  of

                                       52
<PAGE>

the equipment  breakdown business and 15 percent of the property business 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
$85.  $250 million of the  proceeds  were  contributed  by HSB to HSBIIC and $50
million was retained at HSB.  (See note 12).

4. Segment Information

HSB is a multi-national company operating primarily in North American, European,
and Asian markets. The Company operates three principal businesses -- insurance,
engineering services and investments.  The Company primarily offers coverage for
machinery  intensive risks and provides  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 services aimed at
loss prevention.  The Company also offers professional  scientific and technical
consulting for industry and government on a worldwide basis. While the principal
market for insurance and engineering  services is the United States, the Company
continues to see growth opportunities in overseas markets.

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

Revenues from continuing operations

For the years ended December 31,            1997         1996           1995
-------------------------------------------------------------------------------
U.S.                                     $  491.6     $  444.9       $  383.4
Non-U.S                                     111.8        103.9           87.3
                                          -------------------------------------

         Total                           $  603.4     $  548.8       $  470.7
                                          -------------------------------------
-------------------------------------------------------------------------------

Income from continuing operations before taxes and distributions on capital
----------------------------------------------------------------------------
securities
----------

For the years ended December 31,            1997         1996           1995
-------------------------------------------------------------------------------
U.S.                                     $   74.1     $   52.7       $   53.4
Non-U.S.                                     19.6         20.2           18.8
                                       ----------------------------------------
         Total                           $   93.7     $   72.9       $   72.2
                                       ----------------------------------------
-------------------------------------------------------------------------------

Identifiable assets

At December 31,                             1997         1996           1995
-------------------------------------------------------------------------------
U.S.                                     $1,247.7     $  858.3       $  743.1
Non-U.S.                                    292.5        258.0          211.0
                                         --------------------------------------
         Total                           $1,540.2     $1,116.3       $  954.1
                                         --------------------------------------
-------------------------------------------------------------------------------



                                       53
<PAGE>

HSB's foreign operations (primarily insurance) are widely dispersed such that no
country or logical  aggregation of countries in a geographic  area  compromise 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 continuing  operations of the Company
based on industry segments:

Revenues from continuing operations
-----------------------------------
For the years ended December 31,            1997      1996        1995
------------------------------------------------------------------------
         Insurance premiums              $  491.2   $  448.6   $  389.1
         Engineering services                61.3       55.8       49.9
         Net investment income
                  and realized investment
                  gains                      50.9       44.4       31.7
                                         -------------------------------
                           Total         $  603.4   $  548.8   $  470.7
                                         -------------------------------

Income from continuing operations before income taxes and distributions on
--------------------------------------------------------------------------
capital securities
------------------

For the years ended December 31,           1997         1996       1995
--------------------------------------------------------------------------
         Insurance                       $  39.8    $   21.8   $   34.2
         Engineering                         4.3         7.3        6.7
         Investment                         49.6        43.8       31.3
                                   ---------------------------------------
                           Total         $  93.7    $   72.9   $   72.2
--------------------------------------------------------------------------

Identifiable assets
At December 31,                            1997         1996       1995
--------------------------------------------------------------------------
         Insurance                       $ 308.0    $  309.9   $  180.8
         Engineering                        95.6        91.4       97.0
         Investment                        996.7       600.9      553.8
         Other                             139.9       114.1      122.5
                                    --------------------------------------
                           Total        $1,540.2    $1,116.3   $  954.1
--------------------------------------------------------------------------


5. 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 1997
and 1996,  policyholders'  surplus  on a  statutory  basis was $550.8

                                       54
<PAGE>

and $292.4 million, respectively.  Statutory net income, adjusted to include the
earnings of all HSBIIC domestic insurance  subsidiaries for 1997, 1996, and 1995
was $42.9, $32.1, and $66.7 million, respectively.

HSBIIC is currently subject to various regulations that limit the maximum amount
of dividends  available to its shareholders  without prior approval of insurance
regulatory  authorities.  Under SAP,  approximately  $55.1  million of statutory
surplus is available for  distribution to HSB Group,  Inc. in 1998 without prior
regulatory approval.



                                       55
<PAGE>



6. Investments
                                                         1997      1996    1995
--------------------------------------------------------------------------------
Income from Investment Operations
         Net investment income:
                  Short-term interest                 $   6.7    $  4.8  $  6.2
                  Fixed maturities:
                           Taxable interest               9.6       9.8     9.0
                           Tax exempt interest            2.1       1.8     1.9
                           Redeemable preferred
                           dividends                      7.2       7.9     6.3
                  Equity securities:
                           Common dividends               4.7       4.6     4.0
                           Non-redeemable preferred
                           dividends                      8.3       5.9     4.6
                  Other                                   2.1       1.0     1.2
                                                       ------------------------
                           Total investment income       40.7      35.8    33.2
                           Investment expenses           (3.9)     (3.5)   (4.3)
                                                       ------------------------
                                    Net investment
                                    income            $  36.8   $  32.3  $ 28.9
                                                       ------------------------

         Realized investment gains (losses):
                  Fixed maturities:
                           Bonds:
                                    Gains             $   0.5   $   2.0  $  0.7
                                    Losses               (0.3)     (0.2)   (1.5)
                                                       ------------------------

                                      Net gains
                                      (losses)            0.2       1.8    (0.8)
                           Redeemable
                           preferred stocks:
                                    Gains                 0.4       0.3     0.7
                                    Losses               (0.3)     (1.5)   (0.6)
                                                       ------------------------

                                      Net gains
                                      (losses)            0.1      (1.2)    0.1
                  Equity securities:
                           Common stocks:
                                    Gains                48.1      14.6    11.4
                                    Losses               (5.1)     (3.3)   (7.4)
                                                       ------------------------

                                      Net gains          43.0      11.3     4.0
                           Non-redeemable
                           preferred stocks:
                                    Gains                 7.7       4.2     0.2
                                    Losses               (0.2)     (4.0)   (0.7)
                                                       ------------------------
                                      Net gains
                                      (losses)            7.5       0.2    (0.5)
                  Foreign Exchange Losses                (7.4)      --       --
                  Collar Contracts Losses               (30.7)      --       --
                  Other Gains                             1.4       --       --
                                                       ------------------------
                           Realized investment
                           gains                      $  14.1   $  12.1   $ 2.8
                                                       ------------------------
 ------------------------------------------------------------------------------

There  were  no  material  declines  in  the  realizable  value  of  investments
considered  to be other than  temporary  for 1997 or 1995.  Realized  investment
gains and  losses for 1996

                                       56
<PAGE>

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.


                                                     1997      1996     1995
-------------------------------------------------------------------------------
Unrealized Investment Gains, Net of Tax
         Fixed maturities:
                  Gains                            $   7.9  $   6.1  $   9.3
                  Losses                              (0.6)    (1.6)    (1.6)
                                                    ---------------------------
                           Net gains                   7.3      4.5      7.7
         Equity securities:
                  Gains                               94.3     82.0     64.2
                  Losses                              (1.8)    (2.2)    (3.8)
                                                    ---------------------------
                           Net gains                  92.5     79.8     60.4
         Foreign exchange losses                      (4.5)    (2.9)    (2.7)
                                                    ---------------------------
                           Total unrealized
                           investment gains           95.3     81.4     65.4
         Income taxes                                (35.5)   (28.6)   (21.5)
                                                    ---------------------------
                           Unrealized
                           investment
                           gains, net of tax       $  59.8  $  52.8  $  43.9
                                                    --------------------------
------------------------------------------------------------------------------



                                       57
<PAGE>



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:
                                                       1997
--------------------------------------------------------------------------------
                                                 Estimated     Gross    Gross
                                  Amortized         Fair   Unrealized Unrealized
Category                             Cost           Value      Gains    Losses
--------------------------------------------------------------------------------
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
--------------------------------------------------------------------------------



                                                         1996
--------------------------------------------------------------------------------
                                                  Estimated  Gross     Gross
                                    Amortized       Fair   Unrealized Unrealized
Category                              Cost          Value     Gains    Losses
--------------------------------------------------------------------------------
Redeemable preferred
stocks                               $   99.6    $  101.6    $  3.1    $  1.1
States and municipalities                39.4        40.7       1.6       0.3
Foreign governments                      30.1        30.5       0.5       0.1
Corporate and other                      62.2        63.0       0.9       0.1
                                     -------------------------------------------
         Total fixed maturities      $  231.3    $  235.8    $  6.1    $  1.6
--------------------------------------------------------------------------------

The amortized cost and estimated fair value of fixed  maturities at December 31,
by  contractual  years-to-maturity  follows.  Actual  maturities may differ from
contractual   maturities   because  borrowers  may  have  the  right  to  prepay
obligations.

                                                1997
----------------------------------------------------------------
                                                    Estimated
                                       Amortized     Fair
Maturity                                 Cost        Value
----------------------------------------------------------------
One year or less                       $   13.3    $   13.7
Over one year through five years           98.6       101.1
Over five years through ten years          32.8        34.1
Over ten years                             96.4        99.5
                                       --------------------
  Total fixed maturities               $  241.1    $  248.4
                                       --------------------
----------------------------------------------------------------


                                       58
<PAGE>


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:

                                                        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
                              ------------------------------------------
--------------------------------------------------------------------------------



                                                        1996
-------------------------------------------------------------------------------
                                          Estimated    Gross       Gross
                                            Fair     Unrealized  Unrealized
                                 Cost       Value      Gains       Losses
-------------------------------------------------------------------------------

Common stocks                 $   95.7    $  168.3    $  73.6    $  1.0
Non-redeemable preferred
stocks                            87.2        94.4        8.4       1.2
                              ------------------------------------------
         Total equity
         securities           $  182.9    $  262.7    $  82.0    $  2.2
                              ------------------------------------------
-------------------------------------------------------------------------------


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.

The Company's U.S.  common stock portfolio has experienced a total return of $57
million (which includes price  appreciation of approximately  $54 million) since
December 31, 1996,  and has had a price  movement  correlation  with the S&P 500
Index well in excess of 80 percent.

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

                                       59
<PAGE>

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.

The Company held no derivative financial instruments in its investment portfolio
at December  31, 1997 and  December 31,  1995.  The Company  sells  covered call
options, at times, to protect against adverse changes in market values. Premiums
received on options  written are deferred and recognized as a component of gross
realized gains when the option  contracts are exercised or expire.  During 1995,
aggregate  premiums  received by the Company on covered call options amounted to
less than $.1 million.  Net gains recognized on sales of underlying  instruments
amounted to less than $.1 million for 1995.  Generally,  the duration of covered
call options written by the Company does not exceed thirty days.

7. Fixed Assets

Fixed assets are summarized as follows:
                                                          1997             1996
--------------------------------------------------------------------------------
Land and buildings                                      $   5.0         $   7.3
Furniture, equipment, leasehold improvements,
and other                                                  57.1            65.7
Systems development costs                                   6.6             0.6
                                                        ------------------------
                                                        $  68.7         $  73.6
Less accumulated depreciation and amortization            (32.3)          (41.3)
                                                        ------------------------
         Fixed assets                                   $  36.4         $  32.3
                                                        ------------------------
--------------------------------------------------------------------------------

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' life or the
remaining contractual lease term.

The Company has a policy capitalizing certain systems development costs. Systems
development costs are amortized over estimated useful lives of 3 to 5 years.

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. The analysis
indicated  roughly 30 percent of existing code is compliant,  roughly 60 percent
is represented by legacy systems, which were scheduled to be replaced before the
end of 1998 due to current  business needs,  and the remainder will be addressed
through  modification to compliant code or  discontinuation.  The impact of year
2000  expenditures  on a stand alone basis is not clearly evident as the Company
is  replacing  legacy  applications  due to  changing  business  needs  and such
replacement applications will be year 2000 compliant.  However, the overall cost
of modification efforts and application  replacement,  which include substantial
enhancements  to business  functionality,  has been estimated at $13-$20 million
over a three year period.  Certain of the costs  related to the  replacement  of
legacy

                                       60
<PAGE>

applications  due to changing  business needs are being  capitalized  consistent
with the Company's existing capitalization policy.

8. 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 $10.8 and $10.1
million at December 31, 1997 and 1996, 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 term a  proportional
share  of  the  facility's  variable  operating   expenses.   This  amounted  to
approximately  $2.6,  $2.8 and $2.8  million for the years ended 1997,  1996 and
1995, 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 $8.4, $5.7 and $4.7 million in 1997, 1996 and 1995, respectively.

At December 31, 1997,  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:

         1998                                $  5.0
         1999                                   4.4
         2000                                   2.9
         2001                                   1.6
         2002                                   0.8
         2003 and thereafter                    0.3
                                             -------
                  Total                       $15.0
                                             -------



                                       61
<PAGE>



9. Reinsurance

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

                                               1997        1996        1995
--------------------------------------------------------------------------------
Written premiums:
         Direct                             $  361.4     $  338.6     $  285.3
         Assumed                               257.1        232.6        182.9
         Ceded                                (120.0)      (116.8)       (59.9)
                                              ----------------------------------

                  Net written premiums      $  498.5     $  454.4     $  408.3
                                            ------------------------------------
Earned premiums:
         Direct                             $  370.1     $  343.4     $  279.7
         Assumed                               239.2        213.1        175.3
         Ceded                                (118.1)      (107.9)       (65.9)
                                            ------------------------------------
                  Insurance premiums        $  491.2     $  448.6     $  389.1
                                            ------------------------------------
--------------------------------------------------------------------------------

The Company writes direct  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 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.

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.

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

                                       62
<PAGE>

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 $45.2, $113.9 and $28.5 million of reinsurance  recoveries as a
reduction of its claims and adjustment expenses for the years ended December 31,
1997, 1996 and 1995,  respectively.  Reinsurance  recoverable on paid claims and
adjustment expenses was $8.0 million at both December 31, 1997 and 1996.

IRI is a voluntary joint underwriting  association  providing property insurance
for  the  class  of  business   known  as  Highly   Protected   Risks  -  larger
manufacturing,  processing,  and  industrial  businesses  which have invested in
protection against loss through the use of sprinklers and other means. Effective
December 1, 1996,  HSBIIC  increased its  participation  in IRI to 23.5 percent.
Prior to the December 1, 1996 increase in  participation,  HSBIIC's  interest in
IRI was 14 percent. The 1996 increase resulted in HSBIIC assuming  approximately
$15.5 million net unearned  premium  reserves  which have not been  reflected in
written premiums.  Likewise in 1995, HSBIIC increased its participation  from .5
percent to 14 percent  resulting in the  assumption  of $27.9 million in the net
unearned premium reserves which were also not reflected in written premiums. IRI
has a fiscal year ending  November 30 and provides  quarterly  reports to member
companies of the association.  As a result,  HSBIIC's increases in participation
were  initially  reflected  in the  first  quarter  financial  reports  for  the
subsequent year.  Effective January 1, 1998 members of IRI sold their membership
to ERC. (See note 3).


                                       63
<PAGE>


10. 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
--------------------------------------------------------------------
<TABLE>

                                                            1997         1996         1995
------------------------------------------------------------------------------------------
<S>                                                       <C>          <C>         <C>
Gross liability for claims and adjustment expenses
at January 1,                                             $  302.9     $  190.9    $  199.4
Plus:
         Provision for claims and adjustment
           expenses occurring in the current year            263.3        313.3       183.3
         Increase (decrease) in estimated claims and
                  adjustment expenses arising in
                  prior years                                 (0.2)        16.1        12.6
                                                          ---------------------------------
                  Total incurred claims and
                    adjustment expenses                   $  263.1     $  329.4    $  195.9
                                                          ---------------------------------
Less:
         Payment for claims arising in:
                  Current year                                90.6        103.3        65.1
                  Prior years                                198.7        114.1       139.3
                                                          ---------------------------------
                  Total payments                          $  289.3     $  217.4    $  204.4
                                                          ---------------------------------
Gross liability for claims and
         adjustment expenses at December 31,              $  276.7     $  302.9    $  190.9
                                                          ---------------------------------

</TABLE>


                                       64
<PAGE>



Reconciliation of Net Liability for Claims and Adjustment Expenses
------------------------------------------------------------------
<TABLE>

                                                              1997         1996       1995
----------------------------------------------------------------------------------------------
<S>                                                         <C>         <C>          <C>
Net liability for claims and adjustment expenses
at January 1,                                               $  177.8    $  145.5     $  161.3
Plus:
         Provision for claims and adjustment expenses
                  occurring in the current year                209.5       214.2        152.2
         Increase (decrease) in estimated claims and
                  adjustment expenses arising in prior
                  years                                          8.4        (9.8)         2.7
                                                            ----------------------------------
                  Total incurred claims and adjustment
                  expenses                                  $  217.9    $  204.4     $  154.9
                                                            ----------------------------------
Less:
         Payment for claims arising in:
                  Current year                                  82.3        91.4         58.9
                  Prior years                                  122.6        80.7        111.8
                                                            ---------------------------------
                  Total payments                            $  204.9    $  172.1     $  170.7
                                                            ---------------------------------
         Net liability for claims and
                  adjustment expenses at
                  December 31,                              $  190.8    $  177.8     $  145.5
                                                            ---------------------------------
---------------------------------------------------------------------------------------------
</TABLE>



1997 and 1996  claims and  adjustment  expenses  incurred  have been  reduced by
subrogation   recoveries  of  approximately   $3.3  million  and  $4.9  million,
respectively.  Subrogation recoveries applied against 1995 claims and adjustment
expenses are immaterial.

A  reconciliation  of the net  liability to the gross  liability  for claims and
adjustment expenses is as follows:
<TABLE>
                                                        1997        1996        1995
---------------------------------------------------------------------------------------
<S>                                                  <C>          <C>         <C>
Net liability for claims and adjustment expenses
         at December 31,                             $  190.8     $  177.8    $  145.5
Reinsurance recoverable on unpaid claims and
         adjustment expenses                             85.9        125.1        45.4
                                                     ---------------------------------
Gross liability for claims and adjustment expenses
         at December 31,                             $  276.7     $  302.9    $  190.9
                                                     ---------------------------------
--------------------------------------------------------------------------------------
</TABLE>



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  generally  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.

                                       65
<PAGE>

The following table displays  information  concerning the primary participant in
the Company's current reinsurance program as of December 31, 1997:

Reinsurer           Ceded Written        Reinsurance Asset    1997 A.M. Best's
                    Premium                                   Rating
--------------------------------------------------------------------------------
General Reinsurance
Corporation          $38.6                     $50.5               A++(Superior)


As of December 31, 1997 no other  reinsurance  asset of the Company due from any
single  reinsurer  exceeded 3 percent of shareholders'  equity.  Certain Lloyds'
syndicates  participate in the excess of loss reinsurance program,  primarily in
the excess  layers.  The  highest  aggregate  percentage  participation  of such
syndicates, at 44.6 percent, is in the $50 million excess of $100 million layer.
No individual syndicate has more than a 7.7 percent  participation in any of the
excess layers. The Company's reinsurance asset in the aggregate from all Lloyds'
syndicates is less than 2 percent of shareholders'  equity at December 31, 1997.
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 involved in three arbitration or litigation  proceedings regarding the
extent to which certain  explosion events are insured under boiler and machinery
policies of HSBIIC or under the all-risk property  insurance  policies issued by
other companies.  Management  believes HSBIIC's policies do not provide coverage
for losses  resulting  from the  explosion  events that are the subject of these
proceedings.

A lower court ruling in one of these cases held that an explosion did occur, and
that  HSBIIC  was not  liable  for  losses  of the  insured  resulting  from the
explosion.  In a further  action,  the court denied  HSBIIC's motion for summary
judgment on certain issues,  thus leaving HSBIIC  potentially liable for certain
unqualified  losses  resulting from events prior to the explosion.  In the first
quarter of 1997,  HSBIIC and the property  insurer jointly settled the case with
the insured.  HSBIIC's ultimate share of the settlement will be determined in an
arbitration  proceeding  with the property  insurer.  HSBIIC has incurred  gross
losses and loss adjustment  expenses (LAE) of $40.7 million and a net loss after
taking  into  account  reinsurance  recoverables  of $6.5  million,  of which $5
million represents claim costs and the remaining $1.5 million represents LAE. As
a result of payments  made to date, at December 31, 1997,  HSBIIC  carried gross
loss and LAE reserves of $2.8 million and  recoverables  from reinsurers of $2.8
million.

HSBIIC  has  accrued  $6.5  million  with  respect  to the  other  two cases for
potential LAE, including legal costs to defend HSBIIC's position. One case is in
the process of pre-trial summary judgment motions and appeals; the other case is
involved in both  arbitration and litigation  proceedings.  A trial date has not
been set for either  case.  In the event that  HSBIIC is held  liable for one or
both of the  remaining  claims,  amounts  in  excess  of  HSBIIC's  net  maximum
aggregate  retention  of $8.5  million is  recoverable  from  reinsurers.  Claim
amounts  potentially  recoverable  from  reinsurers  in the event of a  possible
adverse outcome in these cases could range,  in the aggregate,  from $40 million
to $195 million.

                                       66
<PAGE>

The  obligations of HSBIIC's  reinsurers  with respect to these cases are not in
dispute. Therefore, management believes that any adverse outcomes in these cases
will not,  in the  aggregate,  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 losses such reinsurers
might incur should these cases 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  arbitration  or  litigation
proceedings  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.

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.

11. Income Taxes

Tax Provision




<TABLE>


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

                                                   1997                    1996                   1995
-----------------------------------------------------------------------------------------------------------
                                                   % 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            $  93.7      100%       $  72.9      100%       $  72.2      100%
-----------------------------------------------------------------------------------------------------------
Tax at statutory rates                 $  32.8       35%       $  25.5       35%       $  25.3       35%
Income taxed at foreign rates              1.0        1            0.5        1            0.2       --
Dividends received deduction              (4.9)      (5)          (4.5)      (6)          (3.9)      (5)
Tax exempt interest                       (0.8)      (1)          (0.6)      (1)          (0.7)      (1)
Tax credits and others                    (3.0)      (3)          (2.6)      (4)          (1.4)      (2)
Total income taxes and effective
tax rate                               $  25.1       27%       $  18.3       25%       $  19.5       27%
                                       ---------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------

</TABLE>



                                       67
<PAGE>




Income taxes (benefit) consisted of the following:
                                                 1997        1996       1995
--------------------------------------------------------------------------------
Current provision:
         U.S                                    $  16.8    $  17.3     $  12.3
         Foreign                                    7.0        7.4         8.2
                                                --------------------------------
                  Total current provision          23.8       24.7        20.5
                                                --------------------------------
Deferred provision:
         U.S                                        1.1       (6.0)        0.4
         Foreign                                    0.2       (0.4)       (1.4)
                                                --------------------------------
                  Total deferred provision          1.3       (6.4)       (1.0)
                                                --------------------------------
                  Total income taxes            $  25.1    $  18.3     $  19.5
                                                --------------------------------
--------------------------------------------------------------------------------



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, 1997 and 1996
are as follows:

                                                             1997        1996
--------------------------------------------------------------------------------
Deferred tax liabilities:
         Prepaid acquisition costs                         $ (13.2)    $ (11.8)
         Accelerated depreciation                             (0.3)       (2.0)
         Pension asset                                       (13.3)      (11.9)
         Unrealized investment gains                         (35.4)      (28.6)
         Other                                               (12.6)      (12.7)
                                                           ---------------------
                      Total deferred tax liabilities         (74.8)      (67.0)
                                                           ---------------------
Deferred tax assets:
         Benefit plans                                         9.0         9.6
         Capital lease                                         4.4         4.1
         Unearned insurance premiums                          15.0        14.0
         Loss reserve discounting                              5.9         6.5
         Other                                                 9.0         9.1
                                                           ---------------------
                      Total deferred tax assets               43.3        43.3
                                                           ---------------------
                         Net deferred tax liabilities      $ (31.5)    $ (23.7)
                                                           ---------------------
--------------------------------------------------------------------------------



Other Information

Federal  income  tax  returns  for the years 1995 and 1994 are  currently  under
examination by the Internal Revenue Service.

                                       68
<PAGE>


12. Capital Structure

HSB's capital structure is as follows:
                                                         1997         1996
---------------------------------------------------------------------------
Short-term borrowings                                  $   42.4    $    3.2
Long-term borrowings *                                 $   25.1    $   25.1
Convertible redeemable preferred stock                     --      $   20.0
Company obligated mandatorily redeemable
         capital securities of subsidiary Trust I
         holding solely junior subordinated
         deferrable interest debenture of the
         Company                                       $  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        --
Common shareholders' equity                            $  345.3    $  345.6
----------------------------------------------------------------------------
         *Excludes capital lease. (See note 8).

Short-term and Long-term Borrowings

HSBIIC has a commercial  paper  program with a limit of $75 million.  Commercial
paper  outstanding  at  December  31,  1997 and 1996 was $42.4  million and $3.2
million, respectively.  Commercial paper outstanding at year end 1997 matured on
or before  January 6, 1998.  Long-term  debt consists of $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 $25.3 million.

Convertible Redeemable Preferred Stock

On December 30, 1996,  HSBIIC  exercised  its right to exchange  2,000 shares of
EIG,  Co.  preferred  stock,  which was issued at the time HSBIIC  acquired  the
remaining  50 percent  interest  in EIG,  Co.  from Gen Re, for 2,000  shares of
HSBIIC's convertible redeemable preferred stock. The stock had no par value, but
had voting  rights and  carried a quarterly  dividend of $162.50.  The stock was
converted on October 30, 1997 into 398,406 shares of HSB common stock at a price
of $50.20 per share.

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

                                       69
<PAGE>

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 6.7 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  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 $85,  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  15.3 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 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

                                       70
<PAGE>

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 and Trust
II is equal to their carrying value.

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 as reductions to additional  paid-in
capital and retained earnings.  These amounts were $85.9 and $59.5 million as of
December 31, 1997 and 1996, respectively. The reclassifications were distributed
as follows:

At December 31,                     1997                      1996
--------------------------------------------------------------------
Additional paid in capital         $  2.8                     $  2.0
Retained earnings                    83.1                       57.5
                                   ---------------------------------
         Total                      $85.9                     $ 59.5
                                   ---------------------------------
--------------------------------------------------------------------


Financial Guarantees

HSBIIC had  guaranteed  40 percent of Radian's  loan  outstanding  with Dow. The
guaranty  was  terminated  on  January 2, 1998 in  conjunction  with the sale of
HSBIIC's interest in Radian to Dow.

13. Pension Plans

HSB  maintains  various  types of pension  plans  covering  employees of certain
subsidiaries.  The 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.  As a  result  of the  plan's
investment  returns,  the Company made no contribution to the plan in 1997, 1996
or 1995. Assets available for plan benefits include  approximately $20.9 million
of Company stock at December 31, 1997.

                                       71
<PAGE>

The pension expense for the U.S.  pension plans was a net credit to earnings for
1997,  1996 and 1995 due to the over  funded  status of the  primary  plan.  The
components of the credit were as follows:

                                     1997        1996        1995
-------------------------------------------------------------------
Service costs                      $   4.1     $   3.6     $   2.9
Interest costs                        10.7        10.2        10.2
Return on assets                     (42.4)      (20.1)      (30.9)
Net amortization and deferral         24.8         4.0        15.3
                                   --------------------------------
         Net pension credit        $  (2.8)    $  (2.3)    $  (2.5)
                                   --------------------------------
-------------------------------------------------------------------


The following table represents a reconciliation  of the U.S. plans funded status
and the amounts recognized in the Company's  Statements of Financial Position at
December 31:
<TABLE>

                                                              Funded                  Unfunded
-----------------------------------------------------------------------------------------------------
                                                      1997        1996         1997        1996
                                                    -------------------------------------------------
<S>                                                 <C>          <C>          <C>         <C>
Actuarial present value of benefit obligations
         Vested benefit obligation                  $  109.8     $   99.4     $  22.5     $  20.3
                                                    ----------------------------------------------
         Accumulated benefit obligation             $  110.7     $  100.0     $  23.8     $  20.9
                                                    ----------------------------------------------
         Projected benefit obligation               $  128.1     $  115.7     $  27.9     $  24.3
Assets available for plan benefits (equity
         securities and fixed income
         investments at fair value)                    213.0        178.0         --          --
                                                    ----------------------------------------------
Assets in excess of (less than) projected
         benefit obligation                             84.9         62.3       (27.9)      (24.3)
                                                    ----------------------------------------------
         Unamortized net transition asset
         (obligation)                                    8.4         10.5        (1.9)       (2.2)
         Unrecognized prior service costs               (1.6)        (1.9)       (1.0)       (1.1)
         Unrecognized net gain (loss)                   21.8          3.9        (8.6)       (7.1)
                                                    ----------------------------------------------
Unrecognized net asset (liability)                      28.6         12.5       (11.5)      (10.4)
Additional liability                                     --           --         (6.0)       (4.6)
                                                    ----------------------------------------------
         Net pension asset (liability)              $   56.3     $   49.8     $ (22.4)    $ (18.5)
                                                    ----------------------------------------------
--------------------------------------------------------------------------------------------------
</TABLE>

Assumptions used for the primary U.S. plan at years ended were as follows:

                                                 1997      1996     1995
-------------------------------------------------------------------------
Discount rate                                    7.25%     7.5%      7.5%
Long-term rate of return on assets              10.00%     9.5%      9.5%
Rate of increase in future compensation
levels                                           4.50%     4.5%      5.0%
-------------------------------------------------------------------------

                                       72
<PAGE>


14. Postretirement Plans

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.
Contributions  totaled  $1.9,  $2.4 and $2.6  million  for 1997,  1996 and 1995,
respectively.  At December  31, 1997,  1996 and 1995 these plans were  unfunded.
Retirees'  contributions to these plans vary, based upon retiree's age, years of
service and coverage elected.  The Company periodically amends the plan changing
the contribution rate of retirees and amounts of coverage.

Components of net periodic postretirement benefit cost were:

For the years ended December 31,                 1997         1996       1995
--------------------------------------------------------------------------------
Service cost                                    $  0.3      $  0.3      $  0.3
Interest cost                                      2.1         2.0         2.3
Amortization of unrecognized obligations           0.1         --          --
         Net periodic postretirement
           benefit cost                         $  2.5      $  2.3      $  2.6
--------------------------------------------------------------------------------


The  following  table  sets forth the  amounts  recognized  in the  Consolidated
Statements  of Financial  Position at December 31, in  accordance  with SFAS No.
106, "Employers Accounting for Postretirement Benefits Other Than Pensions".

                                                               1997       1996
--------------------------------------------------------------------------------
Accumulated postretirement benefit obligations for:
    Retirees                                                 $  23.5    $  22.0
    Other fully eligible plan participants                       1.5        1.0
    Other active plan participants                               4.9        3.8
                                                             -------------------
       Total accumulated postretirement benefit obligation      29.9       26.8
    Unrecognized net loss                                       (5.5)      (3.0)
                                                             -------------------
       Accrued postretirement benefit liability              $  24.4    $  23.8
                                                             -------------------
--------------------------------------------------------------------------------


The  assumptions  used to  calculate  the  obligations  at December  31, were as
follows:

                                                1997        1996
----------------------------------------------------------------
Weighted average discount rate                  7.25%       7.5%
Current year health care cost trend rate        7.00%       8.0%
Ultimate health care cost trend rate            4.50%       4.5%
----------------------------------------------------------------


                                       73
<PAGE>

For measurement purposes,  the annual rate of increase in the per capita cost of
covered health care benefits ranges from 7 percent in 1997 decreasing  gradually
to 4.5 percent by the year 2001 and remaining level thereafter.

The health  care cost  trend rate  assumption  has a  significant  effect on the
amount  reported.  To illustrate,  increasing the assumed health care cost trend
rates by 1 percent  each year  would  increase  the  accumulated  postretirement
benefit  obligation  as of December 31, 1997 of $29.9  million by  approximately
$1.5 million and the  aggregate  of the service and  interest  cost for the year
ended December 31, 1997 by $0.1 million.

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
150,000.

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 $0.6 million in 1997 and 1996 and $1.1
million in 1995. The  unamortized  compensation  expense related to this plan is
included in benefit plans as a component of shareholders'  equity. These amounts
were $1.2 and $0.7 million in 1997 and 1996,  respectively.  A summary of grants
follow:

                                             1997           1996          1995
--------------------------------------------------------------------------------
Restricted shares awarded                    20,396         13,250        9,350
Weighted-average fair value of shares on
          grant date                       $ 47.89         $ 48.85      $  42.78
--------------------------------------------------------------------------------

A stock  option  award under 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.


                                       74
<PAGE>

A summary of the status of HSB's stock options as of December 31, 1997, 1996 and
1995 and changes during the years ended on those dates is presented below:



<TABLE>



                                          1997                          1996                             1995
---------------------------------------------------------------------------------------------------------------------------
                                                Weighted-                      Weighted-                       Weighted-
                                Shares           Average       Shares          Average        Shares           Average
                                              Exercise Price                 Exercise Price                  Exercise Price
---------------------------------------------------------------------------------------------------------------------------
<S>                            <C>              <C>           <C>              <C>           <C>              <C>
Outstanding at
  beginning of year            1,319,650        $   48.67     1,300,000        $   50.86     1,263,550        $   54.42
Granted                          372,500            48.83       394,000            49.81       303,500            42.54
Exercised                       (157,000)           46.68       (24,250)           46.26          --                --
Forfeited                        (50,400)           50.23      (350,100)           58.29      (267,050)           58.39
                               ----------                     ----------                     ----------       ----------
Outstanding at
end of year                    1,484,750            48.86     1,319,650            48.67     1,300,000            50.83
                               ----------                     ----------                     ----------

Options exercisable
at year-end                    1,121,250        $   48.76       949,650        $   48.23     1,003,500        $   53.32

Weighted-average fair
value of options
granted during the year                         $    6.36                      $     7.05                     $    7.42
------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
The following table summarizes information about stock options outstanding as of
December 31, 1997:

                       Options Outstanding             Options Exercisable
--------------------------------------------------------------------------------------
                              Weighted-
Range of                       Average           Weighted-                      Weighted-
Exercise       Number         Remaining           Average           Number       Average
Prices         Outstanding    Contractual Life   Exercise Price   Exercisable   Exercise Price
-----------------------------------------------------------------------------------------------
<S>           <C>                <C>           <C>               <C>           <C>
$41 - $45.99    587,000          8.43          $   44.44           226,500     $   42.27
$46 - $50.99    646,500          6.13              48.63           646,500         48.63
$51 - $55.99     98,800          1.55              51.84            95,800         51.79
$56 - $60.99    152,450          3.33              57.06           152,450         57.06
              ---------                                          ---------
              1,484,750                                          1,121,250
              ---------                                          ---------
-----------------------------------------------------------------------------------------------
</TABLE>



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 APB 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

                                       75
<PAGE>

have been measured at date of grant and recognized over the service period.  Pro
forma net income and  earnings  per share would have been reduced as follows for
1997 and 1996:

                                                   1997              1996
------------------------------------------------------------------------------
Net Income                           As Reported   $66.3            $53.4
                                     Pro Forma      64.5             51.4
Earnings per common share - basic    As Reported   $ 3.32           $ 2.65
                                     Pro Forma       3.22             2.55
Earnings per common share - diluted  As Reported   $ 3.29           $ 2.65
                                     Pro Forma       3.20             2.55
------------------------------------------------------------------------------


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 1997 and
1996,  respectively:  risk-free  interest  rates of 6.3  percent in 1997 and 6.1
percent in 1996; dividend yield of 5 percent for both years; expected lives of 6
years; and volatility of 15.8 percent in 1997 and 16.8 percent in 1996.

16. Stock Purchase Rights

On November 28,  1988,  the Board of Directors  created and  authorized  250,000
shares  of  Series A Junior  Participating  Preferred  Stock at no par value and
declared  a dividend  distribution  of one right for each  outstanding  share of
common stock to shareholders of record on December 8, 1988.

The rights  will  separate  from the common  stock and become  exercisable  if a
person or group  acquires  ownership  of 20 percent  or more of the  outstanding
common stock of the Company,  commences a tender or exchange offer to acquire 20
percent or more of the outstanding  shares, or if any person or group has become
the beneficial  owner of an amount of common stock which the Board determines to
be substantial and not in the best interest of the shareholders.

The rights entitle holders to purchase  preferred shares at an exercise price of
$110 per share.  If an  acquirer  obtains  20  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 will entitle  holders to
purchase common shares of the Company at a discount.  If the Company is involved
in a merger or other transactions in which shares are exchanged, the rights will
entitle holders to purchase common shares of the acquirer at a discount.

The rights  expire on  November  28, 1998 and may be redeemed by the Company for
$.01  per  right  any  time  until  the  tenth  business  day  following  public
announcement that a 20 percent position has been acquired.

                                       76
<PAGE>

17. Consolidated Quarterly Data (unaudited)


<TABLE>

                                             First        Second        Third      Fourth
1997                                        Quarter       Quarter      Quarter    Quarter        Year
--------------------------------------------------------------------------------------------------------------
<S>                                       <C>          <C>          <C>          <C>          <C>
Insurance premiums                        $   122.3    $   117.2    $   121.3    $   130.4    $   491.2
Engineering services                           14.8         15.0         15.5         16.0         61.3
Net investment income                           7.9          8.8          9.1         11.0         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                              $    21.3    $    22.1    $    21.5    $    28.8    $    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                              $    15.8    $    16.4    $    15.2    $    18.9    $    66.3
Discontinued operations:
         Income from
           operations of
           Radian International LLC,
           net of income tax                   --           --           --           --           --
                                          --------------------------------------------------------------------
Net income                                $    15.8    $    16.4    $    15.2    $    18.9    $    66.3
                                          --------------------------------------------------------------------
Earnings per common share - basic:
         Income from
           continuing operations          $     0.78   $     0.81   $     0.77   $     0.96   $     3.32

         Discontinued operations               --           --           --           --           --
                                          --------------------------------------------------------------------
         Net income                       $     0.78   $     0.81   $     0.77   $     0.96   $     3.32
                                          --------------------------------------------------------------------

Earnings per common share - diluted:
         Income from
           continuing operations          $     0.78   $     0.80   $     0.76   $     0.95   $     3.29
         Discontinued operations               --           --           --           --           --
                                          --------------------------------------------------------------------
         Net income                       $     0.78   $     0.80   $     0.76   $     0.95   $     3.29
                                          --------------------------------------------------------------------

Dividends declared per
  common share                            $     0.57   $     0.57   $     0.60   $     0.60   $     2.34
                                          --------------------------------------------------------------------

Common stock price ranges:
         High                                 47 5/8         53 7/8      56 11/16     55 3/4       56 11/16
         Low                                  44 5/8         44          52 7/16      49 13/16     44
         Close                                44 3/4         53 3/8      55 11/16     55 3/16      55  3/16
Shareholders at December 31,                                                                       5,221
--------------------------------------------------------------------------------------------------------------
</TABLE>

                                       77
<PAGE>

<TABLE>


                                             First        Second       Third       Fourth
1996                                         Quarter      Quarter     Quarter      Quarter           Year
----------------------------------------------------------------------------------------------------------
<S>                                       <C>          <C>          <C>           <C>           <C>
Insurance premiums                        $   108.4    $   112.9    $   113.8     $   113.5     $   448.6
Engineering services                           12.7         14.1         14.0          15.0          55.8
Net investment income                           8.0          7.9          7.6           8.8          32.3
Realized investment gains                       0.9          5.1          2.5           3.6          12.1
                                          ----------------------------------------------------------------
         Total revenues*                  $   130.0    $   140.0    $   137.9     $   140.9     $   548.8
                                          ----------------------------------------------------------------
Income from continuing
  operations before income
  taxes and distributions
  on capital securities                   $    19.2    $    15.3    $    15.4     $    23.0     $    72.9
Income taxes                                    4.9          3.3          3.5           6.6          18.3
Distributions on capital
  securities of subsidiary trust,
  net of income tax                            --           --           --            --            --
Income from continuing                    ----------------------------------------------------------------
operations                                $    14.3    $    12.0    $    11.9     $    16.4     $    54.6
Discontinued operations:
         Income from
           operations of Radian
           International LLC,
           net of income tax                    2.7          1.4         (0.3)         (5.0)         (1.2)
                                          ----------------------------------------------------------------
Net income                                $    17.0    $    13.4    $    11.6     $    11.4     $    53.4
                                          ----------------------------------------------------------------
         Income from
           continuing operations          $     0.71   $     0.59   $     0.59    $     0.82    $     2.71
         Discontinued operations                0.13         0.07        (0.01)        (0.25)        (0.06)
                                          ----------------------------------------------------------------
         Net income                       $     0.84   $     0.66   $     0.58    $     0.57    $     2.65
                                          ----------------------------------------------------------------
Earnings per common share - diluted:
         Income from
           continuing operations          $     0.71   $     0.59   $     0.59    $     0.82    $     2.71
         Discontinued operations                0.13         0.07        (0.01)        (0.25)        (0.06)
                                          ----------------------------------------------------------------
         Net income                       $     0.84   $     0.66   $     0.58    $     0.57    $     2.65
                                          ----------------------------------------------------------------
Dividends declared per
common share                              $     0.57   $     0.57   $     0.57    $     0.57    $     2.28
                                          ----------------------------------------------------------------
Common stock price ranges:
         High                                52 1/2          50 3/4       49          47 1/8       52 1/2
         Low                                 48              46           43 1/4      42 3/4       42 3/4
         Close                               50 5/8          49 1/8       44 3/4      46 3/8       46 3/8
Shareholders at December 31,                                                                        5,644
----------------------------------------------------------------------------------------------------------
</TABLE>

*Total revenues  exclude  revenues for  investments  accounted for on the equity
method.

                                       78
<PAGE>

<TABLE>


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

                            Column A                     Column B    Column C       Column D    Column E     Column F     Column G
-------------------------------------------------------- -----------------------   ----------- ------------ -----------   ---------
                                                                   1997                                         1996
                                                         ------------------------------------- ------------------------------------
                                                                                    Amount                                  Amount
                                                                                    Shown                                   Shown
                                                                                    In The                                  In The
                                                                        Market      Balance                      Market     Balance
Type of Investment                                           Cost        Value      Sheet        Cost           Value       Sheet
-------------------------------------------------------- ---------------------------------------------------  ------------  -------
Fixed Maturities:
<S>                                                          <C>         <C>         <C>          <C>            <C>       <C>
   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                                        37.6        39.7        39.7         39.4           40.7      40.7
      Foreign Governments                                    33.1        33.5        33.5         30.1           30.5      30.5
      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                                        28.1        28.7        28.7         51.1           51.9      51.9
      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                              131.2       135.4       135.4         99.6          101.6     101.6
                                                       ---------------------------------     ---------------------------------
         Total Fixed Maturities                            $241.1      $248.4      $248.4       $231.3         $235.8    $235.8

Equity Securities:
   Common Stocks:
      Public Utilities                                       16.3        19.8        19.8         15.3           16.6      16.6
      Banks and Insurance                                    13.4        23.5        23.5         12.0           20.0      20.0
      Industrial and Other                                   67.8       135.7       135.7         68.4          131.7     131.7
   Non-Redeemable Preferred Stocks                          133.8       144.8       144.8         87.2           94.4      94.4
                                                       ---------------------------------     ---------------------------------
         Total Equity Securities                           $231.3      $323.8      $323.8       $182.9         $262.7    $262.7

Short-term Investments and Cash:                           $424.5      $424.5      $424.5       $102.4         $102.4    $102.4

                                                       ---------------------------------     ---------------------------------

         Total Investments                                 $896.9      $996.7      $996.7       $516.6         $600.9    $600.9
                                                       =================================     =================================

</TABLE>

                                       79
<PAGE>


                    HSB GROUP, INC. (Registrant)

       SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
              CONDENSED STATEMENT OF INCOME INFORMATION

       For the period from June 23, 1997 through December 31, 1997
       (In millions)



                                                  1997
                                               ------------

Revenues:
Net investment income                              $ 1.5

Expenses:
Interest expense                                     0.1
                                               ------------

Income before income taxes and                       1.4
distributions on capital securities

Income taxes                                         0.5

Distributions on capital securities of
subsidiary trusts, net of income taxes
of $1.2                                              2.3
                                                ------------

Net Loss - Parent only                              (1.4)

Equity in net income of subsidiaries                35.4
                                               ------------
Consolidated net income                           $ 34.0
                                               ============


                                       80
<PAGE>

                      HSB GROUP, INC. (Registrant)

          SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
                       BALANCE SHEET INFORMATION
                            December 31, 1997
                              (In millions)


                                                                 1997
                                                            ---------------

Assets
Cash                                                                   $ 0.7
Short-term investments, at cost                                         60.5
Investment in subsidiaries                                             657.0
Fixed maturities                                                        11.8
Equity securities, at fair value                                        27.2
Other assets                                                            23.9
                                                            ---------------

     Total assets                                                    $ 781.1
                                                            ===============
Liabilities
Dividends payable                                                     $ 11.8
Other liabilities                                                       15.1
                                                            ---------------

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

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

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

Shareholders' Equity
Common stock                                                            10.0
Paid in capital                                                         31.6
Unrealized investment gains, net of tax                                 59.8
Retained earnings                                                      248.8
Benefit plans                                                           (4.9)
                                                            ---------------

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

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


                                       81
<PAGE>


                    HSB GROUP, INC. (Registrant)

        SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF HSB GROUP, INC.
                  CONDENSED STATEMENT OF CASH FLOWS INFORMATION
           For the period from June 23, 1997 through December 31, 1997
                                  (In millions)

                                                                      1997
                                                                -------------

Operating Activities:
      Net income                                                      $ 34.0
      Undistributed earnings of subsidiary                             (21.2)
      Increase in other assets                                         (26.2)
      Increase in other liabilities                                     14.3

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

Investing Activities:
      Purchase of short-term investments, net                          (60.5)
      Purchase of fixed maturities                                     (11.8)
      Purchase of equity securities                                    (27.0)
      Contribution to subsidiaries                                    (279.5)

                                                                -------------
      Cash used in investing activities                               (378.8)
                                                                -------------

Financing Activities:
      Dividends paid to shareholders                                   (11.9)
      Net proceeds from issuance of company obligated                  408.9
         manditorily redeemable capital securities
      Options Exercised                                                  5.5
      Reacquisition of Stock                                           (36.5)
      Other                                                             12.6

                                                                -------------
      Cash provided by financing activities                            378.6
                                                                -------------

Change in cash                                                           0.7

Cash at beginning of period                                              -

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


                                       82
<PAGE>


                                   Schedule IV
                                 HSB Group, Inc.
                                   Reinsurance
                                  (in millions)



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
-------------------------------------------------------------------------------

-------------------------------------------------------------------------------

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%


1995
Property and
Liability
Insurance          $279.7         $65.9      $175.3     $389.1        45.1%




                                       83
<PAGE>



                                                      SCHEDULE V
                                                    HSB Group, Inc.
                                          Valuation and Qualifying Accounts

                                                     (in millions)
<TABLE>


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

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

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

                              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

                              1995
Reserve for Accounts Receivable      $3.0          $2.3         $0.0          $2.0           $3.3

</TABLE>

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



                                       84
<PAGE>

<TABLE>

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


                                                            For Years Ended December 31, 1997, 1996, 1995


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

Affiliation   Prepaid      Reserves    Discount, if  Unearned  Earned   Net investment Claims and  Amortiza- Paid claims   Premiums
with          Acquisition  for unpaid  any deducted  Premium   Premium  income         Claim       tion of   and claim     written
Registrant    Costs        claims and  in Column C                                     Adjustment  prepaid   adjustment
(Consolidated              claim                                                       Expenses    policy    expenses
property-                  adjustment                                                  incurred    acquisi-
casualty                   expenses                                                    related to  tion costs
entities)
                                                                                     Current Prior
                                                                                     Year    Years
  <S>           <C>          <C>          <C>         <C>       <C>        <C>       <C>     <C>      <C>       <C>          <C>

  1997          45.5         276.7        --          290.3     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


  1995          34.1         190.9        --          216.2     389.1      28.9      152.2    2.7     78.1      170.7        408.3

</TABLE>


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 2001" and "Members of the Board of Directors  Continuing  in Office"
on  pages  2-4  of the  Company's  Proxy  Statement  dated  March  6,  1998  are
incorporated herein by reference. Also see pages 23 - 24 herein.

Item 11.  Executive Compensation.
          ----------------------
     "Meetings and Remuneration of the Directors" on pages 5-6, "Human Resources
Committee Report on Executive Compensation" on pages 8-11, "Summary Compensation
Table" on page 12, "Stock Option and Long-Term  Incentive  Plan Tables" on pages
13-14,  "Retirement  Plans" on pages 14-15,  "Employment  Arrangements" on pages
15-16, "Compensation Committee Interlocks and Insider Participation" on page 16,
and "Performance Graphs" on page 17 of the Company's Proxy Statement dated March
6, 1998 are incorporated herein by reference.

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

     "Security  Ownership of Certain  Beneficial  Owners and Management" on page
6-8 of the Company's Proxy Statement dated March 6, 1998 is incorporated  herein
by reference.

Item 13.  Certain Relationships and Related Transactions.
          -----------------------------------------------
     "Compensation Committee Interlocks and Insider Participation" on page 16 of
the Company's  Proxy  Statement  dated March 6, 1998 is  incorporated  herein by
reference.

                                       85
<PAGE>

                                     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 40 herein are
         filed as part of this report.

     (b) Reports on Form 8-K -

          (i) Form 8-K dated  January  12,  1998 to report  sale of  interest in
          Industrial  risk  Insurers  and $300  million of  convertible  capital
          securities to Employers Reinsurance Corporation; and
          (ii) Form 8-K dated  January 28, 1998 to report  Fourth  Quarter  1997
          Results of Registrant.

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


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                              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
      President and Chief
      Executive Officer
      March 30, 1998

     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                      President, Chief Executive Officer
    March 30, 1998                      Director

  /s/ Saul L. Basch                     Senior Vice President, Treasurer
    Saul L. Basch                       and Chief Financial Officer
    March 30, 1998                      (Principal Financial Officer and
                                        Principal Accounting Officer)

  /s/ Robert C. Walker
      Robert C. Walker                  Senior Vice President and General
      March 30, 1998                    Counsel

(Joel B Alvord)*                        Director


(Colin G. Campbell)*                    Director


(Richard G. Dooley)*                    Director


(William B. Ellis)*                     Director


(E. James Ferland)*                     Director

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(Simon W. Leathes)*                     Director


(Lois Dickson Rice)*                    Director


(John M. Washburn, Jr.)*                Director


(Wilson Wilde)*                         Director



*By: /s/ Robert C. Walker
     Robert C. Walker
     (Attorney-in-Fact)
     March 30, 1998





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                       INDEX TO EXHIBITS

Exhibit
Number      Description

(3)(i)         Certificate of Incorporation of HSB Group, Inc.

(3)(ii)        By-laws of  HSB Group, Inc.

**(4)(i)       Rights  Agreement  dated  November  28, 1988 between The Hartford
               Steam Boiler Inspection and Insurance Company  ("HSBIIC") and The
               First  National  Bank of  Boston,  as Rights  Agent;  assumed  by
               Registrant; incorporated by reference to Exhibit 4(i) to HSBIIC's
               Form 10-K for the year ended December 31, 1995, File No.
               001-10527.

**(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:

               (a)  Purchase  Agreement as of December 31, 1997 among  Employers
                    Reinsurance  Corporation,  ERC Life Reinsurance  Corporation
                    and  Registrant,  incorporated  by reference to Registrant's

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                    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)           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)(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").*

             **(b)  The Hartford Steam Boiler  Inspection and Insurance  Company
                    Long-Term  Incentive Plan, as amended and restated  December
                    23, 1996,  assumed by Registrant;  incorporated by reference
                    to the 1996 10-K.*

             **(c)  The Hartford Steam Boiler  Inspection and Insurance  Company
                    Short-Term  Incentive Plan, as amended and restated December
                    23, 1996,  assumed by Registrant;  incorporated by reference
                    to the 1996 10-K.*

             **(d)  The Hartford Steam Boiler Inspection and Insurance Company
                    1985 Stock Option Plan,  as amended and restated  December
                    23, 1996, assumed by Registrant, incorporated by reference
                    to the 1996 10-K. *

             **(e)  The Hartford Steam Boiler  Inspection and Insurance  Company
                    1995 Stock  Option Plan,

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                    as amended and restated effective December 23, 1996, assumed
                    by Registrant, incorporated by reference to the 1996 10-K. *

             **(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)  The Hartford Steam Boiler  Inspection and Insurance  Company
                    Directors Stock and Deferred  Compensation  Plan, assumed by
                    Registrant, incorporated by reference to the 1996 10-K.*

             **(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 6, 1998. *

(21)           Subsidiaries of the Registrant.

(23)           Consent of experts and counsel - consent of Coopers & Lybrand.

(24)           Power of attorney.

(27)           Financial Data Schedule.



* 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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