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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

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

                   For the fiscal year ended December 31, 1998

                         Commission File Number 1-11422

                         PENNCORP FINANCIAL GROUP, INC.
             (Exact name of Registrant as specified in its charter)

                 Delaware
     (State or other jurisdiction of                   13-3543540
      incorporation or organization)        (I.R.S. employer identification no.)
        c/o Southwestern Financial
           Services Corporation
         717 North Harwood Street                         75201
              Dallas, Texas                            (Zip code)
  (Address of principal executive offices)

       Registrant's telephone number, including area code: (214) 954-7111

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                                 Name of Each Exchange
           Title of Each Class                    on Which Registered
  -------------------------------------  ---------------------------------------
      Common Stock, $.01 par value              New York Stock Exchange
  -------------------------------------  ---------------------------------------
   $3.375 Convertible Preferred Stock,
             $.01 par value                     New York Stock Exchange
  -------------------------------------  ---------------------------------------

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                                      None

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

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

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant as of March 25, 1999: $14,520,796.

The  number  of Common  Stock  shares  outstanding  as of March  25,  1999,  was
29,041,593.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Annual Meeting of Shareholders scheduled
for May 13, 1999, is incorporated by reference into Part III hereof.

--------------------------------------------------------------------------------
<PAGE>



                           ANNUAL REPORT ON FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1998

                                TABLE OF CONTENTS

                                                                            Page

PART I
         Item 1.   Business                                                    3
         Item 2.   Properties                                                 22
         Item 3.   Legal Proceedings                                          22
         Item 4.   Submission of Matters to a Vote of Security Holders        23

PART II
         Item 5.   Market for the Registrant's Common Equity and Related
                    Shareholder Matters                                       24
         Item 6.   Selected Consolidated Financial Data                       25
         Item 7.   Management's Discussion and Analysis of Financial
                    Condition and Results of Operations                       26
         Item 7A.  Quantitative and Qualitative Disclosures about Market
                    Risk Exposures of Financial Instruments for the
                    Retained Businesses                                       43
         Item 8.   Financial Statements and Supplementary Data                47
         Item 9.   Changes in and Disagreements with Accountants on
                    Accounting and Financial Disclosure                      114

PART III
         Item 10.  Directors and Executive Officers of the Registrant        114
         Item 11.  Executive Compensation                                    114
         Item 12.  Security Ownership of Certain Beneficial Owners
                    and Management                                           114
         Item 13.  Certain Relationships and Related Transactions            114

PART IV
         Item 14.  Exhibits, Financial Statement Schedules, and Reports
                    on Form 8-K                                              115



                                        2

<PAGE>



                                     PART I

Item 1.   Business

GENERAL DESCRIPTION AND HISTORY

         PennCorp   Financial  Group,   Inc.   ("PennCorp"  or  the  "Company"),
incorporated  in  Delaware  in  1989,  is  a  holding  company,   the  principal
subsidiaries  of which are  insurance  companies  with  operations in Dallas and
Waco,  Texas;  Raleigh,  North  Carolina;  and Toronto,  Canada.  The  Company's
insurance  subsidiaries  market  and  underwrite  life  insurance,  accumulation
products  and  fixed  benefit  accident  and  sickness  insurance  to lower  and
middle-income  markets  throughout  the United States and Canada.  The Company's
insurance  products are sold through  several  distribution  channels  including
independent  general agents,  exclusive agents,  payroll deduction  programs and
financial institutions. During 1997 the Company restructured its operating units
into three primary business units: the Financial Services Division,  the Payroll
Sales  Division  and the Career  Sales  Division.  Information  relating  to the
Company's  U.S.  and  Canadian  operations  appears  in  Note  4  of  "Notes  to
Consolidated Financial Statements." For more information regarding the Company's
markets, see "Insurance" and "Marketing and Distribution" included herein.

BUSINESSES HELD FOR SALE

         On  February  18,  1998,  the  Company  announced  it had  engaged  the
investment banking firms Salomon Smith Barney, Inc. and Fox-Pitt, Kelton Inc. to
review strategic  alternatives for maximizing  shareholder value,  including the
sale of the  Company's  Career Sales  Division and certain  other  non-strategic
subsidiaries.

         The Career Sales  Division is comprised  in part of the  operations  of
Pennsylvania Life Insurance Company ("PLIC") and PennCorp Life Insurance Company
(together  with PLIC,  "Penn  Life").  Penn Life markets and  underwrites  fixed
benefit  accident and sickness  products and, to a lesser extent,  life products
through a sales force exclusive to the Company  throughout the United States and
Canada.  With  the  acquisition  in  January  1998  of  Southwestern   Financial
Corporation and its subsidiaries  ("SW  Financial"),  the Company has integrated
Union Bankers Insurance Company ("Union  Bankers"),  Constitution Life Insurance
Company   ("Constitution")   and  Marquette   National  Life  Insurance  Company
("Marquette")  into the Career Sales Division.  See "Acquisition of SW Financial
Controlling  Interest  and KB  Interests."  Peninsular  Life  Insurance  Company
("Peninsular") is also part of the Career Sales Division.

         On December 31, 1998, the Company  entered into a definitive  agreement
to sell the Career  Sales  Division  and related  assets to  Universal  American
Financial Corp. ("Universal American").  The purchase price of $175.0 million is
subject to  adjustment  based on the  capital  and  surplus of the Career  Sales
Division at the closing date.  The purchase  price consists of $136.0 million in
cash and $39.0 million  initial  principal  amount,  subject to  adjustment,  of
subordinated  notes of  Universal  American.  The  subordinated  notes will bear
interest  at a rate of 8.0% per annum  and will  mature  ten years  from date of
issuance. The accreted value of the notes will be subject to offset in the event
of  adverse  development  (or  subject  to  increase  in the  event of  positive
development)  in the  disability  income  reserves of PLIC and may be offset for
other indemnification claims under the purchase and sale agreement. In addition,
the  Company is required  under  terms of the  purchase  and sale  agreement  to
deliver the Career Sales Division and related assets with certain minimum levels
of statutory  capital and surplus,  pay certain ongoing costs and other expenses
which the Company  anticipates will result in its receiving net cash proceeds of
approximately $70.0 to $78.0 million. For additional  information concerning the
disability  insurance  reserves  of PLIC,  see  Note 8 of Notes to  Consolidated
Financial Statements.

         Also on December 31, 1998, the Company signed a definitive agreement to
sell  Professional  Insurance  Company  ("Professional").   Professional,  which
previously was included in the Payroll Sales Division, provides individual fixed
benefit and life products utilizing a network of independent agents primarily in
the  southeastern  United States through  employer-sponsored  payroll  deduction
programs. Pursuant to the purchase and sale agreement, Professional will be sold
to GE Financial  Assurance  Holdings,  Inc. ("GEFAH") for $47.5 million in cash.
The purchase price is subject to adjustment based on Professional's  capital and
surplus  at the  closing  date.  In  addition,  GEFAH will pay  interest  on the
purchase  price from  December  31,  1998 to the date of  closing.  The  Company
currently  estimates  receiving net cash proceeds for the  Professional  sale of
approximately $40.0 million to $41.5 million.

         On February 21, 1999, the Company signed a definitive agreement to sell
United Life & Annuity  Insurance  Company  ("United Life") and its  wholly-owned
subsidiary,  United Variable Services,  Inc., to ING America Insurance Holdings,
Inc.  ("ING").  United Life,  which  previously  was  included in the  Financial
Services  Division,  principally  markets fixed and variable  annuities  through
financial institutions and independent general agents, primarily in the southern
and

                                        3

<PAGE>


western United States.  The sale of United Life to ING also includes the sale of
UC Mortgage Corp. ("UC"), Cyberlink Development,  Inc. ("Cyberlink") and certain
assets of Marketing One, Inc.  ("Marketing  One"). The aggregate  purchase price
consists  of $152.0  million  and a dividend  payable by United Life at closing,
which the Company  estimates will be  approximately  $2.1 million.  The purchase
consideration may be reduced as a result of the Company's obligation to purchase
certain  mortgages from United Life at closing.  Additionally,  a portion of the
purchase  price may be escrowed at closing to fund the  Company's  obligation to
purchase  additional  mortgages  from United Life after  closing.  United  Life,
including its subsidiary  United  Variable  Services,  Inc.,  UC,  Cyberlink and
certain  assets of  Marketing  One are  referred to herein  collectively  as the
"United Life Assets." The Company  anticipates  receiving net cash proceeds from
the sale of the United Life Assets of approximately $140.0 million.

         In the third  quarter of 1998,  the Company  made the  decision to sell
KIVEX, Inc. ("KIVEX"), an internet service provider. The Company has engaged the
investment  banking  firm of ING  Barings  Furman  Selz in  this  regard  and is
currently soliciting interest from prospective purchasers.  To date, the Company
has not entered into a  definitive  agreement  to sell KIVEX.  In addition,  the
Company has made the  decision to sell  Marketing  One,  excluding  those assets
included with the sale of United Life.

         As a  result  of the  Company's  agreements  to sell the  Career  Sales
Division,  Professional  and the United Life Assets and the Company's  intent to
sell KIVEX and Marketing One within a period not likely to exceed one year,  the
assets and liabilities relating to the Career Sales Division,  Professional, the
United Life Assets,  KIVEX and  Marketing  One have been  reported as "Assets of
Businesses  Held for Sale" and  "Liabilities of Businesses Held for Sale" in the
Company's audited Consolidated Balance Sheets included elsewhere herein. Because
these assets and  liabilities  have been aggregated for purposes of presentation
in the Company's  financial  statements,  the Company has  similarly  separately
aggregated  such  assets and  liabilities  for  purposes  of much of the textual
disclosures  contained  herein.  For this  purpose,  the assets and  liabilities
relating to the Career  Sales  Division,  Professional,  the United Life Assets,
KIVEX and Marketing One are  collectively  referred to herein as the "Businesses
Held for Sale."

         Consummation of the Career Sales Division, Professional and United Life
Assets sales  transactions is subject to regulatory  approvals and other closing
conditions.  Please  refer to the  reports on Form 8-K filed on January 11, 1999
and March 11, 1999 for more information on these sale transactions.  Included as
Exhibits  2.1 and 2.2 on the Form  10-K  are the  definitive  purchase  and sale
agreements for the Career Sales Division and Professional,  respectively.  There
can be no assurances that the Career Sales Division,  Professional or the United
Life Assets sales will be  consummated  or that the cash proceeds will be in the
amount anticipated by the Company.

RETAINED BUSINESS

         After  giving  effect  to the  sale  of the  United  Life  Assets,  the
Financial  Services  Division is comprised of Security Life and Trust  Insurance
Company  (formerly  Integon Life Insurance  Corporation)  ("Security  Life") and
Southwestern Life Insurance Company ("Southwestern Life"). Security Life markets
life insurance and, to a lesser extent,  annuity  products  through  independent
general  agents who sell directly to individuals  primarily in the  southeastern
United States.  Since its acquisition on January 2, 1998,  Southwestern Life has
been  integrated  and  managed  as  part  of the  Financial  Services  Division.
Southwestern  Life  markets  life  insurance  and, to a lesser  extent,  annuity
products  through  independent  general  agents who sell directly to individuals
primarily in the southwestern United States.

         After  giving  effect to the sale of  Professional,  the Payroll  Sales
Division  includes  the  operations  of AA Life and  Occidental  Life  Insurance
Company of North Carolina ("OLIC").  AA Life, comprised of Pioneer Security Life
Insurance Company ("Pioneer  Security") and its subsidiaries,  American-Amicable
Life  Insurance  Company of  Texas  ("American-Amicable")  and Pioneer  American
Insurance Company ("Pioneer American"),  markets and underwrites customized life
insurance and accumulation  products to U.S.  military  personnel and government
employees through a general agency force. OLIC provides individual fixed benefit
and life products  utilizing a network of  independent  agents  primarily in the
southeastern   United  States  through   employer-sponsored   payroll  deduction
programs.

         For purposes of the Company's  separate  disclosure  of the  Businesses
Held for Sale as described  above,  Security Life,  Southwestern  Life, OLIC, AA
Life and other non-life insurance  corporate entities are collectively  referred
to herein as the "Retained Businesses."


                                        4
<PAGE>


ACQUISITION OF SW FINANCIAL CONTROLLING INTEREST AND KB INTERESTS

         On January 2, 1998,  following  shareholder  approval at the  Company's
1997 annual meeting of  shareholders,  the Company  consummated the acquisition,
from KB Investment Fund I, LP (formerly  Knightsbridge  Capital Fund I, LP) (the
"KB Fund") and Messrs. Steven W. Fickes, a former director,  and David J. Stone,
a director of the Company,  of their respective holdings of common stock and, in
the case of the KB Fund,  common stock  warrants of SW Financial  (collectively,
the "SW Financial  Controlling  Interest")  for an aggregate  purchase  price of
$73.7 million (not including acquisition expenses).

         On January 5, 1998,  following  shareholder approval at the 1997 annual
meeting  of  shareholders,  the  Company  consummated  the  acquisition  of  the
interests  of  Messrs.  Fickes  and  Stone  in KB  Management,  KB  Fund  and KB
Consultants LLC (formerly known as Knightsbridge Consultants LLC) (collectively,
the  "Fickes  and  Stone  Knightsbridge   Interests")  for  total  consideration
estimated to be $10.6 million (not including acquisition  expenses).  Mr. Fickes
will receive  consideration in the form of estimated  annual interest  payments,
ranging from  $301,000 to $330,000,  on April 15 each year through 2001 and will
be issued  173,160  shares of the Company's  Common Stock on April 15, 2001. The
Company issued 173,160 shares to Mr. Stone in July 1998.

         Further  information  regarding the SW Financial  investment appears in
Note 6 of "Notes to Consolidated Financial Statements."  Information relating to
the  relationship  between the Company and the KB Fund,  the  acquisition of the
Fickes  and  Stone  Knightsbridge   Interests  and  the  Southwestern  Financial
Controlling  Interest  appear in Notes 3, 18 and 19 of  "Notes  to  Consolidated
Financial Statements," and in Item 13 hereof.

PRODUCTS

General

         The Company's insurance subsidiaries  underwrite a variety of insurance
products  with the  primary  emphasis  on modest  premium  policies in the life,
accumulation and fixed benefit product sectors.  Life products are primarily low
face amount  traditional  whole life or universal life products which build cash
values that are available to the  policyholder.  Accumulation  products  include
various forms of annuity products which are utilized by policyholders  primarily
as a means of tax deferred  savings.  Fixed benefit products  include  indemnity
insurance  policies in which the benefit amounts are fixed at the time of policy
issue.  Those products  provide  supplemental  income  payments  directly to the
insured who is disabled and unable to work due to accident or sickness.

         Product  profitability  is  achieved  through a pricing  policy that is
based upon what the Company believes to be conservative  actuarial  assumptions,
which take into account the underwriting risks associated with the product being
sold,  including  lapse rates,  mortality,  morbidity and whether the product is
underwritten in the field or by the home office,  as well as the  administrative
expenses  associated  with the  business.  The  Company,  on an  ongoing  basis,
evaluates new products for use by its sales forces.

         The Company believes that, because of the characteristics of the market
it serves  and the nature of its  products,  the lapse  rates for its  products,
although  stable,  tend to be higher  than those  experienced  by other life and
health insurance  companies that operate in more affluent  markets.  The Company
prices  its  products  to  reflect  these  higher  lapse  rates.   To  encourage
policyholders  to maintain  their  coverages  with the  Company,  fixed  benefit
products generally incorporate a small fixed annual increase in benefits.  Early
surrender of  accumulation  and life products is discouraged by either their low
rate of accumulation of cash values or by high surrender charges.


                                        5

<PAGE>
         The following table presents the historical percentages of consolidated
insurance operations revenues derived from these product types:

<TABLE>
<CAPTION>
                                                                         PERCENTAGE OF CONSOLIDATED
                                                                            INSURANCE OPERATIONS
                                                                        REVENUES FOR THE YEARS ENDED
                                                                                DECEMBER 31,
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998        1998(1)
     -------------------------------------------------------  ---------    ---------    ---------    ---------

     <S>                                                        <C>          <C>          <C>          <C> 
     Fixed benefit..........................................     34.1%        29.8%        30.4%         3.9%
     Life...................................................     46.2         43.1         48.7         79.7
     Accumulation...........................................     19.7         27.1         20.9         16.4
                                                              -------      -------      -------      -------
       Total................................................    100.0%       100.0%       100.0%       100.0%
                                                              =======      =======      =======      =======
     ---------------
     (1)  Pro forma 1998  ratios and amounts  exclude the results of  Businesses
          Held for Sale as if  Businesses  Held for Sale  were sold  January  1,
          1998. Such pro forma information is provided for comparative  purposes
          only and does not purport to be indicative of what would have occurred
          had the consummation of the sales transactions  occurred as of January
          1, 1998, or results of the Retained  Businesses which may occur in the
          future.
</TABLE>

         The amount of annualized  premium in force and policy  activity by type
of business for the past three years is as follows:

<TABLE>
<CAPTION>
                                                                         ANNUALIZED PREMIUM IN FORCE
                                                                             AS OF DECEMBER 31,
                                                                              ($ in thousands)
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998        1998(1)
     -------------------------------------------------------  ---------    ---------    ---------    ---------
     <S>                                                      <C>          <C>          <C>          <C>      
     Fixed benefit..........................................  $ 194,475    $ 184,214    $ 209,495    $  13,966
     Life(2)................................................    217,538      219,180      496,712      355,089
                                                              ---------    ---------    ---------    ---------
       Total................................................  $ 412,013    $ 403,394    $ 706,207    $ 369,055
                                                              =========    =========    =========    =========
     ---------------
     (1)  Pro forma 1998  ratios and amounts  exclude the results of  Businesses
          Held for Sale as if  Businesses  Held for Sale  were sold  January  1,
          1998. Such pro forma information is provided for comparative  purposes
          only and does not purport to be indicative of what would have occurred
          had the consummation of the sales transactions  occurred as of January
          1, 1998, or results of the Retained  Businesses which may occur in the
          future.

     (2)  Life annualized  premium in force includes target premium for interest
          sensitive  products.  Interest  sensitive policy revenue may vary from
          target  premium  as  policyholders  have no  obligation  to pay target
          premium.   Additionally,   interest   sensitive  policy  revenues  are
          determined   based   upon   contractual   charges   assessed   against
          policyholder   funds  and  are  not  determined  by  policy   revenues
          collected.
</TABLE>

         The following discussion of the Company's principal products relates to
the Retained Businesses.

Life Insurance Products

         Traditional Whole Life. The Company's whole life policies are permanent
insurance  products  that  combine  life  insurance  protection  with a  savings
component  or cash value  that  gradually  increases  in  amount.  Typically,  a
guaranteed fixed premium, which is higher than for comparable term coverage when
the  policyholder  is younger,  but less than  comparable  term  coverage as the
policyholder  grows older,  is paid over a period of years. A  policyholder  may
borrow  against  the  policy's  accumulated  cash  value,  but the amount of any
outstanding  loans decreases the death benefit under the policy.  A policyholder
may surrender a policy and receive the  accumulated  cash value.  As of December
31, 1998, for the Retained  Businesses,  there were approximately  221,000 whole
life  policies in force with  $2,289.1  million in face amount of insurance  and
$441.0 million in future policy benefit reserves.

         Universal   and    Interest-Sensitive    Life.    The   universal   and
interest-sensitive  life  products  offered by the  Company  provide  whole life
insurance with  adjustable  rates of return related to current  interest  rates.
Universal life products permit  policyholders  to vary the frequency and size of
their premium payments, although policy benefits may also vary.

                                        6

<PAGE>



         The majority of sales of individual life insurance  products,  measured
by premium volume, has been derived from universal and  interest-sensitive  life
insurance products. The Company's universal and interest-sensitive life products
provide  advantages  generally not available to its  traditional  whole life and
term  life  policyholders,  such  as  flexibility  in  available  coverages  and
flexibility  in the  amount and timing of premium  payments.  In  addition,  the
Company's universal and interest-sensitive  life products can, in some respects,
provide higher returns and greater cash values to policyholders as compared with
traditional  whole life  insurance  products.  The Company's  universal life and
interest-sensitive  life insurance products are marketed to individuals directly
and  through  qualified  retirement  plans,  deferred  compensation  plans,  and
employer  sponsored  payroll  deduction  plans. As of December 31, 1998, for the
Retained   Businesses,   there  were   approximately   228,000   universal   and
interest-sensitive  life policies in force with $14,143.0 million in face amount
of insurance and $1,304.5 million in account value.

         Term Life.  Term life products  offer pure  insurance  protection for a
specified period of time, typically one, five or ten years. The Company offers a
variety  of  term  life  products  that  include  some  or all of the  following
features:  current and  guaranteed  premium rates that are level for a specified
number of years; preferred smoker,  preferred nonsmoker,  nonsmoker,  and smoker
underwriting  classes;  and conversion to permanent  insurance allowed to age 65
with premium credit. As of December 31, 1998, for the Retained Businesses, there
were approximately  118,000 term life policies in force with $6,006.7 million in
face amount of insurance and $45.4 million in future policy benefit reserves.

         Total sales of  individual  life  insurance by the Retained  Businesses
were approximately $50.2 million,  $46.8 million and $43.3 million for the years
ended December 31, 1998, 1997 and 1996, respectively.

Accumulation Products

         The Company's  accumulation  products  include single premium  deferred
annuities,  flexible premium deferred  annuities and variable annuity  products.
The principal  annuity  products  marketed by the Company's  retained  insurance
subsidiaries consist of flexible premium deferred annuities ("FPDAs") and single
premium deferred annuities ("SPDAs").

         As of December 31, 1998, the guaranteed  minimum crediting rates of the
Company's deferred annuity products for the Retained Businesses were as follows:

<TABLE>
<CAPTION>
               Guaranteed Minimum                         Funds Under
                 Crediting Rate                            Management
                                                        ($ in millions)
                                                        ---------------
             <S>                                         <C>          
             3.00%.................................      $        49.5
             3.50%.................................                2.4
             4.00%.................................              467.2
             4.50%.................................               88.2
             5.00%.................................                 --
             6.00%.................................               20.5
               No guaranteed minimum...............                6.6
                                                         -------------
                                                         $       634.4
                                                         =============
</TABLE>

         At December  31,  1998,  annuity  liabilities  were  composed of $136.1
million of SPDA  liabilities  and $498.3 million of FPDA  liabilities and $185.5
million of other annuity  liabilities,  for a total of $819.9 million of annuity
liabilities.  Of such  liabilities  $319.0  million  were  subject to  surrender
charges averaging 5.6% as of December 31, 1998.

         Total sales of annuities by the Retained  Businesses were approximately
$31.8 million,  $33.2 million and $20.8 million for the years ended December 31,
1998, 1997 and 1996, respectively.

Fixed Benefit Products

         Fixed benefit  products are sold in large volume and are  characterized
by low average  annual  premiums.  These  products  provide one or more of three
principal  types of  benefits:  (i) fixed  periodic  payments  to an insured who
becomes disabled and unable to work because of an accident and/or sickness, (ii)
fixed periodic payments to an insured who becomes hospitalized,  and (iii) fixed
single  payments  that  vary in  amount  generally  for  specified  surgical  or
diagnostic  procedures.  Because the benefits are fixed in amount at the time of
policy  issuance and are not intended to provide  reimbursement  for medical and
hospital  expenses,  payment amounts are not affected by inflation or the rising
cost of health care services. Fixed

                                        7

<PAGE>



benefit products, primarily those covering inability to work due to an accident,
provide  payments  while the insured is disabled and unable to work,  subject to
the terms and conditions of the applicable policy.  Fixed benefit products under
which  payments  are made to insureds who are disabled and unable to work may be
purchased  with coverage for either (i) specified  types of accidents,  (ii) all
other types of accidents,  or (iii) a combination of accident and sickness.  The
Company's  practice  is to  sell  products  that  together  with  other  similar
coverages,  do not  provide  monthly  benefits in excess of $2,000 or 50% of the
insured's income, if less.

         Certain   fixed   benefit    products,    primarily    those   covering
hospitalization due to sickness,  provide payments during the period the insured
is  hospitalized.  Most of the  Company's  fixed  benefit  products also provide
additional  fixed  periodic  payments to an insured  who  becomes  hospitalized.
Payments  under these products are not designed to cover the actual costs of the
insured's  hospital  stay,  but merely to provide  the  insured  with a means of
paying supplemental  expenses during the  hospitalization  period. The Company's
practice  is to provide  hospitalization  benefits of not more than $250 per day
($1,000 if the insured requires intensive care treatment).

         The accident and sickness  policies  also may be purchased  with riders
providing for fixed single  payments  that vary in amount  generally for various
surgical and  diagnostic  procedures.  The Company's  practice is to sell riders
that do not  provide  benefit  payments  in excess  of  $5,000.  If the  covered
procedure is performed on an out-patient basis, the insured receives one-half of
the scheduled payment.

         Historically, most of the Company's sales of fixed benefit products are
produced by Businesses Held for Sale.  Total sales of fixed benefit  products by
the Retained  Businesses were approximately $3.7 million,  $3.8 million and $4.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.

         During 1998,  Southwestern Life began marketing long-term care products
which are  marketed  to  retirees,  older  self-employed  individuals  and other
persons  in middle  income  levels.  The  Company  believes  that the market for
long-term care insurance  products is attractive because of the general aging of
the  United  States  population  and the  lack of  savings  resources  to  cover
prolonged  illnesses or convalescent  care. As of December 31, 1998,  there were
701  long-term  care policies in force  representing  $1.0 million in annualized
premiums and $.3 million in reserves.  Total sales of long-term care products by
Southwestern Life during 1998 were approximately $1.0 million.

         The  following  table  provides  certain  information  with  respect to
various  categories of insurance  business in force for the Company's  insurance
subsidiaries:

<TABLE>
<CAPTION>
                                                1996                          1997                          1998
                                     --------------------------    ---------------------------   --------------------------
                                      Fixed              Accum-    Fixed                Accum-    Fixed              Accum-
                                     Benefit    Life    ulation    Benefit    Life     ulation   Benefit    Life    ulation
                                     -------    ----    -------    -------    ----     -------   -------    ----    -------
<S>                                  <C>       <C>       <C>       <C>       <C>        <C>      <C>       <C>       <C>
Policies in force - January 1......  733,893   562,620   34,854    698,072   558,697    90,265   654,936   506,913   69,769
   New issues......................   81,547    54,157    4,834     84,286    62,449     5,012    89,218    72,080    8,715
   Business acquired, net..........   15,664    67,731   64,210         --        --        --   112,098   301,537   35,511
   Policies terminated............. (133,032) (125,811) (13,633)  (127,422) (114,233)  (25,508) (159,234) (100,598) (27,383)
                                    --------  --------  -------   --------  --------  --------  --------  --------  -------
   Policies in force - December 31.  698,072   558,697   90,265    654,936   506,913    69,769   697,018   779,932   86,612
                                    ========  ========  =======   ========  ========  ========  ========  ========  =======
</TABLE>

MARKETING AND DISTRIBUTION

         The  Company's  insurance  subsidiaries  collectively  are  licensed to
market the Company's  insurance products in all states (other than New York) and
in the District of Columbia,  all  provinces of Canada and in Puerto Rico,  Guam
and certain Caribbean countries.  In addition, the Company is authorized to sell
its products at U.S. military installations in foreign countries.

         The Company markets and  distributes its products  through four primary
distribution   channels:   agents  contracted   exclusively  with  the  Company,
independent general agents who sell on an individual basis,  independent general
agents  who  sell  through  payroll  deduction  programs  and  arrangements  for
distribution through various financial institutions.


                                        8

<PAGE>



         These market segments are further divided as follows:

         Major Market                  Sub-Market
         ------------                  ----------

         Individual     Low and moderate income households
                        U.S. military enlistees
                        Suburban and rural locales
                        Self-employed individuals

         Government     Employees of local governments and governmental agencies
                        Employees of U.S. federal government

         Each of the  Company's  market  segments  may be  served by each of the
primary distribution channels. Additionally, though there are certain regions in
which all sales forces are active,  the Company's sales forces generally operate
in geographically discrete regions.

         The following tables illustrate,  by direct cash premium collected, (as
reported to  regulatory  authorities)  and relative  percentages,  the principal
marketing regions in which the Businesses Held for Sale and Retained  Businesses
collected  in excess of $10.0  million  of policy  revenues  for the year  ended
December 31, 1998.

<TABLE>
<CAPTION>
                 Businesses Held for Sale Direct Premium Collected
             Jurisdiction                    Amount       Percentage
             ------------                    ------       ----------
                                         ($ in thousands)

             <S>                            <C>              <C>  
             Canada....................     $ 60,094          11.7%
             Texas.....................       43,178           8.4
             Indiana...................       38,434           7.5
             Florida...................       38,328           7.5
             Louisiana.................       36,905           7.2
             Georgia...................       27,875           5.4
             Ohio......................       25,273           4.9
             California................       24,051           4.7
             Wisconsin.................       21,628           4.2
             Pennsylvania..............       16,848           3.3
             Missouri..................       16,628           3.2
             North Carolina............       16,017           3.1
             Oklahoma..................       13,411           2.6
             Virginia..................       12,346           2.4
             Illinois..................       12,051           2.4
                                            --------        ------
               Subtotal................      403,067          78.5
             All Others................      110,226          21.5
                                            --------        ------
               Total...................     $513,293         100.0%
                                            ========        ======

                   Retained Businesses Direct Premium Collected
             Jurisdiction                    Amount       Percentage
             ------------                    ------       ----------
                                         ($ in thousands)

             Texas.....................     $ 58,512          20.2%
             North Carolina............       34,829          12.0
             Georgia...................       26,095           9.0
             California................       19,408           6.7
             Florida...................       13,702           4.7
             Virginia..................       11,991           4.1
                                            --------        ------
               Subtotal................      164,537          56.7
             All Others................      125,489          43.3
                                            --------        ------
               Total...................     $290,026         100.0%
                                            ========        ======
</TABLE>


                                        9

<PAGE>

Financial Services Division

         The Financial  Services Division  includes  marketing units of Security
Life, United Life and Southwestern Life. The Financial Services Division markets
products  to  individual  customers  through  leads  developed  over time.  This
division  utilizes field  marketing  directors,  affiliations  with  independent
marketing organizations,  financial institutions and financial planners to reach
its customer base.

         The sales agents for this division often make sales  presentations on a
one-on-one basis with potential prospects. Sales representatives are often faced
with competition from other agents and/or products from other companies.

         The  following  tables set forth  information  regarding  the Financial
Services  Division.  United Life is excluded on a pro forma basis for 1998 as it
is included in Businesses Held for Sale.

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     FINANCIAL SERVICES DIVISION                                1996          1997         1998         1998
     -------------------------------------------------------  ---------    ---------    ---------    ---------
                                                                               ($ in thousands)
     <S>                                                      <C>          <C>          <C>          <C>   
     Agents under contract..................................      9,164        7,730       19,254       16,607
     Number of agents annually producing new business.......      2,842        2,206        4,894        4,353
     Submitted annualized new business premiums.............  $ 118,528    $ 139,483    $ 160,258    $  72,465
     Annualized new business premium per agent..............  $    41.7    $    63.2    $    32.7    $    16.6
</TABLE>

         The revenue earned by the Financial  Services  Division by product type
is shown below:

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998         1998
     -------------------------------------------------------  ---------    ---------    ---------    ---------
                                                                               ($ in millions)
     <S>                                                      <C>          <C>          <C>          <C>      
     Life...................................................  $   143.7    $   127.9    $   249.3    $   239.6
     Accumulation...........................................      102.2        166.9        167.8         65.7
     Fixed benefit..........................................        5.3          0.3          2.7          2.4
                                                              ---------    ---------    ---------    ---------
       Total................................................  $   251.2    $   295.1    $   419.8    $   307.7
                                                              =========    =========    =========    =========
</TABLE>

         The  percentage  of the  Financial  Services  Division  revenue  to the
Company's  total  insurance  operations  revenue by  insurance  product is shown
below:

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998         1998
     -------------------------------------------------------  ---------    ---------    ---------    ----------
     <S>                                                         <C>          <C>          <C>          <C>  
     Life...................................................     55.1%        46.3%        60.2%        69.1%
     Accumulation...........................................     91.9         95.0         94.2         92.0
     Fixed benefit..........................................      2.8          0.2          1.0         14.3
       Total division revenue to the Company's
         total insurance operations revenue.................     44.5         45.9         49.5         70.7
</TABLE>

Payroll Sales Division

         The Payroll Sales Division includes marketing units of Professional, AA
Life and OLIC. Each of the marketing  units is divided into regions  utilizing a
hierarchical  approach to managing the sales  representative.  Additionally,  AA
Life and OLIC also utilize field marketing  directors and independent  marketing
organizations to access potential policyholders.

         The Payroll Sales Division markets products solely through the channels
of  employer-sponsored  payroll  deduction  or  government-sponsored   allotment
programs.  Under those programs,  the agent is permitted by the employer to meet
on the  employer's  premises  with its  employees  and to make  both  group  and
individual   presentations   implicitly  endorsed  by  the  employer  concerning
available products. If an employee elects to purchase a policy, arrangements are
made with the employer to deduct the premiums  from the  employee's  wages.  The
employer  therefore is able to provide its  employees  with  insurance  benefits
without  incurring  any  premium  costs.  The  Company's  billing  system can be
integrated into the employer's payroll

                                       10

<PAGE>



system without  additional cost to the employer,  a feature that facilitates the
Company's   access  to  employees  of  businesses   that  have  not   previously
participated in payroll deduction programs.

         The following tables set forth information  regarding the Payroll Sales
Division.  Professional  is  excluded  on a pro  forma  basis  for 1998 as it is
included in Businesses Held for Sale:

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     PAYROLL SALES DIVISION                                     1996          1997         1998         1998
     -----------------------------------------------------    ---------    ---------    ---------    ---------
                                                                              ($ in thousands)
     <S>                                                      <C>          <C>          <C>          <C>  
     Agents under contract................................        7,539        6,784        6,941        3,638
     Number of agents annually producing new business.....        2,750        2,955        1,926          783
     Submitted annualized new business premiums...........    $  39,069    $  42,527    $  44,100    $  26,944
     Annualized new business premium per agent............    $    14.2    $    14.4    $    22.9    $    34.4
</TABLE>

         The revenue  earned by the Payroll  Sales  Division by product  type is
shown below:

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998         1998
     -----------------------------------------------------    ---------    ---------    ---------    ---------
                                                                               ($ in millions)
     <S>                                                      <C>          <C>          <C>          <C>      
     Life.................................................    $    84.1    $   116.4    $   112.6    $   107.0
     Fixed benefit........................................         39.5         48.9         48.0         14.6
     Accumulation.........................................          8.0          7.2          5.9          5.7
                                                              ---------    ---------    ---------    ---------
       Total..............................................    $   131.6    $   172.5    $   166.5    $   127.3
                                                              =========    =========    =========    =========
</TABLE>

         The percentage of the Payroll Sales  Division  revenue to the Company's
total insurance operations revenue by insurance product is shown below:

<TABLE>
<CAPTION>
                                                                                                     Pro forma
     INSURANCE PRODUCT TYPE                                     1996          1997         1998         1998
     -----------------------------------------------------    ---------    ---------    ---------    ---------
     <S>                                                         <C>          <C>          <C>          <C>  
     Life...................................................     32.3%        42.2%        27.2%        30.9%
     Fixed benefit..........................................     20.5         25.5         18.6         85.7
     Accumulation...........................................      7.2          4.1          3.3          8.0
       Total division revenue to the Company's
          total insurance operations revenue................     23.3         26.8         19.5         29.3
</TABLE>

Career Sales Division

         Penn Life's agents constitute  substantially all of the sales force for
the Career Sales  Division.  The regional  sales  managers are  responsible  for
approximately  100 sales locations in the United States and Canada.  Commissions
are shared among the regional and branch office  managers and the writing agent.
Commissions  allocated  to the  branch  offices  are  used  to  pay  "overwrite"
commissions to agents who train new agents and to pay the expenses of the branch
office. Any commissions  allocated to the branch offices remaining after payment
of "overwrite"  commissions and expenses,  essentially the branch  "profit," are
allocated  among the senior sales  managers (and the Company for Canadian  Sales
Offices).  Prior to 1998,  the Company  shared in the  profits for all U.S.  and
Canadian Sales Offices.  The Company retained  approximately $1.5 million,  $2.6
million and $2.3 million  during 1998,  1997 and 1996,  respectively,  in profit
sharing income,  which is recorded as an offset to commissions.  During 1997 the
Company  worked  closely  with the U.S.  based career sales force to develop and
implement a new  compensation  structure which resulted in the Company giving up
its rights to a portion of the profit  participation  associated with the branch
compensation structures.  As a result, career sales force agents receive a lower
base  commission  structure  on new  business  and fully absorb all field office
costs.  The new  compensation  structure allows for bonuses to be paid to agents
based upon improving persistency and new sales growth.  Additional consideration
has been granted to the field force in connection  with the  acquisition  of the
Career  Sales  Division  by  Universal  American.  See  Note  19  of  "Notes  to
Consolidated Financial Statements."


                                       11

<PAGE>



         The Penn Life career sales force is a network of regional  managers who
operate  branch  offices.  Each  office  includes  agents  which  focus on three
different marketing strategies:  New Call, Special Services and Individual Life.
The target market for all products is primarily self-employed individuals,  with
plans to expand into the senior market.

         New Call. New Call agents make "cold call"  door-to-door  presentations
and market small denomination  policies that provide scheduled payments in fixed
amounts to insureds  who, as a result of specified  types of  accidents,  become
unable to work or who become hospitalized.

         Special Services.  New Call  policyholders are a significant  source of
leads for the Special  Services  Division.  A Special  Services agent visits the
policyholder's  residence to collect renewal premiums on products  purchased for
the New Call representatives. The sales agent also delivers a standardized sales
presentation  on more  comprehensive  policies.  These  policies  either provide
scheduled  payments to insureds  who are disabled and unable to work as a result
of accident or sickness or scheduled payments to insureds who are required to be
hospitalized as the result of accident or sickness.

         Individual Life. Existing policyholders are the primary source of leads
for the Individual Life representatives,  which sell life products.  The Company
has worked to  restructure  this  division,  expand its  product  portfolio  and
aggressively  recruit new agents.  New product offerings include universal life,
term life and final expense products which have been widely accepted by the Penn
Life sales force.

         With the addition of Union Bankers,  Constitution  and  Marquette,  the
Career Sales  Division  will have the  opportunity  to expand into the brokerage
market offering senior care products.

         The following tables set forth  information  regarding the Career Sales
Division:

<TABLE>
<CAPTION>
                                                                              1996         1997         1998
                                                                           ---------    ---------    ---------
                                                                                     ($ in thousands)
     <S>                                                                   <C>          <C>          <C>      
     ACCIDENT & HEALTH
       Agents under contract...........................................        1,644        1,400        4,173
       Weekly average agents producing new business....................          618          581          491
       Submitted annualized new business premiums......................    $  40,433    $  41,224    $  46,770
       Annualized new business premium per agent.......................    $    65.4    $    71.0    $    95.3

     INDIVIDUAL LIFE
       Agents under contract...........................................          197          182          119
       Weekly average agents producing new business....................           91           78           41
       Submitted annualized new business premiums......................    $   8,224    $   7,006    $   3,706
       Annualized new business premium per agent.......................    $    90.4    $    89.8    $    90.4

     TOTAL ALL CAREER SALES DIVISIONS
       Agents under contract...........................................        1,841        1,582        4,292
       Weekly average agents producing new business....................          709          659          532
       Submitted annualized new business premiums......................    $  48,657    $  48,230    $  50,476
       Annualized new business premium per agent.......................    $    68.6    $    73.2    $    94.9
</TABLE>

         The revenue earned by the career sales  distribution  system by product
type is shown below:

<TABLE>
<CAPTION>

     INSURANCE PRODUCT TYPE                                                   1996         1997         1998
     ------------------------------------------------------------------    ---------    ---------    -------
                                                                                     ($ in millions)
     <S>                                                                   <C>          <C>          <C>      
     Fixed benefit.....................................................    $   148.1    $   142.3    $   207.3
     Life..............................................................         32.8         31.6         52.0
     Accumulation......................................................          1.0          1.6          4.4
                                                                           ---------    ---------    ---------
       Total...........................................................    $   181.9    $   175.5    $   263.7
                                                                           =========    =========    =========
</TABLE>


                                       12

<PAGE>



         The percentage of Career Sales Division  revenue to the Company's total
insurance operations revenue by product type is shown below:

<TABLE>
<CAPTION>

     INSURANCE PRODUCT TYPE                                                   1996         1997         1998
     ------------------------------------------------------------------    ---------    ---------    ---------
     <S>                                                                      <C>          <C>          <C>  
     Fixed benefit.....................................................       76.8%        74.3%        80.4%
     Life..............................................................       12.6         11.5         12.6
     Accumulation......................................................        0.9          0.9          2.5
       Total division revenue to the Company's
         total insurance operations revenue............................       32.2         27.3         31.0
</TABLE>

INSURANCE UNDERWRITING

         In  general,  the  Company  permits  simplified  underwriting  of  life
products,  unless the amount of  requested  coverage is greater  than  specified
levels between $25,000 and $100,000,  depending on the age of the applicant.  If
full underwriting is required, the Company reviews the policy application and an
attending  physician's  report  and may  require a  paramedical  examination  or
complete  physical  examination  depending on the age of the  applicant  and the
amount of coverage  requested.  If the total amount of coverage applied for plus
any  coverage  in  force  with  the  Company  exceeds  $100,000,  a  prospective
policyholder  must submit a screening for antibodies  related to Acquired Immune
Deficiency Syndrome ("AIDS") , to the extent permitted by law. The life products
are specifically designed and priced for the mortality risks associated with the
Company's simplified underwriting procedures.

         Although  the  increasing  incidence  of AIDS  is  expected  to  affect
mortality  adversely  for the life  insurance  industry as a whole,  the Company
believes that the impact of AIDS on its operations should not be material due to
the small average size of the life insurance policies sold. The Company requires
and  considers  AIDS  information  to the  fullest  extent  permitted  by law in
underwriting and pricing decisions.  During the twelve months ended December 31,
1998, 1997 and 1996, the Company estimated it paid  approximately  $1.2 million,
$2.1 million and $3.2 million, respectively in death benefits (representing less
than 1% of total death  benefits  paid by the Company  during each such  period)
under  individual  life  policies  due to deaths  believed  by the Company to be
AIDS-related.

         The Company has identified a block of approximately 290 policies with a
total face amount of  approximately  $30.0 million which it suspects  could have
been issued on applications containing material misrepresentations, particularly
concerning  the  treatment  for or the  diagnosis of AIDS or HIV. The Company is
investigating  each one of these  policies  and  taking  steps  to  rescind  any
contestable policy where material  misrepresentations  are found. The Company is
also  reviewing  its  underwriting  guidelines  to prevent a recurrence  of this
situation and  reviewing  its current cost of insurance  charges to determine if
current charges are sufficient to cover potentially higher mortality  associated
with such policies.

INVESTMENT PORTFOLIO

         The  Company's  investment  portfolio,  which as of  December  31, 1998
excludes  invested  assets of its Businesses  Held for Sale, is managed with the
objectives of maintaining high credit quality and liquidity,  maximizing current
income within acceptable  levels of risk,  minimizing market and credit risk and
matching the anticipated maturities of investments to the Company's liabilities.
To achieve these objectives,  the portfolio  consists primarily of United States
and Canadian government and investment-grade  fixed maturity  securities,  which
together with high quality  short-term  investments  accounted for approximately
84.6% of the Company's  total invested  assets at December 31, 1998. The Company
believes  that the nature of its fixed  benefit  products,  which  have  minimal
inflation  risk, and its life products,  which limit the early  accumulation  of
cash values, permit it to utilize this conservative investment strategy.

         At December 31, 1998,  54.1% of the Company's fixed maturity bonds were
rated AA or higher by Standard & Poor's and  approximately  93.0% were rated BBB
or higher by Standard & Poor's, respectively.  All dollar amounts or percentages
set  forth in this  discussion  are based on  carrying  value  unless  otherwise
indicated.

         Other than issues of the United  States and  Canadian  governments  and
government agencies and authorities, no single issuer represented more than 0.5%
of total invested assets at December 31, 1998.


                                       13

<PAGE>



         The following  table  summarizes the Company's  investments  (excluding
investments of Businesses Held for Sale) as of December 31, 1998:

<TABLE>
<CAPTION>
                                                                                                Percent of
                                                                                                   Total
                                                         Amortized     Fair        Carrying      Carrying
                                                           Cost       Value(1)       Value         Value
                                                           ----       --------       -----         -----
                                                                         ($ in thousands)
         <S>                                           <C>           <C>          <C>               <C> 
         Fixed maturities available for sale:
         U.S. Government and agency bonds............  $   189,766   $   202,700  $   202,700       6.8%
         Debt securities issued or guaranteed by
           foreign governments(2)....................       25,701        27,178       27,178       1.0
         Municipal bonds.............................       45,271        42,127       42,127       1.4
         Corporate bonds.............................    1,099,513     1,129,023    1,129,023      38.2
         Mortgage-backed bonds.......................    1,164,739     1,188,686    1,188,686      40.2
                                                       -----------   -----------  -----------    ------
           Total fixed maturity securities
              available for sale.....................    2,524,990     2,589,714    2,589,714      87.6
         Equity securities available for sale........        2,008         2,035        2,035       0.1
         Commercial mortgages........................       36,382        38,865       36,382       1.3
         Residential mortgages.......................          500           500          500        --
         Real estate.................................       15,904         8,644        8,644       0.3
         Policy loans................................      207,490       207,490      207,490       7.0
         Short-term investments......................       92,727        92,727       92,727       3.1
         Other investments...........................       17,480        18,762       18,762       0.6
                                                       -----------   -----------  -----------    ------
           Total invested assets.....................  $ 2,897,481   $ 2,958,737  $ 2,956,254    100.0%
                                                       ===========   ===========  ===========    =====
         --------------
          (1)  Fair  values  are  obtained   principally   from  the   Company's
               investment advisors.
          (2)  Consists principally of Canadian provincial  government bonds and
               bonds issued or guaranteed by the Canadian federal government (in
               U.S. dollars).
</TABLE>

         The table set forth below  indicates the  composition  of the Company's
fixed maturity  portfolio  (excluding  Businesses Held for Sale) by rating as of
December 31, 1998:

<TABLE>
<CAPTION>
                                                                     Percent of
                                                         Total          Total
                                                       Carrying       Carrying
 Rating                                                  Value          Value
 ------                                                  -----          -----
                                                    ($ in thousands)
 <S>                                                  <C>                <C>  
 AAA(1).............................................  $ 1,264,089         48.8%
 AA.................................................      137,090          5.3
 A..................................................      548,493         21.2
 BBB................................................      458,551         17.7
                                                      -----------        -----
   Total investment grade...........................    2,408,223         93.0
                                                      -----------        -----
 BB.................................................      103,508          4.0
 B or below.........................................       59,744          2.3
                                                      -----------        -----
   Total below-investment grade.....................      163,252          6.3
                                                      -----------        -----

 Nonrated...........................................       18,239          0.7
                                                      -----------        -----
   Total fixed maturities...........................  $ 2,589,714        100.0%
                                                      ===========        =====
--------------
(1)  Includes  approximately  $202.7  million of United  States  government  and
     agency  bonds  and  approximately  $27.2  million  of  Canadian  provincial
     government  bonds and bonds issued or  guaranteed  by the Canadian  federal
     government (in U.S. dollars).
</TABLE>



                                       14

<PAGE>



         The following  table  reflects  investment  results for the Company for
each of the  periods  indicated.  The pro forma  amounts  for 1998  exclude  the
Businesses Held for Sale.

<TABLE>
<CAPTION>
                                                                     FOR THE YEARS ENDED DECEMBER 31,
                                                                                                    Pro forma
                                                               1996         1997         1998         1998
                                                            -----------  -----------  -----------  -----------
                                                                             ($ in thousands)
     <S>                                                    <C>          <C>          <C>          <C>        
     End of period total invested assets(1)...............  $ 3,673,504  $ 3,339,979  $ 4,930,535  $ 2,956,254
     Net investment income(2).............................      210,734      273,237      369,052      215,909
     Net realized investment gains(3).....................        1,257       17,487       14,068        4,956
     Average annual yield.................................          7.5%         7.6%         7.2%         7.0%
     --------------
     (1) Consists of total  investments  plus cash,  less amounts due to brokers
         for  securities  committed to be purchased at end of period.  For 1998,
         invested  assets of Businesses  Held for Sale have been included in end
         of period total invested assets.  In the pro forma 1998, net investment
         income and realized  investment  gains of Businesses Held for Sale have
         been excluded.
     (2) Net investment income is net of investment  expenses,  excludes capital
         gains or losses and is before income taxes.
     (3) Amounts shown above are before income taxes, and include provisions for
         impairments in value which are considered to be other than temporary.
</TABLE>

         The Company's  investments  must comply with the insurance  laws of the
states in which its insurance  subsidiaries  are domiciled and in which they are
licensed  as  well as  applicable  provisions  of the  Company's  9 1/4%  Senior
Subordinated  Notes due 2003.  These  laws and  provisions  prescribe  the kind,
quality and  concentration of investments that may be made by the Company and/or
its insurance subsidiaries.

REINSURANCE

         In keeping with industry  practice,  the Company reinsures  portions of
its  life  insurance  exposure  with  unaffiliated   insurance  companies  under
traditional  indemnity  reinsurance  agreements.  Some new  insurance  sales are
reinsured  above  prescribed  limits and others are reinsured as a percentage of
each  dollar of  coverage  up to  prescribed  limits;  these do not  require the
reinsurer's  prior  approval  under  contracts  that are  renewable on an annual
basis. Generally,  the Company enters into indemnity reinsurance arrangements to
assist in  diversifying  its risk and to limit its  maximum  loss on risks  that
exceed the Company's  policy  retention  limits ranging from $25,000 to $500,000
per life,  depending on insured  issue age, the product type and each  insurance
company's historical practice. Generally, accidental death benefits in excess of
$50,000 per life are reinsured on a bulk basis.  Indemnity  reinsurance does not
fully  discharge the Company's  obligation to pay policy claims on the reinsured
business. The ceding insurer remains responsible for policy claims to the extent
the reinsurer fails to pay such claims. On September 30, 1998, Penn Life entered
into  a  financial   reinsurance   agreement   which  provided  Penn  Life  with
approximately  $20.0  million  of  statutory  surplus.  See  Note 20 of Notes to
Consolidated  Financial  Statements  for additional  information  regarding such
agreement.

         The  Retained  Businesses  are  currently  in the process of  reviewing
existing reinsurance  programs.  This review is expected to be completed in 1999
and may effect retention limits, the cost of its reinsurance  coverage and other
aspects of its reinsurance programs.

         At no time during the past ten years has any present  reinsurer  of any
continuing  block of business  ceded by any of the Company's  insurance  company
subsidiaries  failed  to pay any  policy  claims  with  respect  to  such  ceded
business.  At December 31, 1998 and 1997, of the approximately $36.5 billion and
$24.6 billion of life  insurance in force,  approximately  $6.4 billion and $4.4
billion had been ceded to reinsurers,  respectively. As of December 31, 1998 the
Company's  principal  reinsurers  are  Transamerica  Occidental  Life  Insurance
Company,  Reassurance  Company of Hanover,  Cologne Life  Reinsurance  Co., Life
Reassurance  Corp. of America,  RGA Reinsurance  Company,  Lincoln National Life
Insurance  Company,  Swiss Re Life & Health  Insurance  Company and Allianz Life
Insurance Company, which collectively have reinsured  approximately 72.2% of the
ceded business.



                                       15

<PAGE>

YEAR 2000 ISSUES

         Many computer and software  programs were designed to accommodate  only
two digit fields to represent a given year (e.g.  "98"  represents  1998). It is
highly  likely that such  systems  will not be able to  accurately  process data
containing date information for the year 2000 and beyond.  The Company is highly
reliant upon computer  systems and software as are many of the  businesses  with
which the Company interacts.  The Company's ability to service its policyholders
and  agents is  dependent  upon  accurate  and  timely  transaction  processing.
Transaction  processing in turn is dependent  upon the Company's  highly complex
interdependent  computer  hardware,  software,  telecommunications  and  desktop
applications.  The  inability  of the  Company or any of its  integral  business
partners to complete year 2000 remediation  efforts associated with these highly
complex  and  interdependent  systems  could  lead  to  a  significant  business
interruption.  Such an  interruption  could  result in a decline in current  and
long-term profitability and business franchise value.

         The Company's  overall year 2000  compliance  initiatives,  include the
following components:  (i) assessment of all business critical systems (business
critical  systems includes  computer and other systems),  processes and external
interfaces and dependancies;  (ii) remediation or upgrading of business critical
systems;  (iii)  testing  of  both  modified  and  updated  systems  as  well as
integrated systems testing; (iv) implementation of modified and updated systems;
and (v) contingency  planning. As a part of the process, the Company has written
letters and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance  efforts and follows up  periodically.  Of those
parties that have responded,  the Company's most significant third party vendors
and  business  partners  have  indicated  that  they  have a plan for year  2000
compliance or believe that they are currently year 2000 compliant.

         The Company has engaged outside vendors and focused certain  employees'
full time  efforts to help in the full array of its year 2000  initiative.  This
includes  systems  assessment and monitoring  advice,  actual code  remediation,
communication  and consultation  with critical  business partners and additional
data center and testing  resources.  The Company  originally  projected to incur
internal and external costs  associated  with such expertise  ranging from $10.6
million to $14.5 million, which were anticipated to be incurred primarily during
1998 and early 1999. Based upon revised projections during the fourth quarter of
1998,  the Company  anticipates  incurring  internal and external  costs of $5.0
million during 1999. The Company estimates it has incurred internal and external
costs  aggregating  $13.4 million and $1.9 million for the years ended  December
31, 1998 and 1997, respectively.

         Each  of the  operating  divisions  is  primarily  responsible  for its
remediation efforts with corporate oversight provided as necessary.  The Company
believes  that the Career Sales  Division has  substantially  completed its year
2000 assessment and remediation efforts,  which will be subject to ongoing tests
for the remainder of 1999. In addition,  the Career Sales Division has committed
to a  strategy  of  utilizing  third  party  administrative  experts,  who  have
indicated year 2000 compliance,  to handle the processing of certain  components
of its health insurance  business,  thus eliminating the need for the upgrade or
modification of certain  existing  health  administration  systems.  The Payroll
Sales  Division has  completed  the  remediation  of its largest  administrative
platforms,  except  for AA Life,  and  anticipates  successful  remediation  and
testing of the remaining  sub-systems  and system  interfaces  during 1999.  The
Company  believes that the Payroll Sales Division,  other than AA Life, is 95.0%
complete with its compliancy effort for critical business systems. AA Life is in
the  process  of  upgrading  its  policy  administration  system  to a year 2000
compliant version. AA Life is relying on contracted vendor resources in order to
complete its upgrade process.  Based upon similar internal metrics analysis,  AA
Life has completed 90.0% of the total effort required for its critical  business
systems  to be year 2000  compliant.  The  efforts  of the  Company's  Financial
Services Division are highly dependent on the utilization of outside  resources.
The Company  believes that the Financial  Services  Division has contracted with
sufficient  resources to be able to remediate  its essential  business  systems.
Currently,  the Company believes that the Financial  Services  Division is 85.0%
complete with remediation efforts associated with its critical business systems.
The  Company  believes  that all of its  divisions  will  have  completed  their
remediation  efforts by May 1999,  but each  division  will  continue to perform
testing throughout 1999.

         Although the Company  believes  that its operating  divisions,  outside
vendors and most critical business partners will be sufficiently  compliant that
the year 2000  issue  should not cause a material  disruption  in the  Company's
business,  there can be no assurance that there will not be material disruptions
to the  Company's  business  or an  increase  in the cost of the  Company  doing
business.  Although the Company  believes  that the year 2000 issues  should not
cause a material disruption in the Company's business, the Company has developed
various  contingency  plans associated with remediation  tasks which the Company
believes are at a higher risk for potential failure.

         The  Company  has  provided  certain   assurances  to  each  respective
purchaser of the Businesses Held for Sale with respect to each entity's  ability
to process date-sensitive information for the year 2000 and beyond. Although the
Company believes that it will be able to meet the year 2000  representations and
warranties provided to the respective purchasers, there


                                       16
<PAGE>



can be no assurances.  Failure of the Company to meet such  representations  and
warranties  could result in a decision by the purchaser  not to  consummate  the
transaction and/or indemnification claims for breach of contract.

COMPETITION

         The  accident  and  health  and  life  insurance   industry  is  highly
competitive.  PennCorp  competes  with many  insurance  companies  and insurance
holding  company  systems that have  substantially  greater capital and surplus,
higher A.M. Best Company  ("A.M.  Best")  ratings,  larger and more  diversified
product  portfolios,  and access to larger  agency sales  forces.  In the United
States,  there  are more than  1,700  life and  accident  and  health  insurance
companies,  most of which  compete  in the  states  in which  PennCorp  conducts
business.

         The  Company's  expansion  of its  product  line to  include  a  higher
percentage of life and accumulation product revenue as compared to total revenue
has  resulted  in a  broadening  of the  markets  in  which  the  Company  faces
competition.  The sale of life insurance products,  and to a greater extent, the
sale of accumulation  products is very sensitive to an organization's  A.M. Best
rating, its size and perceived  financial strength and the  competitiveness  and
the financial  performance of the products themselves.  Like the market focus of
its fixed benefit  products,  the Company believes that its target market is not
widely  served by many of the large,  national  insurers,  but does face  direct
competition from smaller regional and niche-market focused companies.

         During 1998,  each of the  Company's  insurance  subsidiaries  received
downgrades  in their  respective  A.M.  Best  rating,  primarily  as a result of
concerns regarding the financial  strength of the Company.  The Company believes
that as a result of the rating action, certain insurance subsidiaries have noted
slight declines in new business  production and modest increases in policyholder
surrenders.  Certain of the Company's  insurance  subsidiaries  market insurance
products that are highly sensitive to competitive  factors  including  financial
strength and ratings. Over time, the Company believes that the rating decline of
its  insurance  subsidiaries  will  negatively  impact  their  ability to market
certain  products and to retain some customers and  distribution  channels.  For
additional  information  on  ratings  see  Business-Ratings  included  elsewhere
herein.

REGULATORY MATTERS

         Life insurance  companies are subject to regulation and  supervision by
the states in which  they  transact  business.  The laws of the  various  states
establish  regulatory agencies with broad  administrative and supervisory powers
related to,  among other  things,  granting  and  revoking  licenses to transact
business,  regulating  trade  practices,   establishing  guaranty  associations,
licensing  agents,  approving  policy  forms,  filing  premium  rates on certain
business,  setting  reserve  requirements,  determining  the form and content of
required  financial  statements,  determining the reasonableness and adequacy of
capital and surplus and  prescribing  the type of permitted  investments and the
maximum concentrations of certain classes of investments.

         The   Company's   insurance   subsidiaries   are  subject  to  periodic
examinations by state regulatory authorities. Current examinations are described
below:

         Business Held for Sale

         The Texas Department of Insurance is conducting its regularly scheduled
         triennial  examinations of  Constitution,  Marquette,  Professional and
         Union Bankers, which are Texas domestic insurers.

         The  Pennsylvania   Department  of  Insurance  is  in  the  process  of
         completing  its  examination  of  PLIC as of  December  31,  1996.  The
         Department has indicated that PLIC's  historical  method of calculating
         statutory   claims   reserves   may  not  provide  the  most   accurate
         determination of claims reserve estimates. PLIC is evaluating differing
         methods for determining its claims estimates on a statutory basis. Such
         differing  methods could likely  produce  materially  different  claims
         reserves estimates. Based upon preliminary findings, PLIC increased its
         statutory claim estimates above historical  levels by approximately $20
         million  during the year ended  December 31, 1998. To offset the impact
         of such reserve increases on PLIC's statutory capital and surplus, PLIC
         entered into a financial  reinsurance  agreement,  which allows PLIC to
         maintain marginally  sufficient  statutory capital and surplus.  Should
         PLIC need to  substantially  increase  its  claims  reserves  estimates
         further it is likely  that PLIC's  risk-based  capital  ("RBC")  ratios
         would decline,  without  further  management  action,  to a level which
         could require certain actions be taken by the  Pennsylvania  Department
         of Insurance.  The Company and PLIC continue to closely  monitor PLIC's
         risk-based capital ratios.


                                       17
<PAGE>

         For the years ended  December  31, 1998 and 1999,  PLIC has  received a
         permitted  statutory  accounting  practice allowing PLIC to utilize its
         own experience and other  modification  factors in the determination of
         statutory  disability  income claims reserves.  If PLIC were to utilize
         the model regulation for the  determination of disability income claims
         reserves,  management estimates that the amount of additional statutory
         claims reserves  necessary to be recorded would be approximately  $16.2
         million. If PLIC were to record such additional reserves on a statutory
         basis, its risk based capital would be reduced  significantly  which in
         turn could lead to regulatory  action.  For the year ended December 31,
         1999, PLIC will be required,  in the event of the non-completion of the
         Career Sales Division  divestiture,  to increase its disability  claims
         reserves  by   approximately   $5.3   million   and   receive   capital
         contributions   of  at  least  $5.3  million  to  offset  such  reserve
         increases.

         Retained Business

         The Texas Department of Insurance is conducting its regularly scheduled
         triennial  examinations of  American-Amicable,  OLIC,  Pacific Life and
         Accident  Insurance  Company  ("PLAIC"),   Pioneer  American,   Pioneer
         Security, Security Life and Southwestern Life, which are Texas domestic
         insurers.

         The Company's insurance  subsidiaries are required,  at least annually,
to perform cash flow and "Asset Adequacy Analysis" under differing interest rate
scenarios.  Certain of the Company's  insurance  subsidiaries  historically sold
certain interest  sensitive life insurance  contracts in which the determination
of policy reserves is highly sensitive to assumptions such as withdrawal  rates,
investment  earnings  rates,  mortality  rates and  premium  persistency.  Minor
changes in such  assumptions  could have a material  impact on future  statutory
reserve  requirements.  Significant increases in statutory reserves would result
in lower statutory  earnings  associated with impacted  insurance  subsidiaries,
which in turn would reduce the dividend capacity of such subsidiaries ultimately
reducing  cash  flow  available  to  the  Company.   Most  states  have  enacted
legislation regulating insurance holding company systems, including acquisitions
of control of insurance companies,  dividends,  the terms of surplus debentures,
the terms of transactions with affiliates, investments in subsidiaries and other
related  matters.  Regulatory  restrictions on investments in  subsidiaries  and
affiliates require the Company to continually review and occasionally  modify or
restructure  the insurance  subsidiaries  within the insurance  holding  company
system.  Additionally,  the Company has entered into an agreement with the Texas
Department of Insurance  dated September 22, 1998 which  establishes  procedures
resulting in greater oversight of the Company and its insurance  subsidiaries by
the Texas  Department  of  Insurance.  The Company is registered as an insurance
holding  company  system  in  North  Carolina,   Pennsylvania   and  Texas  (the
domiciliary states of its insurance  companies),  and routinely reports to other
jurisdictions in which its insurance subsidiaries are licensed.

         There continues to be substantial  scrutiny of the insurance regulatory
framework, and a number of state legislatures have enacted legislative proposals
that alter,  and in many cases increase,  state authority to regulate  insurance
companies  and their  holding  company  systems.  The  National  Association  of
Insurance Commissioners ("NAIC") and state insurance regulators also have become
involved in a process of  re-examining  existing laws and  regulations and their
application to insurance  companies.  In  particular,  this  re-examination  has
focused on  insurance  company  investment  and  solvency  issues  and,  in some
instances,  has resulted in new interpretations of existing law, the development
of new laws and the implementation of internal  guidelines.  The NAIC has formed
committees to study and formulate regulatory proposals on such diverse issues as
the  use  of  surplus  debentures,   accounting  for  reinsurance  transactions,
assumption reinsurance,  valuation of securities, the adoption of RBC rules, the
codification of Statutory Accounting  Principles,  and the regulation of various
products offered by insurance companies.

         In connection with its accreditation of states, the NAIC has encouraged
states to adopt  model NAIC laws on  specific  topics,  such as holding  company
regulations and the definition of  extraordinary  dividends.  Model  legislation
proposed  by the NAIC to  control  the amount of  dividends  that may be paid by
insurance  companies without prior regulatory  approval has been adopted in most
states and is being  considered by the  legislatures of the other states.  North
Carolina,  Pennsylvania  and Texas,  the states of  domicile  for the  Company's
insurance  subsidiaries,  have  adopted  dividend  tests that are  substantially
similar  to that  of the  NAIC's  model  legislation.  Most  states  only  allow
dividends to be paid out of unassigned funds. State laws affecting  dividends by
the Businesses Held for Sale and Retained Businesses are described below.

         Business Held for Sale

         Pursuant  to  the  laws  of  Pennsylvania   (PLIC's  and   Peninsular's
         domiciliary  state),  a dividend may be paid by PLIC and  Peninsular if
         the amount of such dividend  together  with all  dividends  made in the
         preceding  twelve months does not exceed the greater of: (i) 10% of its
         statutory  surplus as of the end of the prior calendar year or (ii) its
         net  income  for the  prior  calendar  year.  Any  dividend  above  the
         prescribed amount


                                       18
<PAGE>



         is an "extraordinary"  dividend, and a Pennsylvania insurer may not pay
         an  "extraordinary"  dividend to its stockholders until the earlier of:
         (i) 30 days after the Pennsylvania  Insurance Commissioner has received
         written  notice of the  declaration  thereof  and has not  within  such
         period  disapproved such payment,  or (ii) the receipt of approval from
         the Pennsylvania Insurance Commissioner.

         Texas law permits its domestic  insurers  which  include  Constitution,
         Marquette,  Professional,  Union  Bankers  and United  Life  (effective
         December  18,  1998,  United  Life was  redomesticated  to  Texas  from
         Louisiana)  to pay a  dividend  without  prior  consent  of  the  Texas
         Insurance  Commissioner  if the amount  paid,  together  with all other
         dividends paid in the preceding 12 months,  does not exceed the greater
         of:  (i)  10% of its  statutory  surplus  as of  the  end of the  prior
         calendar year or (ii) its net income for the prior  calendar  year. Any
         dividend  above this  amount  would be  considered  an  "extraordinary"
         dividend  and could not be paid until the earlier of: (i) 30 days after
         the Texas Insurance Commissioner has received notice of the declaration
         thereof and has not within such period  disapproved  such  payment,  or
         (ii) the Texas Insurance  Commissioner shall have approved such payment
         within the 30 day period.

         Retained Business

         Texas law permits AA Life, OLIC,  Pioneer  American,  Pioneer Security,
         Pacific  Life,  Security Life and  Southwestern  Life to pay a dividend
         without prior consent of the Texas Insurance Commissioner if the amount
         paid,  together  with all  other  dividends  paid in the  preceding  12
         months,  does not  exceed  the  greater  of:  (i) 10% of its  statutory
         surplus as of the end of the prior calendar year or (ii) its net income
         for the prior  calendar  year.  Any dividend above this amount would be
         considered an "extraordinary"  dividend and could not be paid until the
         earlier  of: (i) 30 days  after the Texas  Insurance  Commissioner  has
         received  notice of the  declaration  thereof  and has not within  such
         period   disapproved   such  payment,   or  (ii)  the  Texas  Insurance
         Commissioner shall have approved such payment within the 30 day period.

         On the basis of 1998  statutory  financial  statements  filed  with the
state insurance  regulators,  the NAIC  calculates  twelve  financial  ratios to
assist state  regulators  in  monitoring  the  financial  condition of insurance
companies.  A "usual  range" of results  for each ratio is used as a  benchmark.
Departure  from the  usual  range on four or more of the  ratios  could  lead to
inquiries from individual state insurance departments.  The Company's businesses
experienced the departures from the usual ranges on the following ratios:

         Business Held for Sale

         PLIC had three of the twelve ratios outside of the usual range.  PLIC's
         variances were caused primarily as a result of examination  adjustments
         required by the Pennsylvania  Department of Insurance.  Remedial action
         was taken by the Company in 1997 and 1998.  Constitution had six ratios
         outside the usual ranges  primarily  attributable to realized losses on
         sales of investments  and the recapture of a reinsurance  contract with
         an affiliate.  Union Bankers had four ratios  outside the usual ranges,
         primarily resulting from a loss on an affiliated investment and effects
         from the  amortization  of a deferred gain on a  reinsurance  contract.
         Marquette had two ratios outside the usual ranges  primarily  resulting
         from the  recapture of a  reinsurance  contract.  Professional  had two
         ratios  outside the usual range.  Professional's  variances were caused
         primarily  as a result of  statutory  losses.  Peninsular  also had two
         ratios outside the range.  Peninsular's variances were caused primarily
         as a result  of  increased  reinsurance  between  OLIC and  Peninsular.
         United Life had one of the twelve ratios outside of the usual ranges as
         a result  of  reserve  changes  in its life  business.  United  Life is
         primarily an annuity insurer and the life business is a small component
         of its operations.

         Retained Business

         OLIC had four of the twelve  ratios  outside the usual  ranges.  OLIC's
         variances  were caused  primarily as a result of increased  reinsurance
         between  OLIC and  Peninsular.  PLAIC  had  three  ratios  and  Pioneer
         Security had two ratios  outside of the usual range  established by the
         NAIC.  PLAIC and Pioneer Security are primarily  holding  companies for
         their  principal  assets,  being the  common  stock of  certain  of the
         Company's insurance  subsidiaries.  Security Life had one ratio outside
         the  usual  range as a result  of an  increase  in  policy  surrenders.
         American-Amicable,  Pioneer American and Southwestern  Life had none of
         the twelve ratios outside of the usual ranges.



                                       19
<PAGE>



         In the past, variances in the insurance companies' ratios have resulted
in inquiries from insurance departments to which the Company has responded.  The
Company may receive inquiries from certain insurance departments  concerning its
ratio  results  for  1998,  and there can be no  assurance  that such  insurance
departments will not take action against the insurance companies.

         In December  1992,  the NAIC  adopted  the RBC for Life  and/or  Health
Insurers  Model Act (the "Model  Act").  The main purpose of the Model Act is to
provide a tool for insurance regulators to evaluate the capital of insurers with
respect to the risks assumed by them and  determine  whether there is a need for
possible  corrective  action with respect to them. To date, either the Model Act
or similar  legislation  or regulation  has been adopted in all the  domiciliary
states of the Company's insurance subsidiaries.

         The Model Act provides for four different  levels of regulatory  action
with respect to statutory  financial  statements  for the calendar year 1994 and
thereafter,  each of which  may be  triggered  if an  insurer's  Total  Adjusted
Capital  (as defined in the Model Act) is less than a  corresponding  "level" of
RBC. The "Company  Action  Level" is  triggered if an insurer's  Total  Adjusted
Capital is less than 200.0% of its "Authorized Control Level RBC" (as defined in
the Model Act) or less than 250.0% of its  Authorized  Control Level RBC and the
insurer has a negative  trend.  At the Company  Action  Level,  the insurer must
submit  a  comprehensive  plan  to the  regulatory  authority,  which  discusses
proposed  corrective  actions to improve its capital  position.  The "Regulatory
Action Level" is triggered if an insurer's  Total Adjusted  Capital is less than
150.0% of its Authorized  Control Level RBC. At the Regulatory Action Level, the
regulatory authority will perform a special examination of the insurer and issue
an order specifying  corrective  actions that must be followed.  The "Authorized
Control Level" is triggered if an insurer's Total Adjusted  Capital is less than
100.0% of its  Authorized  Control  Level RBC, and at that level the  regulatory
authority is authorized  (although not mandated) to take  regulatory  control of
the insurer.  The "Mandatory  Control Level" is triggered if an insurer's  Total
Adjusted Capital is less than 70.0% of its Authorized  Control Level RBC, and at
that level the regulatory authority must take regulatory control of the insurer.
Regulatory control may lead to rehabilitation or liquidation of an insurer.

         Calculations   using   the  NAIC   formula   and  the  life   insurance
subsidiaries'  statutory financial  statements as of December 31, 1998, indicate
that each of the  insurance  subsidiaries'  capital  exceeded RBC  requirements,
except for PLIC (see Note 20 of Notes to Consolidated Financial Statements).

         Certain licenses of the Company's  insurance  company  subsidiaries are
subject to limits on the amount of new  business  that may be written in various
states.  Of  these  license  restrictions,   most  were  imposed  prior  to  the
acquisition  of the relevant  insurance  subsidiary  by  PennCorp,  or relate to
events occurring prior to those  acquisitions.  These license  restrictions have
not had a material adverse effect on the Company's results of operations and are
not expected to have a material adverse effect in the future.  In some states, a
license  restriction,  suspension  or  revocation by another state may result in
reciprocal regulatory action.

         The Company may be  required,  under the  solvency or guaranty  laws of
most  states  in which  it does  business,  to pay  assessments  (up to  certain
prescribed  limits) to fund  policyholder  losses or  liabilities  of  insurance
companies that become  insolvent.  Recent  insolvencies  of insurance  companies
increase  the  possibility  that  such   assessments  may  be  required.   These
assessments  may be deferred or forgiven  under most guaranty laws if they would
threaten an  insurer's  financial  strength  and, in certain  instances,  may be
offset against future premium taxes.  The Company paid  approximately  $300,000,
$2.5  million and $2.6 million for the years ended  December 31, 1998,  1997 and
1996, respectively, as a result of such assessments.

         On March 16,  1998,  the NAIC  approved the  codification  of statutory
accounting  practices.  The  codification  will  constitute  the only  source of
"prescribed"  statutory  accounting  practices and is subject to adoption by the
Department  of Insurance of the state of domicile.  The  Statements of Statutory
Accounting Principles established under the codification are generally effective
January 1, 2001.  The Company has not  determined the impact the adoption of the
codification will have on unassigned surplus of each insurance subsidiary.

         Although the federal government does not directly regulate the business
of insurance,  federal legislation and administrative policies in several areas,
including pension  regulation,  age and sex  discrimination,  financial services
regulation and federal taxation can significantly affect the insurance business.

         In addition, there were proposals under consideration since 1994 at the
federal  and state  levels  regarding  reforms to the health  care system in the
United States.  Although these  proposals were not adopted at the federal level,
many states have  adopted  some form of health  care  reform  since then.  These
reforms have focused on the increasing  cost of health care and insurance  plans
that reimburse  insureds or health care providers for medical and related costs.
Because the Company's


                                       20
<PAGE>



fixed benefit  products  provide  supplemental  income payments  directly to the
insured and are not designed to  reimburse  health care  providers,  the Company
does not expect such reforms to have a material adverse effect on its business.

         There can be no  assurance  that  existing  insurance-related  laws and
regulations  will not become more  restrictive  in the future and thereby have a
material  adverse  effect on the operations of the Company and on the ability of
the  insurance  companies  to  pay  dividends.  Additionally,  there  can  be no
assurance that existing  insurance-related  laws and regulations will not have a
material  adverse effect on the ability of  Constitution to make payments on its
respective surplus  debentures.  For further information related to said surplus
debentures,  see "Management's  Discussion and Analysis of Results of Operations
and   Financial   Condition--Financial    Condition,   Liquidity   and   Capital
Resources--Surplus  Debentures and Dividend  Restrictions" and Note 14 of "Notes
to Consolidated  Financial Statements."  Furthermore,  there can be no assurance
that existing  insurance-related  laws and regulations  will not have a material
adverse effect on the ability of PLAIC and Pioneer  Security to make payments on
their respective surplus  debentures.  For further  information  related to said
surplus  debenture,  see  "Management's  Discussion  and  Analysis of Results of
Operations and Financial  Condition--Financial  Condition, Liquidity and Capital
Resources--Surplus  Debentures and Dividend  Restrictions" and Note 14 of "Notes
to Consolidated Financial Statements."

         The Company is continually  evaluating actuarial assumptions associated
with interest  sensitive life insurance  contracts in which the determination of
policy  reserves is highly  sensitive to assumptions  such as withdrawal  rates,
investment earnings rates,  mortality rates, and premium persistency.  Currently
reflected in the Company's financial  statements are policy reserves and account
values  associated with such contracts,  which aggregated  approximately  $525.4
million and $504.6  million as of December 31, 1998 and 1997,  respectively.  If
developing  trends were to  continue,  the  Company  would be required to record
additional  reserves or reduce  intangible  assets,  which could have a material
impact on the Company's financial position and results of operations. Management
is also assessing the potential impact of future management actions, which might
mitigate the financial impact of these trends. Types of management actions would
likely include,  but are not limited to, the  redetermination  of non-guaranteed
charges  and/or   benefits  under  the  contracts,   asset   segmentation,   and
reinsurance.  There  are  risks  associated  with  management  action  including
potential sales disruption and the threat of litigation.

         In January 1999, Security Life initiated  management action in the form
of a new  exchange  program for certain  policyholders  of  Security  Life.  The
program is being offered to all  policyholders  who had certain  policy forms in
force as of January 1, 1998. The program allows the  policyholder  the following
options in exchange for  terminating  his or her policy and executing a release:
(i) refund of 115% of all premiums  paid for the policy prior to January 1, 1999
and 100% of premiums paid thereafter; (ii) exchange the policy, without proof of
insurability, for the same face amount in a universal life policy, or a new term
universal life policy. The policyholder also has the choice of not accepting the
exchange program and keeping the current policy in force.

         The exchange  program is not expected to have a material  effect on the
Company's  financial  position  or results  of  operations.  However,  statutory
surplus of Security  Life could be reduced by  approximately  $12.5 million on a
pre-tax basis if every eligible policyholder elects the exchange option.

         The Company is  continuing to refine its  actuarial  estimates,  likely
management   action   plans  and   associated   sensitivity   testing   of  such
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.

RATINGS

         A.M. Best Company  ("A.M.  Best")  assigns  fifteen  letter  ratings to
insurance companies,  with the highest being "A++ (Superior)." A.M. Best ratings
are based upon factors relevant to policyholders and are not directed toward the
protection  of  investors,  such as  holders  of the  Common  Stock.  All of the
Company's life insurance subsidiaries,  except Peninsular and Marquette, carry a
"B+ (Very Good)"  rating from A. M. Best. A "B+ (Very Good)" rating is the sixth
highest letter  rating.  These ratings  reflect a downgrade  during 1998 from A-
(two  letter  ratings)  for United  Life and AA Life,  and from B++ (one  letter
rating) for Southwestern Life,  Security Life, OLIC,  Professional,  PLIC, Union
Bankers and Constitution.  A.M. Best also has a "Not Assigned"  category,  which
contains nine  classifications for companies not assigned or not eligible for an
A.M. Best rating.  The A.M. Best rating for Peninsular is "NA-9," which is a "no
rating at the company's request." This classification was requested by the prior
owner of Peninsular. The Company does not intend to seek a letter rating at this
time for  Peninsular  from A.M.  Best as  Peninsular  is not  currently a direct
writer of  insurance  products.  The A.M.  Best rating for  Marquette is "NA-3,"
which is  "inapplicable"  as the  Company is not  currently  a direct  writer of
insurance products and has limited activity.  The purchase and sale contract for
the Career Sales  Division  requires  PLIC,  Union Bankers and  Constitution  to
maintain  or be assured of an A.M.  Best rating of at least B+ as of the closing
date.


                                       21
<PAGE>



EMPLOYEES

         At December 31, 1998, the Company had 1,247 full time  employees.  None
of the Company's employees were represented by any union.

Item 2.   Properties

FACILITIES

         The Company's primary  administrative  offices are located in New York,
New York;  Dallas,  Texas;  and Raleigh,  North  Carolina.  The Company owns and
occupies a home office facility comprising approximately 165,000 rentable square
feet, in Raleigh,  North Carolina.  The Company subleases a portion of its prior
Raleigh  home  office  facility  which  has a lease  term  expiring  in 1999 and
requires annual lease payments of approximately $1.1 million.

         The  Company  leases  approximately  100 offices  throughout  its sales
territories and has a separate  Canadian  business office facility that includes
office and storage space.  Southwestern  Financial Services Corporation ("SFSC")
leases  approximately  125,000 square feet in Dallas, Texas at an annual cost of
$1.8 million.  American-Amicable  owns its home office facility in Waco,  Texas.
The Company  believes that the current  makeup of its properties is adequate for
its operations and, based on its recent experience, that it will be able to find
suitable  replacement  properties on acceptable terms for properties the Company
chooses to replace or for which leases are terminated or not renewed.

Item 3.   Legal Proceedings

         On August 25, 1998, the first of ten class-action complaints were filed
in the  United  States  District  Court for the  Southern  District  of New York
against the Company and certain of its current or former directors and officers.

         During a pre-trial  conference on November 9, 1998,  all parties agreed
to the  consolidation  of all  of the  actions  and  the  Court  appointed  lead
plaintiffs on behalf of shareholders  and  noteholders.  The Court also approved
the  selection  of three law  firms as  co-lead  counsel  for  shareholders  and
noteholders.  Pursuant to a schedule agreed to at the conference, a consolidated
and  amended  complaint  was filed on January  22,  1999.  A First  Consolidated
Amended Class Action  Complaint  naming,  as defendants,  the Company,  David J.
Stone,  formerly  Chairman and Chief  Executive  Officer,  and Steven W. Fickes,
formerly  President and Chief Financial Officer was filed on March 15, 1999 (the
"Complaint").

         The Complaint alleges that defendants  violated the Securities Exchange
Act of 1934.  Among other things,  plaintiffs'  claim that  defendants  issued a
series of materially false and misleading  statements and omitted material facts
regarding the Company's financial  condition,  including the value of certain of
its assets, and failed to timely disclose that it was under investigation by the
Securities and Exchange Commission (the "SEC").

         Plaintiffs seek to recover damages in unspecified  amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the  Company's  subordinated  notes  during  the period of  February  8, 1996
through November 16, 1998.

         During a  conference  on March 19,  1999,  defendants  sought  and were
granted permission to file a motion to dismiss the Complaint. Although there are
not assurances that the motion to dismiss will be granted,  management  believes
that  there  are  meritorious  defenses  to the  action  that  will be raised in
connection with the motion,  including  whether the Complaint  adequately pleads
scienter  (i.e.,  intent to defraud) as  required  under the Private  Securities
Litigation Reform Act of 1995.

         The Company has notified  its primary and excess  carriers of directors
and officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15 million of primary
and $10 million of excess coverage,  respectively,  for securities  claims.  The
primary insurance  coverage requires the Company to bear 25% of all expenses and
any losses in excess of the $1 million retention amount.  The primary and excess
carriers have reserved  their rights under the policies with respect to coverage
of the claims set forth in the Complaint.

         The Company expects that this litigation will not affect its ability to
operate  through  December  31,  1999.  While it is not  feasible  to predict or
determine the final outcome of these  proceedings  or to estimate the amounts or
potential range of loss with respect to these matters,  management believes that
if there is an adverse outcome with respect to such  proceedings it would have a
material  adverse  impact on the Company and affect its ability to operate as is
currently intended.


                                       22
<PAGE>



         On July 30, 1998,  the SEC notified the Company that it has commenced a
formal  investigation  into possible  violations of the federal  securities laws
including  matters  relating  to the  Company's  restatement  of  its  financial
statements  for the first nine months of 1997,  and for the years ended December
31, 1994,  1995 and 1996. The Company and its  management are fully  cooperating
with the SEC in its investigation.

         The Company is a party to various  pending or threatened  legal actions
arising in the ordinary course of business, some of which include allegations of
insufficient  policy  illustration  and agent  misrepresentations.  Although the
outcome  of such  actions is not  presently  determinable,  management  does not
believe  that such  matters,  individually  or in the  aggregate,  would  have a
material  adverse  effect on the  Company's  financial  position  or  results of
operations if resolved against the Company.

         In May 1998, the North Carolina Attorney  General's Office (the "NCAG")
initiated an inquiry  concerning  certain life insurance  products  historically
sold by Security  Life and  representations  allegedly  made by Security  Life's
agents and officers  with respect to not changing  insurance  charges  after the
eighth policy year for  non-smoker  insureds.  The NCAG  indicated that Security
Life may be estopped to change its current  practice of not charging the cost of
the insurance because of certain  representations made by agents and officers of
Security  Life.  Although  Security  Life has not charged the cost of  insurance
charges for  non-smoker  policyholders  who recently  reached their ninth policy
year, this practice is not guaranteed  under the life insurance  contracts.  The
contracts  specifically  allow  Security  Life the right to  change  the cost of
insurance  rates in accordance  with the  parameters  set forth in the insurance
contracts.  Security Life has responded to the NCAG's inquiry by denying that it
is  estopped  from  changing  the cost of  insurance  rates based on the alleged
representations,  and continuing to reserve its contractual rights to change the
cost of  insurance  rates in  accordance  with the  parameters  set forth in the
insurance contracts. In June 1998, the NCAG informed Security Life that it could
not  adjudicate  this  matter  and  left  it  mutually  unresolved.  No  further
communications  from the NCAG  have  been  received  to date.  The  Company  has
initiated an exchange program which enables policyholders of such life insurance
products to terminate  their  policies  and obtain  either (i) the refund of all
premiums paid and other consideration or (ii) another Security Life product. See
Item 1. Business --  Regulatory  Matters.  There can be no  assurances  that the
exchange  program will be  successful  or that the Company  will  resolve  these
matters on such life insurance  product on a satisfactory  basis,  or at all, or
that  any such  resolution  would  not have a  material  adverse  effect  on the
Company's financial condition, results of operations or cash flows.

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

         None.



                                       23
<PAGE>



                                     PART II

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

MARKET FOR COMMON STOCK

         The shares of Common  Stock of the  Company  are listed on the New York
Stock Exchange  ("NYSE") under the ticker symbol "PFG." The following table sets
forth for the calendar periods indicated, the high and low sales price per share
of the  Company's  Common Stock as reported on the NYSE and the  quarterly  cash
dividends  declared  on the Common  Stock with  respect  to each  quarter  since
January 1, 1997. The prices do not include mark-ups, mark-downs, or commissions.
As of February 28, 1999,  there are  approximately  260  shareholders  of record
throughout the United States and abroad.

         The price history as provided by NYSE and dividends for the years ended
December 31, 1998 and 1997, are presented below:

<TABLE>
<CAPTION>
                                                             SALES PRICE          DIVIDEND
  FOR THE YEAR ENDED DECEMBER 31, 1998                     HIGH        LOW        DECLARED
  ------------------------------------                   --------   --------    ----------
  <S>                                                    <C>        <C>            <C>   
  Fourth quarter.....................................    $  2.250   $  0.500       $   --
  Third quarter......................................      20.750      1.750           --
  Second quarter.....................................      28.688     20.125         0.05
  First quarter......................................      35.938     27.813         0.05

                                                             SALES PRICE          DIVIDEND
  FOR THE YEAR ENDED DECEMBER 31, 1997                     HIGH        LOW        DECLARED
  ------------------------------------                   --------   --------    ----------

  Fourth quarter......................................   $ 35.875   $ 30.188       $ 0.05
  Third quarter.......................................     40.375     29.500         0.05
  Second quarter......................................     38.500     30.125         0.05
  First quarter.......................................     39.000     32.000         0.05
</TABLE>


                  (Remainder of Page Intentionally Left Blank)



                                       24
<PAGE>
Item 6.   Selected Consolidated Financial Data
<TABLE>
<CAPTION>
For the years ended December 31,                     1998          1997         1996         1995         1994
                                                  -----------  -----------  -----------  -----------   ----------
                                                            (In thousands, except per share amounts)
<S>                                               <C>          <C>          <C>          <C>           <C>      
Revenues:
   Policy revenues..............................  $  459,158   $  345,566   $  348,090   $  301,889    $ 244,422
   Net investment income........................     369,052      273,237      210,734      102,291       51,850
   Other income(1)..............................      37,717       46,476       43,703       21,794        1,056
   Net gains (losses) from the sale
     of investments.............................      14,068       17,487        1,257        3,770       (3,556)
                                                  ----------   ----------   ----------   ----------    ---------
       Total revenues...........................     879,995      682,766      603,784      429,744      293,772
                                                  ----------   ----------   ----------   ----------    ---------
Benefits and expenses:
   Claims incurred..............................     308,432      202,472      188,727      141,876      112,650
   Change in liability for future policy benefits
     and other policy benefits..................     233,330      121,817       83,184       20,047       (9,329)
   Insurance and other operating expenses.......     376,941      264,607      181,678      164,126      111,524
   Interest and amortization of deferred
      debt issuance costs.......................      42,960       23,355       18,579       19,520       18,274
   Impairment provision associated with assets
     of Businesses Held for Sale................     342,960           --           --           --           --
                                                  ----------   ----------   ----------   ----------    ---------
       Total benefits and expenses..............   1,304,623      612,251      472,168      345,569      233,119
                                                  ----------   ----------   ----------   ----------    ---------
Income (loss) before income taxes and
 extraordinary charge...........................    (424,628)      70,515      131,616       84,175       60,653
   Income taxes (benefits)......................      (3,369)      20,375       40,957       27,829       22,163
                                                  ----------   ----------   ----------   ----------    ---------
Income (loss) before extraordinary charge.......    (421,259)      50,140       90,659       56,346       38,490
   Extraordinary charge, net of income taxes....      (1,671)          --       (2,372)          --           --
                                                  ----------   ----------   ----------   ----------    ---------
Net Income (loss)...............................    (422,930)      50,140       88,287       56,346       38,490
   Preferred stock dividend requirements........      18,273       19,533       14,646        6,540        1,151
                                                  ----------   ----------   ----------   ----------    ---------
Net income (loss) applicable to common stock....  $ (441,203)  $   30,607   $   73,641   $   49,806    $  37,339
                                                  ==========   ==========   ==========   ==========    =========
(1)  Includes  $19.0  million,  $21.0  million  and $4.7 million of equity in earnings of unconsolidated
     affiliates for the years ended 1997,  1996 and 1995, respectively.
Per Share Information:
Basic:
   Net income (loss) applicable to common stock
     before extraordinary charge................  $   (15.17)  $     1.09   $     2.79   $     2.26    $     1.95
   Net income (loss) applicable to common stock
     before net gains (losses) from the sale of
     investments, restructuring costs and
     impairment provision associated with assets
     of Businesses Held for Sale and extraordinary
     charge(2)..................................  $    (3.36)  $     1.16   $     2.76   $     2.26    $     2.07
   Extraordinary charge, net of income taxes....  $    (0.06)  $       --   $    (0.09)  $       --    $       --
   Common shares used in computing basic earnings
     per share..................................      29,091       28,016       27,208       22,048        19,112
Diluted:
   Net income (loss) applicable to common stock
      before extraordinary charge...............  $   (15.17)  $     1.07   $     2.49   $     2.12    $     1.88
   Net income (loss) applicable to common stock
     before net gains (losses) from the sale of
     investments, restructuring costs and
     impairment provision associated with assets
     of Businesses Held for Sale and
     extraordinary charge (2)...................  $    (3.36)  $     1.13   $     2.47   $     2.12    $     2.00
   Extraordinary charge, net of income taxes....  $    (0.06)  $       --   $    (0.07)  $       --    $       --
   Common shares used in computing diluted
     earnings per share.........................      29,091       28,645       35,273       25,216        19,851
Cash dividends declared.........................  $     0.10   $     0.20   $     0.20   $     0.06    $     0.04
As of December 31,
Assets:
Investments and cash............................  $2,956,254   $3,340,114   $3,694,609   $2,288,979    $  822,778
Insurance assets................................     347,728      617,318      639,798      499,668       342,547
Other assets....................................     305,615      766,703      474,916      354,271       144,244
Assets of Businesses Held for Sale..............   2,421,804           --           --           --            --
                                                  ----------   ----------   ----------   ----------    ----------
   Total assets.................................  $6,031,401   $4,724,135   $4,809,323   $3,142,918    $1,309,569
                                                  ==========   ==========   ==========   ==========    ==========
Liabilities and shareholders' equity:
Insurance liabilities...........................  $2,867,038   $3,289,925   $3,566,455   $2,221,161    $  788,223
Notes payable...................................     550,923      359,755      210,325      307,271       229,041
Other liabilities...............................     110,945      194,352      170,302      125,351        58,903
Liabilities of Businesses Held for Sale.........   2,066,554           --           --           --            --
Redeemable preferred stock......................          --       19,867       32,864       30,007        37,256
Shareholders' equity............................     435,941      860,236      829,377      459,128       196,146
                                                  ----------   ----------   ----------   ----------    ----------
   Total liabilities and shareholders' equity...  $6,031,401   $4,724,135   $4,809,323   $3,142,918    $1,309,569
                                                  ==========   ==========   ==========   ==========    ==========
(2)   During 1995, the Company incurred restructuring charges aggregating $3.9 million.
</TABLE>
                                       25
<PAGE>

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

         This "Management's  Discussion and Analysis of Financial  Condition and
Results of  Operations"  reviews the  consolidated  financial  condition  of the
Company as of December 31, 1998 and 1997, the consolidated results of operations
for the three years ended December 31, 1998, and where appropriate, factors that
may affect future financial performance.

         The  following  discussion  should  be read  in  conjunction  with  the
accompanying  consolidated financial statements and related notes of this Annual
Report on Form 10-K.

CAUTIONARY STATEMENT

         Cautionary  Statement for purposes of the Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995. All statements, trend analyses
and  other  information  contained  in  this  report  relative  to  markets  for
PennCorp's products and trends in PennCorp's operations or financial results, as
well as  other  statements  including  words  such as  "anticipate,"  "believe,"
"plan,"  "estimate,"   "expect,"   "intend,"  and  other  similar   expressions,
constitute  forward-looking  statements under the Private Securities  Litigation
Reform Act of 1995.  These  forward-looking  statements are subject to known and
unknown risks, uncertainties and other factors which may cause actual results to
be  materially   different  from  those  contemplated  by  the   forward-looking
statements.  Such factors  include,  among other  things:  (1) general  economic
conditions  and other  factors,  including  prevailing  interest rate levels and
stock market  performance,  which may affect the ability of PennCorp to sell its
products,  the market  value of  PennCorp's  investments  and the lapse rate and
profitability  of  insurance   products;   (2)  PennCorp's  ability  to  achieve
anticipated levels of operational  efficiencies and cost-saving  initiatives and
to meet cash requirements based upon projected  liquidity sources;  (3) customer
response to new products,  distribution channels and marketing initiatives;  (4)
mortality,  morbidity,  and other factors which may affect the  profitability of
PennCorp's  insurance  products;  (5) changes in the Federal income tax laws and
regulations  which may affect the relative tax  advantages of some of PennCorp's
products; (6) increasing competition in the sale of insurance and annuities; (7)
regulatory  changes or  actions,  including  those  relating  to  regulation  of
insurance  products  and  of  insurance  companies;   (8)  ratings  assigned  to
PennCorp's  insurance  subsidiaries by independent rating  organizations such as
A.M. Best, which the Company believes are particularly  important to the sale of
annuity and other accumulation  products; (9) PennCorp's ability to successfully
complete its year 2000 remediation  efforts,  (10) the ultimate realizable value
and sales  proceeds to be received  from the  Businesses  Held for Sale and (11)
unanticipated  litigation.  There can be no  assurance  that other  factors  not
currently  anticipated  by  management  will not also  materially  and adversely
affect the Company's results of operations.

GENERAL

         The  Company,   through  its  three   operating   divisions,   provides
accumulation,  life, and fixed benefit accident and sickness  insurance products
throughout the United States and Canada. The Company's products are sold through
several distribution channels,  including independent general agents,  exclusive
agents,  financial institutions and payroll deduction programs, and are targeted
primarily to lower and  middle-income  individuals in rural and suburban  areas.
These  products are  primarily  small  premium  accident and sickness  insurance
policies  with  defined  fixed  benefit  amounts,  traditional  whole  life  and
universal life insurance with low face amounts,  and accumulation  products such
as single premium deferred annuities.

         The Company's  financial  condition  and results of operations  for the
periods  covered by this and future  "Management's  Discussion  and  Analysis of
Financial  Condition  and  Results of  Operations"  are or will be  affected  by
several common factors, each of which is discussed below.

         Planned  Dispositions.  On February 18, 1998, the Company  announced it
had engaged investment  banking firms Salomon Smith Barney and Fox-Pitt,  Kelton
Inc.  to  review  strategic   alternatives  for  maximizing  shareholder  value,
including  the  sale of the  Company's  Career  Sales  Division.  The  Company's
decision to dispose of the Career Sales Division,  within a period not likely to
exceed one year,  resulted  in the assets and  liabilities  of the Career  Sales
Division to be considered "assets and liabilities of Businesses Held for Sale."

         On December 31, 1998, the Company entered into an agreement to sell the
Career Sales  Division and related  assets to Universal  American.  The purchase
price of $175.0  million is  subject  to  adjustment  based on the  capital  and
surplus of the Career Sales  Division at the closing  date.  The purchase  price
consists of $136.0  million in cash,  subject to  adjustment  and $39.0  million
initial  principal  amount of  subordinated  notes of  Universal  American.  The
subordinated  notes  bear  interest  at a rate of 8.0% per annum and  mature ten
years from date of issuance.  The accreted value of the notes will be subject to
offset in the event of adverse  development (or subject to increase in the event
of positive  development)  in the disability  income reserves of PLIC and may be
offset for other  indemnification  claims under the purchase and sale agreement.
In

                                       26
<PAGE>



addition, the Company is required under terms of the purchase and sale agreement
to deliver the Career  Sales  Division and related  assets with certain  minimum
levels of statutory  capital and surplus,  pay certain  ongoing  costs and other
expenses  which the Company  anticipates  will result in its  receiving net cash
proceeds of approximately $70.0 to $78.0 million.

         In  addition,  on  December  31,  1998,  the  Company  entered  into an
agreement to sell  Professional to GEFAH for $47.5 million in cash plus interest
through the closing date. The purchase  price is subject to an adjustment  based
on Professional's capital and surplus at the closing date. The Company currently
estimates receiving net cash proceeds for the Professional Sale of approximately
$40.0 million to $41.5 million.

         On February 21, 1999, the Company signed a definitive agreement to sell
the United Life Assets.  The  purchase  price  consists of $152.0  million and a
dividend payable by United Life at closing,  which the Company estimates will be
approximately  $2.1  million.  The  purchase  consideration  may be reduced as a
result of the Company's  obligation to purchase  certain  mortgages  from United
Life at closing.  Additionally,  a portion of the purchase price may be escrowed
at closing to fund the  Company's  obligation to purchase  additional  mortgages
from  United Life after  closing.  The Company  anticipates  receiving  net cash
proceeds  from  the sale of the  Untied  Life  Assets  of  approximately  $140.0
million.

         The  purchase  and  sale  agreements  for the  Career  Sales  Division,
Professional  and United  Life Assets are subject to  regulatory  approvals  and
other closing conditions.

         In the third quarter of 1998,  the Company made the decision to dispose
of KIVEX, an internet service  provider.  The Company has engaged the investment
banking  firm  of ING  Barings  Furman  Selz  in this  regard  and is  currently
soliciting  interest from prospective  purchasers.  To date, the Company has not
entered into a definitive agreement to sell KIVEX. In addition,  the Company has
made the decision to sell Marketing One,  excluding  those assets  included with
the sale of United Life.

         The  Company's  decision  to  dispose  of the  Career  Sales  Division,
Professional,  KIVEX,  United Life Assets and Marketing One, within a period not
likely to exceed one year resulted in the assets and  liabilities  of the Career
Sales Division, Professional,  KIVEX, United Life Assets and Marketing One to be
considered  "assets and liabilities  held for sale," and as such were segregated
from those of the  Retained  Businesses  for  purposes  of  presentation  of the
Company's financial information.

         The  Company  has   recently   engaged   Wasserstein,   Perella  &  Co.
("Wasserstein  Perella")  to review  the  Company's  capital  structure  and its
recapitalization   and  restructuring   alternatives.   Wasserstein  Perella  is
presently  evaluating  the  Company's  business  plan  alternatives  and capital
structure and will advise and assist it with developing strategies,  tactics and
timetables to  effectuate  financing,  refinancing,  sale,  recapitalization  or
restructuring transactions, as appropriate. These transactions may take the form
of: (i) a restructuring or  recapitalization  of the Company's equity (including
preferred or  preference  shares),  debt  securities  or other  indebtedness  or
obligations,  including an exchange transaction or otherwise; (ii) a sale of the
Company or any subsidiary; and (iii) a sale or placement of the Company's equity
or debt  securities or obligations  with one or more lenders or investors or any
loan or  financing,  or  rights  offering.  There can be no  assurance:  (i) the
Company will be successful in developing and  implementing  one or more of these
transactions;  (ii) the form the transactions will ultimately take; or (iii) the
timing to complete the process.

         Acquisitions  and Other  Transactions.  On January  2, 1998,  following
shareholder  approval at the Company's 1997 annual meeting of shareholders,  the
Company  consummated the acquisition  from KB Fund the SW Financial  Controlling
Interest  for an  aggregate  purchase  price of  $73.7  million  (not  including
acquisition expenses).

         On January 5, 1998,  following  shareholder approval at the 1997 annual
meeting  of  shareholders,  the  Company  consummated  the  acquisition  of  the
interests of Fickes and Stone  Knightsbridge  Interests for total  consideration
estimated to be $10.6 million (not including acquisition  expenses).  Mr. Fickes
will receive  consideration in the form of estimated  annual interest  payments,
ranging from  $301,000 to $330,000,  on April 15 each year through 2001 and will
be issued  173,160  shares of the Company's  Common Stock on April 15, 2001. The
Company issued 173,160 shares to Mr. Stone in July 1998.

         Restructuring  and Other Costs. As a result of the tremendous growth of
the Company and the  diversification of the underlying  business units resulting
from acquisitions over time, the Company began a strategic  business  evaluation
during  the  third  quarter  of  1996.  The  review   resulted  in  the  Company
establishing three divisional  platforms,  Career Sales Division,  Payroll Sales
Division and Financial Services Division in 1997.



                                       27
<PAGE>

         As a result,  the  Company  began to  realign  its  existing  operating
companies  and incurred  restructuring  costs  aggregating  approximately  $19.1
million  during  the year ended  December  31,  1997,  directly  and  indirectly
associated  with  the  initial  divisional  restructuring  which  had no  future
economic benefit ("restructuring costs").

         On January  2, 1998 and  January 5,  1998,  respectively,  the  Company
acquired  the SW  Financial  Controlling  Interest  and  the  Fickes  and  Stone
Knightsbridge  Interests.  The acquisitions  allowed the Company to complete its
divisional  restructuring which began in 1997. As a result, the Company incurred
restructuring  costs aggregating  approximately $11.8 million for the year ended
December  31,  1998,   directly  and  indirectly   associated   with  divisional
restructuring.

         In  addition,  the  Company  recorded  in the  fourth  quarter of 1998,
additional  restructuring  costs  aggregating  approximately  $9.2  million as a
result  of  the  decision  to  consolidate  or  merge  substantially  all of its
corporate functions into the Company's Dallas location.

         The  restructuring  costs  recognized the following for the years ended
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                       1998              1997
                                                                   -------------     -------------
                                                                            ($ in millions)
<S>                                                                <C>               <C>          
 Severance and related benefits incurred due to staff reduction..  $        10.1     $         5.4
 Estimated holding costs of vacated facilities...................            2.2               6.2
 Write-off of certain fixed assets and other impaired assets.....            4.0               1.5
 Estimated contract termination costs............................            4.7                --
 Write-off of investment in certain foreign operations which
   will be closed................................................             --               6.0
                                                                   -------------     -------------
      Total restructuring costs..................................  $        21.0     $        19.1
                                                                   =============     =============
</TABLE>

         During  the  years  ended  December  31,  1998 and  1997,  the  Company
re-evaluated  the  restructuring  costs and  reduced the  remaining  accruals by
approximately  $6.1 million and $2.3 million,  respectively,  as a result of the
final determination of certain obligations.

         The Company  incurred  approximately  $6.3  million and $4.7 million of
pre-tax  incremental  costs  ("period  costs")  associated  with  the  corporate
restructuring for the years ended December 31, 1998 and 1997, respectively. Such
costs are included in the Company's  Results of Operations as  underwriting  and
other administrative expenses.

         On August 30, 1997 the merger  agreement  between  Washington  National
Corporation  ("Washington  National")  and the Company  terminated.  The Company
incurred  legal,  accounting  and financial  advisory fees  associated  with the
merger.  In  addition,  the Company had begun to provide  certain  resources  to
Washington  National  including  personnel to perform policy  administration and
claims  processing  function on  Washington  National's  behalf.  The  aggregate
advisory  and  administration  costs  incurred by the  Company  during 1997 were
approximately $7.6 million.

         Impairment  Provision  Associated  with Assets of  Businesses  Held for
Sale.  For the year ended  December 31, 1998 the Company  recorded an impairment
provision  aggregating  $343.0  million.  In  accordance  with SFAS No. 121, the
Company recorded the impairment  provision in order to reflect the difference in
the  Company's  accounting  basis in the  Businesses  Held for Sale and the fair
value of the  consideration  that the  Company  would  likely  receive  for such
businesses.  The fair value of the consideration  likely to be received has been
primarily  based upon the terms of  definitive  sales  agreements.  The impaired
provisions  for the Career  Sales  Division,  Professional  and the United  Life
Assets were $328.6 million, $3.3 million and $11.1 million, respectively.

YEAR 2000 ISSUES

         Many computer and software  programs were designed to accommodate  only
two digit fields to represent a given year (e.g.  "98"  represents  1998). It is
highly  likely that such  systems  will not be able to  accurately  process data
containing date information for the year 2000 and beyond.  The Company is highly
reliant upon computer  systems and software as are many of the  businesses  with
which the Company interacts.  The Company's ability to service its policyholders
and  agents is  dependent  upon  accurate  and  timely  transaction  processing.
Transaction  processing in turn is dependent  upon the Company's  highly complex
interdependent  computer  hardware,  software,  telecommunications  and  desktop
applications.  The  inability  of the  Company or any of its  integral  business
partners to complete year 2000 remediation efforts associated with these highly


                                       28
<PAGE>



complex  and  interdependent  systems  could  lead  to  a  significant  business
interruption.  Such an  interruption  could  result in a decline in current  and
long-term profitability and business franchise value.

         The Company's  overall year 2000  compliance  initiatives,  include the
following components:  (i) assessment of all business critical systems (business
critical  systems includes  computer and other systems),  processes and external
interfaces and dependancies;  (ii) remediation or upgrading of business critical
systems;  (iii)  testing  of  both  modified  and  updated  systems  as  well as
integrated systems testing; (iv) implementation of modified and updated systems;
and (v) contingency  planning. As a part of the process, the Company has written
letters and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance  efforts and follows up  periodically.  Of those
parties that have responded,  the Company's most significant third party vendors
and  business  partners  have  indicated  that  they  have a plan for year  2000
compliance or believe that they are currently year 2000 compliant.

         The Company has engaged outside vendors and focused certain  employees'
full time  efforts to help in the full array of its year 2000  initiative.  This
includes  systems  assessment and monitoring  advice,  actual code  remediation,
communication  and consultation  with critical  business partners and additional
data center and testing  resources.  The Company  originally  projected to incur
internal and external costs  associated  with such expertise  ranging from $10.6
million to $14.5 million, which were anticipated to be incurred primarily during
1998 and early 1999. Based upon revised projections during the fourth quarter of
1998,  the Company  anticipates  incurring  internal and external  costs of $5.0
million during 1999. The Company estimates it has incurred internal and external
costs  aggregating  $13.4 million and $1.9 million for the years ended  December
31, 1998 and 1997, respectively.

         Each  of the  operating  divisions  is  primarily  responsible  for its
remediation efforts with corporate oversight provided as necessary.  The Company
believes  that the Career Sales  Division has  substantially  completed its year
2000 assessment and remediation efforts,  which will be subject to ongoing tests
for the remainder of 1999. In addition,  the Career Sales Division has committed
to a  strategy  of  utilizing  third  party  administrative  experts,  who  have
indicated year 2000 compliance,  to handle the processing of certain  components
of its health insurance  business,  thus eliminating the need for the upgrade or
modification of certain  existing  health  administration  systems.  The Payroll
Sales  Division has  completed  the  remediation  of its largest  administrative
platforms,  except  for AA Life,  and  anticipates  successful  remediation  and
testing of the remaining  sub-systems  and system  interfaces  during 1999.  The
Company  believes that the Payroll Sales Division,  other than AA Life, is 95.0%
complete with its compliancy effort for critical business systems. AA Life is in
the  process  of  upgrading  its  policy  administration  system  to a year 2000
compliant version. AA Life is relying on contracted vendor resources in order to
complete its upgrade process.  Based upon similar internal metrics analysis,  AA
Life has completed 90.0% of the total effort required for its critical  business
systems  to be year 2000  compliant.  The  efforts  of the  Company's  Financial
Services Division are highly dependent on the utilization of outside  resources.
The Company  believes that the Financial  Services  Division has contracted with
sufficient  resources to be able to remediate  its essential  business  systems.
Currently,  the Company believes that the Financial  Services  Division is 85.0%
complete with remediation efforts associated with its critical business systems.
The  Company  believes  that all of its  divisions  will  have  completed  their
remediation  efforts by May 1999,  but each  division  will  continue to perform
testing throughout 1999.

         Although the Company  believes  that its operating  divisions,  outside
vendors and most critical business partners will be sufficiently  compliant that
the year 2000  issue  should not cause a material  disruption  in the  Company's
business,  there can be no assurance that there will not be material disruptions
to the  Company's  business  or an  increase  in the cost of the  Company  doing
business.  Although the Company  believes  that the year 2000 issues  should not
cause a material disruption in the Company's business, the Company has developed
various  contingency  plans associated with remediation  tasks which the Company
believes are at a higher risk for potential failure.

         The  Company  has  provided  certain   assurances  to  each  respective
purchaser of the Businesses Held for Sale with respect to each entity's  ability
to process date-sensitive information for the year 2000 and beyond. Although the
Company believes that it will be able to meet the year 2000  representations and
warranties  provided to the respective  purchasers,  there can be no assurances.
Failure of the Company to meet such  representations and warranties could result
in a  decision  by  the  purchaser  not to  consummate  the  transaction  and/or
indemnification claims for breach of contract.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Parent Company

         General. PennCorp ("parent company") is a legal  entity,  separate  and
distinct from its  subsidiaries  and has no material  business  operations.  The
parent  company  needs  cash for:  (i)  principal  and  interest  on debt;  (ii)
dividends on


                                       29
<PAGE>



preferred and common stock; (iii) holding company administrative  expenses; (iv)
income taxes and (v) investments in subsidiaries. In September 1998, the Company
suspended  payment of preferred and common stock dividends.  The primary sources
of cash to meet these obligations  include  statutorily  permitted payments from
life  insurance  subsidiaries,  including:  (i) surplus  debenture  interest and
principal payments,  (ii) dividend payments; and (iii) tax sharing payments. The
parent  company may also obtain cash through the sale of  subsidiaries  or other
assets.

         The  following  table  shows the cash  sources  and uses of the  parent
company on a projected basis for 1999 and on an actual basis for the years ended
December 31, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                        Projected
                                                          1999           1998           1997            1996
                                                     -------------   -------------  -------------  -------------
                                                                           ($ in thousands)
   <S>                                               <C>             <C>            <C>            <C>          
   Cash sources:
     Cash from subsidiaries........................  $     283,670   $      73,521  $      34,839  $     143,244
     Other investment income.......................             --           2,865          3,547          2,428
     Sale of equity securities.....................             --          30,500             --             --
     Issuance of preferred and common stock........             --               3             --        294,607
     Additional borrowings.........................             --         203,000        250,000        230,000
     Other, net....................................          5,630           1,303          3,243          2,705
                                                     -------------   -------------  -------------  -------------
           Total sources...........................        289,300         311,192        291,629        672,984
                                                     -------------   -------------  -------------  -------------
   Cash uses:
     Acquisition of businesses.....................             --          73,858             --             --
     Interest paid on debt.........................         39,727          37,849         20,946         16,921
     Operating expenses, including
       restructuring charges.......................         19,882          36,217         24,362          1,136
     Purchase of treasury shares...................             --              --         28,760             --
     Reduction of notes payable....................        237,000         126,015        100,000        273,353
     Capital contributions to subsidiaries.........          1,500           7,853         14,889        208,708
     Purchase of equity securities.................             --           5,000         20,000             --
     Purchase of SW Financial note.................             --              --         40,000             --
     Issuance of surplus note to subsidiary........             --              --             --        155,000
     Redemption of preferred stock.................             --              --         14,705             --
     Dividends on preferred and common stock.......             --          16,210         23,460         17,480
     Other, net....................................          1,550              --          2,142             --
                                                     -------------   -------------  -------------  -------------
           Total uses..............................        299,659         303,002        289,264        672,598
                                                     -------------   -------------  -------------  -------------
   Increase (decrease) in cash and short-term
     investments...................................        (10,359)          8,190          2,365            386
   Cash and short-term investments at beginning
     of year.......................................         12,654           4,464          2,099          1,713
                                                     -------------   -------------  -------------  -------------
   Cash and short-term investments at end of year    $       2,295   $      12,654  $       4,464  $       2,099
                                                     =============   =============  =============  =============
</TABLE>

Cash Sources

         Cash from  Subsidiaries.  Cash  generated  by the  Company's  insurance
subsidiaries is made available to PennCorp principally through periodic payments
of principal and interest on surplus  debentures  issued by PLAIC,  Constitution
and Pioneer Security (collectively,  the "Surplus Note Companies"). With respect
to Constitution and Pioneer Security, the surplus debenture payments are made to
non-insurance intermediate holding companies and paid to the Company in the form
of dividends and tax sharing payments. The amounts outstanding under the surplus
debentures totaled $453.1 million and $358.3 million as of December 31, 1998 and
1997,  respectively.  The  surplus  debentures  generally  require  (subject  to
availability of statutory capital and surplus and in some instances,  regulatory
approval)  principal and interest  payments to be made  periodically  in amounts
sufficient to allow PennCorp to meet its cash requirements.

         The Surplus Note Companies rely upon dividends and tax sharing payments
from their respective insurance subsidiaries. Each of the insurance subsidiaries
is in turn subject to regulatory restrictions with respect to the maximum amount
of  dividends  that can be paid to the Surplus  Note  Companies  within a twelve
month period without prior regulatory


                                       30
<PAGE>



approval.  Such  dividend  restrictions  are  generally  the  greater  of 10% of
statutory  capital and surplus or statutory  earnings.  See  Business-Regulatory
Matters for additional discussions of dividend restrictions.

         For the years  ended  December  31,  1998,  1997 and 1996,  the Company
received surplus debenture  interest and principal  payments from PLAIC of $26.2
million, $16.4 million and $132.0 million,  respectively, and received dividends
and tax sharing  payments of $47.3  million,  $18.4  million and $11.3  million,
respectively.  The Surplus Note Companies received $69.5 million,  $32.1 million
and $25.8  million in dividends and tax sharing  payments from their  respective
insurance subsidiaries.

         Other  Investment  Income.  During  each of the years in the three year
period ended December 31, 1998, the Company  received  other  investment  income
from short-term invested assets held by the parent company.

         Sales of Equity  Securities.  During 1998 the parent company liquidated
its common and preferred stock holdings in ACO Brokerage Holding Corp.  ("ACO"),
the parent company of Acordia Inc. Total proceeds  received from the sale of the
preferred and common stock  aggregated  $30.5 million.  The Company had acquired
the  preferred  stock  interests  in ACO for $20.0  million  during 1997 and the
common stock interests in January 1998 for $5.0 million as part of the Company's
and the KB Capital Fund I  investment  in ACO. See Note 18 to Notes to Financial
Statements for additional information regarding the Company's investment in ACO.

         Issuance  of  Preferred  and Common  Stock.  In August 1996 the Company
issued 2,875,000 shares of $3.50 Series II Convertible  Preferred Stock ("Series
II  Convertible  Preferred  Stock")  for net  proceeds  of  $139.2  million.  In
addition,  in February 1996 PennCorp  completed the sale of 5,131,000  shares of
Common Stock,  netting  proceeds of $155.5 million  ("February 1996 Common Stock
Offering").  See Cash Uses  below  for the use of  proceeds  from the  Series II
Convertible Preferred Stock and February 1996 Common Stock Offerings.

         Additional  Borrowings.  During  each of the  years in the  three  year
period the  Company  borrowed  under then  existing  bank credit  facilities  to
primarily fund acquisitions or repay existing indebtedness.  See Cash Uses below
for the use of proceeds from the additional borrowings.

Cash Uses

         Acquisition  of  Businesses.  During  1998,  the Company  acquired  the
Controlling  Interest in SW Financial  for $73.7  million in cash and the Fickes
and Stone  Knightsbridge  Interests for $10.6  million of which  $200,000 of the
consideration  was paid in cash. To fund such  acquisitions the Company utilized
borrowing under its existing credit facility.  For additional information on the
acquisition of the Controlling Interest in SW Financial and the Fickes and Stone
Knightsbridge   Interests,  see  Note  3  of  Notes  to  Consolidated  Financial
Statements. During 1996, the Company acquired United Life for $110.1 million and
contributed  additional  capital to United Life of approximately  $57.3 million.
The Company  effectuated the  acquisition and capital  contribution by providing
funds to PLAIC in the form of a surplus  note  aggregating  $155.0  million from
proceeds  raised  under  the  Series  II  Convertible  Preferred  Offering.  For
additional  information on the acquisition of United Life see Note 3 of Notes to
Consolidated Financial Statements.

         Interest  Paid on  Indebtedness.  During  the three  year  period,  the
Company utilized varying amounts of leverage in its capital  structure.  For the
years  ended  December  31,  1998,  1997  and  1996,  the  average  indebtedness
outstanding  aggregated  $452.6  million,  $281.6  million  and $257.0  million,
respectively.  The Company's  weighted  average  costs of  borrowings  increased
significantly  during 1998 as a result of the Company's increased leverage ratio
and  projected  weakness in future  liquidity.  The Company  anticipates  higher
interest costs to continue for the year ended 1999.  For additional  information
regarding indebtedness, see Note 9 of Notes to Consolidated Financial Statements
and Results of Operations-Interest and Amortization of Deferred Debt Costs.

         Operating Expenses  Including  Restructuring  Charges.  During 1998 and
1997 the parent  company  directly  and  indirectly,  through  charges  from its
subsidiaries,  incurred significant operating and restructuring  charges.  Total
restructuring charges paid by the parent company during 1998 and 1997 aggregated
$9.1 million and $11.5  million,  respectively.  During 1999, the parent company
anticipates  funding $5.0 million of  restructuring  charges.  During 1998,  the
parent  company also incurred  legal,  accounting  and  investment  banking fees
associated with asset dispositions aggregating $1.5 million.  Operating expenses
also  include  costs  aggregating  $1.8  million   associated  with  shareholder
litigation and the SEC's investigation into the Company's historical  accounting
practices.  The Company anticipates  incurring  additional amounts of such costs
during 1999.



                                       31
<PAGE>

         Purchase of Treasury Shares.  During 1997 the Company utilized proceeds
from its existing credit facility to repurchase  approximately 819,000 shares of
Common Stock for $28.8 million in accordance  with an agreement  with the former
owner of United Life.

         Reduction in Notes  Payable.  In  conjunction  with the Company's  1998
acquisition of the SW Financial Controlling interest, the Company borrowed under
its  existing  $450 million  revolving  bank credit  facility  (the "Bank Credit
Facility") to repay indebtedness of SW Financial aggregating $115.0 million upon
acquisition.  In addition,  during 1998 the Company used  existing  liquidity to
repay $11.0 million of  indebtedness  under the company's Bank Credit  Facility.
During 1997,  the Company  utilized  proceeds  from the Bank Credit  Facility to
retire  indebtedness  aggregating $100.0 million  outstanding under a prior bank
credit  agreement.  The Company utilized  proceeds from its February 1996 Common
Stock Offering to repay approximately $137.0 million of subsidiary indebtedness.
Also during 1996, the Company  entered into a new $175 million  credit  facility
and  utilized  $100.0  million to repay a bridge loan  facility  entered into to
effectuate  the SW Financial  investment in December 1995 and  repurchase  $35.4
million  of  principal  amount  of  the  Company's  9 1/4%  Senior  Subordinated
Debenture due 2003 (the "Notes").

         Capital Contributions to Subsidiaries. For the years ended December 31,
1998,  1997 and 1996,  the Company made capital  contributions  to  subsidiaries
totaling $7.9 million,  $14.9 million and $208.7 million,  respectively.  During
1998, 1997 and 1996, these contributions were primarily made to certain non-life
insurance  subsidiaries,  principally  KIVEX,  to fund  expansion  and for other
corporate purposes. During 1996, the Company contributed $100.0 million to PLAIC
in connection with the acquisition of United Life.

         Purchase of Equity  Securities.  In conjunction with the acquisition of
the Fickes and Stone Knightsbridge  Interests,  the Company acquired Fickes' and
Stone's  interest in the ACO  Brokerage  Common Stock for $5.0  million.  During
1997, the Company invested $20.0 million in ACO Preferred Stock.

         Purchase of SW Financial Note. During 1997, the Company acquired all of
the issued and outstanding convertible subordinated indebtedness of SW Financial
aggregating  $40.0  million.  Such  indebtedness  was  previously  held  by  the
creditors of ICH Corporation.

         Issuance of Surplus Notes to Subsidiaries.  The Company issued a $155.0
million  surplus  note to PLAIC in order to  provide  funding  to PLAIC  for the
purchase  and capital  contributions  necessary  to  effectuate  the United Life
acquisition.

         Redemption  of  Preferred  Stock.  In March 1997 the  Company  utilized
proceeds  available under its then existing credit facility to redeem all of the
outstanding Series B Preferred Stock for $14.7 million.

         Dividends of Preferred and Common Stock. During 1998, 1997 and 1996 the
Company paid common and preferred  stock  dividends  aggregating  $16.2 million,
$23.5  million and $17.5  million,  respectively.  The  increase in amounts paid
during  1997 as  compared  to  1996  was  the  result  of the  $3.50  Series  II
Convertible  Preferred Stock being  outstanding for the entire year. The drop in
dividend  payments during 1998 was due to the Company's  decision to halt common
and  preferred  stock  dividend  payments  as a result  of  impending  liquidity
concerns.

Projected Cash Sources and Uses in 1999

         During 1999,  the Company  anticipates  receiving  approximately  $25.2
million in the form of  principal  and interest  payments or  dividends  and tax
sharing  payments  for the Surplus  Note  Companies  as a result of the ordinary
dividend  flow from the  Surplus  Notes  Companies  insurance  subsidiaries.  In
addition, the Company anticipates receiving principal payments under the surplus
debentures as a result of the sales of the Career Sales  Division,  Professional
and the United Life Assets by the Surplus Note  Companies.  Total cash  proceeds
anticipated  by the  Company  from such sales  aggregates  approximately  $258.5
million. The Company anticipates  utilizing $237.0 million to repay indebtedness
and the remainder of such proceeds to fund interest costs and operating expenses
of the parent company.  Consummation of the Career Sales Division,  Professional
and the United Life Assets sales transactions is subject to regulatory approvals
and other material closing  conditions.  Please refer to the reports on Form 8-K
filed on January 11, 1999 and March 11, 1999 for more  information on these sale
transactions.  Included  as  Exhibits  2.1  and  2.2 on the  Form  10-K  are the
definitive  purchase  and sale  agreements  for the Career  Sales  Division  and
Professional,  respectively.  There can be no  assurances  that the Career Sales
Division,  Professional  or the United Life Assets sales will be  consummated or
that the cash proceeds will be in the amount anticipated by the Company.

                                       32
<PAGE>

         The Company's  ability to receive principal and interest payments above
$25.2 million under the surplus notes is contingent  upon the Company's  ability
to consummate  each of the sales  transactions  of the Businesses  Held for Sale
currently under contract.  The Company has currently estimated net cash proceeds
after required debt reduction  under the Company's Bank Credit Facility of $21.1
million.  Such liquidity is necessary for the Company to fund interest  payments
under the Bank Credit  Facility and the notes and to fund operating  expenses of
the Company.  Though the Company has the  obligation to consummate  the sales of
the  Businesses  Held for Sale and to  prepay  the loans to  certain  covenanted
levels, the Company may not have the requisite ability to effectuate the sale as
a result of the  restrictive  covenants  contained  in the  Amended  Bank Credit
Facility. The accessibility of the cash proceeds of the Businesses Held for Sale
are the subject of regulatory  approval.  While certain  regulatory filings with
respect  to the sale of the  Businesses  Held for Sale have been  made,  not all
filings have been so made and the final structure by which such proceeds will be
upstreamed  to the  Company  have not yet been  finalized.  The  Amended  Credit
Agreement  provides  that the Company  and its  subsidiaries  are  limited  from
entering  into certain  mergers,  consolidations,  amalgamations,  liquidations,
winding up or  dissolutions,  incurring  certain  indebtedness  and liabilities,
making disposition,  prepaying certain  indebtedness,  declaring  dividends,  or
issuing,  redeeming,  purchasing,  retiring,  exchanging or  converting  capital
securities,  in each case with very limited or scheduled  exceptions.  While the
Company believes it has scheduled or otherwise  provided for a great majority of
the possible combinations it will take to effectively upstream the cash proceeds
of the sales of the Businesses  Held for Sale, it is not possible to foresee all
combinations.  Accordingly,  the  mechanism  to  upstream  to  the  Company  the
necessary  cash  to pay the  covenanted  prepayment  under  the  Amended  Credit
Agreement  may be subject to the  approval of the majority  banks which,  if not
given,  would  result in an event of  default  under  the  Amended  Bank  Credit
Agreement. Should the sale transactions not close within specified time periods,
the Company may face  difficulty  in meeting its  existing  and  estimated  cash
obligations  and would be in default of certain  covenants under the Bank Credit
Facility.

         The net proceeds available to the Company from the asset sales may vary
significantly  from  current  estimates  as a result  of (i)  minimum  levels of
statutory  capital and surplus  required to be  delivered at closing for certain
insurance  subsidiaries,  (ii) amounts to be held in escrow,  (iii) valuation of
certain  consideration  to be  received by the  Company,  (iv) the timing of the
closing and (v) various  indemnification  obligations  included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales  Division  requires the purchaser to be satisfied with  disability  claims
reserve  liabilities and other active life reserves.  The Company has engaged an
actuarial  consulting firm to provide  analysis to the purchaser  regarding such
reserves.   The  Company  is  aware  of   potential   deficiencies   aggregating
approximately $16.2 million in the statutory  determination of disability claims
reserves  that will  likely  impact the total  consideration  the  Company is to
receive.  The  Company and the  purchaser  have not  engaged in  discussions  to
resolve the disability claims reserve issue. In addition,  the purchase and sale
agreement  for the United Life Assets  requires the Company to purchase  certain
residential mortgage loans from United Life, should the loans not meet specified
criteria under the purchase and sale agreement or should United Life not be able
to  provide  clear  title to the  loans.  The  residential  loans  are part of a
servicing agreement with United Companies Financial Corporation, the "servicer,"
which has recently filed for bankruptcy. The servicer currently maintains within
its  control  all  applicable  loan  documents.  Should the Company be unable to
obtain satisfactory  control of all of the applicable  documents,  the Company's
anticipated  net  proceeds  from the United  Life Asset sale could be reduced by
approximately $12.6 million.  Such reduction would have a material impact on the
liquidity of the Company.

         In addition to the above proceeds,  there exists $7.0 million of unused
commitments under the Company's existing credit facility that are available only
for the purpose of payments of interests, should the Company not have sufficient
liquidity from other  sources.  Upon  consummation  of the Career Sales Division
divestiture the commitment will be reduced to $5.0 million.

         As a result  of these  anticipated  actions,  management  believes  the
Company  will  likely  have  sufficient  financial   flexibility  and  projected
liquidity sources to meet all cash requirements for 1999. However,  there can be
no assurances actual liquidity sources will develop as currently  projected.  In
the event of a shortfall of actual liquidity  sources,  the Company will explore
options  to  generate  any  necessary   liquidity  such  as:  (i)  the  sale  of
non-strategic subsidiaries and (ii) obtain regulatory approval for extraordinary
dividends  from its  insurance  subsidiaries  (which is  unlikely at the present
time).  If the  Company  is unable to obtain  sufficient  liquidity  to meet its
projected  cash  requirements,  such failure could result in a default on one or
more  obligations and the holders thereof would be entitled to exercise  certain
remedies,  including the acceleration of the maturity of the entire indebtedness
and commencing legal proceedings to collect the indebtedness. In such event, the
Company will examine and  consider  the range of available  alternatives  to the
Company at that time.

Subsidiaries, Principally Insurance Operations

         The insurance  subsidiaries' principal sources of cash are premiums and
investment income. The insurance  subsidiaries'  primary uses of cash are policy
claims, commissions, operating expenses, income taxes and payments to the

                                       33
<PAGE>

Company for  principal and interest due under  surplus  debentures,  tax sharing
payments  and   dividends.   Both  sources  and  uses  of  cash  are  reasonably
predictable.

         Cash  Flow  from  Operating   Activities.   Cash  flow  from  operating
activities,  excluding the parent company, were $34.2 million, $74.6 million and
$135.4  million,  respectively,  for the years ended December 31, 1998, 1997 and
1996. The decreasing trend in cash flow from operating  activities for the years
ended  December  31,  1998,  1997 and 1996,  is  primarily  attributable  to the
accounting treatment for KB Management. During the years ended December 31, 1997
and 1996, the Company maintained a 45% economic interest in KB Management. As of
January 2, 1998, the Company  purchased the remaining  interest in KB Management
(see Note 3 of Notes to Consolidated Financial  Statements).  From the formation
of KB  Management  in  1995,  KB  Management  provided  certain  management  and
acquisition  services to the Company.  From its formation through the year ended
December 31, 1996, the  transaction and management fees derived by KB management
were sufficient to offset the majority of the administrative costs which in turn
minimized the costs  associated  with the Company's 45% economic  interest in KB
Management.  During 1997, KB Management  operating and  administrative  expenses
grew disproportionately to the ability of KB Management to engage and consummate
acquisitions and other business transactions which would generate fee income and
the Company  recognized a net loss related to its 45%  economic  interest.  With
acquisition  of the remaining  interest in KB Management on January 2, 1998, the
net loss derived by KB  Management  for the year ended  December  31, 1998,  was
effectively recognized as a 100% economic interest by the Company.  Supplemental
factors to the  decreasing  trend in cash flow from  operating  activities  were
increasing  costs  associated  with:  (i) Year  2000  remediation  at all of the
insurance  subsidiaries,  (ii) the strategic business evaluations and associated
restructuring of the Company and (iii) the accelerating expansion and transition
of KIVEX from a regional to a national internet service provider.

         During  1995,   the  Company   established   a  portfolio  of  "trading
securities" to provide the Company with the  opportunity  to undertake  interest
rate hedging strategies,  to participate in short-term relative value trades and
to invest in special  situations with the goal of generating  short-term trading
profits. As of December 31, 1997, the Company held no investments in its trading
portfolio.

         Cash Flow from Investing Activities. The Company's investment portfolio
is  managed  with the  objectives  of  maintaining  high  credited  quality  and
liquidity,   maximizing   current  income  within  acceptable  levels  of  risk,
minimizing  market and credit risk, and matching the  anticipated  maturities of
investments to the Company's  liabilities.  The Company  believes a conservative
investment  strategy fits the nature of its insurance products which have little
or no inflation risk and limited build-up of cash accumulation values in earlier
years.

         The Company  continuously  evaluates its  investment  portfolio and the
conditions under which it might sell securities,  including  changes in interest
rates,  changes in prepayment risk,  liquidity needs, asset liability  matching,
tax planning  strategies and other economic  factors.  Those securities that the
Company  believes would be subject to sale prior to the specified  maturity date
are included in  "securities  available  for sale,"  which  amounted to $2,589.7
million,  $2,719.0  million and $2,993.9  million at December 31, 1998, 1997 and
1996,  respectively.  Of those securities  available for sale, 93.0%,  92.5% and
92.1% were rated BBB or above by Standard & Poor's at December  31,  1998,  1997
and 1996, respectively.

         During the years ended  December 31, 1998,  1997 and 1996,  the Company
sold $1,019.9  million,  $801.1 million and $373.7 million of fixed maturity and
equity securities,  and purchased $1,054.7 million,  $1,021.5 million and $955.8
million of fixed maturity and equity  securities,  respectively.  Such sales and
purchases were primarily  effected in order to meet cash flow demands associated
with  policyholder  surrenders  that  in  the  aggregate  increasingly  exceeded
policyholder deposits as well as improve the quality of the investment portfolio
or avoid prepayment risks.

         As a result of the  Company's  decision to exit the  private  placement
bond sector,  the Company  transferred all of its remaining  assets in the fixed
maturities held for investment  portfolio to its fixed maturities  available for
sale  portfolio as of April 1, 1997.  During 1996, the Company sold one security
in its held for investment  portfolio  aggregating $4.9 million as a result of a
dramatic deterioration in its credit rating.

         Mortgage loans on real estate  amounted to 1.2%, 7.2% and 7.2% of total
invested  assets as of December 31, 1998,  1997 and 1996,  respectively.  United
Life is the Company's only  subsidiary  which  actively  originates new mortgage
loans.  United Life invests in first mortgage loans and provides a mortgage loan
warehousing  facility  for its  former  parent  as a means of  obtaining  higher
invested  asset  yields  necessary  to  support   competitively  priced  annuity
products.

         Cash Flow from Financing Activities. Cash used by financing activities,
excluding the parent  company,  were $391.4  million,  $325.9  million and $62.0
million for the years ended December 31, 1998, 1997 and 1996, respectively.  The
majority

                                       34
<PAGE>

of the  cash  outflow  is  attributable  to  policyholder  surrenders  exceeding
deposits by $354.1 million in 1998, $275.7 million in 1997 and $205.2 million in
1996.

RESULTS OF OPERATIONS

         For the years ended  December 31, 1998,  1997 and 1996, the Company has
prepared the following  unaudited  selected pro forma financial  information for
the Company's  remaining  operating  divisions,  the Financial Services Division
(excluding  the United Life Assets) and the Payroll  Sales  Division  (excluding
Professional) and Businesses Held for Sale (Career Sales Division, Professional,
the United  Life  Assets,  KIVEX and  Marketing  One).  The pro forma  financial
information by operating  division is defined as pre-tax income (loss) excluding
the  impact  of: (i)  restructuring  costs,  (ii) gains or losses on the sale of
investments  and (iii) the impact of the  Company's  decision  to dispose of the
Businesses Held for Sale ((i), (ii) and (iii)  collectively,  "Operating  Income
(Loss)"). In addition,  the 1997 and 1996 unaudited selected pro forma financial
information  considers  the impact of the: (i)  acquisition  of the SW Financial
Controlling Interest,  including the financing thereof, and (ii) the acquisition
of the  Fickes  and  Stone  Knightsbridge  Interests,  including  the  financing
thereof.

         The Company has prepared such  information as it believes that: (i) the
acquisition  of  the  SW  Financial  Controlling  Interest,  (ii)  the  intended
disposition of the Businesses  Held for Sale and (iii) the  restructuring  costs
are material enough to make historical  comparative  results not meaningful.  In
addition,  the Company  believes that the pro forma financial  information  will
facilitate the  subsequent  discussion  parallel with how  management  views and
evaluates the operations of the Company.

         The unaudited  selected pro forma  financial  information for the years
ended  December  31, 1997 and 1996,  gives effect to the  acquisition  of the SW
Financial Controlling Interest and the Fickes and Stone Knightsbridge  Interests
as though each had occurred on January 1, 1996.

         The following  unaudited  selected pro forma financial  information has
been  prepared  for  comparative  purposes  only  and  does  not  purport  to be
indicative  of what would have  occurred  had the  acquisitions  been made as of
January 1, 1996, or the results which may occur in the future.

                    SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
   <S>                                                               <C>            <C>            <C>          
   Financial Services Division:
     Operating income.............................................   $      23,206  $      75,555  $      79,438
     Net investment gains.........................................           1,503          6,848          2,055
     Restructuring costs..........................................          (3,803)            --             --
                                                                     -------------  -------------  -------------
                                                                            20,906         82,403         81,493
                                                                     -------------  -------------  -------------
   Payroll Sales Division:
     Operating income (loss)......................................          (2,728)        23,960         22,796
     Net investment gains (losses)................................             (36)         2,654           (176)
     Restructuring costs..........................................              --             --             --
                                                                     -------------  -------------  -------------
                                                                            (2,764)        26,614         22,620
                                                                     -------------  -------------  -------------
   Businesses Held for Sale:
     Operating income (loss)......................................         (18,323)        45,371         89,879
     Net investment gains (losses)................................           9,068          9,827         (1,690)
     Restructuring costs..........................................          (2,643)            --             --
     Impairment valuation.........................................        (342,960)            --             --
                                                                     -------------  -------------  -------------
                                                                          (354,858)        55,198         88,189
                                                                     -------------  -------------  -------------
   Corporate:
     Interest and amortization of deferred debt interest cost.....         (42,960)       (38,653)       (36,130)
     Corporate expenses, eliminations and other...................         (40,054)       (23,842)          (267)
     Net investment gains.........................................           3,533              1              8
     Restructuring costs..........................................          (8,431)       (16,771)            --
                                                                     -------------  -------------  -------------
                                                                           (87,912)       (79,265)       (36,389)
                                                                     -------------  -------------  -------------
   Income (loss) before income taxes and extraordinary charge.....   $    (424,628) $      84,950  $     155,913
                                                                     =============  =============  =============
</TABLE>
                                       35
<PAGE>

RETAINED BUSINESS--FINANCIAL SERVICES DIVISION

         The Financial Services Division includes the operations of Southwestern
Life  and  Security  Life.  Southwestern  Life and  Security  Life  market  life
insurance and, to a lesser extent annuity products,  through independent general
agents who sell  directly  to  individuals  primarily  in the  southwestern  and
southeastern United States.

                    SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
<S>                                                                  <C>            <C>            <C>          
Revenues:
   Policy revenues................................................   $     129,242  $     138,006  $     138,957
   Net investment income..........................................         183,618        201,483        204,392
   Other income...................................................           3,677          1,052         16,521
                                                                     -------------  -------------  -------------
                                                                           316,537        340,541        359,870
                                                                     -------------  -------------  -------------
Benefits and expenses:
   Total policyholder benefits....................................         215,414        195,119        218,647
   Insurance related expenses.....................................          29,592         32,940         24,510
   Other operating expenses.......................................          48,325         36,927         37,275
                                                                     -------------  -------------  -------------
                                                                           293,331        264,986        280,432
                                                                     -------------  -------------  -------------
     Pre-tax operating income.....................................   $      23,206  $      75,555  $      79,438
                                                                     =============  =============  =============
</TABLE>

         Policy  Revenues.  Policy revenues  include:  (i) premiums  received on
traditional  life products  (ii)  mortality  and  administrative  fees earned on
universal life insurance and annuities and (iii) surrender charges on terminated
universal  life and  annuity  products.  In  accordance  with GAAP,  premiums on
universal  life and annuity  products are accounted for as deposits to insurance
liabilities.

         Premiums, net of reinsurance, by major product line for the years ended
December 31, 1998, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
   <S>                                                               <C>            <C>            <C>          
   Life premiums collected:
     Universal life (first year)..................................   $      18,459  $      11,800  $      10,538
     Universal life (renewal).....................................          83,419         92,150         97,695
     Traditional life (first year)................................           7,821          4,333          3,876
     Traditional life (renewal)...................................          34,636         36,646         33,899
                                                                     -------------  -------------  -------------
       Life premiums collected, net of reinsurance................         144,335        144,929        146,008
                                                                     -------------  -------------  -------------
   Annuity premiums collected:
     Traditional fixed (first year)...............................           9,205         24,761         16,098
     Traditional fixed (renewal)..................................           1,947          2,718          3,099
                                                                     -------------  -------------  -------------
       Annuity premiums collected, net of reinsurance.............          11,152         27,479         19,197
                                                                     -------------  -------------  -------------
   Fixed benefit premiums collected:
     Long-term care premiums (all first year).....................             455             --             --
     Accident and Health (all renewal)............................              12            300            249
                                                                     -------------  -------------  -------------
       Fixed benefit premiums collected, net of reinsurance.......             467            300            249
                                                                     -------------  -------------  -------------
   Premiums collected, net of reinsurance.........................         155,954        172,708        165,454
   Less premiums on universal life and annuities which are
     recorded as additions to insurance liabilities and other
     premium adjustments..........................................        (113,662)      (129,393)      (122,298)
                                                                     -------------  -------------  -------------
   Premiums on products with mortality or morbidity risk..........          42,292         43,315         43,156
   Fees and surrender charges on interest sensitive products......          86,950         94,691         95,801
                                                                     -------------  -------------  -------------
   Policy revenues................................................   $     129,242  $     138,006  $     138,957
                                                                     =============  =============  =============
</TABLE>

                                       36
<PAGE>

         Policy revenues  decreased 6.4% during 1998 to $129.2 million  compared
with 1997.  Policy  revenues in 1997  decreased less than 1% compared with 1996.
Life  premiums  collected,  net of  reinsurance,  were  $144.3  million  in 1998
compared  with  $144.9  million in 1997 and $146.0  million in 1996.  First year
universal life premiums  increased 56.4% in 1998 to $18.5 million and first year
traditional  life  increased  80.5% to $7.8  million.  Most of the  increase  in
production was  attributable to Southwestern  Life. The Company expects the A.M.
Best  downgrades,  which occurred during the third quarter of 1998 to negatively
impact 1999 new business production levels relative to 1998. New life sales were
also strong at  Security  Life in the first  half,  of 1998 but  declined in the
third and  fourth  quarters  reflecting  the impact of  ratings  downgrades  and
management  changes in Security  Life's  marketing  management.  The increase in
first  year life  premiums  was  mostly  offset  by  decreases  in life  renewal
premiums,  which  declined 8.3% in 1998 from 1997 compared to a decrease of 2.1%
in 1997 compared with 1996. This reflects  ratings  downgrades and the impact of
certain  management actions instituted by Southwestern Life in the third quarter
of 1997.  Additional management actions are planned or are being considered with
respect to certain interest sensitive life insurance  contracts.  Such plans, if
implemented,  would  likely  result  in  reduced  renewal  premiums  in 1999 and
subsequent  years.  See  Managements'   Discussion  and  Analysis  of  Financial
Condition  and  Results  of  Operations-Total  Policyholder  Benefits,  included
herein.  Annuity  premiums  have  declined  59.4% to $11,152 in 1998 compared to
1997. The sales decline is attributable to a shift in the overall annuity market
to sales of variable  products (which the Financial  Services  Division does not
offer) from fixed products due to  historically  low interest rates and consumer
interest in equities. Annuity sales are also typically more sensitive to Company
ratings than other insurance  products.  Annuity sales are likely to continue to
decline unless market  conditions for fixed annuities  become more favorable and
ratings of Southwestern Life and Security Life improve.

         Net Investment  Income.  Net investment income decreased 8.9% to $183.6
million in 1998 due to a decrease  in  invested  assets  and  reduced  yields on
investments.  Average invested assets declined  approximately  $110.3 million in
1998 compared  with 1997 and decreased  $1.7 million from 1997 compared to 1996.
Most of this  decrease  resulted from the need to liquidate  invested  assets to
provide cash to fund  surrenders  of annuities  issued by Security  Life,  which
totaled $179.0 million in 1998.  Most of these  annuities had reached the end of
their surrender fee period.  A continued  decline in the invested asset base and
related  investment  income is  anticipated as surrenders are expected to remain
high over the next few  years as more  annuities  in force  reach the end of the
surrender fee periods.  The decrease in invested  assets due to  surrenders  was
partially  offset by premiums on new and existing life  policies and  investment
income  collected,  less  commissions and operating  expenses.  Weighted average
yields on invested  assets have  decreased  to 7.1% in 1998  compared to 7.4% in
1997 and 7.5% in 1996.  The decline  reflects a decrease in higher  yielding but
less liquid asset classes such as mortgages,  real estate and collateral  loans.
Also impacting  investments  yields were lower new money rates  available to the
Company  to  invest  as a result  of  extensive  maturities  and calls of higher
yielding  investments and slightly higher investment expenses as a result of the
decision in 1997 to utilize outside investment managers.

         Other Income.  Other income  increased $2.6 million in 1998 compared to
1997.  During 1998, the Company received  approximately  $1.0 million  resulting
from a settlement received associated with securities owned in the past. Most of
the remaining  differences  between the years reflect  changes in  consideration
received on supplemental  contracts.  Supplemental  contract  revenue is derived
from   annuity   contracts   which  have  reached  the   annuitization   period.
Consideration from supplemental  contracts  recognized as other income is offset
by policyholder benefits, resulting in no net effect on the Company's results of
operations.

         Total Policyholder  Benefits.  The following table shows the components
of total  policyholder  benefits for the year ended December 31, 1998,  1997 and
1996:

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                   ($ in thousands)
   <S>                                                               <C>            <C>            <C>          
   Death benefits.................................................   $      87,578  $      77,980  $      77,648
   Other insurance policy benefits and change in
     future policy benefits.......................................         127,836        117,139        140,999
                                                                     -------------  -------------  -------------
   Total policyholder benefits....................................   $     215,414  $     195,119  $     218,647
                                                                     =============  =============  =============
</TABLE>

         During 1998,  policyholder  benefits  increased 10.4% to $215.4 million
compared with 1997. Death benefits increased $9.6 million or 12.3% compared with
1997.  Most of this  increase  was  due to  higher  incidence  of  mortality  at
Southwestern Life during the first half of 1998 compared to prior periods. Death
benefits may vary significantly  from period to period.  Change in future policy
benefits and other benefits  increased  9.1% to $127.8  million in 1998.  During
1997, future policy benefits were reduced approximately $23.9 million related to
the adjustment of certain deficiency reserves on a block of

                                       37
<PAGE>

Southwestern Life interest  sensitive  business.  During 1997,  management began
implementing a plan intended to reduce the  anticipated  losses  associated with
these policies.  Such actions  included  contractually  allowable  reductions in
credited rates and increases in cost of insurance and expense charges.

         The Company is continually  evaluating actuarial assumptions associated
with interest  sensitive life insurance  contracts in which the determination of
policy  reserves is highly  sensitive to assumptions  such as withdrawal  rates,
investment earnings rates,  mortality rates, and premium persistency.  Currently
reflected in the Company's financial  statements are policy reserves and account
values  associated with such contracts,  which aggregated  approximately  $525.4
million and $504.6  million as of December 31, 1998 and 1997,  respectively.  If
developing  trends were to  continue,  the  Company  would be required to record
additional  reserves or reduce  intangible  assets,  which could have a material
impact on the Company's financial position and results of operations. Management
is also assessing the potential impact of future management actions, which might
mitigate the financial impact of these trends. Types of management actions would
likely include,  but are not limited to, the  redetermination  of non-guaranteed
charges  and/or   benefits  under  the  contracts,   asset   segmentation,   and
reinsurance.  There  are  risks  associated  with  management  action  including
potential sales disruption and the threat of litigation.

         In January 1999, Security Life initiated  management action in the form
of a new  exchange  program for certain  policyholders  of  Security  Life.  The
program is being offered to all  policyholders  who had certain  policy forms in
force as of January 1, 1998. The program allows the  policyholder  the following
options in exchange for  terminating  his or her policy and executing a release:
(i) refund of 115% of all premiums  paid for the policy prior to January 1, 1999
and 100% of premiums paid thereafter; (ii) exchange the policy, without proof of
insurability, for the same face amount in a universal life policy, or a new term
universal life policy. The policyholder also has the choice of not accepting the
exchange program and keeping the current policy in force.

         The exchange  program is not expected to have a material  effect on the
Company's  financial  position  or results  of  operations.  However,  statutory
surplus of Security  Life could be reduced by  approximately  $12.5 million on a
pre-tax basis if every eligible policyholder elects the exchange option.

         The Company is  continuing to refine its  actuarial  estimates,  likely
management   action   plans  and   associated   sensitivity   testing   of  such
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.

         Insurance  Related  Expenses.  For  1998,  insurance  related  expenses
(including  commissions,  amortization of deferred policy  acquisition costs and
amortization of present value of insurance in force)  decreased to $29.6 million
in 1998 from $32.9 million in 1997.  Insurance  related expenses  increased $8.4
million in 1997 compared to 1996.  Amortization of deferred  policy  acquisition
costs increased $7.2 million in 1998 compared to 1997 and increased $4.8 million
in 1997  compared with 1996.  These  increases  principally  reflect the growing
block of policies in force,  which have been sold  subsequent  to the  Company's
acquisitions of Security Life and  Southwestern  Life. Also included in the $7.2
million increase in amortization is approximately  $3.2 million of 1998 deferred
costs for  Security  Life which was  written  off as  unrecoverable  from future
profits  as a result of  shifts in the mix of  products  sold  during  the year.
Amortization of present value of future profits decreased $10.8 million to $12.9
million in 1998. This decrease resulted from unlocking assumptions regarding the
future  profitability of certain interest  sensitive life insurance  products at
Southwestern  Life  and  from  lower  amortization  associated  with  blocks  of
pre-purchase business. Amortization of present value of future profits increased
$5.3 million in 1997  compared to 1996.  This increase  resulted from  unlocking
assumptions  regarding future  profitability of certain interest  sensitive life
insurance products of Security Life.

         Other Operating Expenses. For 1998, other operating expenses (including
general operating, overhead and policy maintenance) increased $11.4 million from
1997. Other operating  expenses were consistent  between 1997 and 1996. The 1998
increase is attributable to several  factors:  (i) Security Life  established an
allowance for  uncollectible  agents' debit balances  aggregating  approximately
$2.3 million,  (ii)  approximately  $4.9 million of remediation costs associated
with  Year  2000  systems   conversions   and  upgrades  and  (iii)   additional
non-deferrable expenses such as consulting fees, appraisal costs and other costs
associated   with  the   divisional   realignment   which  are  not   considered
restructuring costs.

RETAINED BUSINESS--PAYROLL SALES DIVISION

         The Payroll Sales Division includes the operations of AA Life and OLIC.
AA Life markets and  underwrites  customized  life  insurance  and  accumulation
products to U.S.  military  personnel  and federal  employees  through a general
agency force. OLIC provides individual fixed benefit and life products utilizing
a network of  independent  agents  primarily in the  southeastern  United States
through employer-sponsored payroll deduction programs.


                                       38
<PAGE>
                    SELECTED PRO FORMA FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  ---------
                                                                                    ($ in thousands)
<S>                                                                  <C>            <C>            <C>          
Revenues:
   Policy revenues................................................   $      89,991  $      89,698  $      83,722
   Net investment income..........................................          39,046         38,161         36,023
   Other income (loss)............................................          (1,967)         4,454            (85)
                                                                     -------------  -------------  -------------
                                                                           127,070        132,313        119,660
                                                                     -------------  -------------  -------------
Benefits and expenses:
   Total policyholder benefits....................................          64,457         64,622         63,642
   Insurance related expenses.....................................          42,131         29,377         18,843
   Other operating expenses.......................................          23,210         14,354         14,379
                                                                     -------------  -------------  -------------
                                                                           129,798        108,353         96,864
                                                                     -------------  -------------  -------------
     Pre-tax operating income (loss)..............................   $      (2,728) $      23,960  $      22,796
                                                                     =============  =============  =============
</TABLE>

     Policy Revenues.  Premiums received,  net of reinsurance,  by major product
line for the years ended December 31, 1998, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
   <S>                                                               <C>            <C>            <C>          
   Life premiums collected:
     Universal life (first year)..................................   $       1,336  $       5,248  $       8,153
     Universal life (renewal).....................................          33,045         30,808         27,168
     Traditional life (first year)................................          17,708         16,139         13,461
     Traditional life (renewal)...................................          30,899         30,138         22,787
                                                                     -------------  -------------  -------------
       Life premiums collected, net of reinsurance................          82,988         82,333         71,569
                                                                     -------------  -------------  -------------
   Annuity premiums collected:
     Traditional fixed (first year)...............................             331          2,526          5,517
     Traditional fixed (renewal)..................................           1,259          1,495          1,448
                                                                     -------------  -------------  -------------
       Annuity premiums collected, net of reinsurance.............           1,590          4,021          6,965
                                                                     -------------  -------------  -------------
   Fixed benefit premiums collected:
     Accident and Health (first year).............................           2,361          3,583          3,149
     Accident and Health (renewal)................................          10,356          9,720          9,220
                                                                     -------------  -------------  -------------
       Fixed benefit premiums collected, net of reinsurance.......          12,717         13,303         12,369
                                                                     -------------  -------------  -------------
   Premiums collected, net of reinsurance.........................          97,295         99,657         90,903
   Less premiums on universal life and annuities which are
     recorded as additions to insurance liabilities and other
     premium adjustments..........................................         (37,031)       (45,084)       (43,050)
                                                                     -------------  -------------  -------------
   Premiums on products with mortality or morbidity risk..........          60,264         54,573         47,853
   Fees and surrender charges on interest sensitive products......          29,727         35,125         35,869
                                                                     -------------  -------------  -------------
   Policy revenues................................................   $      89,991  $      89,698  $      83,722
                                                                     =============  =============  =============
</TABLE>

         Total policy  revenues were  consistent  between 1998 and 1997.  Policy
revenues  increased  $4.3  million  for AA Life in 1998  but  were  offset  by a
decrease of $ 4.1 million for OLIC.  OLIC's decline was  anticipated as a result
of the Company's  decision to cease marketing products through any "non-payroll"
production  sources during 1997.  Policy revenues  increased in 1997 compared to
1996 primarily as a result of new business sales for AA Life.

         Net Investment  Income.  Net investment  income  increased 2.3% in 1998
from 1997 to $39.0  million and  increased  5.9% in 1997  compared to 1996.  The
increase in net investment income was primarily the result of an increase in the
average  invested  assets which  increased  approximately  $14.9 million in 1998
compared to 1997 and  increased  $16.6  million in 1997  compared  to 1996.  The
increases in invested  assets is  primarily  attributed  to modest  increases in
business in force at AA Life.

                                       39
<PAGE>

         Other  Income.  Other  income  decreased  $6.4  million  from  1997 and
resulted in a loss of $2.0 million in 1998 compared to income of $4.5 million in
1997. Included in other income in 1998 is a loss on the sale of OLIC's Guam book
of business totaling $2.6 million. In 1997, OLIC recorded a gain of $4.4 million
on the sale of its Panamanian business.

         Total Policyholder  Benefits.  The following table shows the components
of total  policyholder  benefits for the year ended December 31, 1998,  1997 and
1996:

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
   <S>                                                               <C>            <C>            <C>          
   Death benefits.................................................   $      23,435  $      23,282  $      25,213
   Fixed benefit claims incurred..................................           7,929         10,114          7,427
   Other insurance policy benefits and change in
     future policy benefits.......................................          33,093         31,226         31,002
                                                                     -------------  -------------  -------------
   Total policyholder benefits....................................   $      64,457  $      64,622  $      63,642
                                                                     =============  =============  =============
</TABLE>

         Policyholder  benefits  totaled $64.5 million in 1998, which was little
changed compared to 1997 or 1996.

         Insurance  Related  Expenses.  Insurance  related  expenses  (including
commissions,  amortization of deferred policy acquisition costs and amortization
of present value of insurance in force) increased $12.8 million in 1998 compared
to 1997.  During 1998, OLIC  accelerated  amortization  of deferred  acquisition
costs by $10.7  million  primarily  as a result of  refinements  in  persistency
assumptions  and unlocking of the estimates of future  profits.  Amortization of
deferred  policy  acquisition  costs at AA Life  increased  $2.7 million in 1998
compared to 1997  primarily  reflecting  the growing block of in force  policies
sold since the Company's  acquisition of AA Life. These increases were partially
offset by lower  commissions in 1998 compared to 1997  primarily  resulting from
OLIC's decision to cease writing  certain  products in 1997.  Insurance  related
expenses  increased  $10.5  million to $29.4  million in 1997  compared to 1996.
Amortization  of  deferred  policy  acquisition  costs  increased  $8.5  million
primarily as a result of  refinements to  amortization  schedules for AA Life to
reflect the unlocking of assumptions  regarding  future  profitability  and as a
result of the growing block of policies in force, which had been sold subsequent
to the Company  acquisition  of AA Life.  In addition,  amortization  of present
value of insurance in force for OLIC also  increased from 1996 to 1997 primarily
as a result of unlocking of assumptions regarding future profitability.

         Other Operating  Expenses.  Other operating expenses (including general
operating,  overhead and policy  maintenance)  increased  $8.9 million from 1997
after  remaining flat from 1996 to 1997. The increase is attributable to several
factors,   including:  (i)  approximately  $3.6  million  of  remediation  costs
associated with Year 2000 systems  conversions and upgrades,  (ii) approximately
$2.0  million  of  acquisition  costs at OLIC  which  were  expensed  in 1998 as
unrecoverable from future profits and (iii) additional  non-deferrable  expenses
such as consulting  fees,  appraisals and other costs associated with divisional
realignment which are not considered restructuring costs.

BUSINESSES HELD FOR SALE

         Businesses  Held for Sale  include the  operations  of the Career Sales
Division,  KIVEX,  Professional,  the United Life Assets and Marketing  One. The
Career Sales Division,  which includes the operations of Penn Life,  markets and
underwrites  fixed  benefit  accident  and  sickness  products  and, to a lesser
extent,  life products through a sales force exclusive to the Company throughout
the United  States and  Canada.  With the January 2, 1998,  consummation  of the
acquisition of the SW Financial Controlling Interest, the Company has integrated
Union Bankers,  Marquette and Constitution with the Career Sales Division. KIVEX
is an internet service provider.  Professional provides individual fixed benefit
and life products  utilizing a network of  independent  agents  primarily in the
southeastern   United  States  through   employer-sponsored   payroll  deduction
programs.  United Life principally  markets fixed and variable annuities through
financial institutions and independent general agents, primarily in the southern
and western United States.


                                       40
<PAGE>
                    SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                         1998           1997            1996
                                                                     -------------  -------------  -------------
                                                                                    ($ in thousands)
<S>                                                                  <C>            <C>            <C>          
Revenues:
   Policy revenues................................................   $     239,925  $     263,680  $     327,455
   Net investment income..........................................         147,201        154,087        160,767
   Other income...................................................          33,931         38,181         34,460
                                                                     -------------  -------------  -------------
                                                                           421,057        455,948        522,682
                                                                     -------------  -------------  -------------
Benefits and expenses:
   Total policyholder benefits....................................         261,639        230,818        235,846
   Insurance related expenses.....................................          86,718         93,359        103,288
   Other operating expenses.......................................          91,023         86,400         93,669
                                                                     -------------  -------------  -------------
                                                                           439,380        410,577        432,803
                                                                     -------------  -------------  -------------
     Pre-tax operating income (loss)..............................   $     (18,323) $      45,371  $      89,879
                                                                     =============  =============  =============
</TABLE>
         Policy  Revenues.  Policy  revenues  declined  9.0% or $23.8 million to
$239.9 million in 1998 compared to 1997.  This followed a 19.5% or $63.8 million
decline  in 1997  compared  to 1996.  The  decline  in 1998 of $21.4  million is
primarily  attributable  to  Union  Bankers  which  discontinued  sales of major
medical  health  products  and its life  insurance  products and  increased  its
utilization  of  reinsurance.  Union Bankers also accounts for nearly all of the
$52.0 million of the decrease in policy  revenues in 1997 compared to 1996.  The
remainder  of the  decrease  is  attributable  to Penn  Life  which  experienced
decreases in policy revenues of $3.8 million (2.6%) in 1998 compared to 1997 and
a decrease of $6.4  million  (4.3%) in 1997  compared to 1996  principally  as a
result of lower first year sales.

         Net Investment  Income.  Net investment  income  decreased $6.9 million
(4.5%)  in 1998  compared  to 1997 and  decreased  $6.7  million  (4.2%) in 1997
compared to 1996. The decrease is primarily  attributable to United Life,  where
net  investment  income  decreased  $11.4  million in 1998  compared to 1997 and
decreased  $5.3 million in 1997  compared to 1996.  United Life has  experienced
high surrenders of fixed annuities in 1998 and 1997 reflecting low  reinvestment
rates  available as  annuities  reached the end of their  surrender  fee period.
Surrenders at United Life totaled  $253.2  million in 1998 and $255.6 million in
1997. Such surrenders resulted in a liquidation of approximately  $168.9 million
and $104.0 million of invested assets during 1998 and 1997, respectively,  which
caused the declines in investment  income.  Partially  offsetting the decline at
United  Life are small  increases  for other  companies,  the  largest  of which
related to  investment  income  earned by Marquette  during 1998 from an assumed
reinsurance contract. This contract was terminated as of September 30, 1998.

         Other  Income.  Other income  decreased  $4.3 million  (11.1%) to $33.9
million in 1998 compared to 1997.  Other income  increased  $3.7 million in 1997
compared to 1996. The  substantial  decrease in other income in 1998 compared to
1997 is attributable to a decline in the amortization of Union Bankers' deferred
gain associated with a third party Medicare reinsurance  contract.  The decrease
in amortization is attributable to a decline in the underlying  premium in force
subject  to the  reinsurance  arrangement,  over  time,  which  results in lower
amortization of the gain.  Also  contributing to the decline in other income was
reduced  revenues for Marketing One resulting from the  cancellation of a number
of marketing relationships. These decreases are partially offset by increases in
revenue from KIVEX and  increased  fee income for United  Life.  The increase in
other income from 1997  compared to 1996 is  principally  attributable  to Union
Bankers'  amortization of deferred gain. The amortization was higher in 1997 due
to a full year  amortization  of the gain and higher than expected lapses of its
Medicare  policies.  The deferred gain was primarily  generated as a result of a
June 1996 agreement.

         Total  Policyholder  Benefits.  Policyholder  benefits  increased $30.8
million (13.4%) in 1998 compared to 1997. The policyholder benefits of Penn life
increased $43.0 million in 1998 compared to 1997. The increase was primarily the
result of specific increases in reserve estimates associated with long term care
products and certain  claims  reserves  held by Penn Life.  Policy  reserves and
claims reserves  increases  associated with the changes in estimates  aggregated
approximately  $32.6  million.  The  Company  had been  closely  monitoring  the
development  of claims  reserve  experience  associated  with its  Career  Sales
Division.  The Company has  experienced,  what appears to be, a deterioration of
the adequacy of its claims reserves  associated with disability  income products
sold prior to the Company's ownership of Penn Life. As a result of such possible
trends,  the Company  increased  claims reserves  estimates for the Career Sales
Division  by  approximately  $25.0  million,  which  is  included  above  in the
additional policy benefit  reserves.  See Notes 2 and 8 of Notes to Consolidated
Financial  Statements.  In determining  the amount of the necessary  increase in
policy reserve estimates associated with its long term care products,  Penn Life
allocated  approximately $11.2 million of previously identified redundant policy
reserves to long term care reserves,  and additionally increased policy reserves
by approximately  $7.6 million.  This was partially offset by decreases of $16.9
million

                                       41
<PAGE>

in Union Bankers policyholder  benefits,  reflecting less business in force as a
result of the decision to cease sales of major  medical and life  business,  the
cession of the remaining 20% of the Medicare business and the runoff of existing
business.

         Insurance  Related  Expenses.  Insurance  related  expenses  (including
commissions,  amortization of deferred policy acquisition costs and amortization
of present value of insurance in force)  decreased $6.6 million to $86.7 million
in 1998 compared to 1997.  This followed an $9.9 million (9.6%) decrease in 1997
compared to 1996.  Amortization of present value of insurance in force decreased
$11.6  million  principally  as a result of the Company  recording an impairment
provision  associated  with assets of Businesses  Held for Sale resulting in the
elimination  of  substantially  all insurance  assets  subject to  amortization.
Specifically,  Penn Life and Union  Bankers  wrote off $98.1  million of present
value of  insurance  in force which  reduced  amortization.  This was  partially
offset by an increase in amortization of deferred  policy  acquisition  costs of
$5.3 million,  which included (i) an increase at Professional of $1.8 million in
1998  compared  to 1997 as a result  of  higher  than  expected  lapses on fixed
benefit  products,  (ii) an increase of $1.7 million for United Life as a result
of unlocking future  assumptions  regarding the profitability of certain annuity
products  and (iii) an increase at Union  Bankers of $1.9 million as a result of
higher lapses.  Non-deferrable  commissions decreased approximately $1.0 million
at Union  Bankers  principally  due to the  decision  to stop  writing new major
medical and life business. Most of the decrease in 1997 compared to 1996 relates
to a $14.5 million  decrease in  non-deferrable  commissions  at Union  Bankers,
reflecting  the Medicare  reinsurance  contract  which ceded 80% of its Medicare
business  including new sales,  higher lapses,  and the decision to stop selling
major medical and life policies. The Medicare reinsurance contract also resulted
in lower  amortization of deferred policy acquisition costs and present value of
insurance  in force at Union  Bankers.  However,  this was more  than  offset by
increases in amortization of deferred policy acquisition costs and present value
of insurance in force at United Life and  Professional  primarily as a result of
higher than expected lapses.

         Other Operating  Expenses.  Other operating expenses (including general
operating,  overhead and policy  maintenance)  increased  $4.6 million (5.4%) in
1998  compared  to 1997.  KIVEX's  operating  expenses  increased  $7.4  million
reflecting costs associated with its expansion into new cities. In addition, the
companies included in Businesses Held for Sale experienced  increased costs as a
result of additional  non-deferrable  expenses such as consulting,  overhead and
other costs associated with the divisional realignment, which are not considered
restructuring  costs.  Offsetting the increases in operating expenses is reduced
amortization  of costs in  excess of net  assets  acquired  associated  with the
assets of the Businesses  Held for Sale.  During 1998, a total of $114.5 million
of costs in  excess  of net  assets  acquired  were  written  off as part of the
impairment provision, which decreased amortization by approximately $2.8 million
in 1998 compared to 1997. Other operating expenses decreased $7.3 million (7.8%)
in 1997  compared  to 1996.  Union  Bankers'  expenses  decreased  $6.6  million
principally  as a result of  receiving  an  expense  allowance  on the  Medicare
reinsurance contract for a full year in 1997 and only a partial year in 1996.

GENERAL CORPORATE

         Interest and Amortization of Deferred Debt Issuance Costs. Interest and
amortization  of deferred debt  issuance  costs  increased  $4.3 million in 1998
compared to 1997. This is the result of higher weighted average  borrowing costs
and additional  costs associated with credit facility fees and costs incurred to
amend the credit  agreement.  These are a direct result of the Company's current
financial position.

         Corporate Expenses.  Corporate  expenses,  eliminations and other costs
were $40.1 million, $23.9 million, and $0.3 million for the years ended December
31, 1998, 1997 and 1996, respectively.  The increase is directly attributable to
two factors as follows:  (i) the economics of KB Management,  and (ii) strategic
business evaluation and associated restructuring of the Company.

         During  the  years  ended  December  31,  1997 and  1996,  the  Company
maintained a 45% economic interest in KB Management.  As of January 2, 1998, the
Company  purchased the remaining  interest in KB Management (see Note 3 of Notes
to Consolidated  Financial  Statements).  From the formation of KB Management in
1995, KB Management provided certain management and acquisition  services to the
Company.  From its  formation  through the year ended  December  31,  1996,  the
transaction  and  management  fees derived by KB management  were  sufficient to
offset the  majority of the  administrative  costs which in turn  minimized  the
costs  associated  with the  Company's 45% economic  interest in KB  Management.
During  1997,  KB  Management   operating  and   administrative   expenses  grew
disproportionately  to the  ability of KB  Management  to engage and  consummate
acquisitions and other business transactions which would generate fee income and
the Company  recognized a net loss related to its 45%  economic  interest.  With
acquisition  of the remaining  interest in KB Management on January 2, 1998, the
net loss derived by KB  Management  for the year ended  December  31, 1998,  was
effectively recognized as a 100% economic interest by the Company.



                                       42
<PAGE>

         The strategic business  evaluation and associated  restructuring of the
Company  begun in the early  part of 1997 (see Note 21 of Notes to  Consolidated
Financial  Statements)  was  primarily  funded by the  Company  on behalf of the
subsidiaries.  As a result,  a  significant  portion of the  associated  pre-tax
incremental  costs  ("period  costs") were funded by the  Company.  Period costs
recognized by the Company  increased to $5.7 million for the year ended December
31, 1998,  from $1.8 million for the year ended  December 31, 1997.  Included in
expenses for the year ended December 31, 1998 were $6.8 million  associated with
severance  and  other  employment   agreements  and  a  $3.0  million  write-off
associated with a small marketing  entity which was shut down in anticipation of
the sale of Professional and not considered restructuring.

         In  addition,  during the year ended  December  31,  1997,  the Company
incurred $7.6 million of one time pre-tax  transaction costs associated with the
termination of the Washington National merger agreement.

         Income Taxes.  The  effective  tax rates  (benefit) for the years ended
December 31, 1998,  1997 and 1996, were (0.8)%,  39.5% and 37.0%,  respectively.
The  significant  change  in the  effective  tax rate  between  1998 and 1997 is
substantially due to the non-deductibility of the reduction in carrying value of
the assets  associated  with Businesses Held for Sale and an increase in the tax
valuation  allowance,  primarily  representing  unrecoverable net operating loss
carryforwards at certain non- life companies.  The 1997 and 1996 effective rates
are  higher  than the  statutory  rate of 35%  primarily  due to  non-deductible
amortization  of costs in excess of net assets  acquired  and  foreign  taxes in
excess of foreign taxes utilized.

         The 1996  consolidated life return of Constitution and its subsidiaries
is currently under examination by the Internal Revenue Service.  Tax years prior
to 1996 are closed by statute to examination for the  Constitution  consolidated
life insurance company tax group. The ultimate effect of the current examination
is not known at this time.

         Net  Investment  Gains  (Losses).  The Company  maintains an investment
portfolio  that focuses on maximizing  investment  income,  without  exposure to
unwarranted  interest rate and credit risk. The Company  actively  manages asset
duration  and  liquidity  risks.  As a  result  of this  strategy,  the  Company
routinely sells positions in securities no longer meeting its criteria. Sales of
securities  resulted in the Company  realizing  gains,  on a pro forma basis, of
$14.1  million,  $19.3  million and $0.2  million,  during 1998,  1997 and 1996,
respectively.  During 1998 and 1997, the Company liquidated securities available
for  sale in  order to meet  cash  flow  demands  associated  with  policyholder
surrenders  that in the  aggregate  exceeded  policyholder  deposits  by  $354.1
million and $275.7 million,  respectively.  During 1997, the Company  liquidated
most of its equity holdings and private placement bond holdings.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk Exposures of
         Financial Instruments for the Retained Businesses

         The  Company  analyzes  and  reviews  the  risks  arising  from  market
exposures of financial instruments.  From an overall perspective,  the Company's
investment  portfolio is managed with the objectives of maintaining  high credit
quality and liquidity,  maximizing  current income within  acceptable  levels of
risk, minimizing market and credit risk, and matching the anticipated maturities
of  investments  to the  Company's  liabilities.  The  Company  believes  that a
conservative  investment  strategy  fits the nature of its  insurance  products,
which have minimal inflation risk.

         By aggregating and monitoring the potential  impact of market risk, the
Company  attempts to optimize its risk  adjusted  earnings.  In addition,  these
risks are reviewed and managed  individually by operating  entity using analysis
prepared by the Company's actuaries.  The exposures of financial  instruments to
market risks, and the related risk management process,  are most relevant to the
life insurance and annuity  product  lines.  These product lines require most of
the invested assets to support  accumulation and investment  oriented  insurance
products.

         The Company has material  exposures to market risks including  interest
rate risk and default risk.  Additional  market exposures exist in the Company's
other  insurance  products  and in its debt  structure.  The primary  sources of
interest rate risk include (i) a sustained  decrease in interest rates, and (ii)
to a lesser extent,  near term increases in interest  rates.  As of December 31,
1998, the Company is not utilizing  derivatives in its asset liability  matching
process.  Each of these market risks is  discussed in detail  below.  All of the
subsequent  amounts and percentages  exclude  investments of Businesses Held for
Sale unless noted otherwise and include Southwestern Life for 1997.

INTEREST RATE RISK

         Accumulation  and  Investment  Oriented  Insurance  Products.   General
account  assets  supporting   accumulation  and  investment  oriented  insurance
products total $2,076.3  million or 70.2% and $2,253.7 million or 69.6% of total
invested  assets at December 31, 1998 and 1997,  respectively.  These  insurance
products include single premium and flexible premium fixed


                                       43
<PAGE>

deferred annuities and interest sensitive life,  primarily universal life. Fixed
maturity and equity securities are carried at fair value. Mortgage loans on real
estate are recorded at cost,  adjusted by provision for loan loss, if necessary.
Policy loans are recorded at cost.  Short-term  investments,  considered as cash
equivalents,  are recorded at amortized cost.  Policy  liabilities are generally
carried at policyholder account values with an adjustment, when the policyholder
account  values are deemed  inadequate.  With  respect  to these  products,  the
Company seeks to earn a stable and profitable  spread between  investment income
and interest  credited to policyholder  account values. As of December 31, 1998,
the weighted average interest spread on interest sensitive insurance liabilities
was 2.03%. If the Company has adverse  experience on investments  that cannot be
passed onto its customers, its spreads are reduced. Alternately, the Company may
seek to maintain spreads which may result in  non-competitive  credited interest
rates to customers.  This strategy could result in adverse surrender  experience
and cause the  Company to  liquidate a portion of its  portfolio  to fund excess
cash surrender benefits.  As a result of flexibility in adjusting crediting rate
levels and protection afforded by policy surrender charges, the Company does not
view the near term risk to spreads over the next twelve months to be material.

         Fixed Deferred  Annuities.  Assets of $634.4 million and $822.5 million
as of December  31,  1998 and 1997,  respectively,  support a large  category of
accumulation  and  investment  oriented  insurance   products,   fixed  deferred
annuities.  For these products,  the Company may adjust renewal  crediting rates
monthly,  or in some  cases less  frequently,  subject  to  guaranteed  minimums
ranging from 3% to 6%.  Generally,  an annuity  insurance  policyholder  has the
right to surrender a contract at account value less a surrender  charge.  Due to
the Company's ability to change crediting rates to track investment  experience,
the interest  rate risk of the  underlying  assets is assumed to be a good match
for the  interest  rate risk  inherent in  deferred  annuity  liabilities.  This
assumption,  however, may not be appropriate for either substantial increases or
decreases in interest rates.

         Universal  Life.  Assets of $1,441.9  million and  $1,431.2  million at
December  31,  1998 and 1997,  respectively,  support  the  largest  category of
accumulation and investment  oriented  insurance  products,  universal and other
interest sensitive life products. For these contracts, the Company has the right
to adjust  renewal-crediting  rates subject to guaranteed  minimums from 3.5% to
6.0%.  Similar to annuities,  universal  life insurance  policyholders  have the
right to surrender  their  contracts at account  value less a surrender  charge.
Generally,  the surrender charge protection ranges over a longer period of years
than those applicable to annuity policies,  and in some cases may be much larger
in size  relative  to account  values  being  surrendered.  The  Company  limits
interest rate risk by analyzing  projected  liability cash flows and structuring
investment portfolios with similar cash flow characteristics.

         Other Annuities.  Assets  aggregating $185.5 million and $191.6 million
as of December 31, 1998 and 1997,  respectively,  support  immediate  annuities,
traditional fixed benefit annuities,  deposit funds and supplementary contracts.
Generally,  the cash  flows  expected  on  these  liabilities  do not vary  with
fluctuations  in market  interest  rates and imputed  rates of interest  are not
adjustable  by the  Company.  Accordingly,  spreads  will  tend  to  fall  below
expectations if experience is adverse  relative to the assumptions used to price
these  products at issue.  The Company  attempts to limit its  exposure to these
products by being conservative in pricing,  thereby limiting sales and lessening
the  possibility  of  adverse  experience.  Many  of  these  contracts  are  not
surrenderable at the option of the policyholder.

         Other  General  Account  Insurance  Products.  The  Company  had $566.9
million  and  $597.5  million  of  assets  as of  December  31,  1998 and  1997,
respectively,  supporting  general account products,  including  traditional and
term life  insurance,  accidental  and  health  insurance,  and  long-term  care
insurance.   For  these  products,  the  liability  cash  flows  have  actuarial
uncertainty.  However,  their amounts and timing do not vary  significantly with
changes in interest rates.

         Decreasing  Interest Rates. With the exception of 1996,  interest rates
have  generally  been declining  since 1994.  Under  scenarios in which interest
rates fall and remain at levels  significantly  lower than rates  prevailing  at
December 31, 1998,  minimum  guarantees  for annuity and universal life policies
will cause the spread between the portfolio yield and the interest rate credited
to  policyholders  to narrow.  The earned rate on the annuity and universal life
insurance  portfolios  averaged  7.3%  for the year  ended  December  31,  1998,
providing some cushion for further decline in earned interest rates before there
is  insufficient  margin to cover  minimum  guaranteed  interest  rates plus the
required spread for profitability. The maturity structure and call provisions of
the related  investment  portfolios  also  protect the  imbedded  interest  rate
cushion for a period of time.  However,  spreads  are at risk if interest  rates
fall below current  levels and remain lower for a sustained  period of time. The
Company believes that the portfolios  supporting its accumulation and investment
oriented insurance products have a prudent degree of call protection.

         The   Company   held   $1,188.7   million  and   $1,152.5   million  of
mortgage-backed bonds which represented 40.2% and 35.6% of total invested assets
as of  December  31,  1998  and  1997,  respectively.  The  Company  invests  in
mortgage-backed  securities in order to enhance  portfolio yields and maintain a
reliable cash flow stream from the invested asset portfolio. The


                                       44
<PAGE>

Company  maintains  sophisticated  models to measure the effective  duration and
option-adjusted duration of the consolidated investment portfolio.  These models
are designed to allow accurate  measurement  of the convexity  risks inherent in
that  percentage of the portfolio  invested in  mortgage-backed  securities  and
other  callable  securities.  The Company  manages the portfolio  convexity risk
within  the  context  of  the  overall  asset  and   liability   model  and  the
quantification of disintermediation risk. Due to the combination of recent lower
interest rates and increased  efficiency by mortgage holders in exercising their
prepayment  options,  the riskiness of these securities has increased  without a
compensating adjustment to risk premiums.  Accordingly, the Company may consider
reducing its exposure to the mortgage-backed bonds in future years, reducing its
ability to enhance yield with these types of securities.

         Increasing  Interest  Rates.  For both  annuities  and  universal  life
insurance,  an increase in interest rates in the near term poses risks of either
deteriorating  spreads or excess surrender activity.  The portfolios  supporting
these  products  have fixed  assets with  maturities  ranging from one to twenty
years or more. Accordingly,  the earned rate on each portfolio will not increase
as fast as market yields  increase.  Prepayments on  mortgage-backed  bonds will
likely slow as well,  causing  the earned  rate to fall behind the market  yield
even  further.  If the Company sets its renewal  crediting  rates at the desired
spread level, the difference between its renewal crediting rates and competitors
new  money  rates  may be wide  enough to cause  increased  surrender  activity.
Alternatively, if the Company set its renewal crediting rates at the competitive
level, its spread will narrow.  The Company's  actuaries evaluate these risks by
simulating asset and liability cash flows for numerous  interest rate scenarios.
Nevertheless, the potential impact of a near term increase in interest rates may
be adverse  thereby  exceeding  corporate  risk  tolerance  levels.  The risk of
increasing  interest  rates  is  reduced  to the  extent  renewal  premiums  are
collected on periodic premium paying products.

RISK MANAGEMENT

         The Company seeks to invest its  available  funds in a manner that will
maximize its investment  return and fund future  obligations  to  policyholders,
subject to  appropriate  risk  considerations.  The  Company  seeks to meet this
objective  through  investments  that (i) have  similar  characteristics  to the
liabilities they support;  (ii) are diversified  among  industries,  issuers and
geographic locations;  and (iii) make up a predominantly  investment-grade fixed
maturity  securities  portfolio.  The Company's products  incorporate  surrender
charges, or other features to encourage persistency.  Approximately 73.3% of the
total  insurance  liabilities at December 31, 1998,  had surrender  penalties or
other restrictions and approximately 7.1% are not subject to surrender.

         The  Company  seeks to  maximize  the total  return  on its  investment
through active investment management. Accordingly, management has determined the
entire  portfolio  of  fixed  maturity  securities  is  available  to be sold in
response  to (i)  changes in market  interest  rates;  (ii)  changes in relative
values of individual  securities and asset sectors;  (iii) changes in prepayment
risks;  (iv)  changes in credit  quality  outlook  for certain  securities;  (v)
liquidity needs; and (vi) other factors.

         The Company uses  computer  models to perform  simulations  of the cash
flows  generated from existing  business under various  interest rate scenarios.
These  simulations  enable  management to measure the potential  gain or loss in
fair value of interest-rate  sensitive financial instruments.  In this analysis,
the fair value is  measured  as the  present  value of the  projected  statutory
earnings under a given interest rate scenario, discounted at the earned rates in
that scenario.  It is standard industry practice to base fair value of insurance
businesses on statutory  earnings.  The two scenarios compare one with no change
in interest rates and one with an  instantaneous  parallel  decrease in treasury
yields.

         Selected   fixed-income   assets  in  the  amount  necessary  to  equal
liabilities  are modeled  individually.  These assets include  corporate  bonds,
asset and  mortgage-backed  securities,  and mortgage loans on real estate.  All
significant  insurance  liabilities  are grouped  and modeled in  representative
liability  cells.  The options  embedded in the securities and their  underlying
collateral are modeled directly,  with the incidence of prepayments based on the
type of  collateral  and the level of interest  rates in the  scenarios  tested.
Defaults are modeled based on published credit ratings. The policyholder options
to borrow or surrender are modeled,  with exercise of the options  determined by
product  design  and the level of rates  which  competitors  would  offer in the
tested scenarios.  Other policyholder behavior is estimated from anticipated and
recent actual experience.

         Although the traditional  insurance  liabilities could be excluded from
this  analysis,  they contain loan  provisions  which are interest  sensitive in
nature.  In addition,  the risk of asset and liability  mismatch in a decreasing
interest  rate  environment  can become  significant.  In order to capture these
risks, the traditional insurance product liabilities were included.



                                       45
<PAGE>

         If treasury  yields  were to  decrease  by 100 basis  points from their
December  31, 1998  levels,  the fair value of these  insurance  businesses,  as
defined  above,  would be $54.4  million  less than the fair value  assuming  no
change from the December 31, 1998 levels.

         The  calculations  involved in these computer  simulations  incorporate
numerous  assumptions,  require significant  estimates,  and assume an immediate
change in interest rates without any  management of the investment  portfolio in
reaction to such change.  Consequently,  potential changes in value of financial
instruments  indicated  by the  simulations  will likely be  different  from the
actual  changes  experienced  under  given  interest  rate  scenarios,  and  the
difference may be material. Because the Company actively manages its investments
and  liabilities,  the actual change in fair value could be less than  estimated
above.

DEBT STRUCTURE

         Borrowed capital at December 31, 1998 includes outstanding principal of
$114.6 million of unsecured 9 1/4% Senior Subordinated Notes due 2003 and $434.0
million  of a  revolving  Bank  Credit  Facility  maturing  in 2000.  The senior
subordinated  notes carry fixed rates.  Based on the interest  rate exposure and
prevalent  rules at December 31,  1998,  a relative 300 basis point  decrease in
interest rates would  increase the fair value of fixed rate borrowed  capital by
approximately  $5.1  million.  Interest  expense on the  revolving  Bank  Credit
Facility,  which  contains  floating  rate debt,  will  fluctuate as  prevailing
interest rates change. At December 31, 1998, a relative 100 basis point increase
in  interest  rates  would  increase  interest  expense  on a  pre-tax  basis by
approximately $4.3 million.

INVESTMENTS AND RISK OF DEFAULT

         The Company  continuously  evaluates its  investment  portfolio and the
conditions under which it might sell securities,  including  changes in interest
rates,  changes in prepayment risks,  liquidity needs, asset liability matching,
tax planning  strategies and other economic  factors.  These securities that the
Company  believes would be subject to sale prior to the specified  maturity date
are included in  "securities  available  for sale,"  which  amounted to $2,589.7
million and  $2,719.0  million at December 31, 1998 and 1997,  respectively.  Of
those securities available for sale, 93.0 % and 92.5% were rated BBB or above by
Standard & Poor's at December 31, 1998 and 1997, respectively.

         During the years ended  December 31, 1998,  1997 and 1996, the Company,
inclusive of Businesses Held for Sale, sold $1,019.9 million, $801.1 million and
$373.7 million of fixed maturity and equity  securities,  and purchased $1,054.7
million,  $1,021.5  million  and  $955.8  million of fixed  maturity  and equity
securities,  respectively.  Such  sales and  purchases  were often  effected  to
improve the quality of the investment portfolio or to avoid prepayment risks. As
a result of the Company's  decision to exit the private  placement  bond sector,
the Company transferred all of its remaining assets in the fixed maturities held
for investment portfolio to its fixed maturities available for sale portfolio as
of April 1, 1997. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, the Company  marked all assets subject to the transfer to fair
value resulting in an increase in shareholders' equity, net of applicable income
taxes, of approximately $1.8 million. During 1996, the Company sold one security
in its held for investment  portfolio  aggregating $4.9 million as a result of a
dramatic deterioration in its credit rating.

         During  1997  and  1996,  the  Company  had  a  portfolio  of  "trading
securities" to provide the Company with the  opportunity  to undertake  interest
rate hedging strategies,  to participate in short-term relative value trades and
to invest in special  situations with the goal of generating  short-term trading
profits. As a result of trading activities, the Company, inclusive of Businesses
Held for Sale,  recognized  $1.1 million and $1.3 million of profits during 1997
and 1996,  respectively.  As of December 31, 1998 and 1997,  the Company held no
investments in its trading portfolio.

         Mortgage  loans  on real  estate  amounted  to 1.2%  and  1.8% of total
invested assets as of December 31, 1998 and 1997, respectively.  The Company has
established  a reserve  for loan  loss,  which  aggregated  $4.3  million  as of
December  31,  1998.  As  of  December  31,  1998  and  1997,  the  Company  had
non-performing  loans amounting to $5.0 million and $0.7 million,  respectively.
The Company is in various  stages of  foreclosure  or sales of such  loans.  The
Company believes its current loan loss provision is adequate to cover any future
losses related to currently performing and non-performing loans.

         In  assessing  the risk  that the rate of  default  losses  may  exceed
pricing expectations, the Company considers the entire investment portfolio. The
Company manages the risk of adverse default  experience on these  investments by
applying  disciplined  credit evaluation and underwriting  standards,  prudently
limiting  allocations  to  lower  quality,  higher  yielding  investments,   and
diversifying  exposures  by issuer,  industry  and region.  The Company  remains
exposed to occasional cyclical economic  downturns,  which may result in default
rates significantly higher than historical averages.


                                       46
<PAGE>

Item 8.   Financial Statements and Supplementary Data

                                                                            Page

 Management's Responsibility for Financial Statements......................   48

 PennCorp Financial Group, Inc. and Subsidiaries...........................   49

 Southwestern Financial Corporation and Subsidiaries.......................   90



                                       47
<PAGE>

MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS

         The management of the Company is responsible  for the  preparation  and
fair presentation of the consolidated  financial statements,  financial data and
other  information in this annual report.  They have been prepared in conformity
with generally accepted accounting  principles  appropriate in the circumstances
and include amounts based on the best estimates and judgment of management.  The
Company's  management is also  responsible  for the accuracy and  consistency of
other financial information included in this annual report.

         In recognition of its  responsibility for the integrity and objectivity
of data in the financial statements,  the Company maintains a system of internal
control over financial  reporting which is designed to provide  reasonable,  but
not  absolute,  assurance  with  respect  to the  reliability  of the  Company's
financial statements. The concept of reasonable assurance is based on the notion
that the cost of the  internal  control  system  should not exceed the  benefits
derived.

         Internal  auditors monitor and assess the effectiveness of the internal
control  system  and  report  their  findings  to  management  and the  Board of
Directors throughout the year. The Company's independent auditors are engaged to
express an opinion on the financial  statements and with the coordinated support
of the internal auditors, review the financial records and related data and test
the internal control system over financial reporting.

         The Audit  Committee  of the Board of  Directors,  which is composed of
outside  directors,  serves in an  oversight  role to assure the  integrity  and
objectivity of the Company's  financial  reporting process.  The committee meets
periodically with representatives of management,  as well as the independent and
internal  auditors,  to review matters of a material nature related to financial
reporting  and  the  planning,   results  and  recommendations  of  audits.  The
independent  and  internal  auditors  have free  access to the Audit  Committee,
without management present, to discuss any matter they believe should be brought
to the attention of the committee.  The committee is also responsible for making
recommendations  to the  Board of  Directors  concerning  the  selection  of the
independent auditors.




Keith A. Maib                                  James P. McDermott
President and Chief Executive Officer          Executive Vice President and
                                                 Chief Financial Officer



                                       48
<PAGE>

INDEPENDENT AUDITORS' REPORT

     The Shareholders and Board of Directors of PennCorp Financial Group, Inc.

     We have audited the  accompanying  consolidated  balance sheets of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related  consolidated  statements of operations and comprehensive income (loss),
changes  in  shareholders'  equity  and cash  flows for each of the years in the
three-year  period  ended  December  31,  1998.  These  consolidated   financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

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

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly,  in all material  respects,  the financial  position of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results  of their  operations  and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.

     As discussed in Note 8, the Company  changed its method of recording  claim
reserves associated with disability income products of the Career Sales Division
during the year ended December 31, 1998. The effect of the change in methodology
is  inseparable  from the effect of the change in  accounting  estimates  and is
accordingly  reflected in operations as a change in accounting  estimate for the
year ended December 31, 1998.



KPMG LLP
Dallas, Texas
March 31, 1999



                                       49
<PAGE>
                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
      CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                    (In thousands, except per share amounts)
<TABLE>
<CAPTION>
                                                                             For the years ended December 31,
                                                                            1998           1997          1996
                                                                         -----------   -----------   -----------
<S>                                                                      <C>           <C>           <C>        
REVENUES:
   Premiums, principally accident and sickness.........................  $   337,685   $   254,020   $   256,859
   Interest sensitive policy product charges...........................      121,473        91,546        91,231
   Net investment income...............................................      369,052       273,237       210,734
   Other income........................................................       37,717        27,504        22,666
   Net gains from the sale of investments..............................       14,068        17,487         1,257
                                                                         -----------   -----------   -----------
     Total revenues....................................................      879,995       663,794       582,747
                                                                         -----------   -----------   -----------
BENEFITS AND EXPENSES:
   Claims incurred.....................................................      308,432       202,472       188,727
   Change in liability for future policy benefits and other
     policy benefits...................................................      233,330       121,817        83,184
   Amortization of present value of insurance in force and
     deferred policy acquisition costs.................................      117,446        92,046        56,470
   Amortization of costs in excess of net assets acquired and
     other intangibles.................................................       15,121         9,545         8,648
   Underwriting and other administrative expenses......................      229,497       146,245       116,560
   Interest and amortization of deferred debt issuance costs...........       42,960        23,355        18,579
   Restructuring charge................................................       14,877        16,771            --
   Impairment provision associated with assets of Businesses
     Held for Sale.....................................................      342,960            --            --
                                                                         -----------   -----------   -----------
     Total benefits and expenses.......................................    1,304,623       612,251       472,168
                                                                         -----------   -----------   -----------
Income (loss) before income taxes, equity in earnings of
   unconsolidated affiliates and extraordinary charge..................     (424,628)       51,543       110,579
     Income taxes (benefits)...........................................       (3,369)       20,375        40,957
                                                                         -----------   -----------   -----------
Income (loss) before equity in earnings of unconsolidated affiliates
   and extraordinary charge............................................     (421,259)       31,168        69,622
     Equity in earnings of unconsolidated affiliates...................           --        18,972        21,037
                                                                         -----------   -----------   -----------
Income (loss) before extraordinary charge..............................     (421,259)       50,140        90,659
     Extraordinary charge (net of income taxes of $900, $--and $1,277).       (1,671)           --        (2,372)
                                                                         -----------   -----------   -----------
Net income (loss)......................................................     (422,930)       50,140        88,287
     Preferred stock dividend requirements.............................       18,273        19,533        14,646
                                                                         -----------   -----------   -----------
Net income (loss) applicable to common stock...........................  $  (441,203)  $    30,607   $    73,641
                                                                         ===========   ===========   ===========
PER SHARE INFORMATION:
Basic:
   Net income (loss) applicable to common stock before
    extraordinary charge...............................................  $    (15.17)  $      1.09   $      2.79
     Extraordinary charge, net of income taxes.........................        (0.06)           --         (0.09)
                                                                         -----------   -----------   -----------
   Net income (loss) applicable to common stock........................  $    (15.23)  $      1.09   $      2.70
                                                                         ===========   ===========   ===========
Common shares used in computing basic earnings (loss) per share........       29,091        28,016        27,208
                                                                         ===========   ===========   ===========
Diluted:
   Net income (loss) applicable to common stock before
    extraordinary charge...............................................  $    (15.17)  $      1.07   $      2.49
     Extraordinary charge, net of income taxes.........................        (0.06)           --         (0.07)
                                                                         -----------   -----------   -----------
   Net income (loss) applicable to common stock........................  $    (15.23)  $      1.07   $      2.42
                                                                         ===========   ===========   ===========

Common shares used in computing diluted earnings (loss) per share......       29,091        28,645        35,273
                                                                         ===========   ===========   ===========
COMPREHENSIVE INCOME (LOSS) INFORMATION:
   Net income (loss)...................................................  $  (422,930)  $    50,140   $    88,287
   Change in unrealized foreign currency translation gains (losses),
     net of income taxes...............................................       (6,089)       (5,641)          568
   Change in unrealized gains (losses) on securities available for
     sale of unconsolidated affiliate during the year..................           --        24,277        (6,045)
   Change in unrealized holding gains (losses) arising during the
     year on securities available for sale, net of income taxes
     (benefits) of ($4,818), $6,490 and ($1,828).......................        5,602        27,185        (3,648)
   Reclassification adjustments for gains included in net income (loss)      (14,552)      (15,890)         (596)
                                                                         -----------   -----------   -----------
       Total comprehensive income (loss) applicable to common stock....  $  (437,969)  $    80,071   $    78,566
                                                                         ===========   ===========   ===========

           See accompanying Notes to Consolidated Financial Statements
</TABLE>
                                       50
<PAGE>
                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)
<TABLE>
<CAPTION>
                                                                                            As of December 31,
ASSETS:                                                                                     1998         1997
                                                                                        -----------  -----------
<S>                                                                                     <C>          <C>        
Investments:
   Fixed maturities available for sale, at fair value
     (amortized cost $2,524,990 in 1998 and $2,618,515 in 1997).......................  $ 2,589,714  $ 2,718,982
   Equity securities available for sale, at fair value
     (cost $2,008 in 1998 and $30,084 in 1997)........................................        2,035       30,257
   Mortgage loans on real estate, net of allowance of $4,295 in 1998 and
     $6,041 in 1997...................................................................       36,882      240,879
   Policy loans.......................................................................      207,490      145,108
   Cash and short-term investments....................................................       92,727      109,013
   Other investments..................................................................       27,406       95,875
                                                                                        -----------  -----------
     Total investments ...............................................................    2,956,254    3,340,114
Accrued investment income.............................................................       37,291       43,312
Accounts and notes receivable, net of allowance of $6,201 in 1998 and $9,025 in 1997..       14,319       46,655
Investment in unconsolidated affiliate................................................           --      183,158
Present value of insurance in force...................................................      170,729      263,889
Deferred policy acquisition costs.....................................................      139,708      310,117
Costs in excess of net assets acquired................................................      108,070      116,544
Income taxes, primarily deferred......................................................       46,944           --
Other assets..........................................................................     136, 282      420,346
Assets of Businesses Held for Sale....................................................    2,421,804           --
                                                                                        -----------  -----------
     Total assets ....................................................................  $ 6,031,401  $ 4,724,135
                                                                                        ===========  ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals.......................................................  $ 2,867,038  $ 3,289,925
Notes payable.........................................................................      550,923      359,755
Income taxes, primarily deferred......................................................           --       59,125
Accrued expenses and other liabilities................................................      110,945      135,227
Liabilities of Businesses Held for Sale...............................................    2,066,554           --
                                                                                        -----------  -----------
     Total liabilities................................................................    5,595,460    3,844,032
                                                                                        -----------  -----------
Mandatory redeemable preferred stock:
   Series C, $.01 par value, $100 initial redemption value; authorized, issued and
     outstanding-- in 1998 and 178,500 in 1997........................................           --       19,867

Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value; authorized
   issued and outstanding 2,300,000 in 1998 and 1997..................................      112,454      110,513
$3.50 Series II Convertible Preferred Stock, $.01 par value, $50 redemption value;
   authorized issued and outstanding 2,875,000 in 1998 and 1997.......................      141,673      139,157
Common stock, $.01 par value; authorized 100,000,000; issued and
   outstanding 30,072,344 in 1998 and 28,860,206 in 1997..............................          301          289
Additional paid-in capital............................................................      430,321      397,590
Accumulated other comprehensive income, net of income taxes...........................       19,995       35,034
Retained earnings (deficit)...........................................................     (234,921)     211,055
Treasury shares (1,105,369 in 1998 and 1,009,589 in 1997).............................      (32,391)     (32,130)
Notes receivable and other assets secured by common stock.............................       (1,491)      (1,272)
                                                                                        -----------  -----------
     Total shareholders' equity.......................................................      435,941      860,236
                                                                                        -----------  -----------
     Total liabilities and shareholders' equity ......................................  $ 6,031,401  $ 4,724,135
                                                                                        ===========  ===========
</TABLE>
           See accompanying Notes to Consolidated Financial Statements

                                       51
<PAGE>
                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                 (In thousands)
                        For the years ended December 31,
<TABLE>
<CAPTION>
                                                                            1998           1997          1996
                                                                         -----------   -----------   -----------
<S>                                                                      <C>           <C>           <C>        
Convertible preferred stock:
   Balance at beginning of year........................................  $   249,670   $   249,670   $   110,513
   Issuance of convertible preferred stock.............................           --            --       139,157
   Accrual of dividends in arrears.....................................        4,457            --            --
                                                                         -----------   -----------   -----------
     Balance at end of year............................................      254,127       249,670       249,670
                                                                         -----------   -----------   -----------
Common stock:
   Balance at beginning of year........................................          289           286           229
   Issuance of common stock............................................           10             1            56
   Exercise of stock options...........................................            2             2             1
                                                                         -----------   -----------   -----------
     Balance at end of year............................................          301           289           286
                                                                         -----------   -----------   -----------
Additional paid-in capital:
   Balance at beginning of year........................................      397,590       393,156       220,482
   Issuance of common stock............................................       30,717         1,697       170,393
   Exercise of stock options...........................................        2,014         2,737         2,281
                                                                         -----------   -----------   -----------
       Balance at end of year..........................................      430,321       397,590       393,156
                                                                         -----------   -----------   -----------
Accumulated other comprehensive income:
   Unrealized foreign currency translation losses:
     Balance at beginning of year......................................      (20,602)      (14,961)      (15,529)
     Change in unrealized foreign currency translation gains (losses)
       during the year, net of income taxes............................       (6,089)       (5,641)          568
                                                                         -----------   -----------   -----------
         Balance at end of year........................................      (26,691)      (20,602)      (14,961)
                                                                         -----------   ------------  -----------
   Unrealized gains on securities available for sale:
     Balance at beginning of year......................................       55,636        20,064        30,353
     Change in equity in unrealized gains (losses) on securities
       available for sale of unconsolidated affiliate during the year..           --        24,277        (6,045)
     Change in unrealized holding gains (losses) on securities
       available for sale during the year, net of income taxes.........        5,602        27,185        (3,648)
     Reclassification adjustments for gains included in net
       income (loss)...................................................      (14,552)      (15,890)         (596)
                                                                          ----------    ----------    ----------
         Balance at end of year........................................       46,686        55,636        20,064
                                                                         -----------   -----------   -----------
         Total other comprehensive income..............................       19,995        35,034         5,103
                                                                         -----------   -----------   -----------
Retained earnings (deficit):
   Balance at beginning of year........................................      211,055       186,032       117,987
   Net income (loss)...................................................     (422,930)       50,140        88,287
   Dividends on common stock...........................................       (2,860)       (5,618)       (5,630)
   Accretion of dividends on preferred stock...........................      (18,273)      (19,533)      (14,646)
   Redemption of Series C preferred stock..............................       (1,913)           --            --
   Earned portion of treasury stock awarded to employees...............           --            34            34
                                                                         -----------   -----------   -----------
       Balance at end of year..........................................     (234,921)      211,055       186,032
                                                                         -----------   -----------   -----------
Treasury shares:
   Balance at beginning of year........................................      (32,130)       (3,370)       (3,370)
   Purchases of treasury stock.........................................         (261)      (28,760)           --
                                                                         -----------   -----------   -----------
       Balance at end of year..........................................      (32,391)      (32,130)       (3,370)
                                                                         -----------   -----------   -----------
Notes receivable and other assets secured by common stock:.............       (1,491)       (1,272)       (1,500)
                                                                         -----------   -----------   -----------
       Total shareholders' equity......................................  $   435,941   $   860,236   $   829,377
                                                                         ===========   ===========   ===========
</TABLE>

           See accompanying Notes to Consolidated Financial Statements


                                       52
<PAGE>
                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                        For the years ended December 31,
<TABLE>
<CAPTION>
                                                                                   1998        1997        1996
                                                                                 --------    --------    ---------
<S>                                                                              <C>         <C>         <C>      
Cash flows from operating activities:
   Income (loss) before equity in earnings of unconsolidated affiliates and
     extraordinary charge.....................................................   $(421,259)  $ 31,168    $  69,622
   Adjustments to reconcile income (loss) before equity in earnings of
     unconsolidated affiliates and extraordinary charge to net cash provided
     by operating activities:
       Impairment provision associated with assets of Businesses Held for Sale    342,960          --           --
       Capitalization of deferred policy acquisition costs....................   (128,592)   (109,482)     (98,140)
       Amortization of present value of insurance in force, deferred policy
         acquisition costs, intangibles, depreciation and accretion, net......    123,310      91,902       63,588
       Increase (decrease) in policy liabilities and accruals and other
         policyholder funds...................................................     72,083      (1,644)      77,549
       Sales of trading securities............................................         --      29,914       56,004
       Other, net.............................................................      4,288      11,425      (16,476)
                                                                                 --------    --------    ---------
         Net cash provided (used) by operating activities.....................     (7,210)     53,283      152,147
                                                                                 --------    --------    ---------
Cash flows from investing activities:
   Cash and short-term investments acquired in acquisition of businesses,
      net of cash expended of $82,771, $--and $--in 1998, 1997 and 1996.......     91,492          --      (99,596)
   Purchases of fixed maturity securities held for investment.................         --          --      (27,000)
   Purchases of fixed maturity securities available for sale..................   (1,049,341) (993,768)    (920,430)
   Purchases of equity securities available for sale..........................     (5,391)    (27,776)      (8,398)
   Maturities of fixed maturity securities held for investment................         --          --       42,351
   Maturities of fixed maturity securities available for sale.................    304,122     439,938       81,538
   Sales of fixed maturity securities held for investment.....................         --          --        4,910
   Sales of fixed maturity securities available for sale......................    987,788     777,960      368,331
   Sales of equity securities available for sale..............................     32,062      23,121        5,328
   Acquisitions and originations of mortgage loans............................    (36,965)    (44,375)    (112,473)
   Sales of mortgage loans....................................................     20,867      13,643      151,972
   Principal collected on mortgage loans......................................     50,794      54,145       21,657
   Other, net.................................................................     21,203     (49,712)      75,915
                                                                                 --------    --------    ---------
         Net cash provided (used) by investing activities.....................    416,631     193,176     (415,895)
                                                                                 --------    --------    ---------
Cash flows from financing activities:
   Additional borrowings......................................................    203,000     250,000      177,161
   Issuance of common stock...................................................          3          --      155,450
   Issuance of preferred stock................................................         --          --      139,157
   Purchases of treasury stock................................................         --     (28,760)          --
   Reduction of notes payable.................................................   (126,839)   (100,570)    (330,624)
   Redemption of preferred stock..............................................         --     (14,705)          --
   Receipts from interest sensitive products credited to policyholders'
    account balances..........................................................    251,627     186,166      160,403
   Return of policyholders' account balances on interest sensitive products...   (605,757)   (461,888)    (365,554)
   Cash transferred on reinsurance ceded to an affiliate......................         --     (50,000)          --
   Other, primarily dividends, net............................................    (16,210)    (20,266)     (14,399)
                                                                                 --------    --------    ---------
         Net cash used by financing activities................................   (294,176)   (240,023)     (78,406)
                                                                                 --------    --------    ---------
         Net increase (decrease) in cash......................................    115,245       6,436     (342,154)
Cash and short-term investments at beginning of year..........................    109,013     102,577      444,731
                                                                                 --------    --------    ---------
Cash and short-term investments at end of year (including $131,531 of cash
   and short-term investments classified as assets of Businesses Held for
   Sale in 1998)..............................................................   $224,258    $109,013    $ 102,577
                                                                                 ========    ========    =========
Supplemental disclosures:
   Income taxes paid (refunded)...............................................   $  5,814    $ (1,554)   $  (4,992)
   Interest paid..............................................................     38,017      20,946       18,185
Non-cash financing activities:
   Redemption of Series C Preferred Stock.....................................   $ 22,227    $     --    $      --
   Securities issued in conjunction with acquisition..........................         --          --       14,999
   Debt assumed with acquisition..............................................    115,015          --           --
   Issuance of common stock associated with the acquisition of the Fickes
     and Stone Knightsbridge Interests........................................      8,500          --           --
   Other .....................................................................        261       1,281          948
</TABLE>
           See accompanying Notes to Consolidated Financial Statements

                                       53
<PAGE>
                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

         PennCorp  Financial  Group,  Inc.  ("PennCorp," or the "Company") is an
insurance holding company. Through its wholly-owned life insurance subsidiaries;
Pennsylvania  Life Insurance  Company ("PLIC") and its wholly-owned  subsidiary,
PennCorp  Life  Insurance  Company  (collectively  referred to as "Penn  Life");
Peninsular  Life  Insurance  Company   ("Peninsular");   Professional  Insurance
Corporation ("Professional");  Pioneer Security Life Insurance Company ("Pioneer
Security") and its wholly-owned  subsidiaries  American-Amicable  Life Insurance
Company of Texas and Pioneer American  Insurance  Company (Pioneer  Security and
its subsidiaries collectively referred to as "AA Life");  Southwestern Financial
Corporation ("SW Financial") and its wholly-owned subsidiaries Southwestern Life
Insurance  Company  ("Southwestern  Life"),  Constitution Life Insurance Company
("Constitution"),   Union  Bankers  Insurance  Company  ("Union  Bankers"),  and
Marquette National Life Insurance Company ("Marquette"); Security Life and Trust
Insurance  Company,  formerly  Integon  Life  Insurance  Corporation  ("Security
Life");  Occidental Life Insurance  Company of North Carolina  ("OLIC");  United
Life & Annuity Insurance Company ("United Life");  and Pacific Life and Accident
Insurance  Company  ("PLAIC"),  the Company offers a broad range of accident and
sickness,  life, and accumulation  insurance  products to individuals  through a
sales  force  that  is  contractually  exclusive  to  certain  of the  Company's
subsidiaries  and through  general  agents.  Additionally,  the Company  owns KB
Management,  LLC ("KB  Management"),  which  provides  management  and  advisory
services to the Company;  Marketing One, Inc.  ("Marketing  One"), a third party
marketing organization;  KIVEX, Inc. ("KIVEX"), an internet service provider, UC
Mortgage Corp. ("UC") and Cyberlink Development, Inc. ("Cyberlink").

         As a result of the Company's  announcement  of its decision to sell the
Career Sales  Division (the Career Sales Division is comprised of the operations
of Penn Life,  Peninsular,  Union Bankers,  Constitution and Marquette),  KIVEX,
Professional,  United Life, UC,  Cyberlink and Marketing One within a period not
likely to exceed one year (see Note 3 and 16 of Notes to Consolidated  Financial
Statements),  the assets and  liabilities of the Career Sales  Division,  KIVEX,
Professional,  United Life, UC,  Cyberlink and Marketing One  (collectively  the
"Businesses  Held for Sale")  were  reported as "Assets of  Businesses  Held for
Sale" and "Liabilities of Businesses Held for Sale" at December 31, 1998.

         The  Retained  Businesses  includes  the Payroll  Sales  Division  (the
Payroll  Sales  Division  is  comprised  of AA Life and OLIC) and the  Financial
Services Division (the Financial  Services Division is comprised of Southwestern
Life and Security Life).

         The accompanying consolidated financial statements include the accounts
of the Company and its subsidiaries.  All significant  intercompany accounts and
transactions  have been  eliminated.  All dollar  amounts  presented  hereafter,
except share amounts, are stated in thousands.

         The  financial  statements  are prepared in accordance  with  generally
accepted  accounting  principles  ("GAAP").  These  principles  are  established
primarily by the Financial  Accounting Standards Board ("FASB") and the American
Institute  of  Certified  Public  Accountants  ("AICPA").   The  preparation  of
financial  statements  in  conformity  with  GAAP  requires  management  to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities as well as revenues and expenses. Accounts that the Company deems to
be acutely sensitive to changes in estimates include deferred policy acquisition
costs,  policy  liabilities  and accruals,  present value of insurance in force,
costs in excess of net assets acquired, the fair value of assets and liabilities
classified as held for sale and deferred  taxes.  In addition,  the Company must
determine the requirements  for disclosure of contingent  assets and liabilities
as of the date of the financial  statements based upon estimates.  As additional
information becomes available, or actual amounts are determinable,  the recorded
estimates  may be revised and  reflected in  operating  results.  Although  some
variability  is inherent in these  estimates,  management  believes  the amounts
provided  are  adequate.  In all  instances,  actual  results  could differ from
estimates.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Investments

         Fixed maturities and equity securities classified as available for sale
are  recorded  at fair  value,  as they may be sold in  response  to  changes in
interest rates, prepayment risk, liquidity needs, the need or desire to increase
income,  capital or other  economic  factors.  Changes in  unrealized  gains and
losses  related to  securities  available  for sale are recorded as  accumulated
other comprehensive income, a separate component of shareholders' equity, net of
applicable income taxes and amount  attributable to deferred policy  acquisition
costs and present value of insurance in force related to universal life and

                                       54
<PAGE>

accumulation products.  Securities classified as trading securities are reported
at fair value with realized gains and losses and changes in unrealized gains and
losses  included  in the  determination  of net income as a  component  of other
income. During 1997 and 1996, the Company carried a certain equity investment in
an  affiliate on the equity basis of  accounting  as a result of its  percentage
ownership and lack of voting control.  Mortgage-backed fixed maturity securities
held for  investment  or  available  for sale are  amortized  using the interest
method including  anticipated  prepayments at the date of purchase.  Significant
changes in estimated cash flows from original  assumptions  are reflected in the
period of such  change.  Mortgage  loans on real  estate are  recorded  at cost,
adjusted for amortization of premium or discount and provision for loan loss, if
necessary.  Policy loans,  short-term  investments,  and other  investments  are
recorded at cost.

         As a result of the  Company's  decision to exit the  private  placement
bond sector,  the Company  transferred all of its remaining  assets in the fixed
maturities  held for  investment  portfolio  aggregating  $49,384  to its  fixed
maturities  available for sale portfolio as of April 1, 1997. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, the Company marked
all assets subject to the transfer to fair value  resulting in a net increase in
shareholders' equity, net of applicable income taxes, of $1,800.

         The Company  regularly  evaluates the carrying value of its investments
based on current  economic  conditions,  past credit loss  experience  and other
circumstances. A decline in net realizable value that is other than temporary is
recognized  as a realized  investment  loss and a reduction in the cost basis of
the investment.  The Company discounts expected cash flows in the computation of
net  realizable  value of its  investments,  other than certain  mortgage-backed
securities.  In those  circumstances  where the expected  cash flows of residual
interest and interest only mortgage-backed securities, discounted at a risk-free
rate of return,  result in an amount less than the  carrying  value,  a realized
loss is reflected  in an amount  sufficient  to adjust the  carrying  value of a
given security to its estimated fair value.

         Realized  investment  gains and losses and  declines in value which are
other than temporary,  determined on the basis of specific  identification,  are
included in net income.

Accounts and Notes Receivable

         Accounts and notes receivable consist primarily of agents' balances and
premiums  receivable  from  agents  and  policyholders.   Agents'  balances  are
partially  secured  by  commissions  due to agents in the  future  and  premiums
receivable are secured by policy liabilities. An allowance for doubtful accounts
is established,  based upon specific  identification and general provision,  for
amounts which the Company  estimates  will not  ultimately be collected.  During
1998 and 1997,  the Company wrote off  receivables  totaling  $1,960 and $6,605,
respectively.

Intangible Assets

         During 1996, the Company implemented  Statement of Financial Accounting
Standards ("SFAS") No. 121,  "Accounting for the Impairment of Long-Lived Assets
and Assets to be Disposed of." This accounting standard modified the methodology
companies utilize to evaluate the carrying value of certain assets by requiring,
among  other  things,  companies  evaluate  assets at the lowest  level at which
identifiable cash flows can be determined.

         The Company  continually  monitors the  recoverability  of the carrying
value of intangible assets using the methodology prescribed in SFAS No. 121. The
Company also reviews  long-lived  assets and the related  intangible  assets for
impairment  whenever  events or changes in  circumstances  indicate the carrying
amounts of these assets may not be recoverable.  Recoverability  of these assets
is  determined  by  comparing  the forecast  undiscounted  net cash flows of the
operation  to  which  the  assets  relate,  to the  carrying  amount,  including
associated intangible assets, of such operation.  If the operation is determined
to be unable to recover the carrying amount of its assets, intangible assets are
written  down  initially,  followed  by  the  other  long-lived  assets  of  the
operation,  to fair value.  Fair value is determined  based upon discounted cash
flows or appraised values, depending on the nature of the associated assets.

         During 1998,  the Company  recognized  an aggregate  $342,960  non-cash
charge  related  to  the  fair  value  of  consideration  to  be  received  upon
disposition of certain operating  companies which are aggregated for purposes of
presentation of the Company's  financial  information as "assets and liabilities
of Businesses Held for Sale."

         In accordance  with SFAS No. 121, the Company  recorded the  impairment
provision in order to reflect the difference in the Company's  accounting  basis
in the Businesses Held for Sale and the fair value of the consideration that the
Company  would  likely  receive  for  such  businesses.  The  fair  value of the
consideration  likely to be received has been primarily  based upon the terms of
definitive sales agreements.

                                       55
<PAGE>

Deferred Policy Acquisition Costs

         Estimated  costs of  acquiring  new business  which vary with,  and are
primarily related to, the production of new business,  have been deferred to the
extent  that such  costs are  deemed  recoverable  from  future  revenues.  Such
estimated  costs  include   commissions,   certain  costs  of  policy  issuance,
underwriting,  certain  variable  agency and marketing  expenses and other costs
directly associated with these functions to the extent such costs are determined
to vary with and are primarily related to the production of new business.  Costs
deferred associated with accident and sickness and traditional life policies are
amortized,  with interest,  over the  anticipated  premium-paying  period of the
related  policies  in  proportion  to the ratio of  annual  premium  revenue  to
expected  total  premium  revenue to be received  over the life of the policies.
Expected premium revenue is estimated by using the same mortality, morbidity and
withdrawal assumptions used in computing liabilities for future policy benefits.
For  interest  sensitive   products  and  limited  pay  life  products,   policy
acquisition  costs are  amortized in relation to the  emergence  of  anticipated
gross profits over the life of the policies.

Present Value of Insurance In Force

         The present  value of insurance  in force  represents  the  anticipated
gross profits to be realized  from future  revenues on insurance in force at the
date such insurance was purchased,  discounted to provide an appropriate rate of
return and amortized,  with interest based upon the policy liability or contract
rate,  over the years  that such  profits  are  anticipated  to be  received  in
proportion to the estimated gross profits.  Accumulated amortization was $96,273
and $192,049 as of December 31, 1998 and 1997, respectively.

Costs in Excess of Net Assets Acquired

         Costs in excess of the fair value of net assets  acquired are primarily
amortized  on a  straight-line  basis  ranging  from 5 to 30 years.  Accumulated
amortization  was  $31,024  and  $44,606  as of  December  31,  1998  and  1997,
respectively.  Unamortized  costs in excess of net assets acquired in the amount
of $22,792 were  transferred  to assets of Businesses  Held for Sale in 1998 and
$114,514 was written off in connection with the impairment provision.

         For  each of the  periods  presented,  the  Company  has  made  certain
valuation  determinations  with  respect  to  pre-acquisition  contingencies  or
allocations.  For the year ended December 31, 1998, the Company made a valuation
determination with respect to preacquisition contingencies.  The Company reduced
tax liabilities and associated costs in excess of net assets acquired associated
with  the SW  Financial  and  United  Life  acquisitions  by  $6,407  and  $647,
respectively,  as a result of the Company  resolving  certain  acquisition  date
contingencies.

         For the year ended  December  31,  1997,  the  Company  determined  the
following  with  respect  to  certain  material  acquisition   contingencies  or
allocations:   (i)  the  Company  increased  deferred  tax  assets  and  reduced
associated  costs in excess of net assets acquired  associated with the Security
Life  acquisition  by  $19,600  as a result  of the  Company  resolving  certain
acquisition date tax  contingencies,  (ii) the Company reduced both deferred tax
liabilities  and associated  costs in excess of net assets  acquired  associated
with  the  Marketing  One  acquisition  by  $1,100  as a result  of the  Company
resolving  certain  acquisition  date tax  contingencies,  and (iii) the Company
reduced costs in excess of net assets  acquired and increased  certain  mortgage
loan values by $1,100,  associated  with the  acquisition  of United Life,  as a
result of final appraisals becoming available.

         For the year ended  December  31,  1996,  the  Company  determined  the
following  with  respect  to  certain  material  acquisition   contingencies  or
allocations:  (i) the Company  incurred  additional  costs  associated  with the
acquisition of United Life of $2,500, which resulted in a corresponding increase
to costs in excess of net  assets  acquired,  (ii) the  Company  decreased  real
estate and  mortgage  loan loss  valuations  of Security  Life by $6,800,  which
resulted in a decrease  in costs in excess of net assets  acquired of $4,400 and
deferred tax assets of $2,400,  and (iii) the Company  increased  certain policy
reserves of Security Life aggregating $10,000, which resulted in a corresponding
increase to costs in excess of net assets acquired of $10,000.

Policy Liabilities

         Future  policy  benefits  for  traditional   life  insurance   products
generally have been computed on the net level premium method, based on estimated
future investment yield,  mortality,  morbidity and withdrawals.  Estimates used
are based on  experience  adjusted to provide for  possible  adverse  deviation.
These estimates are periodically  reviewed and compared with actual  experience.
Future policy benefits for interest  sensitive products include the balance that
accrues to the benefit of the

                                       56
<PAGE>

policyholders  and  amounts  that  have been  assessed  to  compensate  the life
insurance subsidiaries for services to be provided in the future.

         Policy and contract claims represent  estimates of both reported claims
and claims  incurred but not reported based on experience.  The Company has been
closely  monitoring the development of claims reserve  experience for Penn Life.
The  methodology  previously  utilized  has  experienced,  what appears to be, a
deterioration of the adequacy of its claims reserves  associated with disability
income products sold prior to the Company's ownership.  During 1998, the Company
changed its methodology in recording these reserves. The effect of the change in
methodology is inseparable from the effect of the change in accounting  estimate
and is  accordingly  reflected in operations as a change in accounting  estimate
for 1998.

Income Taxes

         Income taxes are accounted  for under the asset and  liability  method.
Deferred  tax  assets  and   liabilities  are  recognized  for  the  future  tax
consequences   attributable  to  temporary  differences  between  the  financial
statement  carrying  amounts  of  existing  assets  and  liabilities  and  their
respective  tax bases as well as  operating  loss and tax credit  carryforwards.
Deferred  tax  assets and  liabilities  are  measured  using  enacted  tax rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences are expected to be recovered or settled.  The effect on deferred tax
assets and  liabilities  of a change in tax rates is recognized in income in the
period that includes the enactment date.

         In assessing the  realization of deferred taxes,  management  considers
whether it is more likely than not that some  portion or all of the deferred tax
assets will be  realized.  The  ultimate  realization  of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those  temporary   differences  become  deductible.   Management  considers  the
scheduled reversal of deferred tax liabilities,  projected future taxable income
and tax planning strategies in making this assessment.

Treasury Shares

         Shares  purchased are recorded at cost as a reduction of  shareholders'
equity. Shares abandoned by the associated shareholders are recorded at no cost.

Insurance Revenue Recognition

         Accident and sickness  insurance  premiums  are  recognized  as revenue
ratably over the time period to which premiums relate. Revenues from traditional
life insurance  policies  represent premiums which are recognized as earned when
due.  Benefits and expenses are associated  with earned premiums so as to result
in  recognition of profits over the lives of the policies.  This  association is
accomplished  by  means of the  provision  for  liabilities  for  future  policy
benefits and the deferral and amortization of policy acquisition costs.

         Revenues for interest  sensitive  products  such as universal  life and
annuity contracts represent charges assessed against the policyholders'  account
balance  for the  cost  of  insurance,  surrenders  and  policy  administration.
Benefits  charged to expenses  include benefit claims incurred during the period
in excess of policy  account  balances and interest  credited to policy  account
balances.

Net Income (Loss) per Common Share

         Net income (loss) per common share is computed in accordance  with SFAS
No. 128, "Earnings Per Share." Basic earnings (loss) per share excludes dilution
and is computed by dividing income (loss)  applicable to common  shareholders by
weighted  average number of common shares  outstanding  for the period.  Diluted
earnings (loss) per share represents the potential  dilution that could occur if
all  convertible  securities,  warrants  and stock  options were  exercised  and
converted into common stock, if the effect of doing so is dilutive.  The diluted
earnings  per share  calculation  assumes that the  proceeds  received  upon the
conversion  of all  dilutive  options and warrants  are used to  repurchase  the
Company's  common  shares at the average  market price of such shares during the
period.

         The  Company  adopted  the  disclosure  requirements  of SFAS No.  123,
"Accounting for Stock-Based  Compensation,"  in 1996. This statement  provides a
choice for the  accounting of employee stock  compensation  plans. A company may
elect to use a new  fair-value  methodology,  under which  compensation  cost is
measured and  recognized  in results of  operations,  or continue to account for
these plans under Accounting  Principles  Board ("APB") No. 25,  "Accounting for
Stock Issued to Employees," and related Interpretations. Note 13 of the Notes to
Consolidated Financial

                                       57
<PAGE>

Statements  contains a summary of the pro forma  effects to reported  net income
applicable to common stock and earnings per share for 1998, 1997 and 1996, as if
the  Company  had  elected to account  for  employee  stock  compensation  plans
utilizing the fair value methodology prescribed by SFAS No. 123.

Business Combinations

         Business  combinations  accounted  for  as a  purchase  result  in  the
allocation  of the purchase  consideration  to the fair values of the assets and
liabilities acquired  establishing such fair values as the new accounting bases.
Purchase  consideration  in excess of the fair value of net assets  acquired  is
allocated to "costs in excess of net assets  acquired." Should the fair value of
the net  assets  acquired  exceed the  purchase  consideration,  such  excess is
utilized  to reduce  certain  intangible  assets,  primarily  "present  value of
insurance in force."  Allocation of purchase price is performed in the period in
which the purchase is consummated and may be preliminary.  Adjustments resulting
from  completion  of the  purchase  allocation  process  affect the value of the
assets and liabilities acquired.

Foreign Currency Translation

         The financial statement accounts of the Company's Canadian  operations,
which are denominated in Canadian  dollars,  are translated into U.S. dollars as
follows:  (i) Canadian  currency  assets and  liabilities  are translated at the
rates of  exchange as of the  balance  sheet  dates and the  related  unrealized
translation  adjustments are included as accumulated other comprehensive income,
a separate component of shareholders'  equity,  and (ii) revenues,  expenses and
cash flows,  expressed  in Canadian  dollars,  are  translated  using a weighted
average of exchange rates for each of the periods presented.

Reinsurance

         Financial reinsurance that does not transfer significant insurance risk
is accounted for as deposits.  The cost of reinsurance  related to long-duration
contracts is accounted for over the life of the underlying  reinsured  policies.
Balances  due to,  or  from,  reinsurers  have  been  reflected  as  assets  and
liabilities  rather than being  netted  against the  related  account  balances.
Realized  gains  on  retroactive  reinsurance   arrangements  are  deferred  and
amortized into net income over the estimated duration of the reinsured business.

Accounting Pronouncements Not Yet Adopted

         In June 1998, the FASB issued SFAS No. 133,  "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 defines derivative instruments
and  provides   comprehensive   accounting  and  reporting   standards  for  the
recognition  and  measurement  of derivative and hedging  activities  (including
certain instruments embedded in other contracts).  It requires derivatives to be
recorded  in the  Consolidated  Balance  Sheet  at fair  value  and  establishes
criteria for hedges of changes in the fair value of assets,  liabilities or firm
commitments,  hedges of  variable  cash flows of  forecasted  transactions,  and
hedges of foreign currency  exposures of net investments in foreign  operations.
Changes in the fair value of derivatives not meeting  specific hedge  accounting
criteria would be recognized in the Consolidated  Statement of Operations.  SFAS
No. 133 is effective for all fiscal  quarters of all years  beginning after June
15, 1999. The Company is currently evaluating SFAS No.133 and has not determined
its effect on the consolidated financial statements.

         In December 1997, the AICPA issued  Statement of Position ("SOP") 97-3.
SOP 97-3 provides:  (1) guidance for determining when an entity should recognize
a liability  for  guaranty-fund  and other  insurance-related  assessments,  (2)
guidance on how to measure the  liability,  (3) guidance on when an asset may be
recognized for a portion or all of the assessment  liability or paid  assessment
that can be recovered through premium tax offsets or policy surcharges,  and (4)
requirements  for disclosure of certain  information.  This SOP is effective for
financial  statements  for fiscal years  beginning  after December 15, 1998. The
Company's present accounting methodology for guaranty fund and other reinsurance
assessments substantially conforms to the requirements of this SOP.

         In March 1998, the AICPA issued SOP 98-1,  "Accounting for the Costs of
Computer  Software  Developed or Obtained  for Internal  Use." This SOP provides
guidance for  determining  whether  costs of software  developed or obtained for
internal use should be  capitalized  or expensed as incurred.  In the past,  the
Company  has  expensed  such  costs  as they  were  incurred.  This  SOP is also
effective for fiscal years  beginning  after  December 15, 1998.  The Company is
currently  completing  its  evaluation  of the  financial  impact as well as the
changes to its related disclosures.


                                       58

<PAGE>

Reclassifications

         Certain  prior year  amounts have been  reclassified  to conform to the
current year presentation.

(3) ACQUISITIONS AND DISPOSITIONS

Acquisitions of SW Financial Controlling Interest,  Knightsbridge  Interests and
United Life

         On January 2, 1998,  following  shareholder  approval at the  Company's
1997 annual meeting of  shareholders,  the Company  consummated the acquisition,
from KB Investment Fund I, LP (formerly  Knightsbridge  Capital Fund I, LP) (the
"KB Fund") and Messrs. Steven W. Fickes, a former director and David J. Stone, a
director of the Company,  of their  respective  holdings of common stock and, in
the case of the KB Fund,  common stock  warrants of SW Financial  (collectively,
the "SW Financial  Controlling  Interest")  for an aggregate  purchase  price of
$73,658  (not  including  acquisition  expenses).  The fair  value of net assets
acquired  amounted  to  $45,520  resulting  in $28,138 of costs in excess of net
assets  acquired  which  will  be  amortized  over  30  years.  As  part  of the
acquisition  of the SW  Financial  Controlling  Interest on January 2, 1998,  SW
Financial  Subordinated Notes in the amount of $40,000  previously  purchased by
the Company were reclassified to purchase  consideration  for SW Financial.  The
acquisition of the SW Financial Controlling Interest has been accounted for as a
step purchase  transaction  in accordance  with  generally  accepted  accounting
principles, and accordingly, fair values of assets and liabilities acquired have
been determined as of January 2, 1998.

         On January 5, 1998,  following  shareholder approval at the 1997 annual
meeting  of  shareholders,  the  Company  consummated  the  acquisition  of  the
interests  of  Messrs.  Fickes  and  Stone  in KB  Management,  KB  Fund  and KB
Consultants LLC (formerly known as Knightsbridge Consultants LLC) (collectively,
the  "Fickes  and  Stone  Knightsbridge   Interests")  for  total  consideration
estimated to be $10,564 (not including  acquisition  expenses).  Mr. Fickes will
receive consideration in the form of estimated annual interest payments, ranging
from $301 to $330, on April 15 each year through 2001 and will be issued 173,160
shares of the Company's Common Stock on April 15, 2001. Mr. Stone was issued his
173,160  shares in July 1998  which he  pledged  to  financial  institutions  in
connection with his appeal of a judgment awarded against him and his spouse. The
fair value of net assets acquired  amounted to ($1,701)  resulting in $12,294 of
costs in excess of net assets acquired which will be amortized over seven years.
The  acquisition  of the  Fickes  and  Stone  Knightsbridge  Interests  has been
accounted for as a purchase  transaction in accordance  with generally  accepted
accounting  principles,  and accordingly,  preliminary fair values of assets and
liabilities  acquired were recorded as of the acquisition  date which became the
new accounting basis.

         The Company  acquired United Life in 1996 for a total purchase price of
$110,056  including expenses incurred of $9,706 and earnings through the date of
consummation of the acquisition of $3,608.  The United Life acquisition has been
accounted for as a purchase  transaction in accordance  with generally  accepted
accounting principles, the fair value of net assets acquired amounted to $82,580
(as  adjusted)  resulting  in $27,476  (as  adjusted)  of costs in excess of net
assets acquired which will be amortized over 20 years.

Businesses Held for Sale

         On  February  18,  1998,  the  Company  announced  it had  engaged  the
investment banking firms Salomon Smith Barney, Inc. and Fox-Pitt, Kelton Inc. to
review strategic  alternatives for maximizing  shareholder value,  including the
sale of the  Company's  Career Sales  Division and certain  other  non-strategic
subsidiaries.

         The Career Sales  Division is comprised  in part of the  operations  of
Penn Life. With the acquisition in January 1998 of SW Financial, the Company has
integrated  Union  Bankers,  Constitution  and  Marquette  into the Career Sales
Division.

         On December 31, 1998, the Company  entered into a definitive  agreement
to sell the Career  Sales  Division  and related  assets to  Universal  American
Financial  Corp.  ("Universal  American").  The  purchase  price of  $175,000 is
subject to  adjustment  based on the  capital  and  surplus of the Career  Sales
Division at the closing date.  The purchase  price  consists of $136,000 in cash
and $39,000 initial  principal  amount,  subject to adjustment,  of subordinated
notes of Universal American. The subordinated notes will bear interest at a rate
of 8.0% per annum and will mature ten years from date of issuance.  The accreted
value of the notes will be subject to offset in the event of adverse development
(or subject to increase in the event of positive  development) in the disability
income reserves of PLIC and may be offset for other indemnification claims under
the purchase and sale  agreement.  In  addition,  the Company is required  under
terms of the  purchase and sale  agreement to deliver the Career Sales  Division
and related assets with certain minimum levels of statutory capital and surplus,
pay certain  ongoing costs and other  expenses  which will result in the Company
receiving net cash proceeds of approximately $70,000

                                       59

<PAGE>

to $78,000.  For additional  information  concerning  the  disability  insurance
reserves of PLIC, see Note 8 of Notes to Consolidated Financial Statements.

         Also on December 31, 1998, the Company signed a definitive agreement to
sell  Professional.  Professional,  which previously was included in the Payroll
Sales Division,  provides individual fixed benefit and life products utilizing a
network of  independent  agents  primarily  in the  southeastern  United  States
through employer-sponsored payroll deduction programs.  Pursuant to the purchase
and  sale  agreement,  Professional  will  be  sold  to GE  Financial  Assurance
Holdings,  Inc.  ("GEFAH") for $47,500 in cash. The purchase price is subject to
adjustment based on  Professional's  capital and surplus at the closing date. In
addition,  GEFAH will pay interest on the purchase  price from December 31, 1998
to the date of settlement.  The Company currently  estimates  receiving net cash
proceeds for the Professional sale of approximately $40,000 to $41,500.

         On February 21, 1999, the Company signed a definitive agreement to sell
United Life and its wholly-owned subsidiary,  United Variable Services, Inc., to
ING America Insurance Holdings,  Inc. ("ING"). United Life, which previously was
included in the  Financial  Services  Division,  principally  markets  fixed and
variable  annuities  through  financial  institutions  and  independent  general
agents,  primarily in the southern and western United States. The sale of United
Life to ING also  includes  the sale of UC,  Cyberlink  and  certain  assets  of
Marketing One. The aggregate  purchase price consists of $152,000 and a dividend
payable  by  United  Life  at  closing,  which  the  Company  estimates  will be
approximately  $2,100. The purchase  consideration may be reduced as a result of
the  Company's  obligation  to purchase  certain  mortgages  from United Life at
closing.  Additionally,  a portion  of the  purchase  price may be  escrowed  at
closing to fund the Company's  obligation to purchase additional  mortgages from
United Life after closing. United Life, including its subsidiary United Variable
Services,  Inc., UC,  Cyberlink and certain assets of Marketing One are referred
to herein  collectively  as the "United Life  Assets."  The Company  anticipates
receiving  net  cash  proceeds  from  the  sale of the  United  Life  Assets  of
approximately $140,000.

         In the third  quarter of 1998,  the Company  made the  decision to sell
KIVEX,  an internet  service  provider.  The Company has engaged the  investment
banking  firm  of ING  Barings  Furman  Selz  in this  regard  and is  currently
soliciting  interest from prospective  purchasers.  To date, the Company has not
entered into a definitive agreement to sell KIVEX. In addition,  the Company has
made the decision to sell Marketing One,  excluding  those assets  included with
the sale of United Life.

         Separate selected pro forma financial  information is presented in Note
17 to  illustrate  the effects of the purchase of the SW  Financial  Controlling
Interests and the Fickes and Stone Knightsbridge Interest as well as the sale of
Businesses Held for Sale for the years ended December 31, 1998 and 1997.

(4) BUSINESS SEGMENT INFORMATION

         The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise  and Related  Information"  which  requires that  companies  disclose
segment data on a basis that is used  internally  by management  for  evaluating
segment  performance and allocating  resources to segments.  The Company defines
its operating divisions based on the distribution channels of its products.  The
Company  has  three  reportable  operating  segments:   (i)  Financial  Services
Division,  which is based in Dallas, Texas, and markets life insurance and fixed
annuities through independent general agents; (ii) Payroll Sales Division, which
is based in Waco,  Texas, and markets and underwrites  customized life insurance
and  accumulation  products to U.S.  military  personnel  and federal  employees
through a general  agency force and provides  individual  fixed benefit and life
products  through  employer-sponsored  payroll  deduction  programs;  and  (iii)
Businesses Held for Sale.

         The Company's Chief  Executive  Officer  evaluates  performance of each
segment  based on profit or loss from  operations  excluding  (i)  restructuring
costs,  (ii) net gains on the sale of investments,  (iii)  impairment  valuation
associated  with Businesses  Held for Sale,  (iv) interest  expense,  (v) income
taxes and (vi) equity in earnings of unconsolidated subsidiaries. The accounting
policies  of  segments  are the  same  as  those  described  in the  summary  of
significant  accounting policies (see Note 2 of Notes to Consolidated  Financial
Statements). Segment data for 1997 and 1996 have been restated to conform to the
1998 presentation.


                                       60

<PAGE>

<TABLE>
<CAPTION>
                                                                        1998           1997            1996
                                                                     -----------    -----------    -----------
     <S>                                                             <C>            <C>            <C>      
     Premiums and policy product charges:
         Financial Services Division..............................   $   129,242    $    69,830    $    71,758
         Payroll Sales Division...................................        89,991         89,699         83,747
         Businesses Held for Sale (United States).................       194,995        141,834        149,808
         Businesses Held for Sale (Canada)........................        44,930         44,203         42,777
                                                                     -----------    -----------    -----------
                                                                     $   459,158    $   345,566    $   348,090
                                                                     ===========    ===========    ===========

     Net investment income:
         Financial Services Division..............................   $   183,618    $    90,787    $    94,185
         Payroll Sales Division...................................        39,046         38,161         36,023
         Businesses Held for Sale.................................       147,201        138,355         75,860
         Corporate................................................          (813)         5,934          4,666
                                                                     -----------    -----------    -----------
                                                                     $   369,052    $   273,237    $   210,734
                                                                     ===========    ===========    ===========

     Operating profit (loss):
         Financial Services Division..............................   $    23,206    $    27,756    $    39,156
         Payroll Sales Division...................................        (2,728)        23,960         22,796
         Businesses Held for Sale.................................       (18,323)        37,479         63,840
                                                                     -----------    -----------    -----------
                                                                     $     2,155    $    89,195    $   125,792
                                                                     ===========    ===========    ===========

     Amortization  of present  value of insurance  in force and
       deferred  policy acquisition costs:
         Financial Services Division..............................   $    26,122    $    19,468    $     9,996
         Payroll Sales Division...................................        37,977         24,271         13,078
         Businesses Held for Sale.................................        53,347         48,307         33,396
                                                                     -----------    -----------    -----------
                                                                     $   117,446    $    92,046    $    56,470
                                                                     ===========    ===========    ===========

     Total assets:
         Financial Services Division..............................   $ 2,823,007    $ 1,386,751    $ 1,529,821
         Payroll Sales Division...................................       695,777        751,261        732,871
         Businesses Held for Sale (United States).................     2,294,945      2,129,751      2,219,771
         Businesses Held for Sale (Canada)........................       126,859        181,768        183,500
                                                                     -----------    -----------    -----------
                                                                     $ 5,940,588    $ 4,449,531    $ 4,665,963
                                                                     ===========    ===========    ===========
</TABLE>

                  (Remainder of Page Intentionally Left Blank)


                                       61
<PAGE>

     Reconciliations  of segment data to the Company's  consolidated data are as
follows:

<TABLE>
<CAPTION>
                                                                        1998           1997            1996
                                                                     -----------    -----------    -----------
     <S>                                                             <C>            <C>            <C>        
     Total revenues:
         Segments--premiums and policy product charge.............   $   459,158    $   345,566    $   348,090
         Segments--net investment income..........................       369,052        273,237        210,734
         Other income.............................................        37,717         27,504         22,666
         Net gain from sale of investments........................        14,068         17,487          1,257
                                                                     -----------    -----------    -----------
                                                                     $   879,995    $   663,794    $   582,747
                                                                     ===========    ===========    ===========
     Income (loss) before taxes, equity in earnings of
        unconsolidated affiliates and extraordinary charge:
         Segments.................................................   $     2,155    $    89,195    $   125,792
         Corporate expenses and eliminations......................       (40,054)       (15,013)         2,109
         Impairment provision associated with
           assets of Businesses Held for Sale.....................      (342,960)            --             --
         Interest and amortization of deferred debt
           issuance costs.........................................       (42,960)       (23,355)       (18,579)
         Net gains on the sale of investments.....................        14,068         17,487          1,257
         Restructuring costs......................................       (14,877)       (16,771)            --
                                                                     -----------    -----------    -----------
                                                                     $  (424,628)   $    51,543    $   110,579
                                                                     ===========    ===========    ===========
     Total assets:
         Segments.................................................   $ 5,940,588    $ 4,449,531    $ 4,665,963
         Corporate and other......................................        90,813        274,604        143,360
                                                                     -----------    -----------    -----------
                                                                     $ 6,031,401    $ 4,724,135    $ 4,809,323
                                                                     ===========    ===========    ===========
</TABLE>

(5) INVESTMENTS

         The amortized cost and fair value of  investments  in fixed  maturities
available for sale were as follows as of December 31:

<TABLE>
<CAPTION>
                                                                                1998
                                                                        Gross         Gross
                                                      Amortized       Unrealized     Unrealized         Fair
                                                         Cost           Gains         Losses           Value
                                                         ----           -----         ------           -----
   <S>                                               <C>             <C>            <C>            <C>
   Mortgage-backed securities, principally
     obligations of U.S. Government agencies.......  $ 1,164,739     $    33,930    $     9,983    $ 1,188,686
   U.S. Treasury securities and obligations of
     U.S. Government corporations and agencies.....      235,037          15,849          6,059        244,827
   Debt securities issued by foreign governments...       25,701           1,477             --         27,178
   Corporate securities............................    1,099,513          41,723         12,213      1,129,023
                                                     -----------     -----------    -----------    -----------
                                                     $ 2,524,990     $    92,979    $    28,255    $ 2,589,714
                                                     ===========     ===========    ===========    ===========
</TABLE>

<TABLE>
<CAPTION>
                                                                                1997
                                                                        Gross          Gross
                                                      Amortized      Unrealized     Unrealized         Fair
                                                         Cost           Gains         Losses           Value
                                                         ----           -----         ------           -----
 <S>                                                 <C>             <C>            <C>            <C>
 Mortgage-backed securities, principally
     obligations of U.S. Government agencies.......  $ 1,242,805     $    46,157    $     1,313    $ 1,287,649
   U.S. Treasury securities and obligations of
     U.S. Government corporations and agencies.....      135,255           7,551            120        142,686
   Debt securities issued by foreign governments...       66,635           7,188             12         73,811
   Corporate securities............................    1,173,820          49,164          8,148      1,214,836
                                                     -----------     -----------    -----------    -----------
                                                     $ 2,618,515     $   110,060    $     9,593    $ 2,718,982
                                                     ===========     ===========    ===========    ===========
</TABLE>

                                       62
<PAGE>

         The  amortized  cost and fair value of fixed  maturities  available for
sale as of December 31, 1998, by contractual maturity, are shown below:

<TABLE>
<CAPTION>
                                                              Amortized        Fair
                                                                Cost           Value
                                                                ----           -----
  <S>                                                       <C>            <C>          
  Due in one year or less ...............................   $      57,449  $      57,946
  Due after 1 through 5 years ...........................         404,727        413,521
  Due after 5 through 10 years ..........................         439,041        453,840
  Due after 10 years ....................................         459,034        475,721
  Mortgage-backed securities, principally
     obligations of U.S. Government agencies.............       1,164,739      1,188,686
                                                            -------------  -------------
                                                            $   2,524,990  $   2,589,714
                                                            =============  =============
</TABLE>

         Expected  maturities will differ from  contractual  maturities  because
borrowers  may have the  right to call or  prepay  obligations  with or  without
prepayment penalties.

         Included in fixed maturities available for sale as of December 31, 1998
and 1997,  are  below  investment-grade  securities  with an  amortized  cost of
$177,263 and $165,511 and a fair value of $163,252 and  $167,518,  respectively.
Included in fixed  maturities  available  for sale as of December 31, 1998,  are
unrated  securities  with an  amortized  cost of  $18,211  and a fair  value  of
$18,239. Included in fixed maturities available for sale as of December 31, 1997
are unrated securities with an amortized cost and a fair value of $26,563.

         As  of  December  31,  1998,  net  unrealized  appreciation  in  equity
securities available for sale of $27 consisted of gross unrealized gains of $27.
As of December  31,  1997,  net  unrealized  appreciation  in equity  securities
available for sale of $173  consisted of gross  unrealized  gains of $242,  less
gross unrealized losses of $69.

         The Company's  commercial and residential  mortgage  portfolios had net
carrying  values  $36,882  and  $240,879,  respectively,  and,  fair  values  of
approximately  $38,865 and $248,052,  respectively,  as of December 31, 1998 and
1997.

         As of December 31,  1998,  commercial  and  residential  mortgage  loan
investments were concentrated in the following states:

<TABLE>
<CAPTION>
                                                                          Percent of Total
                                                        Carrying Value     Carrying Value
                                                        --------------    ----------------
 <S>                                                      <C>                   <C>  
 Texas...............................................     $   17,885             48.5%
 North Carolina......................................          7,730             21.0
 Kansas..............................................          2,250              6.1
 Illinois............................................          1,926              5.2
 Nevada..............................................          1,805              4.9
 Alabama.............................................          1,604              4.3
 All other (less than 4% individually)...............          3,682             10.0
                                                          ----------            -----
                                                          $   36,882            100.0%
                                                          ==========            =====
</TABLE>

         Investments  with a carrying  value of  $146,385  and  $68,219  were on
deposit with certain  regulatory  authorities  as of December 31, 1998 and 1997,
respectively.

                                       63

<PAGE>
         Realized,  and changes in  unrealized  gains and losses on  investments
were as follows for the years ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>        
     Realized gains (losses) on dispositions of investments:
       Securities held for investment:
         Gross gains from sales........................................  $        --  $        --  $        --
         Gross losses from sales.......................................           --           --          (28)
         Net gains (losses) from redemptions...........................           --           --         (105)
                                                                         -----------  -----------  -----------
                                                                                  --            --        (133)
       Securities available for sale:
         Gross gains from sales........................................       20,509       22,076        2,562
         Gross losses from sales.......................................       (5,960)      (6,186)      (1,800)
         Net gains (losses) from redemptions...........................            3           --         (166)
                                                                         -----------  -----------  -----------
                                                                              14,552       15,890          596
                                                                         -----------  -----------  -----------
       Mortgage loans..................................................       (6,545)        (284)         794
       Other investments...............................................        6,061        1,881           --
                                                                         -----------  -----------  -----------
           Net realized gains..........................................  $    14,068  $    17,487  $     1,257
                                                                         ===========  ===========  ===========
     Change in unrealized gains (losses):
       Securities held for investment..................................  $        --  $    (2,429) $     2,441
                                                                         ===========  ===========  ===========
       Securities available for sale...................................  $   (27,038) $    44,627  $   (18,250)
       Securities available for sale of unconsolidated affiliate.......           --       24,277       (6,045)
       Less effect on other balance sheet accounts:
         Value of business acquired, deferred acquisition costs and other,
           principally unearned revenue on interest sensitive products.       13,270      (26,842)      12,178
         Deferred income taxes (benefits)..............................        4,818       (6,490)       1,828
                                                                         -----------  -----------  -----------
           Net change in unrealized gains..............................  $    (8,950) $    35,572  $   (10,289)
                                                                         ===========  ===========  ===========
     Trading portfolio:
       Net gains (losses) from sales...................................  $        --  $      (142) $     4,930
       Net change in unrealized gains (losses).........................           --        1,258       (3,626)
                                                                         -----------  -----------  -----------
           Total net trading gains ....................................           --  $     1,116  $     1,304
                                                                         ===========  ===========  ===========
</TABLE>

         Major  categories of net investment  income  consisted of the following
for the years ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>        
     Fixed maturity securities.........................................  $   310,798  $   231,867  $   169,847
     Mortgage loans on real estate ....................................       27,773       26,498       11,888
     Policy loans .....................................................       16,235        9,037        8,409
     Short-term investments ...........................................        9,016        6,366       12,966
     Other investments.................................................       13,553        9,177       13,100
                                                                         -----------  -----------  -----------
       Gross investment income ........................................      377,375      282,945      216,210
     Less: investment expenses.........................................        8,323        9,708        5,476
                                                                         -----------  -----------  -----------
       Net investment income ..........................................  $   369,052  $   273,237  $   210,734
                                                                         ===========  ===========  ===========
</TABLE>

                                       64
<PAGE>

         The  Retained  Businesses  had  non-income  producing   investments  at
December 31, 1998 with an amortized cost and fair value as follows:

<TABLE>
<CAPTION>
                                                                         Amortized        Fair
                                                                           Cost           Value
                                                                           ----           -----
 <S>                                                                    <C>            <C>        
 Fixed maturities..................................................     $    6,762     $       605
 Mortgage loans....................................................          5,018           5,018
 Other investments.................................................          6,630           6,630
                                                                        ----------     -----------
                                                                        $   18,410     $    12,253
                                                                        ==========     ===========
</TABLE>

(6) SOUTHWESTERN LIFE INVESTMENT

         On December 14, 1995, SW Financial (see Notes 18 and 19 of the Notes to
Consolidated  Financial Statements) purchased SW Life, Union Bankers and certain
other related assets from I.C.H. Corporation for $260,000.

         Through its initial direct  investment of $120,000 in SW Financial (the
"Southwestern Life Investment"), the Company beneficially owned, at December 31,
1997 and 1996, 74.8% of SW Financial's  outstanding common stock, including 100%
of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common
stock,  and  100% of SW  Financial  preferred  stock.  PennCorp  is also a 16.3%
limited partner in KB Fund. As a result, the Company had an economic interest in
SW Financial aggregating 78.0 percent. Retained earnings of the Company included
undistributed  earnings of SW  Financial  aggregating  $40,919 and $21,947 as of
December 31, 1997 and 1996, respectively.

         On August 5, 1997, the Company  purchased $40,000 of SW Financial Notes
from the liquidating trust for the creditors of ICH Corporation,  SW Financial's
former  parent.  SW Financial  had issued the SW Financial  Notes as part of the
acquisition  consideration paid to the liquidating trust. The SW Financial Notes
were  purchased by the Company at par and were included in other  investments as
of December 31, 1997. Interest due under the SW Financial Notes is currently set
at 7.0%, per annum.

         On January 2, 1998, the Company  acquired the SW Financial  Controlling
Interest (see Note 3 of the Notes to Consolidated Financial Statements).

                  (Remainder of Page Intentionally Left Blank)



                                       65
<PAGE>

         The Company accounted for its investment in SW Financial  utilizing the
equity method for the years ended December 31, 1997 and 1996.  The  consolidated
condensed  results of operations  for the years ended December 31, 1997 and 1996
and financial position of SW Financial at December 31, 1997, are provided below:

<TABLE>
<CAPTION>
                                                                                   For the years ended
                                                                                       December 31,
                                                                                   1997           1996
                                                                                ----------     -----------
         <S>                                                                    <C>            <C>        
         Revenues:
         Policy revenues.....................................................   $  145,818     $   196,912
         Net investment income...............................................      126,427         128,692
         Other income (including limited partnership
           distributions of $15,811 in 1996).................................       16,039          27,439
         Net gains from the sale of investments..............................        1,841             516
                                                                                ----------     -----------
                Total revenues...............................................      290,125         353,559
                                                                                ----------     -----------
         Benefits and expenses:
         Claims incurred.....................................................      201,385         211,460
         Change in liability for future policy benefits and
           other policy benefits.............................................      (35,103)        (13,616)
         Insurance and other operating expenses..............................       66,319          92,632
         Interest and amortization of deferred debt issuance costs...........       13,773          14,052
                                                                                ----------     -----------
              Total benefits and expenses....................................      246,374         304,528
                                                                                ----------     -----------
         Income before income taxes..........................................       43,751          49,031
           Income taxes......................................................       16,416          18,149
                                                                                ----------     -----------
         Net income .........................................................       27,335          30,882
           Preferred stock dividend requirements.............................        3,012           2,754
                                                                                ----------     -----------
         Net income applicable to common stock...............................   $   24,323     $    28,128
                                                                                ==========     ===========

                                                                                               December 31,
                                                                                                  1997
                                                                                                  ----
         Assets:
         Invested assets.....................................................................  $ 2,026,768
         Insurance assets....................................................................      114,395
         Other assets........................................................................      283,717
                                                                                               -----------
         Total assets........................................................................  $ 2,424,880
                                                                                               ===========

         Liabilities and Shareholders' Equity:
         Insurance liabilities...............................................................  $ 1,942,214
         Long-term debt......................................................................      154,750
         Other liabilities...................................................................       98,509
         Redeemable preferred stock..........................................................       36,891
         Shareholders' equity................................................................      192,516
                                                                                               -----------
           Total liabilities and shareholders' equity .......................................  $ 2,424,880
                                                                                               ===========
</TABLE>

                                       66
<PAGE>

(7) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE

         Information relating to deferred policy acquisition costs is as follows
for the years ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
       <S>                                                               <C>          <C>          <C>        
       Balance as of January 1.........................................  $   310,117  $   252,428  $   185,570
       Policy acquisition costs deferred:
         Commissions...................................................       86,441       59,238       49,775
         Underwriting and issue costs .................................       42,151       50,244       48,365
         Addition due to acquisition, including $171 of unrealized loss       30,606           --           --
                                                                         -----------   ----------   ----------
                                                                             469,315      361,910      283,710
       Policy acquisition costs amortized .............................      (79,291)     (44,323)     (30,744)
       Unrealized investment loss adjustment ..........................       (1,213)      (2,344)        (461)
       Foreign currency translation adjustment ........................       (1,038)      (1,482)         (77)
       Reduction due to sale of blocks of business.....................       (4,129)      (3,644)          --
       SFAS No. 121 impairment for Businesses Held for Sale............     (191,595)          --           --
       Amounts transferred to assets of Businesses Held for Sale.......      (52,341)          --           --
                                                                         -----------  -----------  -----------
         Balance as of December 31.....................................  $   139,708  $   310,117  $   252,428
                                                                         ===========  ===========  ===========
</TABLE>

         As a part of the purchase accounting for the Company's acquisitions,  a
present value of insurance in force is established which represents the value of
the right to receive future cash flows from insurance  contracts existing at the
date of acquisition.  Such value is the actuarially  determined present value of
the  projected  cash  flows  from  the  acquired  policies,   discounted  at  an
appropriate risk rate of return.

         The methods used by the Company to value the fixed  benefit,  life, and
accumulation  products  purchased are consistent with the valuation methods used
most commonly to value blocks of insurance business.  It is also consistent with
the basic methodology  generally used to value insurance assets. The method used
by the Company  includes  identifying  the future  cash flows from the  acquired
business,  the risks  inherent  in  realizing  those  cash flows and the rate of
return the Company  believes it must earn in order to accept the risks  inherent
in realizing the cash flows, and determining the value of the insurance asset by
discounting  the  expected  future cash flows by the  discount  rate the Company
requires.

         The discount  rate used to determine  such values is the rate of return
required in order to invest in the business  being  acquired.  In selecting  the
rate of return,  the Company  considered  the magnitude of the risks  associated
with the type of  business  acquired  and  actuarial  factors  described  in the
following  paragraph,  cost of  capital  available  to the  Company  to fund the
acquisition,  compatibility  with other  Company  activities  that may favorably
affect future profits, and the complexity of the acquired company.

         Expected future cash flows used in determining such values are based on
actuarial  determinations of future premium  collection,  mortality,  morbidity,
surrenders,  operating  expenses  and  yields  on  assets  held to  back  policy
liabilities  as well as other  factors.  Variances  from  original  projections,
whether  positive  or  negative,  are  included in income as they occur and will
affect the present value of insurance in force  amortization rates for insurance
products accounted for under SFAS No. 97, "Accounting and Reporting by Insurance
Enterprises  for Certain  Long-Duration  Contracts  and for  Realized  Gains and
Losses from Sales of Investments."  To the extent that these variances  indicate
that future cash flows will differ from those included in the original scheduled
amortization of the present value of insurance in force, future amortization may
be  adjusted.  Recoverability  of the  present  value of  insurance  in force is
evaluated annually and appropriate adjustments are then determined and reflected
in the financial statements for the applicable period.

                                       67
<PAGE>
         Information  related to the present  value of  insurance in force is as
follows:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>        
     Balance as of January 1 ..........................................  $   263,889  $   339,010  $   283,106
     Addition due to acquisition, including $1,235 of unrealized loss..       58,564           --       69,077
     Accretion of interest ............................................        4,693       20,371       27,205
     Amortization .....................................................      (42,848)     (68,094)     (52,931)
     Transfer to unconsolidated affiliate pursuant to
       reinsurance transaction.........................................           --       (2,291)          --
     SFAS No. 121 impairment for Business Held for Sale................      (98,164)          --           --
     Unrealized investment gain (loss) adjustment .....................       14,025      (24,444)      12,582
     Foreign currency translation adjustment ..........................         (333)        (663)         (29)
     Amounts transferred to assets of Businesses Held for Sale.........      (25,987)          --           --
     Reduction due to sale of block of business and other..............       (3,110)          --           --
                                                                         -----------  -----------  -----------
       Balance as of December 31 ......................................  $   170,729  $   263,889  $   339,010
                                                                         ===========  ===========  ===========
</TABLE>

         Expected gross amortization of the present value of insurance in force,
based upon current  assumptions and accretion of interest at a policy  liability
or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as
follows:

<TABLE>
<CAPTION>
                                                  Beginning        Gross         Accretion         Net
                                                   Balance     Amortization    of Interest    Amortization
                                                   -------     ------------    -----------    ------------
 <S>                                              <C>            <C>            <C>             <C>     
 1999..........................................   $ 170,729      $  27,757      $   8,827       $ 18,930
 2000..........................................     151,799         25,078          7,951         17,127
 2001..........................................     134,672         22,372          7,187         15,185
 2002..........................................     119,487         20,347          6,477         13,870
 2003..........................................     105,617         18,653          5,821         12,832
</TABLE>

(8) FUTURE POLICY BENEFITS

         The liability for future policy benefits consists of reserves for fixed
benefit, life and accumulation products. For interest sensitive life and annuity
products,  the liability for future policy  benefits is equal to the accumulated
fund value.  Fund values are equal to the premium received and interest credited
to the fund value less  deductions  for  mortality  costs and  expense  charges.
Current  declared  interest  rates  credited  range  from  4.0 to 6.75  percent.
Mortality  costs and expense  charges are  established by the Company based upon
its experience and cost structure and in accordance with policy terms.

         For traditional life products, the liability for future policy benefits
is based primarily upon  Commissioners'  Standard  Ordinary Tables with interest
rates  ranging  from 2.5 to 6.0  percent.  Fixed  benefit  products  establish a
liability for future policy benefits equal to the excess of the present value of
future benefits to or on behalf of the policyholder  over the future net premium
discounted  at  interest  rates  ranging  primarily  from  4.5 to  8.0  percent.
Traditional  life products and fixed benefit products future policy benefits may
also be  determined  using Company  experience  as to  mortality,  morbidity and
lapses with a provision for adverse deviation.  The Company may vary assumptions
by year of policy issue.

         The Company is continually  evaluating actuarial assumptions associated
with interest  sensitive life insurance  contracts in which the determination of
policy  reserves is highly  sensitive to assumptions  such as withdrawal  rates,
investment earnings rates,  mortality rates, and premium persistency.  Currently
reflected in the Company's financial  statements are policy reserves and account
values associated with such contracts,  which aggregated  approximately $525,445
and  $504,562 as of  December  31, 1998 and 1997,  respectively.  If  developing
trends  were to  continue,  the Company  would be required to record  additional
reserves or reduce intangible assets,  which could have a material impact on the
Company's  financial  position  and results of  operations.  Management  is also
assessing  the  potential  impact  of future  management  actions,  which  might
mitigate the financial impact of these trends.  Type of management actions would
likely  include,  but not  limited  to, the  redetermination  of  non-guaranteed
charges  and/or   benefits  under  the  contracts,   asset   segmentation,   and
reinsurance.  There  are  risks  associated  with  management  action  including
potential  sales  disruption  and  the  treat  of  litigation.  The  Company  is
continuing to refine its actuarial estimates, likely management action plans and
associated  sensitivity  testing of such  interdependencies  on policy  reserves
associated  with these contracts which could result in changes in such estimates
in the future.

                                       68
<PAGE>
         Total future  policy  benefits  consist of the following as of December
31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                           1998           1997
                                                                        ----------     -----------
 <S>                                                                    <C>            <C>        
 Future policy benefits on traditional products:
   Traditional life insurance contracts..............................   $  671,637     $   527,078
   Health............................................................       10,824          40,628
   Unearned premiums.................................................          730          13,359
                                                                        ----------     -----------
                                                                           683,191         581,065
 Interest sensitive products:
   Universal life....................................................    1,441,912       1,968,548
   Annuities.........................................................      634,370         527,507
                                                                        ----------     -----------
                                                                         2,076,282       2,496,055
 Policy and contract claims:
   Health............................................................       13,073         119,157
   Life and other....................................................       25,245          24,177
   Other policyholder funds..........................................       69,247          69,471
                                                                        ----------     -----------
      Total future policy benefits...................................   $2,867,038     $ 3,289,925
                                                                        ==========     ===========
</TABLE>

         The following  table  presents  information on changes in the liability
for health claims for the years ended December 31:

<TABLE>
<CAPTION>
                                                                        1998         1997         1996
                                                                     -----------  -----------  -----------
         <S>                                                         <C>          <C>          <C>        
         Claim liability as of January 1..........................   $   125,005  $   130,392  $   127,078
           Less reinsurance recoverables..........................         5,848        2,242        1,372
                                                                     -----------  -----------  -----------
              Net balance as of January 1.........................       119,157      128,150      125,706
                                                                     -----------  -----------  -----------
         Addition due to acquisition..............................        26,229           --        1,079
                                                                     -----------  -----------  -----------
         Add claims incurred during the year related to:
           Current year...........................................       116,170       60,727       63,673
           Prior years............................................        31,545        6,344       (6,816)
                                                                     -----------  -----------  -----------
              Total claims incurred...............................       147,715       67,071       56,857
                                                                     -----------  -----------  -----------
         Less claims paid during the year related to:
           Current year...........................................        57,370       28,268       19,057
           Prior years............................................        65,736       47,796       36,435
                                                                     -----------  -----------  -----------
              Total claims paid...................................       123,106       76,064       55,492
                                                                     -----------  -----------  -----------
         Less reduction for liabilities of Business Held for Sale.       156,922           --           --
                                                                     -----------  -----------  -----------
         Net balance as of December 31............................        13,073      119,157      128,150
           Plus reinsurance recoverables..........................         1,390        5,848        2,242
                                                                     -----------  -----------  -----------
              Claim liability as of December 31...................   $    14,463  $   125,005  $   130,392
                                                                     ===========  ===========  ===========
</TABLE>

         As a result of changes in methodology  (described  below) and estimates
of insured  events in prior years,  the liability for health policy and contract
claims  increased net of  reinsurance  by $31,545 in 1998 and $6,344 in 1997 and
decreased, net of reinsurance by $6,816 in 1996.

         The Company  has been  closely  monitoring  the  development  of claims
reserve  experience  associated with its Career Sales Division.  The methodology
previously utilized has experienced,  what appears to be, a deterioration of the
adequacy of its claims reserves  associated with disability income products sold
prior  to  the  Company's  ownership.  During  1998,  the  Company  changed  its
methodology in recording these reserves. As a result of the trends and change in
methodology the Company increased claims reserves estimates for the Career Sales
Division by $25,000. The effect of the change in methodology is inseparable from
the effect of the change in accounting estimate and is accordingly  reflected in
operations  as a change in accounting  estimate for the year ended  December 31,
1998.

                                       69
<PAGE>

(9) NOTES PAYABLE

         The outstanding  principal  amounts of the notes payable consist of the
following as of December 31:

<TABLE>
<CAPTION>
                                                                                  1998             1997
                                                                                ----------      -----------

       <S>                                                                      <C>             <C>        
       Unsecured 9 1/4% Senior Subordinated Notes due 2003(a)................   $  114,646      $   114,646
       Revolving Bank Credit Facility maturing 2002(b).......................      434,000          242,000
       Other.................................................................        2,277            3,109
                                                                                ----------      -----------
                                                                                $  550,923      $   359,755
                                                                                ==========      ===========
</TABLE>
       --------------
       (a) Interest costs under the Unsecured 9 1/4% Senior  Subordinated  Notes
           due 2003 (the "Notes")  totaled  $10,622,  $11,461 and $13,545 during
           1998,  1997 and 1996,  respectively.  As of December  31,  1998,  the
           effective rate for the Notes was approximately 9 1/4%.
       (b) Interest costs under the $450,000  revolving  credit facility totaled
           $30,680  and  $9,188  during  1998 and 1997.  The  effective  rate of
           interest as of December 31, 1998 was  approximately  8.4%,  including
           facility fees of 0.75% as of December 31, 1998. During 1997 and 1996,
           the Company had a $175,000  revolving  credit  facility  for which it
           incurred interest costs of $1,855 and $1,558, respectively.

         The aggregate maturities of notes payable during each of the five years
after December 31, 1998, are as follows: 1999, $726; 2000, $728; 2001, $434,666;
2002, $157; and 2003, $114,646.

         Covenants  and  Liquidity.  The Notes  and the  revolving  bank  credit
agreement (the "Bank Credit  Facility") impose certain covenants on the Company,
including  covenants  restricting  the  amount of  additional  indebtedness  the
Company  may  incur,  limit its  ability  to engage in future  acquisitions  and
certain other business transactions, and the amount of dividends the Company may
declare and pay (see Note 12 of Notes to Consolidated Financial Statements), and
requires the Company to maintain  specified  financial ratios and meet specified
financial  tests.  At December 31, 1998, the Company and its  subsidiaries  were
either in compliance with or had received waivers from all applicable covenants.

         On  March  30,  1999,  the  Company  entered  into  an  amendment  (the
"amendment") to its existing Bank Credit  Facility.  The amendment  provides for
additional  covenants and revises certain financial covenants to the Bank Credit
Agreement.  In addition,  the  amendment  changes the maturity  date of the Bank
Credit  Facility  to May 2000.  Significant  additional  covenants  include  the
requirement for the Company to repay indebtedness at specified dates and amounts
throughout 1999,  based upon anticipated  dates and cash proceeds to be received
from the consummation of the Career Sales Division,  Professional and the United
Life Asset sales. The timing and required debt reduction follows:

                 Date                          Amount
                 ----                          ------

             April 30, 1999                 $    40,000
             May 31, 1999                       127,000
             June 30, 1999                       70,000

         The Company's ability to meet the debt reduction  covenants of the Bank
Credit  Facility is  dependent on being able to  consummate  the sales of Career
Sales Division,  Professional and the United Life Assets (see Note 3 to Notes to
Consolidated Financial Statements) to generate sufficient cash proceeds. Failure
to consummate such  transactions  could result in action from ratings  agencies,
state regulatory agencies,  and/or creditors.  Based upon current conditions and
circumstances,  management  intends and  believes the Company has the ability to
consummate  such  sales  to  generate  sufficient  cash  proceeds  to  meet  the
covenants.

         The  amendment  requires  the  Company  to work with the bank  group on
aggregating cash at the parent company level,  provide information on asset sale
transactions,  obtain the bank's consent to the potential sale of KIVEX and meet
certain  cash flow  payment  requirements  from the Surplus  Note  Companies  on
specified dates. In addition,  the amendment eliminates the Company's ability to
pay dividends on its common and preferred  stock and severely  limits ability of
the Company to  effectuate  the sale of capital  securities  or to borrow  funds
available  under the Bank  Credit  Facility.  With  respect to  borrowings,  the
Company may only borrow funds,  up to $7,000,  for the payment of interest under
the Bank Credit  Facility and the Notes  subject to certain  restrictions.  Upon
consummation  of the Career Sales Division  divestiture,  the commitment will be
reduced to $5,000.  Finally,  the amendment  modifies pricing spreads,  fees and
other costs associated with the Bank

                                       70
<PAGE>
Credit Facility.  Total  annualized  interest and associated costs with the Bank
Credit   Facility  are  expected  to  exceed  LIBOR  based  borrowing  rates  by
approximately 400 basis points.

     Projected  Cash  Sources  and  Uses  in  1999.  During  1999,  the  Company
anticipates  receiving  approximately  $25,200  in the  form  of  principal  and
interest  payments or  dividends  and tax sharing  payments for the Surplus Note
Companies  as a result of the  ordinary  dividend  flow from the  Surplus  Notes
Companies insurance subsidiaries. In addition, the Company anticipates receiving
principal  payments under the surplus debentures as a result of the sales of the
Career Sales  Division,  Professional  and the United Life Assets by the Surplus
Note Companies.  Total cash proceeds  anticipated by the Company from such sales
aggregates approximately $258,500. The Company anticipates utilizing $237,000 to
repay indebtedness and the remainder of such proceeds to fund interest costs and
operating expenses of the parent company.

     The  Company's  ability to receive  principal and interest  payments  above
$25,200  under the surplus notes is  contingent  upon the  Company's  ability to
consummate  each of the  sales  transactions  of the  Businesses  Held  for Sale
currently under contract.  The Company has currently estimated net cash proceeds
after  required  debt  reduction  under the  Company's  Bank Credit  Facility of
$21,100.  Such liquidity is necessary for the Company to fund interest  payments
under the Bank Credit  Facility and the notes and to fund operating  expenses of
the Company.  Though the Company has the  obligation to consummate  the sales of
the  Businesses  Held for Sale and to  prepay  the loans to  certain  covenanted
levels, the Company may not have the requisite ability to effectuate the sale as
a result of the  restrictive  covenants  contained  in the  Amended  Bank Credit
Facility. The accessibility of the cash proceeds of the Businesses Held for Sale
are the subject of regulatory  approval.  While certain  regulatory filings with
respect  to the sale of the  Businesses  Held for Sale have been  made,  not all
filings have been so made and the final structure by which such proceeds will be
upstreamed  to the  Company  have not yet been  finalized.  The  Amended  Credit
Agreement  provides  that the Company  and its  subsidiaries  are  limited  from
entering  into certain  mergers,  consolidations,  amalgamations,  liquidations,
winding up or  dissolutions,  incurring  certain  indebtedness  and liabilities,
making disposition,  prepaying certain  indebtedness,  declaring  dividends,  or
issuing,  redeeming,  purchasing,  retiring,  exchanging or  converting  capital
securities,  in each case with very limited or scheduled  exceptions.  While the
Company believes it has scheduled or otherwise  provided for a great majority of
the possible combinations it will take to effectively upstream the cash proceeds
of the sales of the Businesses  Held for Sale, it is not possible to foresee all
combinations.  Accordingly,  the  mechanism  to  upstream  to  the  Company  the
necessary  cash  to pay the  covenanted  prepayment  under  the  Amended  Credit
Agreement  may be subject to the  approval of the majority  banks which,  if not
given,  would  result in an event of  default  under  the  Amended  Bank  Credit
Agreement. Should the sale transactions not close within specified time periods,
the Company may face  difficulty  in meeting its  existing  and  estimated  cash
obligations  and would be in default of certain  covenants under the Bank Credit
Facility.

     The net  proceeds  available  to the Company  from the asset sales may vary
significantly  from  current  estimates  as a result  of (i)  minimum  levels of
statutory  capital and surplus  required to be  delivered at closing for certain
insurance  subsidiaries,  (ii) amounts to be held in escrow,  (iii) valuation of
certain  consideration  to be  received by the  Company,  (iv) the timing of the
closing and (v) various  indemnification  obligations  included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales  Division  requires the purchaser to be satisfied with  disability  claims
reserve  liabilities and other active life reserves.  The Company has engaged an
actuarial  consulting firm to provide  analysis to the purchaser  regarding such
reserves.   The  Company  is  aware  of   potential   deficiencies   aggregating
approximately  $16,200  in the  statutory  determination  of  disability  claims
reserves  that will  likely  impact the total  consideration  the  Company is to
receive.  The  Company and the  purchaser  have not  engaged in  discussions  to
resolve the disability claims reserve issue. In addition,  the purchase and sale
agreement  for the United Life Assets  requires the Company to purchase  certain
residential mortgage loans from United Life, should the loans not meet specified
criteria under the purchase and sale agreement or should United Life not be able
to  provide  clear  title to the  loans.  The  residential  loans  are part of a
servicing agreement with United Companies Financial Corporation, the "servicer,"
which has recently filed for bankruptcy. The servicer currently maintains within
its  control  all  applicable  loan  documents.  Should the Company be unable to
obtain satisfactory  control of all of the applicable  documents,  the Company's
anticipated  net  proceeds  from the United  Life Asset sale could be reduced by
approximately  $12,600.  Such  reduction  would  have a  material  impact on the
liquidity of the Company.

     As a result of these anticipated  actions,  management believes the Company
will  likely have  sufficient  financial  flexibility  and  projected  liquidity
sources  to meet  all cash  requirements  for  1999.  However,  there  can be no
assurances actual liquidity sources will develop as currently projected.  In the
event of a shortfall  of actual  liquidity  sources,  the Company  will  explore
options  to  generate  any  necessary   liquidity  such  as:  (i)  the  sale  of
non-strategic  subsidiaries,  (ii) obtain regulatory  approval for extraordinary
dividends  from its  insurance  subsidiaries  (which is  unlikely at the present
time) and (iii) borrowing on a secured basis. If the Company is unable to obtain
sufficient liquidity to meet its projected cash requirements, such failure could
result in a default on one or more  obligations and the holders thereof would be
entitled  to  exercise  certain  remedies,  including  the  acceleration  of the
maturity of the entire  indebtedness and commencing legal proceedings to collect
                                       71
<PAGE>

the indebtedness. In such event, the Company will examine and consider the range
of available alternatives to the Company at that time.

         Extraordinary  Charges.  For the year  ended  December  31,  1998,  the
Company  realized an after-tax  extraordinary  charge of $1,671 which represents
the write-off of the deferred financing costs associated with the refinance of a
SW Financial existing note that the Company assumed as a part of the acquisition
of SW Financial Controlling Interest.

         For the year ended December 31, 1996, the Company realized an after-tax
extraordinary  charge of $2,372. The charge represents (i) the write-off of $816
of deferred financing costs related to the retirement of certain indebtedness of
the Company and its  subsidiaries,  and (ii) the write-off of $1,556 of deferred
financing,  swap  cancellation  and other  costs  related to the  repurchase  of
approximately $35,354 in principal amount of the Notes.

(10) INCOME TAXES (BENEFITS)

         The  Company  and a number  of its  non-insurance  subsidiaries  file a
consolidated federal income tax return.  Marketing One and its subsidiaries file
a consolidated  federal income tax return. The life insurance  subsidiaries file
federal  income  tax  returns  with  either  PLAIC,  or  Pioneer  Security,   or
Constitution as the parent of the particular consolidated life insurance company
tax group.

         Total income taxes  (benefits)  were allocated as follows for the years
ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
       <S>                                                               <C>          <C>          <C>        
       Income (loss) before income taxes, equity in earnings of
         unconsolidated affiliates and extraordinary charge............  $    (3,369) $    20,375  $    40,957
       Extraordinary charge............................................         (900)          --       (1,277)
                                                                         -----------  -----------  -----------
                                                                         $    (4,269) $    20,375  $    39,680
                                                                         ===========  ===========  ===========
</TABLE>

         The provisions for income tax expense (benefit)  attributable to income
(loss) before income taxes, equity in earnings of unconsolidated  affiliates and
extraordinary charge are as follows for the years ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>         
     Current U.S.......................................................  $   (12,031) $     3,775  $    (1,285)
     Current foreign...................................................          778        3,598        2,319
     Deferred U.S......................................................       10,108       10,984       35,482
     Deferred foreign..................................................       (2,224)       2,018        4,441
                                                                         -----------  -----------  -----------
       Income tax expense (benefit)....................................  $    (3,369) $    20,375  $    40,957
                                                                         ===========  ===========  ===========
</TABLE>

         Taxes (benefits)  computed using the federal  statutory rate of 35% are
reconciled to the Company's actual income tax expense (benefit)  attributable to
income  (loss)  before  extraordinary  charge as  follows  for the  years  ended
December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>        
     Tax expense (benefit) computed at statutory rate..................  $  (148,620) $    18,040  $    38,702
     Dividends received deduction......................................         (268)      (1,450)        (977)
     Amortization of costs in excess of net assets acquired............        3,678        3,341        3,040
     Impairment on assets held for sale................................      116,886           --           --
     Change in valuation allowance.....................................       23,492         (525)      (1,265)
     Foreign taxes net of U.S. tax benefit.............................         (181)         263        1,507
     Other.............................................................        1,644          706          (50)
                                                                         -----------  -----------  -----------
       Income tax expense (benefit)....................................  $    (3,369) $    20,375  $    40,957
                                                                         ===========  ===========  ===========
</TABLE>

                                       72
<PAGE>

         Temporary  differences between the financial statement carrying amounts
and tax bases of assets  and  liabilities  that  give rise to the  deferred  tax
assets and liabilities relate to the following as of December 31:

<TABLE>
<CAPTION>
                                                                    1998                       1997
                                                        ---------------------------  -------------------------
                                                          Deferred      Deferred     Deferred       Deferred
                                                             Tax           Tax         Tax            Tax
                                                           Assets      Liabilities   Assets        Liabilities
                                                        ----------     -----------   ----------    -----------
       <S>                                              <C>            <C>           <C>           <C>       
       Deferred policy acquisition costs..............  $       --     $   21,536    $       --    $   90,151
       Present value of insurance in force............          --         55,248            --        74,192
       Future policy benefits.........................     106,212             --        62,131            --
       Net operating losses...........................      41,081             --        38,584            --
       Foreign and alternative minimum tax credits....          --             --        22,851            --
       Unrealized gain on investment securities.......          --         16,890            --        20,140
       Other..........................................      35,762             --        19,133         1,593
                                                        ----------     ----------    ----------    ----------
                                                           183,055         93,674       142,699       186,076
       Valuation allowance............................     (44,784)            --       (10,367)           --
                                                        ----------     ----------    ----------    ----------
                                                        $  138,271     $   93,674    $  132,332    $  186,076
                                                        ==========     ==========    ==========    ==========
</TABLE>

         The valuation allowance for deferred tax assets as of December 31, 1998
and 1997,  was $44,784 and  $10,367,  respectively.  The net change in the total
valuation  allowance  for the years ended  December  31,  1998 and 1997,  was an
increase  (decrease) of $23,492 and ($5,525)  (including $5,000 that was used in
1997 to reduce costs in excess of net assets acquired),  respectively.  The 1998
increase in valuation  allowance is largely  attributable to deferred tax assets
resulting from net operating losses generated by the Company's non-life members.
During 1997, an additional  $14,635  increase to the deferred tax asset was used
to reduce costs in excess of net assets  acquired  related to the Security  Life
acquisition as acquisition date tax contingencies were resolved.

         In assessing the  realization of deferred taxes,  management  considers
whether it is more likely than not that some  portion or all of the deferred tax
assets will be  realized.  The  ultimate  realization  of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those  temporary   differences  become  deductible.   Management  considers  the
scheduled reversal of deferred tax liabilities,  projected future taxable income
and tax  planning  strategies  in  making  this  assessment.  Based  upon  those
considerations,  management  has  established a valuation  allowance for all net
deferred tax assets associated with the non-life insurance members of its group.
Management believes it is more likely than not that the Company will realize the
remaining  benefits  of  these  deductible  differences,  net  of  the  existing
valuation allowance as of December 31, 1998.

         The Company's recording of an impairment  provision associated with the
Businesses  Held for Sale results in a reduction in deferred tax  liabilities of
$95,137 related to such assets.

         As of  December  31,  1998,  the  Company  has  life  consolidated  net
operating loss  carryforwards of approximately  $97,362 for tax return purposes,
of which $47,813  relates to Retained  Businesses,  which,  if not utilized will
begin to  expire  in  2005.  The  Company  has life  consolidated  capital  loss
carryforwards  of  approximately  $7,516 of which,  $5,792  relates to  Retained
Businesses,  which, if not utilized,  will expire in 2001. In addition, OLIC and
Peninsular  have available,  on a separate return basis,  acquired net operating
loss  carryforwards  of approximately  $10,417.  The utilization of acquired net
operating loss carryforwards is limited in any one year to the lesser of (i) the
life insurance  group's  consolidated  taxable  income or (ii) the  subsidiary's
taxable income computed on a separate  return basis.  The acquired net operating
loss carryforwards will expire in 2004 and 2005.

         As of December 31,  1998,  the Company has  non-life  consolidated  net
operating loss carryforwards of approximately $60,860 for tax purposes which, if
not utilized, will begin to expire in 2012.

         Under provisions of the Life Insurance Company Tax Act of 1959, certain
special  deductions were allowed to life insurance  companies for federal income
tax purposes.  These special  deductions  were repealed by the Tax Reform Act of
1984,  and the untaxed  balances were frozen at their  December 31, 1983 levels.
These balances aggregate  approximately $42,301 for the Company's life insurance
subsidiaries  and are subject to taxation if certain levels of premium income or
life insurance reserves are not maintained,  or if the life insurance  companies
make excess distributions to shareholders. In addition, on February 1, 1999, the
Clinton  administration  released its Fiscal Year 2000 Budget  which  included a
revenue raising provision that would require life insurance companies to include
the balance of these special deductions in income

                                       73
<PAGE>

over a ten year period as of the  beginning of the first  taxable year  starting
after  the  date of  enactment.  At this  time,  it is  uncertain  whether  this
provision  will be included in any  legislation  proposed  by  Congress,  and if
included,  whether  such  provision  would be  enacted  into  law.  As it is not
currently considered likely that a tax would become due on any such balances, no
deferred  income taxes have been provided.  However,  if such tax were to become
payable, it would amount to approximately $14,805.

         The 1996  consolidated life return of Constitution and its subsidiaries
is currently under examination by the Internal Revenue Service.  Tax years prior
to 1996 are closed by statute to examination for the  Constitution  consolidated
life insurance company tax group. The ultimate effect of the current examination
is not known at this time.

(11) COMPUTATION OF EARNINGS (LOSS) PER SHARE

         The following is a  reconciliation  of net income (loss)  applicable to
common stock as well as common stock used to compute basic and diluted  earnings
(loss) per share for the years ended December 31:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
<S>                                                                      <C>          <C>          <C>        
Reconciliation of net income (loss) applicable to common stock:
  Basic net income (loss) applicable to common stock:
     Net income (loss) applicable to common stock before
       extraordinary charge............................................  $  (439,532) $    30,607  $    76,013
         Redemption of Series C Preferred Stock........................       (1,913)          --           --
                                                                         -----------  -----------  -----------
                                                                            (441,445)      30,607       76,013
         Extraordinary charge..........................................       (1,671)          --       (2,372)
                                                                         -----------  -----------  -----------
                                                                         $  (443,116) $    30,607  $    73,641
                                                                         ===========  ===========  ===========
Diluted net income (loss) applicable to common stock:
     Net income (loss) applicable to common stock before
       extraordinary charge............................................  $  (439,532) $    30,607  $    76,013
         Redemption of Series C Preferred Stock........................       (1,913)          --           --
                                                                         -----------  -----------  -----------
                                                                            (441,445)      30,607       76,013
         Common stock equivalents:
           Convertible preferred stock dividend requirements...........           --           --       11,788
                                                                         -----------  -----------  -----------
                                                                            (441,445)      30,607       87,801
         Extraordinary charge..........................................       (1,671)          --       (2,372)
                                                                         -----------  -----------  -----------
                                                                         $  (443,116) $    30,607  $    85,429
                                                                         ===========  ===========  ===========
</TABLE>

                                       74
<PAGE>

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
<S>                                                                      <C>          <C>          <C>   
Common stock used to compute basic and diluted earnings (loss) per share:
Basic:

     Shares outstanding beginning of period............................       28,860       28,648       22,880
     Common stock issuance:
       Issuance of 5,131 common shares on March 5, 1996................           --           --        4,232
       Acquisition of United Life (483,839 common shares)..............           --           --          212
     Incremental shares applicable to Stock Warrants/Stock Options.....          374          143           74
     Acquisition of the Fickes and Stone Knightsbridge Interests.......          346           --           --
     Redemption of Series C Preferred Stock............................          521           --           --
     Treasury shares...................................................       (1,010)        (775)        (190)
                                                                         -----------  -----------  -----------
                                                                              29,091       28,016       27,208
                                                                         ===========  ===========  ===========
Diluted:
     Shares outstanding beginning of period............................       28,860       28,648       22,880
     Common stock issuance:
       Issuance of 5,131 common shares on March 5, 1996................           --           --        4,232
       Acquisition of United Life (483,839 common shares)..............           --           --          212
     Incremental shares applicable to Stock Warrants/Stock Options.....          374          772        1,347
     Acquisition of the Fickes and Stone Knightsbridge Interests.......          346           --           --
     Redemption of Series C Preferred Stock............................          521           --           --
     Treasury shares...................................................       (1,010)        (775)        (190)
     Conversion of $3.375 Convertible Preferred Stock at a rate of
       2.2123 common shares to 1 preferred share.......................           --           --        5,088
     Conversion of $3.50 Series II Convertible Preferred Stock at a
       rate of 1.4327 common shares to 1 preferred share...............           --           --        1,704
                                                                         -----------  -----------  -----------
                                                                              29,091       28,645       35,273
                                                                         ===========  ===========  ===========
</TABLE>

(12) COMMON AND PREFERRED STOCK

         At December  31, 1998 the  Company had  100,000,000  shares of $.01 par
value common stock authorized and 30,072,344 shares issued and outstanding.  The
common stock has no  preemptive  or other  subscription  rights and there are no
conversion  rights,  redemption or sinking fund  provisions with respect to such
shares.

         A portion of the  consideration  for the  acquisition of the Fickes and
Stone  Knightsbridge  Interests  included 173,160 shares of the Company's Common
Stock due each of Messrs. Fickes and Stone on April 15, 2001. As a result of the
acquisition,  common  stock and  additional  paid in  capital  increased  $3 and
$8,497,  respectively,  for the year ended December 31, 1998.  Common shares due
Mr. Stone were issued as of December 31, 1998.

         During the year ended December 31, 1998,  certain  employees  exercised
stock  options and warrants  resulting in the issuance of 616,572  shares of the
Company's  Common Stock.  The result of such  exercises  was to increase  common
stock and additional paid in capital by $2 and $2,014, respectively.

         During the year ended  December  31, 1998,  83,260  stock  options were
exercised and issued to certain employees as discounted  restricted common stock
of the Company  with  vesting  periods of three and four years.  During the year
ended December 31, 1998, the Company recognized $2,751 of deferred  compensation
associated  with the  issuance of this common  stock and $2,267 of  compensation
expense. As of December 31, 1998, the balance of deferred  compensation was $484
and was recorded as an offset to shareholders' equity.

         Associated  with  the   restructuring  and  the  consolidation  of  all
corporate  functions into the Company's Dallas location,  certain employees were
severed.  For the year ended December 31, 1998, two notes receivable  secured by
7,500 shares of common stock were  discharged  and 88,280 shares of common stock
were abandoned as a result of the severance. The result was to increase treasury
stock, and decrease notes receivable secured by common stock, by $261.

         The  Company  issued   2,875,000   shares  of  $50   redemption   value
(liquidation preference,  $50 plus accrued and unpaid dividends) $3.50 Series II
Convertible  Preferred  Stock (the "Series II Convertible  Preferred  Stock") on
August 2, 1996. The Series II Convertible  Preferred Stock is convertible at the
option of the holder, unless previously redeemed, into 1.4327

                                       75

<PAGE>

shares of common stock for each share,  subject to adjustment in certain events.
As of December 31, 1998,  the estimated  fair value of the Series II Convertible
Preferred Stock, based upon market-maker quotes, was $23,431 or $8.15 per share.

         On July 25, 1995,  the Company  issued  127,500  shares of 10% Series B
Preferred  Stock and  178,500  shares of 9% Series C  Preferred  Stock to fund a
portion of the Security Life purchase  price.  The Series B Preferred  Stock and
the Series C Preferred Stock were  mandatorily  redeemable on or before June 30,
1997 and June 30, 1998,  respectively.  On March 15, 1997, the Company  redeemed
all of the  previously  outstanding  Series  B  preferred  stock  at its  stated
redemption value of $14,705.  Effective March 31, 1998, the Company redeemed all
of the outstanding Series C Preferred Stock into 691,528 shares of the Company's
Common Stock under  provisions of the Series C Preferred  Stock  certificate  of
designation.  The result of such  redemption  was to increase  common  stock and
additional  paid in capital by $7 and $22,220,  respectively,  as well as reduce
retained earnings by $1,913  reflecting the difference  between the reported and
redemption amounts of the Series C Preferred Stock. Such difference is reflected
in both the basic and diluted earnings per share  calculation for the year ended
December 31, 1998.

         The  Company  issued   2,300,000   shares  of  $50   redemption   value
(liquidation   preference,   $50  plus  accrued  and  unpaid  dividends)  $3.375
Convertible  Preferred  Stock (the  "Convertible  Preferred  Stock") on July 14,
1995.  The  Convertible  Preferred  Stock is  convertible  at the  option of the
holder, unless previously redeemed,  into 2.2124 shares of common stock for each
share,  subject to adjustment in certain  events.  As of December 31, 1998,  the
estimated  fair value of the  Convertible  Preferred  Stock,  based upon  active
market quotes, was $20,125 or $8.75 per share.

         As of December 31, 1998 and 1997,  accrued and unpaid  dividends on the
$3.375 Convertible Preferred Stock amounted to $3,558 and $1,617,  respectively.
As of December  31, 1998 and 1997,  accrued  and unpaid  dividends  on the $3.50
Convertible Preferred Stock amounted to $4,193 and $1,677, respectively.

         The  Company  has  suspended  the  payment  of  cash  dividends  on its
outstanding  $3.375  Convertible  Preferred  Stock,  $3.50 Series II Convertible
Preferred Stock and Common Stock.  Under the amended terms of the Company's Bank
Credit  Facility  the  Company  may not pay  dividends  on its  Common  Stock or
Preferred  Stock  issues.  Under  the  terms of the two  series  of  convertible
preferred stock, if dividends are in arrears for six or more quarterly  dividend
periods (whether or not consecutive),  the holders of the convertible  preferred
stock,  voting as a single class,  will have the right to elect two directors of
the Company.  In addition,  for as long as there are dividend  arrearages on the
convertible  preferred  stock,  the  Company  will  be  prohibited  from  paying
dividends on the Common Stock or  purchasing,  redeeming or otherwise  acquiring
Common Stock.

(13) STOCK OPTIONS AND WARRANTS

         The Company has established two management stock option plans, the 1992
Stock  Option  Plan which set aside up to 475,635  shares for grant and the 1996
Stock  Option  Plan which set aside up to  2,800,000  shares for grant.  Options
granted  under the 1992 Stock  Option  Plan are deemed to be in four equal units
which are  earned  over four  years  from the date of grant and are  exercisable
during a one-year  period  immediately  following the fourth  anniversary of the
date of grant.  The 1996 Stock Option Plan allows for awards of stock or options
subject to such terms, conditions, and restrictions, and/or limitations, if any,
as the Stock Option Committee of the Board of Directors deems appropriate.

         The Company has also established a senior management warrant award plan
("Warrant  Plan").  The  Warrant  Plan  allows  for  grants to senior  executive
officers of PennCorp and Directors of PennCorp who are not executive officers of
the  Company.  Grant  prices are  determined  based on the average  price of the
shares traded on the date of grant.  Warrants granted under the Warrant Plan are
determined by the  Compensation  Committee and are exercisable at such times and
in such amounts as the Compensation  Committee shall  determine,  but no warrant
granted under the Warrant Plan will be exercisable more than ten years after the
date of grant. Upon change of control (as defined) of PennCorp,  all outstanding
warrants become immediately vested and exercisable, and any warrants that remain
unexercised  shall be canceled and  replacement  warrants shall be issued by the
surviving entity.

         As part of agreements  effective  July 1998,  the Company issued to the
Chairman of the Board of Directors  as well as the three senior  officers of the
Company,  1,550,000  stock  appreciation  rights at $3.88 per  share.  The stock
appreciation  rights provide  compensation to each individual in an amount equal
to the excess of the fair value of each stock  appreciation  right over the fair
value of each stock  appreciation right at the date of grant.  Compensation,  if
any, is payable in either  shares of common stock of the Company or cash, at the
election  of  the  recipient.  As of  December  31,  1998,  there  has  been  no
compensation expense accrued associated with these stock appreciation rights.

                                       76
<PAGE>
         As part of an employment  agreement  effective August 1990, the Company
issued to a former  officer of the  Company,  warrants to purchase up to 570,760
shares of the  common  stock of the  Company at any time up to 10 years from the
date of the  agreement.  The  warrants are  exercisable  at a price of $4.00 per
share which was fair value on the date of grant and as such no  compensation  is
recorded.

         The Company has established a U.S. Sales Manager incentive stock option
plan in  which  the  senior  sales  manager  of one of the  Company's  insurance
subsidiaries  may earn stock  options in the  amount of  275,000  shares  over a
five-year period, subject to achieving certain performance goals, in addition to
an initial  grant of 100,000  options.  Such options are vested  immediately  as
earned,  except for the initial 100,000 which vest in September 1999, and option
prices range from $15 per share,  for the initial 100,000  options,  to the fair
value of the common  stock of the Company on the date of grant for those  shares
subject to performance goals and as such no compensation expense is recorded.

         The  following  table  summarizes  data  relating to stock  options and
warrants  activity  and  associated   weighted  average  option  exercise  price
information for the years ended December 31:

<TABLE>
<CAPTION>
                                                  1998                    1997                     1996
                                          --------------------    ----------------------    --------------------
<S>                                        <C>        <C>          <C>        <C>           <C>          <C>    
Number of shares subject to option/warrant:
   Outstanding at beginning of year.....   3,344,477  $  21.73     1,984,049  $   11.56     2,148,599    $ 10.86
   Granted..............................   1,244,072  $  29.93     1,565,500  $   32.34        44,000    $ 31.09
   Expired/cancelled....................    (542,500) $  30.11       (46,303) $   11.41       (59,000)   $ 13.82
   Exercised............................    (616,572) $  14.36      (158,769) $    7.97      (149,550)   $  5.40
                                          ----------              ----------                ---------
     Outstanding at end of year ........   3,429,477  $  24.70     3,344,477  $   21.73     1,984,049    $ 11.56
                                          ==========              ==========                =========

Exercisable at end of year..............   2,649,446  $  22.47     2,037,067  $   15.38     1,808,207    $ 11.40
                                          ==========              ==========                =========

Available for future grant at end of year    726,292               1,488,460                2,792,000
                                          ==========              ==========                =========
</TABLE>

         The following table summarizes  information  concerning outstanding and
exercisable options and warrants as of December 31, 1998:

<TABLE>
<CAPTION>
                                   Options/Warrants Outstanding                  Options/Warrants Exercisable
                        --------------------------------------------------     ---------------------------------
                                            Weighted           Weighted                              Weighted
       Range of           Number        Average Remaining       Average          Number               Average
    Exercise Prices     Outstanding     Contractual Life    Exercise Price     Exercisable        Exercise Price
    ---------------     -----------     ----------------    --------------     -----------        --------------
   <S>        <C>           <C>               <C>               <C>               <C>                <C>     
   $ 4.00-    $ 4.00        570,760           1.64              $   4.00          570,760            $   4.00
   $15.00-    $23.50        647,500           3.80              $  16.59          587,500            $  15.96
   $27.25-    $38.40      2,211,217           1.67              $  31.45        1,490,561            $  32.11
                        -----------                                           -----------
                          3,429,477                                             2,648,821
                        ===========                                           ===========
</TABLE>

                  (Remainder of Page Intentionally Left Blank)

                                       77

<PAGE>
         As allowed under the  provisions of SFAS No. 123, the Company  utilizes
APB Opinion  No. 25 and  related  Interpretations  in  accounting  for its stock
option and warrant plans and, accordingly,  does not recognize compensation cost
based on fair value as a component of net income  applicable to common stock. If
the Company had elected to recognize  compensation  cost based on the fair value
of the options and warrants as of the grant date, estimated utilizing the Black-
Scholes multiple options approach  prescribed by SFAS No. 123, the Company's net
income (loss)  applicable  to common stock as well as earnings  (loss) per share
would have been  reduced by the pro forma  amounts  indicated  in the  following
table:

<TABLE>
<CAPTION>
                                                                              1998         1997         1996
                                                                          -----------  -----------  -----------
     <S>                                                                  <C>          <C>          <C>        
     Reconciliation of net income (loss)  applicable to common stock:
      Basic net income (loss) applicable to common stock:
       Net income (loss) applicable to common stock before
         extraordinary charge (as reported).............................  $  (439,532) $    30,607  $    76,013
           Redemption of Series C Preferred Stock.......................       (1,913)          --           --
                                                                          -----------  -----------  -----------
                                                                             (441,445)          --       76,013
           Extraordinary charge.........................................       (1,671)          --       (2,372)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common
                stock (as reported).....................................     (443,116)      30,607       73,641
           Pro forma compensation expense, net of tax benefits..........       (3,316)     (10,229)        (287)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common stock (pro forma)    $  (446,432) $    20,378  $    73,354
                                                                          ===========  ===========  ===========
     Diluted net income (loss) applicable to common stock:
       Net income (loss) applicable to common stock before
          extraordinary charge (as reported)............................  $  (439,532) $    30,607  $    76,013
           Redemption of Series C Preferred Stock.......................       (1,913)          --           --
                                                                          -----------  -----------  -----------
                                                                             (441,445)      30,607       76,013
           Common stock equivalents:
              Convertible preferred stock dividend requirements.........           --           --       11,788
                                                                          -----------  -----------  -----------
                                                                             (441,445)      30,607       87,801
           Extraordinary charge.........................................       (1,671)          --       (2,372)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common
                stock (as reported).....................................     (443,116)      30,607       85,429
           Pro forma compensation expense, net of tax benefits..........       (3,316)     (10,229)        (287)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common stock (pro forma)    $  (446,432) $    20,378  $    85,142
                                                                          ===========  ===========  ===========
     Per share information:
     Basic net income (loss) applicable to common stock:
       Net income (loss) applicable to common stock before
         extraordinary charge (as reported).............................  $    (15.17) $      1.09  $      2.79
           Extraordinary charge.........................................        (0.06)          --        (0.09)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common
                stock (as reported).....................................       (15.23)        1.09         2.70
           Pro forma compensation expense...............................        (0.11)       (0.37)       (0.01)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common stock (pro forma)    $    (15.34) $      0.72  $      2.69
                                                                          ===========  ===========  ===========
     Common shares used in computing basic earnings (loss) per share....       29,091       28,016       27,208
                                                                          ===========  ===========  ===========
     Diluted net income (loss) applicable to common stock:
       Net income (loss) applicable to common stock before
         extraordinary charge (as reported).............................  $    (15.17) $      1.07  $      2.16
           Common stock equivalents:
              Convertible preferred stock dividend requirements.........           --           --         0.33
           Extraordinary charge.........................................        (0.06)          --        (0.07)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common
                stock (as reported).....................................       (15.23)        1.07         2.42
           Pro forma compensation expense...............................        (0.11)       (0.36)       (0.01)
                                                                          -----------  -----------  -----------
              Net income (loss) applicable to common stock (pro forma)    $    (15.34) $      0.71  $      2.41
                                                                          ===========  ===========  ===========
     Common shares used in computing diluted earnings (loss) per share         29,091       28,645       35,273
                                                                          ===========  ===========  ===========
</TABLE>
                                       78

<PAGE>
         The fair value of each option and warrant  grant used to determine  the
pro forma  amounts  indicated in the previous  table is estimated on the date of
grant using the following weighted average assumptions for 1998, 1997 and 1996:

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

     <S>                                                                 <C>          <C>          <C>  
     Weighted average risk-free interest rate..........................       6.06%        6.34%        6.62%
     Weighted average dividend yields..................................         --%          --%          --%
     Volatility factors................................................       0.83          .61          .61
     Weighted average expected life (years)............................       1.90         4.50         5.00
     Weighted average fair value per share.............................  $   15.02    $   15.67    $   18.57
</TABLE>

         The  Black-Scholes  option  valuation  model was  developed  for use in
estimating the fair value of traded options having no vesting  restrictions  and
are fully transferable.  In addition,  option valuation models require the input
of highly subjective  assumptions including the expected stock price volatility.
As  employee  stock  options and  warrants  have  characteristics  significantly
different  from those of traded  options,  and  because  changes  in  subjective
assumptions  can  materially  affect the fair value  estimate,  in  management's
opinion,  the existing  models do not provide a reliable  single  measure of the
fair value of employee stock options and warrants.  As SFAS No. 123 is effective
only for  awards  granted  after  January  1,  1995,  the pro forma  disclosures
provided above may not be  representative  of the effects on reported net income
for future years.

(14) STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS

         Cash  generated  by  the  Company's  insurance   subsidiaries  is  made
available to PennCorp  principally  through  periodic  payments of principal and
interest  on  surplus  debentures  issued by  PLAIC,  Constitution  and  Pioneer
Security (collectively,  the "Surplus Note Companies").  The amounts outstanding
under the surplus  debentures  totaled  $453,118 and $358,346 as of December 31,
1998 and 1997, respectively. These surplus debentures generally require (subject
to  availability  of  statutory  capital  and  surplus  and in  some  instances,
regulatory approval) principal and interest payments to be made quarterly.

         Dividend payments by the Company's  insurance  subsidiaries are limited
by, or subject to the  approval of the  insurance  regulatory  authority of each
subsidiary's  state  of  domicile.   Such  dividend  requirements  and  approval
processes  vary  significantly  from  state to  state.  In 1999,  the  Company's
retained  insurance  subsidiaries,  subject to availability  of cash,  statutory
capital and surplus and  regulatory  approval,  will be able to pay a maximum of
$25,848 in dividends to the Surplus Note Companies (including SW Financial).

         Statutory   capital  and  surplus  of  the  Company's   life  insurance
subsidiaries  as reported to  regulatory  authorities  at December  31, 1998 and
1997, totaled $399,766 and $299,062,  respectively.  Statutory net income (loss)
of  the  Company's  life  insurance   subsidiaries  as  reported  to  regulatory
authorities  totaled  ($44,563),  $18,776  and  ($28,600)  for the  years  ended
December 31, 1998, 1997 and 1996, respectively. Surplus note interest expense of
$40,531,  $34,758 and $51,254 for the years ended  December 31,  1998,  1997 and
1996, respectively, is included in statutory net income (loss).

         For the years  ended  December  31,  1998 and 1999 PLIC has  received a
permitted  statutory  accounting  practice  allowing  PLIC  to  utilize  its own
experience  and other  modification  factors in the  determination  of statutory
disability income claims reserves.  If PLIC were to utilize the model regulation
for the determination of disability income claims reserves, management estimates
that the amount of additional statutory claims reserves necessary to be recorded
would be approximately  $16,200. If PLIC were to record such additional reserves
on a statutory  basis,  its risk based  capital  would be reduced  significantly
which in turn could lead to regulatory  action.  For the year ended December 31,
1999, PLIC will be required,  in the event of the  non-completion  of the Career
Sales  Division  divestiture,  to increase  its  disability  claims  reserves by
approximately  $5,300 and receive  capital  contributions  of at least $5,300 to
offset such reserve increases.

         In December  1992,  the NAIC  adopted  the RBC for Life  and/or  Health
Insurers  Model Act (the "Model  Act").  The main purpose of the Model Act is to
provide a tool for insurance regulators to evaluate the capital of insurers with
respect to the risks assumed by them and  determine  whether there is a need for
possible  corrective  action with respect to them. To date, either the Model Act
or similar  legislation  or regulation  has been adopted in all the  domiciliary
states of the Company's insurance subsidiaries.

         Calculations   using   the  NAIC   formula   and  the  life   insurance
subsidiaries'  statutory financial  statements as of December 31, 1998, indicate
that each of the  insurance  subsidiaries'  capital  exceeded RBC  requirements,
except for PLIC (see Note 20 of Notes to Consolidated Financial Statements).

                                       79

<PAGE>

(15) RETIREMENT AND PROFIT SHARING PLANS

         During  1998,  the  Company  implemented  SFAS  No.  132,   "Employer's
Disclosures about Pensions and Other  Postretirement  Benefits." This accounting
standard   revised  the   disclosure   requirements   for   pensions  and  other
postretirement  benefit plans,  but does not change the measurement or financial
statement recognition of such plans.

         On October 1, 1990,  the Company  established  the PennCorp  Financial,
Inc.  Retirement and Savings Plan, a defined  contribution  retirement plan, for
eligible  employees.  This plan and the Marketing One Incorporated 401(k) Profit
Sharing Plan merged with the Southwestern Financial Services Corporation Savings
Investment  Plan effective  January 1, 1998 and the name of the plan was changed
to the PennCorp Financial Group, Inc. Retirement and Savings Plan ("the PennCorp
Plan").  Employees are eligible to  participate  in the plan after six months of
employment  in which they are credited  with 500 hours of service.  Participants
may  contribute  from 1 to 15% of pre-tax  compensation  and/or from 1 to 10% of
after tax  compensation.  Each employer  participating  in the plan matches each
pay-period,  50% of pre-tax contributions up to 6% of compensation.  If approved
by the Board of Directors, each employer may make a discretionary profit sharing
contribution annually on behalf of employees eligible to participate in the plan
based on their compensation for the prior plan year. Employee  contributions are
fully  vested  at all  times.  The  employer  matching  contributions  made  for
employees who participated in the PennCorp Plan prior to January 1, 1998 vest at
the  rate  of  50%  per  calendar  year  of  service.   The  employer   matching
contributions  made for all other  participants  and the employer  discretionary
contribution vests at the rate of 20% per year of service.  All participants are
fully vested at death,  disability  or  attainment of age 65. The assets of each
account are  invested at the  direction  of the  participant.  Eleven funds with
various investment  objectives are available to the participants.  Distributions
are normally  made in a lump sum.  Participants  of the  PennCorp  Plan prior to
January 1, 1998 may elect to receive  an  annuity in various  forms of  payment.
Expenses  related to this plan for years ended December 31, 1998,  1997 and 1996
amounted to $3,341, $1,483 and $1,520.

         The  Company has an  established  bonus plan for  insurance  subsidiary
officers.  The amount  available to pay awards for any year is  determined  by a
committee of senior  executives  of the Company and is subject to the review and
recommendation  of the  Compensation  Committee  and  approval  of the  Board of
Directors  of the Company.  Awards are based  primarily  on the  achievement  of
specified operating objectives and the performance of eligible participants. The
Company  accrued or paid  $3,390,  $1,417 and $1,144  under this plan during the
years ended December 31, 1998, 1997 and 1996, respectively.

         The Company and, through its wholly-owned subsidiary,  SW Financial (as
a result of the acquisition of the SW Financial Controlling Interest, see Note 3
of Notes to Consolidated Financial  Statements),  provide certain postretirement
benefits to eligible  retirees.  The plans provide  certain health care and life
insurance  benefits for retired  employees.  Employees  meeting  certain age and
length of service requirements become eligible for these benefits. The Company's
obligation  for accrued  postretirement  benefits is  unfunded.  Following is an
analysis of the  accumulated  benefit  obligation  and the liability for accrued
postretirement benefits for the year ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                                   1998           1997
                                                                                ----------     -----------
           <S>                                                                  <C>            <C>        
           Benefit obligation at beginning of year...........................   $   10,380     $    11,059
           Service cost......................................................          184              --
           Interest cost.....................................................        1,533             789
           Plan participants' contributions..................................          364              65
           Actuarial (gain) loss.............................................        1,975            (478)
           Acquisition.......................................................       14,827              --
           Benefit paid......................................................       (2,661)         (1,055)
                                                                                ----------     -----------
              Benefit obligation at end of year..............................   $   26,602     $    10,380
                                                                                ==========     ===========
</TABLE>

         The liability for accrued benefit obligation  includes the following at
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                                   1998           1997
                                                                                ----------     -----------
           <S>                                                                  <C>            <C>        
           Accumulated benefit obligation....................................   $   26,602     $    10,380
           Unrecognized prior service cost...................................          162             216
           Unrecognized transition obligation................................       (5,185)         (4,202)
           Unrecognized actuarial loss.......................................          827           3,502
                                                                                ----------     -----------
              Benefit obligation at end of year..............................   $   22,406     $     9,896
                                                                                ==========     ===========
</TABLE>

                                       80
<PAGE>

         Components  of net periodic  benefit cost include the following for the
year ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                                   1998           1997
                                                                                ----------     -----------
           <S>                                                                  <C>            <C>        
           Service cost......................................................   $      130     $        --
           Interest cost.....................................................        1,533             789
           Amortization of transition obligation.............................          657             288
           Recognized net actuarial loss.....................................         (108)           (147)
                                                                                ----------     -----------
              Net periodic benefit cost......................................   $    2,212     $       930
                                                                                ==========     ===========
</TABLE>

         At December  31,  1998,  the  accumulated  benefit  obligation  and the
liability  for  accrued  postretirement   benefits  included  $4,717  and  $933,
respectively, related to Businesses Held for Sale.

         For measurement  purposes, an annual rate increase ranging from 5.5% to
7% in the health care cost trend rate was assumed for 1998; the rate was assumed
to decrease  gradually  to 4% by year 2015 and remain at that level  thereafter.
The  weighted  average  discount  rates  used  in  determining  the  accumulated
postretirement benefit obligation ranged from 6.5% to 7.5%. The health care cost
trend rate  assumption  has a  significant  effect on the  amounts  reported.  A
one-percentage-point  change in assumed  health care cost trend rates would have
the following effects:

<TABLE>
<CAPTION>
                                                                                   One            One
                                                                                Percentage     Percentage
                                                                                   Point          Point
                                                                                 Increase       Decrease
                                                                                 --------       --------
         <S>                                                                    <C>            <C>         
         Effect on total of service and interest cost components.............   $      121     $      (104)
         Effect on postretirement benefit obligation.........................        1,544          (1,331)
</TABLE>

(16) ASSETS AND LIABILITIES OF BUSINESSES HELD FOR SALE

         As a result of the Company's  announcement  of its decision to sell the
Career Sales  Division,  KIVEX,  Professional,  United Life,  UC,  Cyberlink and
Marketing  One within a period  not  likely to exceed  one year,  the assets and
liabilities of the Career Sales Division, KIVEX, Professional,  United Life, UC,
Cyberlink and  Marketing  One were  reported as "Assets of  Businesses  Held for
Sale" and  "Liabilities of Businesses Held for Sale" at December 31, 1998 in the
accompanying  consolidated  balance  sheet (see Note 3 of Notes to  Consolidated
Financial Statements). The assets and liabilities of Businesses Held for Sale at
December 31, 1998 were as follows:

 Invested assets...................................................  $ 1,974,280
 Insurance assets..................................................      329,950
 Other assets......................................................      117,574
                                                                     -----------
   Total assets....................................................  $ 2,421,804
                                                                     ===========

 Insurance liabilities.............................................  $ 1,853,163
 Other liabilities.................................................      213,391
                                                                     -----------
   Total liabilities...............................................  $ 2,066,554
                                                                     ===========

         For  the  year  ended  December  31,  1998  the  Company  recorded  the
impairment provision  aggregating $342,960. In accordance with SFAS No. 121, the
Company  recorded an impairment  provision in order to reflect the difference in
the  Company's  accounting  basis in the  Businesses  Held for Sale and the fair
value of the consideration  that the Company would be likely to receive for such
businesses.  The fair value of the consideration  likely to be received is based
primarily  upon  the  terms  of  definitive  sales  agreements.  The  impairment
provisions  for the Career  Sales  Division,  Professional  and the United  Life
Assets  were  $328,584,  $3,263 and  $11,113,  respectively.  The  Company  will
continue to  evaluate  the terms and  conditions  of the  definitive  agreements
relative  to its  accounting  basis in the  Businesses  Held for Sale and,  as a
result, may need to reflect additional  impairment  provisions prior to ultimate
disposition of the Businesses Held for Sale.

                                       81

<PAGE>

(17) PRO FORMA FINANCIAL INFORMATION

         The following  unaudited  selected pro forma financial  information has
been  prepared to  illustrate  the pro forma  effects of the  purchase of the SW
Financial  Controlling  Interest  as well as the Fickes and Stone  Knightsbridge
Interests and the sales of Career Sales Division,  KIVEX,  Professional,  United
Life, UC,  Cyberlink and Marketing  One. The pro forma  statements of operations
for the years ended December 31, 1998 and 1997 give effect to such purchases and
sales as if they had  occurred on January 1, 1997.  The  unaudited  selected pro
forma financial  information has been prepared for comparative purposes only and
does not purport to be indicative of what would have occurred had such purchases
and sales been made as of January  1,  1997,  or results  which may occur in the
future.

<TABLE>
<CAPTION>
                                                                                     (Unaudited)
                                                                       As Reported    Pro Forma
                                                                          1998           1998
                                                                       ----------     -----------
                                                                          (In thousands, except
                                                                            per share amounts)
<S>                                                                    <C>            <C>        
Total revenues......................................................   $  879,995     $   449,868
Income (loss) before extraordinary charge...........................     (421,259)        (66,328)
Income (loss) before extraordinary charge applicable to common stock     (439,532)        (84,601)
Per share information:
  Net income (loss) before extraordinary charge applicable
     to common stock-basic..........................................   $   (15.17)    $     (2.97)
  Net income (loss) before extraordinary charge applicable
     to common stock-diluted........................................       (15.17)          (2.97)
</TABLE>

<TABLE>
<CAPTION>
                                                                                     (Unaudited)
                                                                       As Reported    Pro Forma
                                                                          1997           1997
                                                                       ----------     ----------
                                                                          (In thousands, except
                                                                            per share amounts)
<S>                                                                    <C>            <C>        
Total revenues......................................................   $  663,794     $   490,564
Income (loss) before extraordinary charge...........................       50,140         (16,863)
Income (loss) before extraordinary charge applicable to common stock       30,607         (36,396)
Per share information:
  Net income (loss) before extraordinary charge applicable to
     common stock-basic.............................................   $     1.09     $     (1.30)
  Net income (loss) before extraordinary charge applicable to
     common stock-diluted...........................................         1.07           (1.27)
</TABLE>

(18) RELATED PARTY TRANSACTIONS

         Related party transactions  described herein include those transactions
not included elsewhere in the Notes to Consolidated Financial Statements.

         On September 1, 1997, the Company,  through its insurance subsidiaries,
purchased $25,000 of ACO Acquisition Corp.  (subsequently re-named Acordia, Inc.
("Acordia")  subordinated  indebtedness and the Company purchased $20,000 of ACO
Brokerage  Holdings  Corporation  ("ACO"),  an affiliate  of Acordia,  preferred
stock. The Acordia  subordinated notes pay interest on a current basis at 12.5%,
per annum,  payable in semi-annual  installments.  Acordia was 28.6% owned by KB
Investment  Fund I, LP  (formerly  Knightsbridge  Capital Fund I, L.P.) (the "KB
Fund").  PennCorp received fees aggregating  $1,100 in 1997 from Acordia for its
underwriting and  participation  in the  subordinated  notes and preferred stock
offering.  Knightsbridge  Management,  L.L.C.  ("KM") received  sponsor fees and
other fees aggregating  $1,714 in 1997 from Acordia for its role in consummating
the Acordia acquisition.

         During  1998 the  Company  liquidated  its common and  preferred  stock
holdings in ACO.  Total  proceeds  received  from the sale of the  preferred and
common  stock  aggregated  $30,500.  The  Company- had acquired the common stock
interest in January 1998 for $5,000 as part of the  Company's and the KB Capital
Fund I investment in ACO.

                                       82
<PAGE>

         The  Company  owns  66,555  shares  of  redeemable  preferred  stock of
Portsmouth Financial Group, Inc. ("Portsmouth") with a carrying value of $6,656.
Southwestern  Life may,  subject to regulatory  approvals,  make up to a $10,000
preferred equity investment in Portsmouth. The preferred stock pays dividends of
18.0%  of which  12% is in cash  with the  remainder  in the form of  additional
preferred  stock.  The  shares  are  mandatorily  redeemable  in June 30,  2002.
Portsmouth  underwrites,  acquires  and  holds to  receipts  of  benefits,  life
insurance contacts covering individuals facing terminal illnesses.
Portsmouth is owned by KB Fund and its affiliates.

         As of December  31,  1998,  the Company  invested a total of $12,641 in
transactions  sponsored by Wand  Partners  L.L.C.  ("Wand  Partners") in which a
director of the Company is a managing  member.  The  Company  has  committed  to
invest up to an  additional  $11,393 in future  transactions  sponsored  by Wand
Partners.

         For the  years  ended  December  31,  1997 and 1996,  PennCorp  paid or
accrued $2,385 and $2,548 in transaction  fees and expenses to KM related to the
Washington National,  United Life and SW Financial  transactions,  respectively.
During 1997 and 1996, certain of the Company's  affiliates and subsidiaries paid
management fees to KM amounting to $5,325 and $3,333, respectively. SW Financial
and United Life incurred KM investment  advisory fees totaling $4,358 and $2,426
during 1997 and 1996, respectively. In addition during 1996, PennCorp received a
$1,000 stand-by  commitment fee from SW Financial for contingent  financing on a
real estate transaction. SW Financial did not draw upon the commitment which has
expired.

         During  1998  and  1997,  the  Company's  insurance  subsidiaries  paid
management and  commitment  fees  aggregating  $718 and $444,  respectively,  to
investment funds managed by a member of the Board of Directors.

         Certain  individuals,  who are  shareholders and directors of PennCorp,
and affiliates of these  individuals,  provide  services to the Company.  During
1997 and 1996, payments  aggregating $250 and $250,  respectively,  were made to
these  individuals and their affiliates for services provided in connection with
the Company's acquisition activity.

(19) OTHER COMMITMENTS AND CONTINGENCIES

         The Company and its subsidiaries are obligated under operating  leases,
primarily for office space.  Rent expense,  net of sublease income,  was $5,299,
$5,178 and $8,416 in 1998, 1997 and 1996, respectively.

         Minimum lease commitments for the Retained Businesses are:

 1999..............................................................  $     3,821
 2000..............................................................        2,690
 2001..............................................................        2,676
 2002..............................................................        2,521
 2003..............................................................        2,375
 2004 and thereafter...............................................        2,242
                                                                     -----------
    Total minimum payments required................................  $    16,325
                                                                     ===========

         In January 1996,  stockholder  derivative lawsuits styled Tozour Energy
Systems  Retirement  Plan v.  David J.  Stone et al and the  PennCorp  Financial
Group,  Inc.,  C.A. No.  14775 (the  "Tozour  Case") and Lois Miller v. David J.
Stone et al,  and the  PennCorp  Financial  Group,  Inc.,  C. A. No.  14795 (the
"Miller  Complaint")  were filed against the Company and each of its  directors,
individually,  in the Delaware  Court of Chancery.  The  complaint in the Miller
suit was never served on the Company or the other defendants.  Both suits allege
that  the  SW  Financial  Investment  involved  the  usurpation  of a  corporate
opportunity and a waste of the Company's assets by Messrs. Stone and Fickes, and
that the directors of the Company in approving that  transaction,  failed to act
in good faith and breached their fiduciary duties, including the duty of loyalty
to the Company and its  stockholders,  having  favored the  interests of Messrs.
Stone and Fickes over the Company and its  stockholders.  These lawsuits  sought
judgments against each of the defendants for the amount of damages sustained, or
to be  sustained,  by the Company as a result of the breaches of fiduciary  duty
alleged in the complaint, the imposition of a constructive trust for the benefit
of the Company on profits or  benefits  obtained  by any  defendant  through the
alleged  breaches of fiduciary duty,  attorney's fees and costs,  and such other
relief as the court determines to be just, proper or equitable.

         The defendants and the  plaintiffs'  counsel entered into a stipulation
of  settlement  on March 28,  1997 (the  "Original  Proposed  Settlement").  The
Original Proposed Settlement consisted of the following principal elements:  (i)
Messrs.  Stone and Fickes  will  cancel the 335,564 SW  Financial  common  stock
warrants they hold for no consideration enabling PennCorp

                                       83
<PAGE>

to purchase the SW  Financial  Controlling  Interest  for $67,500,  reducing the
price  to be paid by  PennCorp  for the SW  Financial  Controlling  Interest  by
approximately  $2,000, (ii) the PennCorp Board will proceed with the purchase of
The Fickes and Stone Knightsbridge Interests, having received a fairness opinion
of a nationally  recognized investment banking firm with respect to the price to
be paid for The Fickes and Stone  Knightsbridge  Interests,  (iii) the  PennCorp
Board  will  proceed  with  the  acquisition  of  the SW  Financial  Controlling
Interest,  having  received  a  fairness  opinion  of  a  nationally  recognized
investment  banking  firm  with  respect  to the  price  to be  paid  for the SW
Financial  Controlling  Interest,  (iv)  the  PennCorp  Board  will  submit  the
purchases of The Fickes and Stone  Knightsbridge  Interests and the SW Financial
Controlling  Interest  to a  shareholder  vote  of a  majority  of the  PennCorp
stockholders  present at a meeting and entitled to vote, and  stockholders  must
approve both transactions, (v) Messrs. Stone and Fickes will abstain from voting
on the  proposals to approve the purchase of The Fickes and Stone  Knightsbridge
Interests and the SW Financial  Controlling  Interest,  and (vi) the plaintiffs'
counsel will be entitled to conduct confirmatory discovery.

         On December 1, 1997, the defendants and the plaintiffs'  counsel agreed
in principle  to amend the  Original  Proposed  Settlement  (as so amended,  the
"Amended Proposed Settlement") following the PennCorp Board's conclusion that it
would be  appropriate  to  increase  the  amount  paid to the KB Fund for the SW
Financial  Controlling  Interest to compensate  the limited  partners for, among
other things,  the unexpected and substantial  delay in the  consummation of the
purchase  of the SW  Financial  Controlling  Interest.  The terms of the Amended
Proposed  Settlement  are  identical  to  the  terms  of the  Original  Proposed
Settlement,  except  that the  Amended  Proposed  Settlement  provides  that the
Company will acquire the SW Financial Controlling Interest for $73,658, and will
provide a one-time "price  protection"  payment associated with a disposition of
the SW Financial  Controlling  Interest by PennCorp  during the 12-month  period
ending November 25, 1998. The Amended Proposed  Settlement also requires Messrs.
Stone and Fickes to grant  PennCorp a price  protection  right in the event of a
sale of their Portsmouth investment.

         The Amended Proposed Settlement was subject to approval by the Chancery
Court after notice to PennCorp  stockholders.  As discussed above, Messrs. Stone
and Fickes agreed that, if the Amended  Proposed  Settlement was approved by the
Chancery Court,  they would cancel their SW Financial  common stock warrants and
they  would not  participate  in the  increased  consideration  (other  than the
possible price protection  right) for the SW Financial  Controlling  Interest to
the extent it relates to their $7,000 personal investment in SW Financial, which
together  would  reduce the price to be paid by  PennCorp  for the SW  Financial
Controlling  Interest  by  approximately   $3,667.   Because  the  Knightsbridge
restructuring  would  have the  effect of  substantially  eliminating  potential
future conflicts of interest between Messrs. Stone and Fickes and PennCorp,  and
because the Amended  Proposed  Settlement  would have the effect of reducing the
price paid for the SW Financial  Controlling Interest and would obviate the need
to expend considerable management and director time to litigate the actions, the
PennCorp Board determined that the Amended  Proposed  Settlement was in the best
interests of PennCorp and its shareholders and conferred a substantial  economic
benefit on PennCorp.  Accordingly,  the PennCorp Board authorized the payment to
plaintiffs'  counsel of legal fees of $785 and documented expenses not to exceed
$50 in connection with the lawsuits and the related settlement negotiations.

         The Amended  Proposed  Settlement was approved by the Chancery Court on
May 12,  1998.  The time period for filing an appeal had expired and the Company
paid  $835 to  plaintiffs  counsel  representing  fees of  $785  and  documented
expenses of $50.

         On August 25, 1998, the first of ten class-action complaints were filed
in the  United  States  District  Court for the  Southern  District  of New York
against the Company and certain of its current or former directors and officers.

         During a pre-trial  conference on November 9, 1998,  all parties agreed
to the  consolidation  of all  of the  actions  and  the  Court  appointed  lead
plaintiffs on behalf of shareholders  and  noteholders.  The Court also approved
the  selection  of three law  firms as  co-lead  counsel  for  shareholders  and
noteholders.  Pursuant to a schedule agreed to at the conference, a consolidated
and  amended  complaint  was filed on January  22,  1999.  A First  Consolidated
Amended Class Action  Complaint  naming,  as defendants,  the Company,  David J.
Stone,  formerly  Chairman and Chief  Executive  Officer,  and Steven W. Fickes,
formerly  President and Chief Financial Officer was filed on March 15, 1999 (the
"Complaint").

         The Complaint alleges that defendants  violated the Securities Exchange
Act of 1934.  Among other things,  plaintiffs'  claim that  defendants  issued a
series of materially false and misleading  statements and omitted material facts
regarding the Company's financial  condition,  including the value of certain of
its assets, and failed to timely disclose that it was under investigation by the
Securities and Exchange Commission (the "SEC").

                                       84
<PAGE>

         Plaintiffs seek to recover damages in unspecified  amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the  Company's  subordinated  notes  during  the period of  February  8, 1996
through November 16, 1998.

         During a  conference  on March 19,  1999,  defendants  sought  and were
granted permission to file a motion to dismiss the Complaint. Although there are
not assurances that the motion to dismiss will be granted,  management  believes
that  there  are  meritorious  defenses  to the  action  that  will be raised in
connection with the motion,  including  whether the Complaint  adequately pleads
scienter  (i.e.,  intent to defraud) as  required  under the Private  Securities
Litigation Reform Act of 1995.

         The Company has notified  its primary and excess  carriers of directors
and officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15,000 of primary and
$10,000 of excess coverage,  respectively,  for securities  claims.  The primary
insurance  coverage  requires  the Company to bear 25% of all  expenses  and any
losses in excess of the $1,000 retention amount. The primary and excess carriers
have  reserved  their rights under the policies  with respect to coverage of the
claims set forth in the Complaint.

         The Company expects that this litigation will not affect its ability to
operate  through  December  31,  1999.  While it is not  feasible  to predict or
determine the final outcome of these  proceedings  or to estimate the amounts or
potential range of loss with respect to these matters,  management believes that
if there is an adverse outcome with respect to such  proceedings it would have a
material  adverse  impact on the Company and affect its ability to operate as is
currently intended.

         On July 30, 1998,  the SEC notified the Company that it has commenced a
formal  investigation  into possible  violations of the federal  securities laws
including  matters  relating  to the  Company's  restatement  of  its  financial
statements  for the first nine months of 1997,  and for the years ended December
31, 1994,  1995 and 1996. The Company and its  management are fully  cooperating
with the SEC in its investigation.

         The Company is a party to various  other  pending or  threatened  legal
actions  arising  in the  ordinary  course of  business,  some of which  include
allegations of insufficient  policy  illustration and agent  misrepresentations.
Although the outcome of such actions is not presently  determinable,  management
does not believe that such matters, individually or in the aggregate, would have
a material  adverse  effect on the  Company's  financial  position or results of
operations if resolved against the Company.

         In May 1998, the North Carolina Attorney  General's Office (the "NCAG")
initiated an inquiry  concerning  certain life insurance  products  historically
sold by Security  Life and  representations  allegedly  made by Security  Life's
agents and officers  with respect to not changing  insurance  charges  after the
eighth policy year for  non-smoker  insureds.  The NCAG  indicated that Security
Life may be estopped to change its current  practice of not charging the cost of
the insurance because of certain  representations made by agents and officers of
Security  Life.  Although  Security  Life has not charged the cost of  insurance
charges for  non-smoker  policyholders  who recently  reached their ninth policy
year, this practice is not guaranteed  under the life insurance  contracts.  The
contracts  specifically  allow  Security  Life the right to  change  the cost of
insurance  rates in accordance  with the  parameters  set forth in the insurance
contracts.  Security Life has responded to the NCAG's inquiry by denying that it
is  estopped  from  changing  the cost of  insurance  rates based on the alleged
representations,  and continuing to reserve its contractual rights to change the
cost of  insurance  rates in  accordance  with the  parameters  set forth in the
insurance contracts. In June 1998, the NCAG informed Security Life that it could
not  adjudicate  this  matter  and  left  it  mutually  unresolved.  No  further
communications  from the NCAG  have  been  received  to date.  The  Company  has
initiated an exchange program which enables policyholders of such life insurance
products to terminate  their  policies  and obtain  either (i) the refund of all
premiums paid and other consideration or (ii) another Security Life product. See
Item 1. Business --  Regulatory  Matters.  There can be no  assurances  that the
exchange  program will be  successful  or that the Company  will  resolve  these
matters on such life insurance  product on a satisfactory  basis,  or at all, or
that  any such  resolution  would  not have a  material  adverse  effect  on the
Company's financial condition, results of operations or cash flows.

         In  connection  with a potential  leveraged  buyout of the Career Sales
Division,  the sales force of Penn Life agreed to a reduction in the  commission
rates over the life of the policy  contract on new sales on and after January 1,
1998,  in  exchange  for the  opportunity  to  participate  in the  equity  in a
newly-formed  leveraged  entity.  Discussions  have also been held  relating  to
equity incentive  programs based on sales  production and persistency  measures.
Additionally,  the Company has held discussions  with a marketing  organization,
which it has  contracted  with for the  development  and  marketing  of products
focused on the senior  marketplace,  concerning  the  issuance  of equity in the
newly-formed  leveraged  entity based on a percentage of profits  contributed by
such  marketing  organization.  In  connection  with  the  Company's  definitive
agreement  to sell the Career  Sales  Division  and related  assets to Universal
American,  the sales  force of Penn  Life and the  marketing  organization  will
receive  equity in Universal  American and will  participate  in certain  equity
incentive programs of Universal

                                       85
<PAGE>

American. A portion of the proceeds to be received by the Company from Universal
American  for the sale of the  Career  Sales  Division  will be used to fund the
equity of Universal American to be issued to the sales force of Penn Life and to
make  certain  other  payments  to the  sales  force in  exchange  for a release
relating to the potential  leveraged  buyout. If the Company does not consummate
its transaction with Universal  American,  then it will pursue alternatives with
the  Penn  Life  sales  force  in  light  of the  modifications  to  commissions
associated  with new  business  production  after  January  1, 1998 and with the
marketing organization in light of the marketing contract.

     The life  insurance  companies  are required to be members of various state
insurance  guaranty  associations in order to conduct  business in those states.
These  associations  have the authority to assess member  companies in the event
that an insurance  company  conducting  business in that state is unable to meet
its policyholder obligations. Assessments from guaranty associations, which have
not been material, are recorded as assessments when received.

     In May 1998,  the three senior  executive  of the Company  entered into two
year employment  agreements with the Company which have various annual bonus and
termination  provisions.  For the year ended  December 31, 1998, the Company has
accrued  compensation  expense of $1,800  and  $3,036  for the annual  bonus and
termination   provisions,   respectively,   of  these   employment   agreements.
Termination  provisions  are  payable  upon  the  expiration  of the  employment
agreement  or  termination  by the officer  for "good  reason" as defined in the
employment agreement.

     Many computer and software  programs were designed to accommodate  only two
digit fields to represent a given year (e.g. "98" represents 1998). It is highly
likely that such systems will not be able to accurately  process data containing
date  information  for the year 2000 and beyond.  The Company is highly  reliant
upon computer  systems and software as are many of the businesses with which the
Company interacts. The Company's ability to service its policyholders and agents
is  dependent  upon  accurate  and timely  transaction  processing.  Transaction
processing in turn is dependent upon the Company's highly complex interdependent
computer hardware,  software,  telecommunications and desktop applications.  The
inability  of the Company or any of its integral  business  partners to complete
year  2000  remediation   efforts  associated  with  these  highly  complex  and
interdependent systems could lead to a significant business  interruption.  Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.

     Although the Company believes that its operating divisions, outside vendors
and most critical business partners will be sufficiently compliant that the year
2000 issue should not cause a material  disruption  in the  Company's  business,
there can be no  assurance  that there will not be material  disruptions  to the
Company's  business or an increase  in the cost of the Company  doing  business.
Although  the  Company  believes  that the year 2000  issues  should not cause a
material disruption in the Company's business, the Company has developed various
contingency  plans associated with remediation  tasks which the Company believes
are at a higher risk for potential failure.

     The Company has provided certain assurances to each respective purchaser of
the  Businesses  Held for Sale with respect to each entity's  ability to process
date-sensitive  information  for the year 2000 and beyond.  Although the Company
believes  that  it  will be able to  meet  the  year  2000  representations  and
warranties  provided to the respective  purchasers,  there can be no assurances.
Failure of the Company to meet such  representations and warranties could result
in a  decision  by  the  purchaser  not to  consummate  the  transaction  and/or
indemnification claims for breach of contract.

     The Company has  outstanding  commitments to invest up to $7,600 in various
unaffiliated limited partnership funds and other investments.

     The Company has a contingent  obligation for mortgage loans previously sold
aggregating $5,905 as a result of the Company acting as a servicing conduit.

(20) REINSURANCE

     In the normal course of business, the Company reinsures portions of certain
policies  that it  underwrites  to limit  disproportionate  risks.  The  Company
retains  varying  amounts of individual  insurance up to a maximum  retention of
$500 on any life. Amounts not retained are ceded to other insurance  enterprises
or reinsurers on an automatic or  facultative  basis.  The Company cedes varying
amounts of certain  accident  and sickness  policies up to a maximum  cession of
$800, as well as varying  portions of certain  disability  income  policies on a
facultative basis.

     On September 30, 1998, PLIC entered into a financial  reinsurance agreement
with an unaffiliated  reinsurer to coinsure certain in force individual life and
health business written or acquired by PLIC prior to January 1, 1998. Such

                                       86
<PAGE>

reinsurance  provided PLIC with  approximately  $20,000 of additional  statutory
capital and  surplus  allowing it to  maintain  its RBC at the  "Company  Action
Level" for the year ended December 31, 1998.

         Reinsurance  contracts do not relieve the Company from its  obligations
to policyholders.  Therefore, the Company is contingently liable for recoverable
unpaid claims and policyholder  liabilities  ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial  condition of its reinsurers to minimize its exposure to
significant  losses from  reinsurer  insolvencies.  The effect of reinsurance on
policy revenues earned is as follows:

<TABLE>
<CAPTION>
                                                                            1998          1997         1996
                                                                         -----------  -----------  -----------
     <S>                                                                 <C>          <C>          <C>        
     Direct policy revenues and amounts assessed
       against policyholders...........................................  $   586,317  $   375,538  $   358,825
     Reinsurance assumed...............................................        6,018        2,527        1,320
     Reinsurance ceded.................................................     (133,177)     (32,499)     (12,055)
                                                                         -----------  -----------  -----------
       Net premiums and amounts earned.................................  $   459,158  $   345,566  $   348,090
                                                                         ===========  ===========  ===========

     Policyholder benefits ceded.......................................  $   109,079  $    33,612  $    35,868
                                                                         ===========  ===========  ===========
</TABLE>

         Fees incurred for financial  reinsurance  were  approximately,  $675 in
1998, $145 in 1997, and $265 in 1996.

(21) RESTRUCTURING AND OTHER COSTS

         As  a  result  of  the  tremendous   growth  of  the  Company  and  the
diversification of the underlying business units resulting from acquisition over
time, the Company began a strategic business  evaluation in the third quarter of
1996.  The  review  resulted  in  the  Company   establishing  three  divisional
platforms,  Career Sales Division, Payroll Sales Division and Financial Services
Division in 1997.

         As a result,  the  Company  began to  realign  its  existing  operating
companies and incurred  restructuring  costs aggregating  approximately  $19,071
during the year ended December 31, 1997, directly and indirectly associated with
the  initial  divisional  restructuring  which  had no future  economic  benefit
("restructuring costs").

         On January 2, 1998,  and  January 5, 1998,  respectively,  the  Company
acquired  the SW  Financial  Controlling  Interest  and  the  Fickes  and  Stone
Knightsbridge  Interest.  The  acquisition  allowed the Company to complete  its
divisional  restructuring which began in 1997. As a result, the Company incurred
restructuring  costs  aggregating  approximately  $11,767  for  the  year  ended
December  31, 1998,  directly  and  indirectly  associated  with the  divisional
restructuring.

         In  addition,  the  Company  recorded  in the  fourth  quarter  of 1998
additional  restructuring costs aggregating  approximately $9,274 as a result of
the  Company's  decision  to  consolidate  or  merge  substantially  all  of its
corporate functions into the Company's Dallas location.

         The  restructuring  costs  recognized  the following for the year ended
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                                   1998           1997
                                                                                ----------     -----------
         <S>                                                                    <C>            <C>        
         Severance and related benefits incurred due to staff reduction......   $   10,090     $     5,355
         Estimated holding costs of vacated facilities.......................        2,205           6,166
         Write-off of certain fixed assets and other impaired assets.........        4,085           1,526
         Estimated contract termination costs................................        4,661              24
         Write-off of investment in certain foreign operations
           which will be closed..............................................           --           6,000
                                                                                ----------     -----------
              Total restructuring costs......................................   $   21,041     $    19,071
                                                                                ==========     ===========
</TABLE>

         During  the  years  ended  December  31,  1998 and  1997,  the  Company
re-evaluated  the  restructuring  costs and  reduced the  remaining  accruals by
approximately  $6,164  and  $2,300,  respectively,  as a  result  of  the  final
determination of certain obligations.

                                       87
<PAGE>

         The  Company  incurred  approximately  $6,296  and  $4,652  of  pre-tax
incremental costs ("period costs")  associated with the corporate  restructuring
for the years ended  December  31, 1998 and 1997,  respectively.  Such costs are
included  in the  Company's  Results of  Operations  as  underwriting  and other
administrative expenses.

         On August 30, 1997, the merger agreement  between  Washington  National
Corporation  ("Washington  National")  and the Company  terminated.  The Company
incurred  legal,  accounting  and financial  advisory fees  associated  with the
merger.  In  addition,  the Company had began to provide  certain  resources  to
Washington  National  including  personnel to perform policy  administration and
claims  processing  function on  Washington  National's  behalf.  The  aggregate
advisory  and  administrative  costs  incurred by the  Company  during 1997 were
$7,646.

(22) FINANCIAL INSTRUMENTS

         The following is a summary of the carrying  value and fair value of the
Company's financial instruments at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                        1998                      1997
                                                              ------------------------  ------------------------
                                                               Carrying        Fair       Carrying       Fair
                                                                 Value         Value        Value        Value
                                                                 -----         -----        -----        -----
<S>                                                           <C>          <C>          <C>          <C>        
Assets:
   Cash and short-term investments..........................  $    92,727  $    92,727  $   109,013  $   109,013
   Fixed maturities.........................................    2,589,714    2,589,714    2,718,982    2,718,982
   Equity securities........................................        2,035        2,035       30,257       30,257
   Mortgage loans...........................................       36,882       38,865      240,879      248,052
   Policy loans.............................................      207,490      207,490      145,108      145,108
   Other investments........................................       27,406       27,406       95,875       95,875
   Accounts and notes receivable............................       14,319       14,319       46,655       46,655
Liabilities:
   Notes payable............................................      550,923      497,039      359,755      364,914
   Universal life and investment contract liabilities.......    2,063,823    1,756,762    2,496,055    2,092,348
</TABLE>

         The  following  methods  and  assumptions  are used by the  Company  in
estimating its fair value disclosures for financial instruments:

         Cash and Short-term  Investments,  Accounts and Notes  Receivable:  The
         carrying  value  approximates  their fair  value due to the  short-term
         maturity of these instruments.

         Fixed  Maturities  Available for Sale and Equity  Securities:  The fair
         values  for  fixed  maturities  available  for sale are based on quoted
         market  prices,  where  available.  For fixed  maturities  not actively
         traded,   fair  values  are  estimated   using  values   obtained  from
         independent  pricing services or are estimated based on expected future
         cash flows using current  market rate  applicable to the yield,  credit
         quality  and  maturity of the  investments.  The fair values for equity
         securities are based on quoted market prices.

         Mortgage  Loans:  The fair values are estimated  using  discounted cash
         flow  analyses,  based on interest  rates  currently  being offered for
         similar  loans to borrowers  with similar  credit  ratings.  Loans with
         similar   characteristics   are   aggregated   for   purposes   of  the
         calculations.

         Policy  Loans:  Policy  loans are an  integral  part of life  insurance
         policies which the Company has in force and, in the Company's  opinion,
         cannot be valued  separately.  These loans  typically carry an interest
         rate that is tied to the crediting  rate applied to the related  policy
         and contract reserves.

         Other  Investments:  Other  investments  consist  primarily  of limited
         partnerships  and joint  ventures.  These are  evaluated  periodically.
         Carrying  value  represents  the  underlying   equity  of  the  limited
         partnerships  or joint ventures of their cost which  approximates  fair
         value.

         Notes Payable:  The carrying  value for  outstanding  notes  receivable
         other than the senior subordinated notes approximates the fair value as
         they carry  variable  interest  rates of interest which adjust at least
         every 90 days.  The fair  value  of the  senior  subordinated  notes is
         determined based upon quotes from market makers.

                                       88
<PAGE>

         Universal Life and Investment Contract Liabilities:  The  fair value of
         accumulation products approximates their cash surrender value.

(23) SUBSEQUENT EVENTS

         On March 22, 1999,  the Company  received  regulatory  approval for the
sale of  Professional.  The  Company  anticipates  the  transaction,  subject to
certain closing conditions, will be finalized on or about March 31, 1999.

(24) UNAUDITED QUARTERLY FINANCIAL DATA

         The following is a summary of the quarterly  results of operations  for
the years ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
(In thousands, except per share amounts)

1998 Quarter-ended                                      March 31        June 30     September 30    December 31
---------------------------------------------------  -------------   -------------  ------------   -------------
<S>                                                   <C>             <C>            <C>            <C>        
Total revenues.....................................   $   232,651     $   227,888    $   225,682    $   193,774
Net income (loss) applicable to common stock.......   $    (3,686)    $  (163,904)   $  (165,088)   $  (108,525)
Net income (loss) per share of common
   stock - basic...................................   $     (0.20)    $     (5.60)   $     (5.64)   $     (3.71)
Net income (loss) per share of common
   stock - diluted.................................   $     (0.20)    $     (5.60)   $     (5.64)   $     (3.71)

1997 Quarter-ended                                      March 31        June 30     September 30    December 31
---------------------------------------------------  -------------   -------------  ------------   -------------

Total revenues.....................................   $   168,116     $   163,608    $   172,968    $   159,102
Net income (loss) applicable to common stock.......   $     7,436     $    13,209    $    26,070    $   (16,108)
Net income (loss) per share of common
   stock - basic...................................   $      0.26     $      0.47    $      0.93    $     (0.58)
Net income (loss) per share of common
   stock - diluted.................................   $      0.25     $      0.45    $      0.80    $     (0.58)
</TABLE>

         The Company's fourth quarter 1998 reported loss primarily resulted from
an additional impairment provision associated with assets of Businesses Held for
Sale totaling  $57,475.  In addition,  the Company  unlocked  certain  actuarial
assumptions  on interest  sensitive  blocks of business  resulting in additional
amortization of deferred policy acquisition costs and present value of insurance
in force amounting to approximately $16,250 and incurred  restructuring costs of
$7,228.

         The Company's  fourth quarter 1997 reported loss was primarily a result
of reserve strengthening aggregating $12,373 associated with the Businesses Held
for Sale and certain  non-recurring  charges including transaction costs, period
restructuring  costs and other costs  aggregating  $5,222,  associated  with the
Retained  Businesses.  In  addition,  the  Company  unlocked  certain  actuarial
assumptions  on interest  sensitive  blocks of business  resulting in additional
amortization of deferred policy acquisition costs and present value of insurance
in force amounting to $6,944.

                                       89
<PAGE>












                          INDEPENDENT AUDITORS' REPORT


Board of Directors
Southwestern Financial Corporation:

     We  have  audited  the   accompanying   consolidated   balance   sheets  of
Southwestern  Financial Corporation and subsidiaries as of December 31, 1997 and
1996 and the related consolidated  statements of income,  shareholders'  equity,
and cash flows for the years then ended. These consolidated financial statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an  opinion  on these  consolidated  financial  statements  based on our
audits.

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

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material respects, the financial position of Southwestern
Financial  Corporation and subsidiaries as of December 31, 1997 and 1996 and the
results  of their  operations  and their  cash flows for the years then ended in
conformity with generally accepted accounting principles.



KPMG Peat Marwick LLP
Dallas, Texas
March 19, 1998


                                       90

<PAGE>



               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                         as of December 31,1997 and 1996
                    (In thousands, except share information)
<TABLE>
<CAPTION>
                                                                                        1997              1996
                                                                                    ------------     -------------
<S>                                                                                 <C>              <C>
ASSETS
Investments:
   Fixed maturities available for sale at fair value (cost $1,643,769
      and $1,270,507).............................................................  $  1,677,508     $   1,255,270
   Equity securities available for sale at fair value (cost $688 and $959)........         1,079             1,129
   Mortgage loans on real estate, net of allowance of $680 in 1997 and
      $1,000 in 1996..............................................................        51,070            59,993
   Policy loans...................................................................       123,041           128,551
   Short-term investments.........................................................       157,140           135,203
   Collateral loans...............................................................           --             21,308
   Real estate....................................................................         1,893             7,649
   Other investments..............................................................         8,461             5,553
                                                                                    ------------     -------------
     Total investments............................................................     2,020,192         1,614,656
Cash..............................................................................         6,576            26,692
Due from reinsurers...............................................................       109,051           259,288
Accrued investment income.........................................................        25,224            20,802
Accounts and notes receivable, net of allowance of $181 and $561..................         5,507            13,773
Present value of insurance in force...............................................        58,565            71,333
Deferred policy acquisition costs.................................................        30,606            15,095
Deferred income taxes, net........................................................        34,746            47,954
Other assets......................................................................        19,025            18,549
Costs in excess of net assets acquired............................................       115,388           119,760
                                                                                    ------------     -------------
     Total assets.................................................................  $  2,424,880     $   2,207,902
                                                                                    ============     =============
LIABILITIES
Policy liabilities and accruals:
   Future policy benefits on traditional products.................................  $    554,998     $     584,179
   Universal life and investment contract liabilities.............................     1,315,496         1,088,335
   Policy and contract claims ....................................................        57,517            55,011
   Other policyholder funds.......................................................        14,203            17,635
                                                                                    ------------     -------------
     Total policy liabilities and accruals........................................     1,942,214         1,745,160
Federal income taxes payable......................................................         1,298             9,118
Notes payable.....................................................................       154,750           159,750
Accrued expenses and other liabilities............................................        97,211           118,119
                                                                                    ------------     -------------
     Total liabilities............................................................     2,195,473         2,032,147
                                                                                    ------------     -------------
Mandatorily redeemable preferred stock:
   Series  A  10%,  $.01  par  value,  $100  redemption  value;  500,000  shares
      authorized, 257,070 and 232,890 issued and outstanding at
      December 31, 1997 and 1996, respectively....................................        25,707            23,289
   5.5% preferred stock $.01 par value, $10,000 redemption value; 2,000 shares
     authorized, 1,118 and 1,059 shares issued and outstanding at
     December 31, 1997 and 1996, respectively.....................................        11,184            10,590

SHAREHOLDERS' EQUITY
Common Stock, Class A, $.01 par value; 18,000,000 shares authorized;
   3,500,000 shares issued and outstanding........................................            35                35
Common Stock, Class B, non-voting $.01 par value; 10,000,000 shares authorized;
   8,400,000 shares issued and outstanding........................................            84                84
Additional paid in capital........................................................       116,992           120,626
Unrealized gains (losses) on securities available for sale,
   net of tax (benefit) of $11,776 and ($4,224)...................................        21,870            (8,081)
Retained earnings.................................................................        53,535            29,212
                                                                                    ------------     -------------
     Total shareholders' equity...................................................       192,516           141,876
                                                                                    ------------     -------------
     Total liabilities and shareholders' equity...................................  $  2,424,880     $   2,207,902
                                                                                    ============     =============
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.

                                       91

<PAGE>



               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                 for the Years Ended December 31, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                        1997              1996
                                                                                    ------------     -------------
<S>                                                                                 <C>              <C>
Revenues:
   Premiums.......................................................................  $    103,138     $     152,803
   Interest sensitive policy product charges......................................        42,680            44,109
   Net investment income..........................................................       126,427           128,692
   Net gains from sale of investments.............................................         1,841               516
   Other income, including $15,811 in earnings of limited partnership in 1996.....        16,039            27,439
                                                                                    ------------     -------------
     Total revenues...............................................................       290,125           353,559
                                                                                    ------------     -------------

Benefits and expenses:
   Policyholder benefits incurred.................................................       201,385           234,773
   Change in liability for future policy benefits and other policy benefits.......       (35,103)          (36,929)
   Amortization of present value of insurance
     in force and deferred policy acquisition costs...............................        21,589            23,392
   Amortization of costs in excess of net assets acquired.........................         4,130             4,130
   Underwriting and other administrative expenses.................................        40,600            65,110
   Interest and amortization of deferred debt issuance costs......................        13,773            14,052
                                                                                    ------------     -------------
     Total benefits and expenses..................................................       246,374           304,528
                                                                                    ------------     -------------

Income before income taxes........................................................        43,751            49,031
     Income taxes.................................................................        16,416            18,149
                                                                                    ------------     -------------
Net income........................................................................        27,335            30,882
     Preferred stock dividend requirements........................................         3,012             2,754
                                                                                    ------------     -------------
Net income available to common shareholders.......................................  $     24,323     $      28,128
                                                                                    ============     =============
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.


                                       92

<PAGE>



               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                 for the Years Ended December 31, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                             Unrealized
                                                                             Gain (Loss)
                                      Common       Common     Additional   on Securities
                                       Stock        Stock       Paid in       Available     Retained
                                      Class A      Class B      Capital     for Sale, Net   Earnings       Total
                                    -----------  -----------  -----------   -----------   -----------   ----------
<S>                                 <C>          <C>          <C>           <C>           <C>           <C>
Balance at December 31, 1995.....   $        35  $        84  $   120,626   $     2,413   $     1,084   $  124,242
Net income.......................           --           --           --            --         30,882       30,882
Preferred dividends..............           --           --           --            --         (2,754)      (2,754)
Unrealized loss on securities
   available for sale, net.......           --           --           --        (10,494)          --       (10,494)
                                    -----------  -----------  -----------   -----------   -----------   ----------
Balance at December 31, 1996.....            35           84      120,626        (8,081)       29,212      141,876
Net income.......................           --           --           --                       27,335       27,335
Preferred dividends..............           --           --           --                       (3,012)      (3,012)
Deemed dividend to eliminate
   effects of reinsurance contract
   with affiliate................           --           --        (3,634)        4,161           --           527
Unrealized gain on securities
   available for sale, net.......           --           --           --         25,790           --        25,790
                                    -----------  -----------  -----------   -----------   -----------   ----------
Balance at December 31, 1997.....   $        35  $        84  $   116,992   $    21,870   $    53,535   $  192,516
                                    ===========  ===========  ===========   ===========   ===========   ==========
</TABLE>


          See accompanying Notes to Consolidated Financial Statements.


                                       93

<PAGE>



               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 for the Years Ended December 31, 1997 and 1996
                                 (In thousands)
<TABLE>
<CAPTION>
                                                                                          1997           1996
                                                                                      ----------     ----------
<S>                                                                                   <C>            <C>
Cash flows from operating activities:
   Net income.....................................................................    $   27,335     $   30,882

   Adjustments to reconcile net income to net cash used by operating activities:
     Adjustments relating to universal life and investment products:
       Interest credited to account balances......................................        55,135         56,203
       Charges for mortality and administration...................................       (50,687)       (50,689)
     Capitalization of deferred policy acquisition costs..........................       (24,808)       (16,806)
     Amortization of intangibles, depreciation and accretion, net.................        26,545         29,427
     Decrease in policy liabilities, accruals and other policyholder funds........       (24,319)       (54,427)
     Decrease in accrued expenses and other liabilities...........................       (19,673)        (7,477)
     Decrease (increase) in notes and accounts receivable and
       accrued investment income..................................................         3,844         (3,000)
     (Decrease) increase in taxes payable.........................................        (7,820)         5,218
     Deferred income taxes........................................................          (836)        12,847
     Equity in undistributed earnings of limited partnership......................           --         (15,811)
     Net gains from sales of investments..........................................        (1,841)          (516)
     Other, net...................................................................         5,330          7,916
                                                                                      ----------     ----------
       Net cash used by operating activities......................................       (11,795)        (6,233)
                                                                                      ----------     ----------
Cash flows from investing activities:
   Sales of fixed maturities available for sale...................................       201,402         52,085
   Maturities and other redemptions of fixed maturities available for sale........       129,600        147,114
   Sales of mortgages, real estate and other investments..........................         7,512         57,278
   Principal collected on mortgage loans and collateral loans.....................        28,030          4,687
   Change in short-term investments, net..........................................       (21,929)        19,369
   Distributions from limited partnership.........................................           --          53,520
   Purchases of fixed maturities available for sale...............................      (419,525)      (323,585)
   Purchases of other investments.................................................          (764)          (694)
                                                                                      ----------     ----------
       Net cash (used) provided by investing activities...........................       (75,674)         9,774
                                                                                      ----------     ----------
Cash flows from financing activities:
   Receipts from interest sensitive products credited to
     policyholders' account balances..............................................       103,243         99,409
   Return of policyholders' account balances on interest sensitive products.......      (102,112)      (117,806)
   Cash provided by reinsurance recapture.........................................        21,222            --
   Cash provided by assumed reinsurance with affiliate............................        50,000            --
   Reduction of notes payable.....................................................        (5,000)          (250)
                                                                                      ----------     ----------
       Net cash provided (used) by financing activities...........................        67,353        (18,647)
                                                                                      ----------     ----------
Decrease in cash..................................................................       (20,116)       (15,106)
Cash at beginning of year.........................................................        26,692         41,798
                                                                                      ----------     ----------
Cash at end of year...............................................................    $    6,576     $   26,692
                                                                                      ==========     ==========
Supplemental disclosures:
   Income taxes paid..............................................................    $   25,072     $       84
   Interest paid..................................................................        12,305         12,714
Non-cash financing activities:
   Preferred stock issued as dividends............................................         3,012          2,754
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.

                                       94

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           December 31, 1997 and 1996
                                 (In thousands)

1. Basis of Presentation

On December 14, 1995 (the acquisition date),  Southwestern Financial Corporation
(SWF or the  Company),  a newly  organized  corporation,  was formed by PennCorp
Financial  Group,  Inc.  (PennCorp)  and  Knightsbridge  Capital  Fund  I,  L.P.
(Knightsbridge).   A  wholly-owned   subsidiary  of  SWF  acquired  from  I.C.H.
Corporation (ICH),  Southwestern Life Insurance Company  (Southwestern Life) and
its wholly-owned subsidiary,  Constitution Life Insurance Company (Constitution)
and its 83% owned subsidiary, ICH Funding Corp. (ICH Funding), and Union Bankers
Insurance  Company (Union Bankers) and its  wholly-owned  subsidiary,  Marquette
National  Life  Insurance  Company  (Marquette).  In  addition,  a  wholly-owned
subsidiary  of SWF  acquired  from  ICH  substantially  all of  the  assets  and
liabilities  of  Facilities  Management  Installation,  Inc.  (FMI),  which  had
provided management services to ICH's insurance  companies.  The acquisition was
accounted for as a purchase in accordance  with  generally  accepted  accounting
principles (GAAP) and,  accordingly,  the purchase price was allocated to assets
and  liabilities  acquired  based on  estimates  of their  fair  value as of the
acquisition date, which became the new cost basis.  Subsequently,  the insurance
companies  were  reorganized  such  that  Constitution   became  the  parent  of
Southwestern  Life and  Union  Bankers.  Effective  January  2,  1998,  PennCorp
acquired   Knightsbridge's  interest  in  SWF  and  SWF  became  a  wholly-owned
subsidiary of PennCorp. (See Note 16).

In August 1997, the Company  acquired from ICH the remaining 17% interest in ICH
Funding  and  certain  other  assets  and  released  ICH  from   indemnification
obligations  relative to certain tax,  litigation  and other  matters.  Minority
interest in ICH  Funding,  totaling  $1,486 at December  31, 1996 is included in
accrued expenses and other liabilities as of December 31, 1996.

SWF and its subsidiaries  market and underwrite a broad range of life insurance,
annuities and accident and health products to individuals  through a sales force
of independent agents. The insurance subsidiaries are licensed to write business
in 48 states,  the  District of Columbia  and Guam.  Approximately  27.4% of the
total direct premium of the Company's insurance  subsidiaries was generated from
business  written in Texas.  No other states  accounted for more than 10% of the
direct premium of the Company in 1997.

The accompanying  consolidated  financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.

The  preparation  of  financial  statements  in  conformity  with GAAP  requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the reported  amounts of revenues and expenses during
the reporting period. Accounts that the Company deems to be acutely sensitive to
changes in estimates include deferred policy  acquisition  costs,  future policy
benefits, policy and contract claims and present value of insurance in force. In
addition,  the Company must determine  requirements for disclosure of contingent
assets and  liabilities  as of the date of the financial  statements  based upon
estimates. In all instances, actual results could differ from estimates.

2. Summary of Significant Accounting Policies

(a) Investments

     Fixed maturity and equity  securities  classified as available for sale are
     recorded  at fair  value,  as they may be sold in  response  to  changes in
     interest rates,  prepayment  risk,  liquidity  needs, the need or desire to
     increase  income  or  capital  and  other  economic  factors.   Changes  in
     unrealized  gains and losses  related to securities  available for sale are
     recorded as a separate component of shareholders' equity, net of applicable
     taxes and amount  attributable  to deferred  policy  acquisition  costs and
     present  value  of  insurance  in  force  related  to  universal  life  and
     investment-type  products.  Mortgage-backed  securities are amortized using
     the  interest  method  including  anticipated  prepayments  at the  date of
     purchase.  Significant  changes  in  estimated  cash  flows  from  original
     assumptions  are reflected in the period of such change.  Mortgage loans on
     real  estate are  recorded at cost,  adjusted  for the  provision  for loan
     losses,  if  necessary.  Policy  loans  are  recorded  at cost.  Short-term
     investments  purchased with maturities generally less than three months are
     recorded at cost, which approximates market. All short-term investments are
     considered to be cash equivalents.

                                       95
  

<PAGE>

             SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2. Summary of Significant Accounting Policies (Continued)


     Real estate,  substantially all of which was acquired through  foreclosure,
     is recorded at the lower of fair value,  minus  estimated costs to sell, or
     cost. If the fair value of the foreclosed real estate minus estimated costs
     to sell is less than  cost,  a  valuation  allowance  is  provided  for the
     deficiency. Increases in the valuation allowance are charged to income.

     Collateral loans are carried at their aggregate unpaid principal balances.

     The Company  regularly  evaluates the carrying  value of their  investments
     based on current economic conditions, past credit loss experience and other
     circumstances.  A  decline  in net  realizable  value  that is  other  than
     temporary is  recognized as a realized  investment  loss and a reduction in
     the cost basis of the investment. The Company discounts expected cash flows
     in the computation of net realizable value of its  investments,  other than
     certain  mortgage-backed  securities.  In  those  circumstances  where  the
     expected cash flows of residual interest and interest-only  mortgage-backed
     securities,  discounted at a risk-free rate of return,  result in an amount
     less than the  carrying  value,  a realized  loss is reflected in an amount
     sufficient  to adjust the  carrying  value of a given  security to its fair
     value.

     Realized  investment gains and losses and declines in value which are other
     than  temporary,  determined on the basis of specific  identification,  are
     included in the determination of net income.

(b) Insurance Revenue Recognition

     Accident and health  insurance  premiums are recognized as revenue  ratably
     over the time period to which premiums  relate.  Revenues from  traditional
     life insurance  policies  represent premiums which are recognized as earned
     when due.  Benefits and expenses are associated  with earned premiums so as
     to result in  recognition  of profits over the lives of the policies.  This
     association is  accomplished  by means of the provision for liabilities for
     future  policy  benefits  and  the  deferral  and  amortization  of  policy
     acquisition costs.

     Revenues for interest sensitive products such as universal life and annuity
     contracts  represent  charges assessed against the  policyholders'  account
     balance for the cost of insurance,  surrenders  and policy  administration.
     Benefits  charged to expenses  include  benefit claims  incurred during the
     period in excess of policy account balances and interest credited to policy
     account balances.

(c) Policy Liabilities and Accruals

     Liabilities  for future  policy  benefits  for  traditional  life  products
     generally  have been  computed on the net level  premium  method,  based on
     estimated future investment yield, mortality, and withdrawals. For accident
     and health products, liabilities for future policy benefits are established
     equal to the excess of the present value of future benefits to or on behalf
     of policyholders  over discounted net future  premiums.  Estimates used are
     based on the Company's  experience adjusted to provide for possible adverse
     deviation.  These  estimates  are  periodically  reviewed and compared with
     actual  experience.  Liabilities  for future  policy  benefits for interest
     sensitive  products  include the balance that accrues to the benefit of the
     policyholders  and amounts that have been assessed to  compensate  the life
     insurance subsidiaries for services to be provided in the future.

     Policy and  contract  claims  represent  estimates  of reported  claims and
     claims incurred but not reported based on experience.

(d) Accounts and Notes Receivable

     Accounts and notes  receivable  consist  primarily of agents'  balances and
     premium  receivable  from agents and  policyholders.  Agents'  balances are
     partially  secured by commissions  due to agents in the future and premiums

                                       96

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2. Summary of Significant Accounting Policies (Continued)

     receivable  are secured by policy  liabilities.  An allowance  for doubtful
     accounts is  established,  based upon specific  identification  and general
     provision,  for amounts which the Company  estimates will not ultimately be
     collected.

(e) Deferred Policy Acquisition Costs

     Estimated  costs  of  acquiring  new  business  which  vary  with,  and are
     primarily related to, the production of new business, have been deferred to
     the extent that such costs are deemed  recoverable  from  future  revenues.
     Such  estimated  costs  include  commissions  and  certain  costs of policy
     issuance  and  underwriting.  Costs  deferred  on  accident  and health and
     traditional   life  policies  are  amortized,   with  interest,   over  the
     anticipated  premium-paying period of the related policies in proportion to
     the ratio of annual premium revenue to expected total premium revenue to be
     received  over  the  life of the  policies.  Expected  premium  revenue  is
     estimated by using the same mortality, morbidity and withdrawal assumptions
     used in computing  liabilities  for future  policy  benefits.  For interest
     sensitive products and limited pay life products,  policy acquisition costs
     are  amortized in relation to the  emergence of  anticipated  gross profits
     over the life of the policies.

(f) Present Value of Insurance In Force

     The present value of insurance in force  represents the  anticipated  gross
     profits to be realized  from future  revenues on  insurance in force at the
     date such  insurance was  purchased,  discounted to provide an  appropriate
     rate of return and amortized,  with interest,  based on credited rate, over
     the years that such profits are anticipated to be received in proportion to
     the  estimated  gross  profits.  Accumulated  amortization  was $35,386 and
     $22,889 as of December 31, 1997 and 1996, respectively.

(g) Deferred Debt Issuance Costs

     Deferred debt issuance costs, which are included in other assets, represent
     costs incurred in connection with obtaining  long-term debt financing which
     have been  capitalized  and are being amortized on an interest yield method
     over the terms of the  respective  debt.  Deferred costs totaled $2,530 and
     $3,309  which are net of  accumulated  amortization  of $1,580  and $801 at
     December 31, 1997 and 1996, respectively.

(h) Costs in Excess of Net Assets Acquired

     Costs in excess of the fair value of net assets acquired are amortized on a
     straight-line basis over 30 years.  Accumulated amortization totaled $8,260
     and $4,130 at December 31, 1997 and 1996, respectively.

(i) Recoverability of Long-lived Assets

     The Company  continually  monitors long-lived assets and certain intangible
     assets, such as costs in excess of net assets acquired and present value of
     insurance in force,  for impairment.  An impairment loss is recorded in the
     period in which the carrying  value of the assets exceeds the fair value or
     expected future cash flows.  Any amounts deemed to be impaired are charged,
     in the  period in which  such  impairment  was  determined,  as an  expense
     against earnings.  For the period presented there was no charge to earnings
     for the impairment of long-lived assets.

(j) Income Taxes

     Income  taxes are  accounted  for under  the  asset and  liability  method.
     Deferred  tax  assets and  liabilities  are  recognized  for the future tax
     consequences   attributable  to  (i)  temporary   differences  between  the
     financial statement carrying amounts of existing assets and liabilities and
     their  respective  tax  bases,  and (ii)  operating  losses  and tax credit
     carryforwards.  Deferred  tax assets and  liabilities  are  measured  using
     enacted tax rates expected to apply to taxable income in the years in which
     the  temporary  differences  are expected to be  recovered or settled.  The
     effect

                                       97

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2. Summary of Significant Accounting Policies (Continued)


     on  deferred  tax  assets  and  liabilities  of a  change  in tax  rates is
     recognized in income in the period that includes the enactment date.

(k) Reinsurance

     Financial  reinsurance that does not transfer significant insurance risk is
     accounted  for as a deposit and is  reflected  as a  component  of due from
     reinsurers.  The cost of reinsurance related to long-duration  contracts is
     accounted  for  over  the  life  of the  underlying  reinsurance  policies.
     Balances  due to, or from,  reinsurers  have been  reflected  as assets and
     liabilities rather than reducing the related account balances.

3. Investments

Investments in a single entity, other than obligations of the U.S. Government or
agencies  thereof,  totaling  in excess of 10% of total  shareholders  equity at
December 31, 1997 and 1996 are listed below:

<TABLE>
<CAPTION>
                                                                  1997                       1996
                                                        -------------------------- --------------------------
                                                                      Percent of                 Percent of
                                                         Carrying    Shareholders'   Carrying   Shareholders'
                                                           Value        Equity         Value       Equity
                                                           -----        ------         -----       ------
<S>                                                     <C>             <C>        <C>             <C>  
Fund America Investors Corp., Ser. 93-C,
  Class B Certificates................................  $  19,271       10.0%      $  16,250       11.2%
James M. Fail and Stone Capital, Inc.
  Collateral loans....................................        --          --          21,308       14.7
</TABLE>


The amortized cost and fair value of investments in fixed  maturities  available
for sale at  December  31,  1997 and 1996 by  categories  of  securities  are as
follows:

<TABLE>
<CAPTION>
                                                                              Gross        Gross
                                                             Amortized     Unrealized   Unrealized       Fair
                                                               Cost           Gains       Losses         Value
                                                          ------------  ------------  ------------  -------------
<S>                                                       <C>           <C>           <C>           <C>
December 31, 1997:
     Mortgage-backed securities........................   $    820,837  $     22,791  $     (1,434) $     842,194
     U.S. Treasury securities and obligations of
       U.S. Government corporations and agencies.......         27,492            91           (12)        27,571
     Debt securities issued by states of the United States
        and political subdivisions of the states.......         22,469           365          (130)        22,704
     Debt securities issued by foreign governments.....         20,525           821           --          21,346
     Corporate debt securities.........................        752,446        14,664        (3,417)       763,693
                                                          ------------  ------------  ------------  -------------
       Total fixed maturities available for sale.......   $  1,643,769  $     38,732  $     (4,993) $   1,677,508
                                                          ============  ============  ============  =============
</TABLE>

                                       98

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


3. Investments (Continued)

<TABLE>
<CAPTION>
                                                                              Gross        Gross
                                                             Amortized     Unrealized   Unrealized       Fair
                                                               Cost           Gains       Losses         Value
                                                          ------------  ------------  ------------  -------------
<S>                                                       <C>           <C>           <C>           <C>          
December 31, 1996:
     Mortgage-backed securities........................   $    609,593  $      8,153  $     (7,304) $     610,442
     U.S. Treasury securities and obligations of
       U.S. Government corporations and agencies.......         49,598           224          (343)        49,479
     Debt securities issued by states of the United States
        and political subdivisions of the states.......         15,226            --          (388)        14,838
     Debt securities issued by foreign governments.....         22,698           176          (870)        22,004
     Corporate debt securities.........................        573,392         1,429       (16,314)       558,507
                                                          ------------  ------------  ------------  -------------
       Total fixed maturities available for sale.......   $  1,270,507  $      9,982  $    (25,219) $   1,255,270
                                                          ============  ============  ============  =============
</TABLE>

The amortized  cost and fair value of fixed  maturities at December 31, 1997, by
contractual maturity, are shown below:

<TABLE>
<CAPTION>
                                                                             Amortized       Fair
                                                                                Cost         Value
                                                                           ------------  ------------
<S>                                                                        <C>           <C>         
Available for sale:
  Due in one year or less................................................  $     28,929  $     28,921
  Due after one year through five years..................................       234,776       236,677
  Due after five years through ten years.................................       272,127       275,248
  Due after ten years....................................................       287,100       294,468
                                                                           ------------  ------------
                                                                                822,932       835,314
  Mortgage-backed securities.............................................       820,837       842,194
                                                                           ------------  ------------
                                                                           $  1,643,769  $  1,677,508
                                                                           ============  ============
</TABLE>

Expected  maturities will differ from contractual  maturities  because borrowers
may have the  right to call or prepay  obligations  with or  without  prepayment
penalties.

Investments  with a fair value of $119,695  and  $121,617  were on deposit  with
certain regulatory authorities at December 31, 1997 and 1996, respectively.

Included in fixed  maturities  available for sale at December 31, 1997 and 1996,
are below  investment-grade  securities  with  amortized  costs of  $71,467  and
$40,177,  respectively,  and fair values of $74,227 and  $39,955,  respectively.
Included in fixed  maturities  available  for sale as of December 31, 1997,  are
unrated securities with an amortized cost and fair value of $11,811.

During 1997, the Company  purchased  $7,650 of subordinated  indebtedness of ACO
Acquisition Corp., which was subsequently re-named Acordia, Inc. (Acordia).  The
Acordia  subordinated  notes pay interest on a current basis at 12.5% per annum,
payable in semi-annual installment.  Acordia is an insurance broker specializing
in the marketing of commercial property and casualty programs.  Acordia is 28.6%
owned by Knightsbridge.

In addition,  during 1997,  the Company  acquired  41,605  shares of  redeemable
preferred stock of Portsmouth Financial Group, Inc. (Portsmouth) for $4,161. The
preferred  stock  pays  dividends  of 18.0% of which  12.5% is in cash  with the
remainder in the form of additional  preferred stock. The shares are mandatorily
redeemable  on June 30, 2002.  Portsmouth  underwrites,  acquires,  and holds to
receipt of  benefits,  life  insurance  contracts  covering  individuals  facing
terminal illnesses. Portsmouth is owned by Knightsbridge and its affiliates. The
Company has agreed,  subject to required  regulatory  approvals  to make up to a
$10,000 preferred equity investment in Portsmouth.


                                       99

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



3. Investments (Continued)

The Company had  non-income  producing  investments at December 31, 1997 with an
amortized cost and fair value as follows:

<TABLE>
<CAPTION>
                                                      Amortized
                                                         Cost        Fair Value
                                                    -------------  -------------
 <S>                                                <C>            <C>
 Fixed maturities................................   $         487  $          66
 Equity securities...............................             688          1,079
 Other investments...............................           5,778          5,791
                                                    -------------  -------------
                                                    $       6,953  $       6,936
                                                    =============  =============
</TABLE>

     At December 31, 1997 net unrealized  appreciation  of equity  securities of
$391 consisted of gross unrealized gains of $415, less unrealized losses of $24.
At December  31, 1996 net  unrealized  appreciation  of $170  consisted of gross
unrealized gains of $207, less unrealized losses of $37.

     Following is an analysis of net gains (losses) from sale of investments for
the years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                             1997           1996
                                                        -------------  -------------
<S>                                                     <C>            <C>
 Fixed maturities................................       $         553  $       1,385
 Equity securities...............................                 --             (43)
 Other investments...............................               1,146          1,736
 Real estate.....................................                 134           (125)
 Mortgage loans..................................                 --          (2,437)
 Short-term investments..........................                   8            --
                                                        -------------  -------------
                                                        $       1,841  $         516
                                                        =============  =============
</TABLE>

For the year  ended  December  31,  1997,  net  realized  gains on sale of fixed
maturities  consisted of gross gains of $2,779 and gross  losses of $2,226.  For
the year ended December 31, 1996, net realized gains on sale of fixed maturities
consisted of gross gains of $2,923 and gross losses of $1,538.

Following are changes in unrealized  appreciation  (depreciation) on investments
for the years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                           1997              1996
                                                                       ------------     -------------
<S>                                                                    <C>              <C>
Investments carried at fair value:
   Fixed maturities..................................................  $     48,976     $     (18,991)
   Equity securities.................................................           221               194
   Other investments.................................................          (713)            1,652
                                                                       ------------     -------------
                                                                             48,484           (17,145)

Eliminate effects from reinsurance contract with affiliate...........        (4,161)              --
Less effect on other balance sheet accounts:
   Value of business acquired and deferred acquisition costs.........        (2,768)            1,362
   Deferred income taxes.............................................       (16,000)            5,524
   Minority interest in unrealized losses............................           235              (235)
                                                                       ------------     -------------
Change in unrealized investment gains and losses.....................  $     25,790     $     (10,494)
                                                                       ============     =============
</TABLE>

                                       100

<PAGE>

               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



3. Investments (Continued)

Major categories of net investment  income for the years ended December 31, 1997
and 1996 consist of the following:

<TABLE>
<CAPTION>
                                                                 1997              1996
                                                             ------------     -------------
<S>                                                          <C>              <C>
   Fixed maturities........................................  $     98,906     $      87,348
   Equity securities.......................................           --                 58
   Mortgage loans..........................................         5,490            11,156
   Policy loans............................................         7,621             8,011
   Short-term investments..................................         4,442             7,738
   Collateral loans........................................         2,218             2,947
   Real estate.............................................           441             3,956
   Investments held in trust under reinsurance treaty(a)...         9,617            12,130
   Other investments.......................................         1,250             1,503
   Investment expenses.....................................        (3,558)           (6,155)
                                                             ------------     -------------
                                                             $    126,427     $     128,692
                                                             ============     =============
-------------------
(a)  Investments  held in trust by a reinsurer with carrying  values of $121,016
     as of December 31, 1996, are included in amounts due from reinsurers.  This
     contract was recaptured during 1997 (see Note 10).
</TABLE>


At December  31,  1997 and 1996 the  Company  held  mortgage  loans  principally
involving  commercial  real estate with carrying  values of $51,070 and $59,993,
respectively,  net of an allowance for losses of $680 and $1,000 at December 31,
1997 and 1996,  respectively.  Estimated  fair values of mortgage  loans totaled
$51,816  and $59,993 at December  31, 1997 and 1996,  respectively.  The average
outstanding  loan  balances were  approximately  $1,027 and $955 at December 31,
1997 and 1996, respectively. At December 31, 1997 mortgage loan investments were
concentrated in the following states:

<TABLE>
<CAPTION>
                                                                                   Percent of Total
                                                                  Carrying Value    Carrying Total
                                                                  --------------    --------------
<S>                                                                <C>                   <C>
 Texas...........................................................  $   23,832            46.7%
 Illinois........................................................       7,029            13.7
 Oklahoma........................................................       4,915             9.6
 Florida.........................................................       3,180             6.3
 Kansas..........................................................       2,527             4.9
 All other.......................................................       9,587            18.8
                                                                   ----------           -----
 Balance, end of period..........................................  $   51,070           100.0%
                                                                   ==========           =====
</TABLE>


     During 1996, the Company had a limited partnership investment  representing
a 50% interest in a partnership,  GSSW,  L.P.  (GSSW) formed to acquire  through
auction  certain  mortgage loans and real estate formerly held by failed savings
and loan associations.  Effective December 31, 1996, GSSW liquidated the general
partner  interests  through  distribution of certain assets at fair value,  sold
substantially  all  remaining  investments  and utilized the proceeds to buy the
limited  partnership  interest  not owned by the  Company.  As a result of these
transactions,  the Company became the parent of GSSW,  realized earnings on GSSW
of $13,171,  received net cash  distributions  of $47,520 and paid  PennCorp,  a
shareholder, a fee of $1,000 as guarantor in GSSW's sale of assets.


                                       101

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



3. Investments (Continued)

Following is an analysis of the investment in the GSSW limited  partnership  for
the year ended December 31, 1996:

<TABLE>
<S>                                                              <C>
Balance, beginning of period..................................   $    39,600
Equity in operating earnings during year......................         3,640
Equity in earnings on transactions at December 31, 1996.......        13,171
Distributions during year.....................................        (6,000)
Net distributions at December 31, 1996........................       (47,520)
                                                                 -----------
Balance, December 31, 1996....................................   $     2,891
                                                                 ===========
</TABLE>

At December 31, 1997 and 1996,  the accounts of GSSW are  consolidated  into the
accompanying consolidated balance sheet.

4. Policy Liabilities and Accruals

For interest  sensitive  life products and annuity  products,  the liability for
future policy benefits is equal to the accumulated  fund value.  Fund values are
equal to the excess  premium  received and  interest  credited to the fund value
less deductions for mortality costs and expense charges.  Current interest rates
credited  range  from  4%  to  8%.  Mortality  costs  and  expense  charges  are
established by the Company based upon its experience and cost structure.

For traditional life products, the liability for future policy benefits has been
computed by the net level premium  method based on estimated  future  investment
yield,  mortality,  and withdrawal experience.  Reserve interest assumptions are
graded  and range  from  6.25% to 7.375%.  For  accident  and  health  products,
liabilities for future policy  benefits are  established  equal to the excess of
the  present  value of future  benefits  to or on behalf of  policyholders  over
future net premiums  discounted at interest rates ranging primarily from 6.5% to
8.0%. The future policy  benefits of traditional  life products and accident and
health  products  are  determined  using  mortality,  morbidity  and  withdrawal
assumptions  that reflect the experience of the Company modified as necessary to
reflect  anticipated trends and to include  provisions for possible  unfavorable
deviations. The assumptions vary by plan, year of issue and duration.

The Company has carefully  monitored a block of interest sensitive life policies
where  overall  financial  performance  was not  satisfactory.  During the third
quarter  of 1997,  management  implemented  certain  corrective  actions.  These
actions included reduction in credited interest rates, increased monthly expense
charges and cost of insurance  increases on selected  policy forms. As a result,
reserves on this block were reduced approximately $17,000.

Policy and contract claims include  provisions for reported claims in process of
settlement,  valued in  accordance  with the terms of the related  policies  and
contracts, as well as provisions for claims incurred and unreported based on the
Company's prior experience.

While management believes the estimated amounts included in financial statements
for policy liabilities and accruals are adequate,  such estimates may be more or
less than the amounts ultimately paid when the claims are settled.  In addition,
the Company is involved in certain litigation regarding  policyholder  benefits.
The Company intends to vigorously  defend its position relative to these claims;
however,  if  unsuccessful,  the level of reserves  currently  provided could be
adversely effected.


                                       102

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



4. Policy Liabilities and Accruals (Continued)

Total policy  liabilities  and accruals  consist of the following as of December
31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                        1997             1996
                                                                   -------------     -------------
<S>                                                                <C>               <C>
 Future policy benefits on traditional products:
   Traditional life insurance contracts..........................  $     335,283     $     344,520
   Traditional annuity products..................................        105,663           105,246
   Individual accident and health................................         87,152           104,071
   Unearned premiums.............................................         26,900            30,342
                                                                   -------------     -------------
      Total future policy benefits                                       554,998           584,179
                                                                   -------------     -------------
 Universal life and investment contract liabilities:
   Universal life and annuities..................................      1,315,333         1,086,632
   Guaranteed investment contracts...............................            163             1,703
                                                                   -------------     -------------
      Total universal and investment contract liabilities........      1,315,496         1,088,335
                                                                   -------------     -------------
 Policy and contract claims......................................         57,517            55,011
 Other policyholder funds........................................         14,203            17,635
                                                                   -------------     -------------
      Total policy liabilities and accruals......................  $   1,942,214     $   1,745,160
                                                                   =============     =============
</TABLE>

The following table presents  information on changes in the liability for policy
and contract claims for the years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                                1997             1996
                                                                           -------------     -------------
<S>                                                                        <C>               <C>          
         Policy and contract claims at January 1.........................  $      55,011     $      62,140
         Less reinsurance recoverables...................................            153               118
                                                                           -------------     -------------
           Net balance at January 1......................................         54,858            62,022
                                                                           -------------     -------------
         Add claims incurred, net of reinsurance related to:
           Current year..................................................         81,168            91,496
           Prior years...................................................         (6,012)           (2,646)
                                                                           -------------     -------------
                                                                                  75,156            88,850
                                                                           -------------     -------------
         Deduct claims paid, net of reinsurance related to:
           Current year..................................................         58,658            52,240
           Prior years...................................................         13,839            43,774
                                                                           -------------     -------------
                                                                                  72,497            96,014
                                                                           -------------     -------------
         Policy and contract claims, net of related reinsurance
            recoverables at December 31..................................         57,517            54,858
         Plus reinsurance recoverables...................................            --                153
                                                                           -------------     -------------
         Policy and contract claims at December 31.......................  $      57,517     $      55,011
                                                                           =============     =============
</TABLE>

As a result of  changes  in  estimates  of insured  events in prior  years,  the
liability  for policy and contract  claims  decreased,  net of  reinsurance,  by
$6,012 in 1997 and $2,646 in 1996.


                                       103

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



5. Notes Payable

The outstanding principal amounts of notes payable at December 31, 1997 and 1996
consist of the following:

<TABLE>
<CAPTION>
                                                                        1997             1996
                                                                   -------------     -------------
<S>                                                                <C>               <C>
 Revolving bank debt.............................................  $      90,250     $      95,000
 Bank debt with quarterly principal requirements.................         24,500            24,750
 7.0% convertible subordinated note..............................         40,000            40,000
                                                                   -------------     -------------
                                                                   $     154,750     $     159,750
                                                                   =============     =============
</TABLE>

Interest  costs under the revolving  bank debt totaled $7,860 and $8,128 for the
years ended December 31, 1997 and 1996,  respectively.  The interest rate of the
debt is based on, at the Company's option,  either a floating rate (based on the
base rate of the First  National  Bank of  Chicago)  plus a margin of 1.75% or a
Eurodollar  rate (based on the London  Interbank  Offered  Rate or LIBOR) plus a
margin of 2.75%.  At December 31, 1997, the effective rate of the revolving loan
was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.

Interest  costs under the bank term debt totaled $2,229 and $2,250 for the years
ended  December 31, 1997 and 1996,  respectively.  The interest rate of the term
debt is based on, at the Company's option,  either a floating rate (based on the
base rate of the First  National  Bank of  Chicago)  plus a margin of 2.25% or a
Eurodollar  rate (based on LIBOR) plus a margin of 3.25%.  At December 31, 1997,
the effective rate of the term loans was approximately 9.63%. The bank term debt
was repaid on January 2, 1998.

As part of the  consideration  for the acquisition of Southwestern  Life,  Union
Bankers,  Constitution  and  Marquette  from ICH,  the  Company  issued to ICH a
$40,000 aggregate principal amount of SWF's 7.0% Convertible  Subordinated Notes
due 2005. The notes are convertible into an aggregate 3,200,000 shares of common
stock of SWF, of which 800,000 will be Class B non-voting  common stock.  In the
aggregate  the shares upon  conversion  represent  approximately  21.2% of SWF's
fully  diluted  shares at  closing  before  giving  effect to  certain  warrants
outstanding. During 1997, PennCorp acquired the notes from the liquidating trust
for the  creditors  of ICH for $40,000 plus accrued  interest.  The  Convertible
Notes are unsecured obligations and are subordinate in right of payment to SWF's
bank  debt  and  all of the  indebtedness  of  SWF.  Interest  costs  under  the
Convertible Notes totaled $2,800 for the years ended December 31, 1997 and 1996.
The Company agreed to maintain  sufficient cash and cash equivalents to fund the
interest  payments  on the  Convertible  Notes for the  first  three  years.  At
December  31,  1997 and  December  31,  1996,  restricted  cash  and  short-term
investments totaled $3,339 and $5,959, respectively.

In  conjunction  with the bank debt,  the Company  entered  into  interest  rate
protection  agreements  in the form of a series  of  interest  rate  caps in the
notional  amount of $62,500 which expire May 1998.  These entitle the Company to
revenue  should  three-month  LIBOR exceed the cap rate of 7.5%. At December 31,
1997, three-month LIBOR was 5.81%.

6. Preferred and Common Stock

On December 14, 1995,  the Company  issued  210,000 shares of Series A preferred
stock  with  a  liquidation  value  of  $21,000  to  PennCorp  and  one  of  its
subsidiaries.  The Series A preferred stock accrues dividends at a rate of 10.0%
per annum,  compounded  quarterly and is mandatorily  redeemable at December 31,
2005. Dividends on the Series A preferred stock are payable in cash, or at SWF's
option,  are payable in kind. The Series A preferred  stock is not redeemable at
the option of the Company but at  maturity  will be required to be redeemed  for
approximately  $56 million in cash assuming no cash dividend  distributions.  If
the Company fails to satisfy its mandatory redemption obligation, the holders of
the Series A preferred stock

                                       104

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



6. Preferred and Common Stock (Continued)


will be entitled  to elect  49.0% of the  members of the Board of SWF and,  upon
receipt of regulatory approval, a majority of the directors of SWF. The Series A
preferred stock is senior preferred stock. The holders of the Series A preferred
stock are entitled to class voting rights under certain circumstances, including
in  connection  with a merger of SWF or a sale of all or  substantially  all its
assets or the authorization or issuance of senior or pari passu preferred stock,
and as  otherwise  provided by law.  For the years ended  December  31, 1997 and
1996, 24,180 and 21,900 additional shares were issued with a redemption value of
$2,418  and  $2,190,   respectively   in  lieu  of  cash  to  satisfy   dividend
requirements.

In addition,  certain of PennCorp's  insurance  subsidiaries  purchased  $10,000
liquidation  value of 5.5%  Mandatorily  Redeemable  Preferred  Stock, par value
$0.01 per share (the 5.5%  Preferred  Stock) of  Southwestern  Life  Acquisition
Corporation,  a wholly-owned  subsidiary of SWF.  During 1996 SLAC was dissolved
and the  5.5%  Preferred  Stock  was  exchanged  for  5.5%  Preferred  Stock  of
Southwestern Life Companies,  Inc. (SLC), also a wholly-owned subsidiary of SWF.
The 5.5%  Preferred  Stock  accrues  dividends  payable  in cash or,  subject to
certain conditions,  through the issuance of additional shares of 5.5% Preferred
Stock.  The 5.5%  Preferred  Stock is not  subject to  optional  redemption  and
matures on December 31, 2005. If SLC fails to satisfy its  mandatory  redemption
obligation or if dividends  payable on the 5.5%  Preferred  Stock are in arrears
for four or more quarterly  dividend periods,  the holders of the 5.5% Preferred
Stock will be entitled  to elect 49.0% of the members of the Board of  Directors
of SLC and,  upon  receipt of  regulatory  approval,  a majority of the Board of
Directors of SLC. The 5.5% Preferred  Stock is the only  preferred  stock of SLC
authorized for issuance. The holders of the 5.5% Preferred Stock are entitled to
class voting rights under certain circumstances,  including in connection with a
merger  of  SLC  or a  sale  of  all or  substantially  all  its  assets  or the
authorization or issuance of senior pari passu preferred stock, and as otherwise
provided by law.  For the years  ended  December  31,  1997 and 1996,  59 and 59
additional  shares  were  issued  with a  redemption  value  of $594  and  $590,
respectively in lieu of cash to satisfy dividend requirements.

7. Income Taxes

The Company  and its  non-insurance  subsidiaries  file a  consolidated  federal
income  tax  return.  The  Company's  life  insurance  subsidiaries  also file a
consolidated federal income tax return.

     Total  income  taxes for the years ended  December 31, 1997 and 1996 are as
follows:

<TABLE>
<CAPTION>
                                                                      1997             1996
                                                                 -------------     -------------
<S>                                                              <C>               <C>
Current........................................................  $      17,252     $       5,302
Deferred.......................................................           (836)           12,847
                                                                 -------------     -------------
                                                                 $      16,416     $      18,149
                                                                 =============     =============
</TABLE>

Income  taxes  computed  using  the  prevailing  corporate  tax  rate of 35% are
reconciled to the Company's actual income tax expense attributable to income for
the years ended December 31, 1997 and 1996, as follows:

<TABLE>
<CAPTION>
                                                                      1997             1996
                                                                 -------------     -------------
<S>                                                               <C>               <C>
Tax expense computed at statutory rate..........................  $      15,313     $      17,161
Amortization of costs in excess of net assets acquired..........          1,445             1,445
Change in deferred tax asset valuation allowance................            364              (183)
Other...........................................................           (706)             (274)
                                                                  -------------     -------------
                                                                  $      16,416     $      18,149
                                                                  =============     =============
</TABLE>

                                       105

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



7. Income Taxes (Continued)

Temporary  differences,   including  $1,956  in  1997  of  deferred  tax  assets
transferred  in  association  with a  reinsurance  contract  with an  affiliate,
between the  financial  statement  carrying  amounts and tax bases of assets and
liabilities that give rise to the deferred tax assets  (liabilities) at December
31, 1997 and 1996 relate to the following:

<TABLE>
<CAPTION>
                                                                         1997             1996
                                                                    -------------     -------------
<S>                                                                 <C>               <C>
  Deferred tax assets:
    Deferred policy acquisition costs.............................  $       9,548     $      10,407
    Future policy benefits........................................         73,660           112,408
    Invested assets, subject to capital gains treatment...........         24,907            16,770
    Net unrealized loss...........................................            --              4,224
                                                                    -------------     -------------
                                                                          108,115           143,809
                                                                    -------------     -------------
  Deferred tax liabilities:
    Present value of insurance in force...........................        (20,498)          (24,967)
    Other assets and liabilities..................................        (20,123)          (50,280)
    Net unrealized gain...........................................        (11,776)              --
                                                                    -------------     -------------
                                                                          (52,397)          (75,247)
                                                                    -------------     -------------
    Net deferred tax asset........................................         55,718            68,562
    Valuation allowance...........................................        (20,972)          (20,608)
                                                                    -------------     -------------
                                                                    $      34,746     $      47,954
                                                                    =============     =============
</TABLE>

The valuation  allowances  at December 31, 1997 and 1996,  are  attributable  to
deferred tax assets  principally  arising from  differences  in the book and tax
bases of invested  assets subject to capital gains  treatment that existed as of
the date of acquisition of the company's insurance  subsidiaries.  To the extent
that income tax benefits  relative to such tax assets are  ultimately  realized,
the reduction in the related  valuation  allowance  would be allocated to reduce
costs in excess of net assets acquired.

In assessing  the  realizability  of deferred tax assets,  management  considers
whether it is more likely than not that some  portion or all of the deferred tax
assets will be  realized.  The  ultimate  realization  of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those  temporary   differences  become  deductible.   Management  considers  the
scheduled reversal of deferred tax liabilities,  projected future taxable income
and tax  planning  strategies  in  making  this  assessment.  Based  upon  those
considerations,  management believes it is more likely than not that the Company
will realize the benefits of these deductible  differences,  net of the existing
valuation allowance at December 31, 1997.

8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force

Deferred policy  acquisition  costs  represent  commissions and certain costs of
policy issuance and  underwriting.  Information  relating to these costs for the
years ended December 31, 1997 and 1996, is as follows:

<TABLE>
<CAPTION>
                                                                         1997             1996
                                                                   -------------     -------------
<S>                                                                <C>               <C>
 Balance at beginning of period..................................  $      15,095     $         --
 Policy acquisition costs deferred:
   Commissions...................................................         17,443            11,810
   Underwriting and issue costs..................................          7,366             4,996
 Released by 80% coinsurance of Medicare business (see Note 10)              --             (1,243)
 Policy acquisition costs amortized..............................         (9,092)             (503)
 Unrealized investment (gain) loss adjustment....................           (206)               35
                                                                   -------------     -------------
 Unamortized deferred policy acquisition costs at period end.....  $      30,606     $      15,095
                                                                   =============     =============
</TABLE>

                                       106

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8.   Deferred Policy  Acquisition  Costs and Present Value of Insurance in Force
     (Continued)

As part of the purchase  accounting  for the Company's  acquisitions,  a present
value of insurance in force asset is established  which  represents the value of
the right to receive future cash flows from insurance  contracts existing at the
date of acquisition.  Such value is the actuarially  determined present value of
the  projected  cash  flows  from  the  acquired  policies,   discounted  at  an
appropriate risk rate of return.

The methods used by the Company to value the health,  life and annuity  products
purchased are consistent with the valuation  methods used most commonly to value
blocks of insurance  business.  It is also consistent with the basic methodology
generally  used to  value  insurance  assets.  The  method  used by the  Company
includes identifying the future cash flows from the acquired business, the risks
inherent in realizing those cash flows,  the rate of return the Company believes
it must earn in order to accept the risks  inherent in realizing the cash flows,
and  determining  the value of the insurance  asset by discounting  the expected
future cash flows by the discount rate the Company requires.

The discount rate used to determine  such values is the rate of return  required
in order to invest in the business  being  acquired.  In  selecting  the rate of
return,  the Company  considered  the  magnitude  of the risks  associated  with
actuarial  factors  described  in  the  following  paragraph,  cost  of  capital
available  to the  Company  to fund the  acquisition,  compatibility  with other
Company activities that may favorably affect future profits,  and the complexity
of the acquired company.

Expected  future  cash  flows  used in  determining  such  values  are  based on
actuarial  determinations of future premium  collection,  mortality,  morbidity,
surrenders,  operating  expenses  and  yields  on  assets  held to  back  policy
liabilities  as well as other  factors.  Variances  from  original  projections,
whether  positive or  negative,  are  included  in income as they occur.  To the
extent  that these  variances  indicate  that future cash flows will differ from
those  included  in the  original  scheduled  amortization  of the  value of the
insurance  in  force,   current  and  future   amortization   may  be  adjusted.
Recoverability  of the value of  insurance  in force is  evaluated  annually and
appropriate  adjustments  are then  determined  and  reflected in the  financial
statements for the applicable period.

Information  related to the present  value of  insurance  in force for the years
ended December 31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                                         1997             1996
                                                                   -------------     -------------
 <S>                                                               <C>               <C>
 Balance at beginning of year....................................  $      71,333     $     115,831
 Released by 80% coinsurance of Medicare business (see Note 10)              --            (22,936)
 Accretion of interest...........................................          3,806             4,415
 Amortization....................................................        (16,303)          (27,304)
 Transferred on assumed reinsurance contract with affiliate......          2,291               --
 Unrealized investment (gain) loss adjustment....................         (2,562)            1,327
                                                                   -------------     -------------
   Balance at end of year........................................  $      58,565     $      71,333
                                                                   =============     =============
</TABLE>

Expected amortization,  based upon current assumptions and accretion of interest
at a policy  liability  or contract  rate ranging from 5.5% to 6.6% for the next
five years of the present value of insurance in force is as follows:

<TABLE>
<CAPTION>
                                            Beginning           Gross          Accretion            Net
                                             Balance        Amortization      of Interest      Amortization
                                             -------        ------------      -----------      ------------

<S>                                       <C>              <C>               <C>              <C>
1998...................................   $      58,565    $      12,805     $       3,226    $       9,579
1999...................................          48,986            7,806             2,719            5,087
2000...................................          43,899            8,374             2,315            6,059
2001...................................          37,840            6,957             1,989            4,968
2002...................................          32,872            5,673             1,724            3,949
</TABLE>

                                       107

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. Statutory Accounting and Dividend Restrictions

Pursuant to the terms of the surplus  debenture  issued by  Constitution  to the
benefit  of SLC,  a  non-insurance  subsidiary  of SWF,  Constitution  may  make
principal  and  interest  payments  to the extent that  Constitution's  surplus,
excluding the statutory  carrying value of Southwestern  Life and Union Bankers,
exceeds  $1,200.  Constitution's  surplus at December 31, 1997 was $174,715,  of
which $161,098 was attributable to its ownership of Southwestern  Life and Union
Bankers.

The Company's cash flow is derived  principally from dividends and principal and
interest payments owed on the surplus  debenture by Constitution.  The principal
source of repayment of the surplus  debenture is dividends  from  Constitution's
subsidiaries,  Southwestern Life and Union Bankers. Generally, the net assets of
the insurance  subsidiaries available for transfer to the Company are limited to
the greater of the subsidiary net gain from operations during the preceding year
or 10% of the  subsidiary  net statutory  surplus as of the end of the preceding
year as  determined  in  accordance  with  accounting  practices  prescribed  or
permitted by insurance regulatory authorities. Payment of dividends in excess of
such amounts would  generally  require  approval by the regulatory  authorities.
Based upon Constitution's  earned surplus at December 31, 1997, no dividends can
be paid to its parent without prior regulatory approval.

The insurance  subsidiaries  prepare  their  statutory  financial  statements in
accordance with accounting practices prescribed or permitted by their respective
state insurance  departments.  Prescribed statutory accounting practices include
state laws, regulations,  and general administrative rules, as well as a variety
of publications of the National Association of Insurance  Commissioners  (NAIC).
Permitted statutory accounting practices encompass all accounting practices that
are approved by insurance  regulatory  authorities;  such practices  differ from
state to state,  and may differ from company to company within a state,  and may
change in the future.  Furthermore,  the NAIC has a project to codify  statutory
accounting  practices,  the result of which is expected to  constitute  the only
source  of  "prescribed"  statutory  accounting  practices.   Accordingly,  that
project,  will likely  change to some  extent  prescribed  statutory  accounting
practices,  and may result in changes to the accounting practices that insurance
enterprises use to prepare their statutory financial statements.

Statutory  capital and surplus of the Company's life insurance  subsidiaries  as
reported  to  regulatory  authorities  at  December  31,  1997 and 1996  totaled
approximately $174,715 and $177,510,  respectively.  Statutory net income (loss)
of  the  Company's  life  insurance   subsidiaries  as  reported  to  regulatory
authorities  totaled  ($2,521) and $24,919 for the years ended December 31, 1997
and 1996.

10. Reinsurance

In the normal  course of  business,  the Company  reinsures  portions of certain
policies  that it  underwrites  to limit  disproportionate  risks.  The  Company
retains  varying  amounts of individual  insurance up to a maximum  retention of
$500 on any life. Amounts not retained are ceded to other insurance  enterprises
or reinsurers on an automatic or facultative basis.

Reinsurance  contracts  do not  relieve  the  Company  from its  obligations  to
policyholders.  Therefore,  the Company is  contingently  liable for recoverable
unpaid claims and policyholder  liabilities  ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial  condition of its reinsurers to minimize its exposure to
significant  losses from  reinsurer  insolvencies.  The effect of reinsurance on
policy revenues earned and the related benefits  incurred by such reinsurers for
the years ended December 31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                                           1997             1996
                                                                      -------------     -------------
<S>                                                                   <C>               <C>
Direct policy revenues and amounts assessed against policyholders...  $     252,656     $     255,352
Reinsurance assumed.................................................          1,182             3,483
Reinsurance ceded...................................................       (108,020)          (61,923)
                                                                      -------------     -------------
Net premiums and amounts earned.....................................  $     145,818     $     196,912
                                                                      =============     =============
Policyholder benefits ceded.........................................  $      78,767     $      25,513
                                                                      =============     =============
</TABLE>

                                       108

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


10. Reinsurance (Continued)

Effective July 1, 1996, Union Bankers entered into  reinsurance  agreements with
Cologne Life  Reinsurance  Company  ("Cologne")  to coinsure 80% of its Medicare
supplement business in force on July 1, 1996 and to coinsure 80% of its Medicare
policies  issued on or after July 1, 1996. The Company  recorded a deferred gain
on the transaction of $53,893 as of July 1, 1996,  which is being amortized into
income over the life of the business.  For the year ended  December 31, 1997 and
for the period  from July 1, 1996 to  December  31,  1996  $14,222  and  $6,445,
respectively  of the deferred gain has been  recognized and is included in other
income. The Company is not subject to any negative experience adjustments if the
ceded  business is  unprofitable;  however,  the Company  may  participate  in a
portion of future  earnings from the ceded business  after Cologne  recovers its
initial  ceding  commission  plus  interest at a specified  rate.  Union Bankers
retained  administration  for the ceded block of business and is  reimbursed  by
Cologne for  administrative  costs at the rate of 8.5% of ceded renewal premiums
and 11.5% of ceded first year premiums.

Southwestern  Life  previously  ceded a block of annuities  under a  reinsurance
agreement  with  Employees  Reassurance  Corporation  (ERC).  Such  reinsurance,
accounted for as a financing  arrangement,  is not reflected in the accompanying
financial  statements  except  for the risk  fees paid to ERC.  The  reinsurance
agreement was terminated as of November 30,  1997.Statutory  surplus provided by
this treaty totaled $8,714 at December 31, 1996. Risk fees paid to the reinsurer
were 2% of the net amount of surplus  provided,  but not less than a minimum fee
of $40 per quarter,  and totaled $110 and $222 for the years ended  December 31,
1997 and 1996,  respectively.  Amounts due from reinsurers  included amounts due
from ERC of $121,016 at December 31, 1996. The underlying assets held by ERC had
carrying values of $121,016 and fair values of $122,639 at December 31, 1996.

At December 31, 1997,  Southwestern  Life entered into a  reinsurance  agreement
with Integon Life  Insurance  Corporation  (Integon),  an indirect  wholly-owned
subsidiary  of PennCorp,  to coinsure  certain  annuities  which had GAAP policy
liabilities of $256,673.  Cash of $50,000 and securities  were  transferred at a
cost  basis  of  $198,793  which  had fair  values  equal  to  statutory  policy
liabilities  of $255,195.  The present value of insurance in force which Integon
had recorded on these policies was estimated to be $2,291.  Because Southwestern
Life  and  Integon  are  affiliates,  the  historical  GAAP  book  value  of the
securities  and the present  value of insurance in force at Integon was retained
by Southwestern Life. Rather than record a loss of $3,634, which is net of taxes
of $1,956,  on a GAAP basis,  Southwestern  Life recorded a "deemed dividend" of
this amount as a direct charge to its paid in capital.  In addition,  the change
in unrealized investment gain (loss) associated with the transferred  securities
is recorded as an adjustment to prior unrealized gains.

11. Retirement and Profit Sharing Plans

The Company has a defined  contribution  retirement  plan (Defined  Contribution
Plan)  for all  employees  who  have  attained  age 21 and  completed  a year of
service.  Contributions  to the  Plan  are  made  pursuant  to  salary  deferral
elections  by  participants  in an  amount  equal to 1% to 15% of  their  annual
compensation. In addition, the Company makes matching contributions in an amount
equal to 50% of each participant's  salary deferral to a maximum of 3% of annual
compensation.  The Defined  Contribution  Plan also provides for a discretionary
employer profit sharing contribution,  which is determined annually by the Board
of Directors for the  succeeding  plan year.  Profit sharing  contributions  are
credited  to   participant's   accounts   on  the  basis  of  their   respective
compensation.  Salary  deferral  contribution  accounts  are at all times  fully
vested,  while matching  contribution and profit sharing  contribution  accounts
vest ratably  from one to five years of service.  All  participant  accounts are
fully vested at death,  disability or  attainment  of age 65.  Payment of vested
benefits under the Defined  Contribution Plan may be elected by a participant in
a variety of forms of payment. Expenses related to this plan for the years ended
December 31, 1997 and 1996 amounted to $936 and $696, respectively.

In addition,  the Company has a bonus plan for certain key officers.  The amount
available  to pay awards for any year is  determined  by a  committee  of senior
executives  of the Company and is subject to approval of the Board of  Directors
of the  Company.  Awards are based on the  performance  of the  Company  and the
performance  of eligible  participants.  The Company  accrued or paid $1,350 and
$1,700  under  this plan  during the years  ended  December  31,  1997 and 1996,
respectively.

The Company provides certain health care and life insurance benefits for retired
employees.  Employees  meeting  certain  age and length of service  requirements
become  eligible  for these  benefits.  The  Company's  obligation  for  accrued
postretirement

                                       109

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



11. Retirement and Profit Sharing Plans (Continued)

health and welfare benefits is unfunded.  Following is an analysis of the change
in the  liability  for  accrued  postretirement  benefits  for the  years  ended
December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                            1997             1996
                                                                       -------------     -------------
<S>                                                                    <C>               <C>
 Accrued postretirement benefits, beginning of year .................  $      12,686     $      12,821
                                                                       -------------     -------------
 Recognition of components of net periodic postretirement benefit cost:
   Service cost .....................................................            269               244
   Interest cost.....................................................            930               834
                                                                       -------------     -------------
   Net periodic postretirement benefit cost..........................          1,199             1,078
 Benefit payments....................................................         (1,290)           (1,213)
                                                                       -------------     -------------
 Net change..........................................................            (91)             (135)
                                                                       -------------     -------------
 Accrued postretirement benefits, end of year........................  $      12,595     $      12,686
                                                                       =============     =============

The  liability  for accrued  postretirement  benefits  includes the following at
December 31, 1997 and 1996:

 Accumulated postretirement benefit obligation:
   Retirees..........................................................  $      11,167     $      10,884
   Active eligible...................................................          1,076             1,194
   Active ineligible.................................................            944               831
                                                                       -------------     -------------
                                                                              13,187            12,909
 Unrecognized actuarial loss.........................................           (592)             (223)
                                                                       -------------     -------------
 Accrued postretirement benefits.....................................  $      12,595     $      12,686
                                                                       =============     =============
</TABLE>

For measurement  purposes,  an 5.5% annual rate increase in the health care cost
trend rate was assumed for 1998;  the rate was assumed to decrease  gradually to
4.0% by the year 2015 and remain at that level thereafter.  The health care cost
trend rate  assumption  has a  significant  effect on the amounts  reported.  To
illustrate,  increasing  the  assumed  health  care  cost  trend  rates  by  one
percentage  point in each year would  increase  the  accumulated  postretirement
health care benefit obligation as of December 31, 1997 by $767 and the aggregate
of the service and interest  components  of net periodic  postretirement  health
care benefit cost for 1997 by $127. The weighted  average  discount rate used in
determining the accumulated postretirement benefit obligation was 7.0%.

12. Related Party Transactions

Related party  transactions  described  herein  include those  transactions  not
included elsewhere in the Notes to Consolidated Financial Statements.

The Company and its  subsidiaries  have management and services  agreements with
entities  affiliated with  Knightsbridge,  a shareholder.  In connection with an
Advisory  and  Management  Services  Agreement  with  Knightsbridge  Management,
L.L.C.,  the Company pays an annual fee of $1,500 plus expenses.  Each insurance
subsidiary   has  an  Investment   Management   Agreement   with   Knightsbridge
Consultants,  L.L.C.  For the years  ended  December  31,  1997 and  1996,  fees
incurred totaled $1,871 and $1,658, respectively.

The Company agreed to pay PennCorp,  a shareholder,  $1,000 in conjunction  with
the GSSW  transaction  in 1996 (see Note 3). The Company paid interest of $1,400
in 1997  in  conjunction  with  PennCorp's  acquisition  of the  Company's  7.0%
convertible subordinated note.

The Company  provides  services for a wholly-owned  subsidiary of PennCorp.  The
Company  charges  the  subsidiary  for its direct  costs and a share of overhead
costs based upon time and utilization studies. These costs totaled approximately
$5,178 during 1997.

                                       110

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


13. Other Commitments and Contingencies

The Company and its subsidiaries are obligated under operating leases, primarily
for office space.  Rent expense was $2,169 in 1997 and $2,058 in 1996. There was
no significant sublease income in 1997 or 1996.

<TABLE>
<CAPTION>
Minimum lease commitments are:
    <S>                                                             <C>
    1998..........................................................  $     2,381
    1999..........................................................        2,685
    2000..........................................................        2,666
    2001..........................................................        2,652
    2002..........................................................        2,497
    2003 and thereafter...........................................       10,704
                                                                    -----------
      Total minimum payments required.............................  $    23,585
                                                                    ===========
</TABLE>

Certain  lawsuits  have  been  brought  against  the  Company's  life  insurance
subsidiaries  in the  normal  course of the  insurance  business  involving  the
settlement  of  various  matters  and  seeking  compensatory  and in some  cases
punitive damages.  Management  believes that the ultimate settlement of all such
litigation  will  not  have  a  materially   adverse  effect  on  the  Company's
consolidated financial position or results of operation.

The life  insurance  companies  are  required  to be members  of  various  state
insurance  guaranty  associations in order to conduct  business in those states.
These  associations  have the authority to assess member  companies in the event
that an insurance  company  conducting  business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered   through  a  reduction  in  future  premium   taxes.   The  insurance
subsidiaries  paid  assessments  of $980 in 1997 and  $1,357  in 1996.  Based on
information currently available,  the insurance subsidiaries have accrued $3,194
at  December  31,  1997  for  future  assessments,  net of  future  premium  tax
reductions.

14. Other Operating Information

Underwriting and other administrative  expenses for the years ended December 31,
1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                                   1997             1996
                                                              -------------     -------------
<S>                                                           <C>               <C>
Non-deferrable commission expense...........................  $      19,746     $      30,768
Commission allowances on reinsurance ceded..................        (12,696)           (8,331)
Taxes, licenses and fees....................................          7,492             9,214
General and administrative expenses.........................         34,467            39,241
Expense allowance on reinsurance ceded......................         (8,409)           (5,782)
                                                              -------------     -------------
  Underwriting and other administrative expenses............  $      40,600     $      65,110
                                                              =============     =============
</TABLE>


                                       111

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

15. Financial Instruments

The following is a summary of the carrying value and fair value of the Company's
financial instruments at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                        1997                      1996
                                                              ------------------------  ------------------------
                                                               Carrying         Fair       Carrying       Fair
                                                                 Value         Value        Value        Value
                                                              -----------  -----------  -----------  -----------
<S>                                                           <C>          <C>          <C>          <C>
Assets:
   Cash and short-term investments..........................  $   163,716  $   163,716  $   161,895  $   161,895
   Fixed maturities.........................................    1,677,508    1,677,508    1,255,270    1,255,270
   Equity securities........................................        1,079        1,079        1,129        1,129
   Mortgage loans...........................................       51,070       51,816       59,993       59,993
   Policy loans.............................................      123,041      123,041      128,551      128,551
   Collateral loans.........................................          --           --        21,308       21,308
   Other investments........................................        8,461        8,461        5,553        5,553
   Interest rate cap........................................           41          --           145          --
   Agent and premium receivables............................        5,508        5,508       13,773       13,773
Liabilities:
   Notes payable............................................      154,750      154,750      159,750      159,750
   Universal life and investment contract liabilities.......    1,315,496    1,315,496    1,088,335    1,088,335
</TABLE>

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:

     Cash  and  Short-term  Investments,  Agent  and  Premium  Receivables:  The
     carrying value of short-term investments and amounts receivable approximate
     their fair value due to the short-term maturity of these instruments.

     Fixed  Maturities  and Equities  Available for Sale:  Fair values for fixed
     maturities  available  for sale are based on quoted  market  prices,  where
     available.  For fixed  maturities  not  actively  traded,  fair  values are
     estimated using values obtained from  independent  pricing  services or are
     estimated  based on expected  future cash flows using a current market rate
     applicable to the yield,  credit quality,  and maturity of the investments.
     The fair values for equity securities are based on quoted market prices.

     Mortgage and Collateral  Loans: The fair values for mortgage and collateral
     loans are estimated using discounted cash flow analyses,  based on interest
     rates  currently  being offered for similar loans to borrowers with similar
     credit  ratings.  Loans with similar  characteristics  are  aggregated  for
     purposes of the calculations.

     Other  Investments:  The fair value of  Company's  investment  in  residual
     interests in  mortgage-backed  securities  was obtained from an independent
     broker-dealer.  The fair values of other miscellaneous invested assets have
     not been estimated due to their relative immateriality.

     Interest  rate cap:  The fair value of the  interest  rate cap is $0 as the
     current interest rate is below the cap rate.

     Policy Loans:  Policy loans are an integral part of life insurance policies
     which the  Company has in force and, in the  Company's  opinion,  cannot be
     valued  separately.  These loans  typically  carry an interest rate that is
     tied to the  crediting  rate  applied to the  related  policy and  contract
     reserves.

     Notes Payable:  Fair values of the Company's bank  obligations  approximate
     carrying values due to the variable interest  structure.  The fair value of
     the Company's  convertible  note payable is not valued at December 31, 1997
     as it was owned by PennCorp and canceled in February 1998.

                                       112

<PAGE>


               SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



15. Financial Instruments (Continued)

     Universal Life and Investment Contract Liabilities:  The carrying value and
     fair  values  for  the  Company's  liabilities  under  universal  life  and
     investment-type  insurance  contracts  are the same as the  interest  rates
     credited  to these  products  are  periodically  adjusted by the Company to
     reflect  market  conditions.  The fair  values  of  liabilities  under  all
     insurance  contracts are taken into consideration in the overall management
     of interest rate risk, which minimizes  exposure to changing interest rates
     through  the  matching  of  investment  maturities  with  amounts due under
     insurance contracts.

16. Subsequent Event

On January 2, 1998,  PennCorp acquired all of the outstanding  common stock held
by  Knightsbridge  and certain other parties for  aggregate  cash  consideration
ranging from $73,777 to $77,444  (excluding  anticipated  acquisition  expenses)
depending upon the outcome of certain  contingencies.  As a result, SWF became a
wholly-owned subsidiary of PennCorp.  After the acquisition of the common stock,
PennCorp  repaid SWF's bank revolving debt in the amount of $90,250 and its bank
term debt in the amount of $24,500.  Consequently,  the Company  will realize an
extraordinary  charge  in 1998 for the  writeoff  of  deferred  costs of  $2,571
associated with these loans. In addition, PennCorp canceled the $40,000 SWF note
it acquired from ICH.

On February 18, 1998,  PennCorp announced that it had engaged investment banking
firms  to  review  strategic  alternatives  for  maximizing  shareholder  value,
including  the  sale  of  certain   divisions,   which  include  Union  Bankers,
Constitution,   Marquette  and  affiliated  service  providing   companies  ("SW
Financial  businesses held for sale"). As of and for the year ended December 31,
1997, the total assets,  net liabilities,  total revenues and net loss of the SW
Financial  businesses held for sale aggregated $530,866,  $49,697,  $109,387 and
$5,201, respectively.



                                      113

<PAGE>


Item 9.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure

         None.

                                    PART III

Item 10.  Directors and Executive Officers of the Registrant

         Information  required  by this Item is  incorporated  by  reference  to
"Election  of  Directors"  and  "Executive  Officers"  in  the  Company's  Proxy
Statement for its 1998 Annual Meeting of the Shareholders.

Item 11.  Executive Compensation

         Information  required  by this Item is  incorporated  by  reference  to
"Director-Fees,"    "Executive   Compensation   and   Other   Information"   and
"Compensation  Committee Interlocks and Insider  Participation" in the Company's
Proxy  Statement  for its 1998 Annual  Meeting of  Shareholder,  except that the
information required by paragraphs (k) and (l) of Item 402 of Regulation S-K and
set forth in such Proxy Statement is specifically not incorporated by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

         Information  required  by this Item is  incorporated  by  reference  to
"Security  Ownership  of  Certain  Beneficial  Owners  and  Management"  in  the
Company's Proxy Statement for its 1998 Annual Meeting of Shareholders.

Item 13.  Certain Relationships and Related Transactions

         Information  required  by this Item is  incorporated  by  reference  to
"Compensation  Committee  Interlocks  and Insider  Participation"  and  "Certain
Transactions"  in the Company's  Proxy  Statement for its 1998 Annual Meeting of
Shareholders.

                  (Remainder of Page Intentionally Left Blank)




                                      114
<PAGE>



                                     PART IV

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

(a)  Documents

     1.   The  financial  statements  of  PennCorp  Financial  Group,  Inc.  and
          Subsidiaries  set forth on pages 50 through  89,  and the  Independent
          Auditors'  Report set forth on page 49 hereof are in  response  to the
          information required by this Item.

     2.   An index to the financial  statement schedules required to be filed by
          Item 8 of this Report on Form 10-K is set forth immediately before the
          attached financial statement schedules on page 122 of this filing.

     3.   Exhibits

          2.1  Purchase  Agreement dated as of December 31, 1998 among Universal
               American Financial Corp., PennCorp Financial Group, Inc., Pacific
               Life and Accident Insurance Company,  Pennsylvania Life Insurance
               Company,  Southwestern Financial  Corporation,  Constitution Life
               Insurance Company and PennCorp Financial Services, Inc. (23)

          2.2  Stock Purchase Agreement dated as of December 31, 1998 between GE
               Financial Assurance Holdings,  Inc. and Pacific Life and Accident
               Insurance Company. (23)

          2.3  Agreement  dated as of  December  31, 1998  between GE  Financial
               Assurance Holdings, Inc. and PennCorp Financial Group, Inc. (23)

          3.1  Restated By-Laws of PennCorp Financial Group, Inc. (9)

          3.2  Third Restated Certificate of Incorporation of PennCorp Financial
               Group, Inc. (17)

          4.1  Certificate of Designation of Series C Preferred Stock. (4)

          4.2  Corrected   Certificate  of  Designation  of  $3.375  Convertible
               Preferred Stock. (4)

          4.3  Certificate   of  Designation  of  $3.50  Series  II  Convertible
               Preferred Stock. (3)

          4.4  Indenture between PennCorp  Financial Group, Inc. and The Bank of
               New York, as trustee,  with respect to 9 1/4% Senior  Subordinate
               Notes due 2003. (8)

          10.1 Surplus Debenture Number Four in the original principal amount of
               $162,539,890,  issued  by  Pacific  Life and  Accident  Insurance
               Company to PennCorp Financial Group, Inc., dated January 1, 1994.
               (7)

          10.2 Surplus Debenture Number Five in the original principal amount of
               $17,606,203,  issued  by  Pacific  Life  and  Accident  Insurance
               Company to PennCorp  Financial  Group,  Inc., dated September 29,
               1994. (12)

          10.3 Surplus Debenture Number Six in the original  principal amount of
               $55,000,000,  issued  by  Pacific  Life  and  Accident  Insurance
               Company to PennCorp  Financial Group,  Inc., dated July 24, 1996.
               (11)

          10.4 10%  Promissory  Note  in  the  original   principal   amount  of
               $30,661,996, issued by American- Amicable Holdings Corporation to
               Pennsylvania Life Insurance Company, dated July 1, 1996. (11)

                             MANAGEMENT COMPENSATION
                               RELATED AGREEMENTS

               10.5 PennCorp Financial, Inc. Retirement and Savings Plan. (10)


                                      115
<PAGE>


               10.6 PennCorp Financial Group, Inc.  Retirement and Savings Plan.
                    (1)

               10.7 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (10)

               10.8 PennCorp  Financial Group,  Inc. Senior  Management  Warrant
                    Award Program. (10)

               10.9 Form of Restricted  Stock Agreement by and between  PennCorp
                    Financial Group, Inc. and certain participants, effective as
                    of April 1, 1994. (6)

              10.10 Employment  Agreement between PennCorp Financial Group, Inc.
                    and David J. Stone entered into June 7, 1996. (11)

              10.11 Employment  Agreement between PennCorp Financial Group, Inc.
                    and Steven W. Fickes entered into June 7, 1996. (11)

              10.12 Amendment  Number  One  to  Employment   Agreement   between
                    PennCorp  Financial  Group,  Inc.  and David J. Stone  dated
                    April 28, 1997. (12)

              10.13 Amendment  Number  One  to  Employment   Agreement   between
                    PennCorp  Financial  Group,  Inc. and Steven W. Fickes dated
                    April 28, 1997. (12)

              10.14 Amendment No. 2 to  Employment  Agreement  between  PennCorp
                    Financial  Group,  Inc.  and  David J.  Stone  entered  into
                    January 5, 1998. (18)

              10.15 Amendment No. 2 to  Employment  Agreement  between  PennCorp
                    Financial  Group,  Inc.  and Steven W. Fickes  entered  into
                    January 5, 1998. (18)

              10.16 Amendment No. 3 to Employment  Agreement  dated the 10th day
                    of  November,  1998  and  effective  as of the  21st  day of
                    August,  1998 by and between PennCorp  Financial Group, Inc.
                    and David J. Stone. (21)

              10.17 Executive  Retention  Agreement between Charles  Lubochinski
                    and PennCorp Financial Group, Inc. (18)

              10.18 Schedule of similar Executive Retention Agreements. (18)

              10.19 PennCorp  Financial  Group,  Inc. 1996 Stock Award and Stock
                    Option Plan. (11)

              10.20 Amendment Number One to PennCorp  Financial Group, Inc. 1996
                    Stock Award and Stock Option Plan. (17)

              10.21 Amendment Number Two to PennCorp  Financial Group, Inc. 1996
                    Stock Award and Stock Option Plan. (1)

              10.22 PennCorp  Financial Group, Inc. 1996 Senior Executive Annual
                    Incentive Award Plan. (11)

              10.23 Amendment   Agreement  dated  July  29,  1998  to  Executive
                    Retention  Agreement  by  and  between  Michael  Prager  and
                    PennCorp Financial Group, Inc. (21)

              10.24 Accommodation  Agreement  entered into as of July 6, 1998 by
                    and between  PennCorp  Financial  Group,  Inc.  and David J.
                    Stone. (21)

              10.25 Executive  Employment  Agreement  dated May 22,  1998 by and
                    between  PennCorp   Financial  Group,   Inc.  and  James  P.
                    McDermott. (19)

              10.26 Executive  Retention  Agreement  dated  May 22,  1998 by and
                    between  PennCorp   Financial  Group,   Inc.  and  James  P.
                    McDermott. (19)



                                      116
<PAGE>


              10.27 Executive  Employment  Agreement  dated May 22,  1998 by and
                    between  PennCorp   Financial  Group,   Inc.  and  Scott  D.
                    Silverman. (19)

              10.28 Executive  Retention  Agreement  dated  May 22,  1998 by and
                    between  PennCorp   Financial  Group,   Inc.  and  Scott  D.
                    Silverman. (19)

              10.29 Executive  Employment  Agreement  dated  July 1, 1998 by and
                    between PennCorp  Financial  Group,  Inc. and Keith A. Maib.
                    (19)

              10.30 Executive  Retention  Agreement  dated  July 1,  1998 by and
                    between PennCorp  Financial  Group,  Inc. and Keith A. Maib.
                    (19)

              10.31 Letter  Agreement  dated May 21, 1998 for Option to Purchase
                    Shares of ACO Brokerage Holdings  Corporation by and between
                    PennCorp Financial Group, Inc. and James P. McDermott. (1)

              10.32 Letter  Agreement  dated May 21, 1998 for Option to Purchase
                    Shares of ACO Brokerage Holdings  Corporation by and between
                    PennCorp Financial Group, Inc. and Scott D. Silverman (1)

              10.33 Letter  Agreement  dated May 21, 1998 for Option to Purchase
                    Shares of ACO Brokerage Holdings  Corporation by and between
                    PennCorp Financial Group, Inc. and Charles Lubochinski (1)

              10.34 Letter  Agreement  dated May 21, 1998 for Option to Purchase
                    Shares of ACO Brokerage Holdings  Corporation by and between
                    PennCorp Financial Group, Inc. and Michael Prager (1)

              10.35 Conversion,  Standstill and  Registration  Rights  Agreement
                    between United Companies Financial  Corporation and PennCorp
                    Financial Group, Inc. dated as of July 24, 1996. (11)

              10.36 Registration  Rights  Agreement  dated as of August 2, 1996,
                    by and among PennCorp  Financial  Group,  Inc., Smith Barney
                    Inc.,  Donaldson,  Lufkin & Jenrette Securities  Corporation
                    and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (11)

              10.37 Credit  Agreement dated March 12, 1997 by and among PennCorp
                    Financial  Group,  Inc. and The Chase  Manhattan  Bank,  The
                    First  National Bank of Chicago,  and  NationsBank,  NA., as
                    Managing  Agents,  Fleet National Bank,  Mellon Bank,  N.A.,
                    Bank of Montreal,  CIBC Inc., and Dresdner Bank AG, New York
                    Branch and Grand Cayman  Branch as Co-Agents and The Bank of
                    New York, as Administrative Agent. (13)

              10.38 Amendment  No. 1 and  Waiver  dated  as of June 13,  1997 to
                    Credit  Agreement  dated as of March  12,  1997 by and among
                    PennCorp  Financial Group,  Inc.,  lenders  signatory to the
                    Credit Agreement and The Bank of New York. (19)

              10.39 Amendment  No. 2 and  Waiver  dated as of April 17,  1998 to
                    Credit  Agreement  dated as of March  12,  1997 by and among
                    PennCorp  Financial Group,  Inc.,  lenders  signatory to the
                    Credit Agreement and The Bank of New York. (19)

              10.40 Waiver  dated as of  August  14,  1998 to  Credit  Agreement
                    dated as of March 12, 1997 by and among  PennCorp  Financial
                    Group,  Inc.,  lenders signatory to the Credit Agreement and
                    The Bank of New York. (1)

              10.41 Amendment  No. 3 dated as of  September  11,  1998 to Credit
                    Agreement  dated as of March 12, 1997 by and among  PennCorp
                    Financial  Group,  Inc.,  lenders  signatory  to the  Credit
                    Agreement and The Bank of New York. (20)



                                      117
<PAGE>



              10.42 Amendment  No. 4 and Waiver dated as of November 16, 1998 to
                    Credit  Agreement  dated as of March  12,  1997 by and among
                    PennCorp  Financial Group,  Inc.,  lenders  signatory to the
                    Credit Agreement and The Bank of New York. (22)

              10.43 Amendment  No. 5 dated as of  December  31,  1998 to  Credit
                    Agreement  dated as of March 12, 1997 by and among  PennCorp
                    Financial  Group,  Inc.,  lenders  signatory  to the  Credit
                    Agreement and The Bank of New York. (23)

              10.44 United Life Consent  Agreement  dated as of March 5, 1999 by
                    and among PennCorp  Financial Group, Inc., lenders signatory
                    to the Credit  Agreement  dated as of March 12, 1997 and The
                    Bank of New York. (24)

              10.45 Revision  Agreement,  dated as of May 30, 1997, by and among
                    United Companies Financial  Corporation,  PennCorp Financial
                    Group, Inc., Pacific Life and Accident Insurance Company and
                    each  additional  party  set  forth on the  signature  pages
                    thereto. (14)

              10.46 Amendment to Surplus  Debenture  in the  original  principal
                    amount  of  $73,000,000  issued  by  Pioneer  Security  Life
                    Insurance Company to American-Amicable Holdings Corporation,
                    dated May 17, 1996. (14)

              10.47 Second  Amendment  to  Surplus  Debenture  in  the  original
                    principal  amount of $73,000,000  issued by Pioneer Security
                    Life  Insurance   Company  to   American-Amicable   Holdings
                    Corporation, effective January 1, 1997. (14)

              10.48 Third  Amendment  to  Surplus   Debenture  in  the  original
                    principal  amount of $73,000,000  issued by Pioneer Security
                    Life  Insurance   Company  to   American-Amicable   Holdings
                    Corporation, effective May 14, 1997. (14)

              10.49 Amendment to Surplus  Debenture  Number Four in the original
                    principal amount of $162,539,890, issued by Pacific Life and
                    Accident  Insurance  Company to  PennCorp  Financial  Group,
                    Inc., effective January 1, 1997. (14)

              10.50 Second  Amendment  to Surplus  Debenture  Number Four in the
                    original principal amount of $162,539,890, issued by Pacific
                    Life and Accident  Insurance  Company to PennCorp  Financial
                    Group, Inc., effective May 14, 1997. (14)

              10.51 Amendment to Surplus  Debenture  Number Five in the original
                    principal amount of $17,606,203,  issued by Pacific Life and
                    Accident  Insurance  Company to  PennCorp  Financial  Group,
                    Inc., effective January 1, 1997. (14)

              10.52 Second  Amendment  to Surplus  Debenture  Number Five in the
                    original principal amount of $17,606,203,  issued by Pacific
                    Life and Accident  Insurance  Company to PennCorp  Financial
                    Group, Inc., effective May 14, 1997. (14)

              10.53 Amendment  to Surplus  Debenture  Number Six in the original
                    principal amount of $55,000,000,  issued by Pacific Life and
                    Accident  Insurance  Company to  PennCorp  Financial  Group,
                    Inc., effective January 1, 1997. (14)

              10.54 Second  Amendment  to  Surplus  Debenture  Number Six in the
                    original principal amount of $55,000,000,  issued by Pacific
                    Life and Accident  Insurance  Company to PennCorp  Financial
                    Group, Inc., effective May 14, 1997. (14)

              10.55 Amendment to Surplus  Debenture  dated  December 14, 1995 in
                    the  original  principal  amount  of  $80,000,000  issued by
                    Constitution   Life   Insurance   Company  to   Southwestern
                    Financial Corporation. (19)



                                      118
<PAGE>



              10.56 Amendment to Surplus  Debenture dated January 1, 1996 in the
                    original   principal   amount  of   $40,000,000   issued  by
                    Constitution   Life   Insurance   Company  to   Southwestern
                    Financial Corporation. (19)

              10.57 Note Purchase,  Release and Settlement Agreement, dated July
                    13, 1997, executed by Lone Star Liquidating Trust,  PennCorp
                    Financial Group, Inc. and Southwestern Financial Corporation
                    . (15)

              10.58 Amended  and  Restated  Assignment  Agreement  dated  as  of
                    January 2, 1998 by and  between  PennCorp  Financial  Group,
                    Inc. and Knightsbridge Capital Fund I, L.P. (16)

              10.59 Amended  and  Restated  Assignment  Agreement  dated  as  of
                    January 2, 1998 by and  between  PennCorp  Financial  Group,
                    Inc.,  David J. Stone,  Steven W.  Fickes,  the Steven Wayne
                    Fickes,  Jr.  Trust dated  December 21, 1995 and the Kathryn
                    Elizabeth Fickes Trust dated December 21, 1995. (16)

              10.60 Agreement  dated  September  22, 1998 by PennCorp  Financial
                    Group,  Inc.  and  certain  subsidiaries  signatory  to  the
                    Agreement and the Texas Department of Insurance. (21)

               12   Computation of ratio of earnings to fixed charges. (1)

               21   List of subsidiaries of the Registrant. (1)

               23.1 Auditors consent. (1)

               23.2 Auditors consent. (1)

               27   Financial Data Schedule. (1)

(1)  Filed herewith.

(2)  Such exhibit is  incorporated  by reference to the Form 8-K dated  November
     25, 1996,  which was filed with the Securities  and Exchange  Commission by
     PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the
     Amended and Restated Agreement and Plan of Merger with Washington  National
     Corporation.

(3)  Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-3  (Registration  No. 333- 13285) of PennCorp  Financial Group, Inc.
     filed with the Securities and Exchange Commission on October 10, 1996.

(4)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1995 of PennCorp  Financial  Group,
     Inc.

(5)  Such  exhibit is  incorporated  by reference to the Form 8-A dated July 11,
     1995 which was filed by PennCorp  Financial Group, Inc. with the Securities
     and Exchange Commission on July 12, 1995.

(6)  Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1994 of PennCorp  Financial
     Group, Inc.

(7)  Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1994 of PennCorp  Financial Group,
     Inc.

(8)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1993 of PennCorp  Financial  Group,
     Inc.

(9)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1992 of PennCorp  Financial  Group,
     Inc.

(10) Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-1  (Registration  No. 33-50530) of PennCorp  Financial  Group,  Inc.
     filed on August 6, 1992.



                                      120
<PAGE>



(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1996 of PennCorp  Financial  Group,
     Inc.

(12) Such exhibit is  incorporated  by  reference  to Amendment  Number 2 to the
     Annual  Report on Form 10-K for fiscal  year  ended  December  31,  1996 of
     PennCorp Financial Group, Inc.

(13) Such exhibit is  incorporated  by reference  to the  Amendment  Number 1 to
     Annual  Report on Form 10-K for the fiscal year ended  December 31, 1996 of
     PennCorp Financial Group, Inc.

(14) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1997 of PennCorp  Financial Group,
     Inc.

(15) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1997 of PennCorp  Financial
     Group, Inc.

(16) Such exhibit is incorporated by reference to the Form 8-K dated January 13,
     1998  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc.  on  January  13,  1998  relating  to the
     acquisition  of common  stock and common  stock  warrants  of  Southwestern
     Financial  Corporation not previously  owned by PennCorp  Financial  Group,
     Inc.

(17) Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-8  (Registration  No.  333-48629) of PennCorp  Financial Group, Inc.
     filed on March 24, 1998.

(18) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1997 of PennCorp  Financial  Group,
     Inc.

(19) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1998 of PennCorp  Financial Group,
     Inc.

(20) Such exhibit is  incorporated  by reference to the Form 8-K dated September
     15, 1998 which was filed with the  Securities  and Exchange  Commission  by
     PennCorp  Financial Group, Inc. on September 15, 1998 relating to Amendment
     No. 3 to Credit Agreement.

(21) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1998 of PennCorp  Financial
     Group, Inc.

(22) Such exhibit is  incorporated  by reference to the Form 8-K dated  November
     17, 1998 which was filed with the  Securities  and Exchange  Commission  by
     PennCorp  Financial Group,  Inc. on November 17, 1998 relating to Amendment
     No. 4 and Waiver of Credit Agreement.

(23) Such exhibit is incorporated by reference to the Form 8-K dated January 11,
     1999  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc.  on  January  11,  1999  relating  to the
     acquisition of Pennsylvania Life Insurance Company, Union Bankers Insurance
     Company and related  entities,  the acquisition of  Professional  Insurance
     Company, and Amendment No. 5 to Credit Agreement.

(24) Such exhibit is  incorporated  by reference to the Form 8-K dated March 11,
     1999  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc. on March 11, 1999  relating to the United
     Life Consent Agreement by and among PennCorp  Financial Group, Inc. lenders
     signatory to the Credit  Agreement  dated as of March 12, 1997 and The Bank
     of New York.

(b)  Reports on Form 8-K.

          A report on Form 8-K,  dated  November  17,  1998,  was filed with the
     Securities and Exchange  Commission by PennCorp  Financial  Group,  Inc. on
     November 17, 1998, providing Amendment No. 4 and Waiver to Credit Agreement
     dated as of March 12, 1997 by and among PennCorp Financial Group, Inc., the
     lenders signatory to the Credit Agreement and The Bank of New York.



                                      120
<PAGE>



                                   SIGNATURES

         Pursuant  to the  requirements  of Section  13 or Section  15(d) of the
Securities  Exchange Act of 1934, PennCorp Financial Group, Inc. has duly caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.

                                   PENNCORP FINANCIAL GROUP, INC.
                                   (Registrant)


                                   By:  /s/ Keith A. Maib
                                        -------------------------
                                        Keith A. Maib
                                        President and Chief Executive Officer


                                  Date: March 31, 1999

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


/s/ Keith A. Maib                       /s/ Thomas A. Player
-----------------                       --------------------
Keith A. Maib                           Thomas A. Player
Director                                Director


Date: March 31, 1999                    Date: March 31, 1999



/s/ Kenneth Roman                       /s/ Bruce W. Schnitzer
-----------------                       ----------------------
Kenneth Roman                           Bruce W. Schnitzer
Director                                Director

Date: March 31, 1999                    Date: March 31, 1999



/s/ David J. Stone                      /s/ David C. Smith
------------------                      ----------------------
David J. Stone                          David C. Smith
Director                                Chairman of the Board and Director

Date: March 31, 1999                    Date: March 31, 1999



/s/ Allan D. Greenberg
----------------------
Allan D. Greenberg
Director


Date: March 31, 1999

                                      121
<PAGE>



                 PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

Financial Statements:

Reference  is made  to  data  appearing  on  pages  50  through  89,  and to the
Independent Auditors' Report appearing on page 49 hereof.

Schedules:*                                                              Page

Independent Auditors' Report - Financial Statement Schedules......      Ex. 23

Schedule II       Condensed Financial Information of Registrant...        123
Schedule III      Supplementary Insurance Information.............        126
Schedule IV       Reinsurance.....................................        127
Schedule V        Valuation and Qualifying Accounts...............        128

*    All other  schedules  have been omitted as they are not  applicable  or not
     required,  or the information is given in the financial  statements,  notes
     hereto or in other schedules.



                                      122
<PAGE>



                                                                     SCHEDULE II

                         PENNCORP FINANCIAL GROUP, INC.
                              (PARENT COMPANY ONLY)

                    CONDENSED STATEMENTS OF INCOME (LOSS) For
                the years ended December 31, 1998, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                          1998            1997           1996
                                                                       -----------    -----------    -----------
<S>                                                                    <C>            <C>            <C>        
Revenue:
   Interest income from subsidiaries.................................  $    19,663    $    21,173    $    35,525
   Other interest income.............................................        2,865          3,547          2,428
   Net gains from sale of investments................................          577             --             --
   Other income......................................................          589            249            423
                                                                       -----------    -----------    -----------
       Total revenue.................................................       23,694         24,969         38,376
                                                                       -----------    -----------    -----------

Operating expenses:
   General and administrative expenses...............................       19,429         36,939          2,493
   Interest and amortization of deferred debt issuance costs.........       42,730         23,103         17,920
   Restructuring charges.............................................        4,529             --             --
   Impairment provision associated with assets of
     Businesses Held for Sale........................................        9,000             --             --
                                                                       -----------    -----------    -----------
       Total operating expenses......................................       75,688         60,042         20,413
                                                                       -----------    -----------    -----------

Income (loss) before income taxes (benefits), equity in earnings of
   subsidiaries and extraordinary charge.............................      (51,994)       (35,073)        17,963
     Income tax expense (benefit)....................................       (3,132)        (8,689)           251
                                                                       -----------    -----------    -----------
Income (loss) before equity in earnings of subsidiaries
   and extraordinary charge..........................................      (48,862)       (26,384)        17,712
     Equity in earnings (losses) of subsidiaries.....................     (374,068)        76,524         72,305
                                                                       -----------    -----------    -----------
Income (loss) before extraordinary charge............................     (422,930)        50,140         90,017
     Extraordinary charge, net of income taxes of $--, $--and $932              --             --         (1,730)
                                                                       -----------    -----------    -----------
Net income (loss)....................................................  $  (422,930)   $    50,140    $    88,287
                                                                       ===========    ===========    ===========
</TABLE>

                 See accompanying independent auditors' report.



                                      123
<PAGE>



                                                                     SCHEDULE II

                         PENNCORP FINANCIAL GROUP, INC.
                              (PARENT COMPANY ONLY)

                            CONDENSED BALANCE SHEETS
                        As of December 31, 1998 and 1997
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                         1998           1997
                                                                                      -----------    ----------
<S>                                                                                   <C>            <C>        
ASSETS
   Investments:
     Investment in subsidiaries.....................................................  $   730,436    $   932,931
     Notes receivable from subsidiaries.............................................      257,442        275,146
     Equity securities available for sale...........................................           --         22,948
     Other..........................................................................           --          1,075
                                                                                      -----------    -----------
       Total investments............................................................      987,878      1,232,100

   Cash and short term investments..................................................       12,654          4,464
   Accrued investment income due from subsidiaries..................................           --          8,697
   Deferred debt issuance costs.....................................................        4,896          2,219
   Other assets.....................................................................        1,145          6,849
                                                                                      -----------    -----------
       Total assets.................................................................  $ 1,006,573    $ 1,254,329
                                                                                      ===========    ===========

LIABILITIES
   Notes payable....................................................................  $   548,646    $   356,646
   Due to subsidiaries..............................................................           --          8,404
   Accrued expenses and other liabilities...........................................       21,986          9,176
                                                                                      -----------    -----------
       Total liabilities............................................................      570,632        374,226
                                                                                      -----------    -----------

   Mandatory redeemable preferred stock, Series C...................................           --         19,867

SHAREHOLDERS' EQUITY
   $3.375 Convertible preferred stock...............................................      112,454        110,513
   $3.50 Series II convertible preferred stock......................................      141,673        139,157
   Common stock.....................................................................          301            289
   Additional paid in capital.......................................................      430,321        397,590
   Accumulated other comprehensive income...........................................       19,995         35,034
   Retained earnings (deficit)......................................................     (234,921)       211,055
   Treasury shares..................................................................      (32,391)       (32,130)
   Notes receivable and other assets secured by common stock........................       (1,491)        (1,272)
                                                                                      -----------    -----------
       Total shareholders' equity...................................................      435,941        860,236
                                                                                      -----------    -----------
       Total liabilities and shareholders' equity...................................  $ 1,006,573    $ 1,254,329
                                                                                      ===========    ===========
</TABLE>


                 See accompanying independent auditors' report.



                                      124
<PAGE>



                                                                     SCHEDULE II
                         PENNCORP FINANCIAL GROUP, INC.
                              (PARENT COMPANY ONLY)

                     CONDENSED STATEMENTS OF CASH FLOWS For
                the years ended December 31, 1998, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                          1998            1997           1996
                                                                       -----------    -----------    -----------
<S>                                                                    <C>            <C>            <C>        
Cash flows from operating activities:
   Net income (loss).................................................  $  (422,930)   $    50,140    $    88,287
   Adjustments to reconcile net income (loss) to net cash
     provided (used) in operating activities:
       Amortization of intangibles and depreciation..................        1,966          1,389          1,238
       Impairment provision associated with assets of
         Businesses Held for Sale....................................        9,000             --             --
       Equity in earnings (loss) of subsidiaries.....................      374,068        (76,524)       (72,305)
       Increase (decrease) in liabilities and due to subs............       (6,164)        12,870           (544)
       Other, net....................................................        2,644         (9,227)            79
                                                                       -----------    -----------    -----------
         Net cash provided (used) by operations......................      (41,416)       (21,352)        16,755
                                                                       -----------    -----------    -----------

Cash flows from investing activities:
   Acquisition of businesses.........................................      (73,858)            --             --
   Purchase of equity security.......................................       (5,000)       (20,000)            --
   Sale of equity security...........................................       30,500             --             --
   Issuance of surplus note to subsidiary............................           --             --       (155,000)
   Principal payment on surplus note.................................           --             --        100,000
   Dividend received from subsidiary.................................       44,327         14,677         11,283
   Capital contribution to subsidiary................................       (7,853)       (14,889)      (208,708)
   Other, net........................................................          712        (42,142)            --
                                                                       -----------    -----------    -----------
       Net cash used by investing activities.........................      (11,172)       (62,354)      (252,425)
                                                                       -----------    -----------    -----------

Cash flows from financing activities:
   Issuance of notes payable.........................................      203,000        250,000        230,000
   Issuance of common stock..........................................            3             --        155,450
   Issuance of preferred stock.......................................           --             --        139,157
   Purchase of treasury stock........................................           --        (28,760)            --
   Reduction of notes payable........................................     (126,015)      (100,000)      (273,353)
   Redemption of preferred stock.....................................           --        (14,705)            --
   Other, primarily dividends, net...................................      (16,210)       (20,464)       (15,198)
                                                                       -----------    -----------    -----------
       Net cash provided by financing activities.....................       60,778         86,071        236,056
                                                                       -----------    -----------    -----------

Net increase in cash.................................................        8,190          2,365            386
Cash and short-term investments at beginning of year.................        4,464          2,099          1,713
                                                                       -----------    -----------    -----------
Cash and short-term investments at end of year.......................  $    12,654    $     4,464    $     2,099
                                                                       ===========    ===========    ===========
Supplemental Disclosure:
   Interest paid.....................................................  $    37,849    $    20,946    $    16,921
   Taxes paid (refunded).............................................         (213)            --            200
Non-cash financing activities:
   Redemption of Series C Preferred Stock............................       22,227             --             --
   Debt assumed with acquisition.....................................      115,015             --             --
   Securities issued in conjunction with acquisition.................           --             --         14,999
   Issuance of common stock associated with the acquisition of the
     Fickes and Stone Knightsbridge Interests........................        8,500             --             --
   Other ............................................................          261          1,281            948
</TABLE>


                 See accompanying independent auditors' report.


                                      125
<PAGE>


                                                                    SCHEDULE III


                         PENNCORP FINANCIAL GROUP, INC.

                       SUPPLEMENTARY INSURANCE INFORMATION
              For the years ended December 31, 1998, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                      Future
                                      Policy                                               Amorti-
                                     Benefits                                Benefits,    zation of
                        Deferred      Losses,                                 Claims,     Deferred
                         Policy       Claims                      Net        Losses &      Policy        Other
                       Acquisition    & Loss       Premium    Investment    Settlement   Acquisition   Operating
                          Costs      Expenses      Revenue      Income       Expenses       Costs      Expenses
                          -----      --------      -------      ------       --------       -----      --------
<S>                   <C>           <C>          <C>          <C>          <C>          <C>          <C>        
1998
Fixed benefit.......  $        --   $    24,190  $   216,219  $    25,826  $   160,135  $    27,251  $   107,772
Life................      136,420     2,086,957      234,540      174,249      267,074       49,265       98,906
Accumulation........        3,288       755,891        8,399      168,977      114,553        2,775       22,819
                      -----------   -----------  -----------  -----------  -----------  -----------  -----------
   Total............  $   139,708   $ 2,867,038  $   459,158  $   369,052  $   541,762  $    79,291  $   229,497
                      ===========   ===========  ===========  ===========  ===========  ===========  ===========

1997
Fixed benefit.......  $   160,974   $   175,524  $   168,974  $    19,206  $    54,630  $    19,386  $    73,488
Life................      122,376     1,342,563      169,518       94,442      164,878       24,154       59,879
Accumulation........       26,767     1,771,838        7,074      159,589      104,781          783       12,878
                      -----------   -----------  -----------  -----------  -----------  -----------  -----------
   Total............  $   310,117   $ 3,289,925  $   345,566  $   273,237  $   324,289  $    44,323  $   146,245
                      ===========   ===========  ===========  ===========  ===========  ===========  ===========

1996
Fixed benefit.......  $   127,091   $   294,068  $   169,311  $    22,730  $    63,663  $    16,446  $    55,161
Life................      105,063     1,212,374      169,974       88,220      137,867       12,010       48,706
Accumulation........       20,274     2,060,013        8,805       99,784       70,381        2,288       12,693
                      -----------   -----------  -----------  -----------  -----------  -----------  -----------
   Total............  $   252,428   $ 3,566,455  $   348,090  $   210,734  $   271,911  $    30,744  $   116,560
                      ===========   ===========  ===========  ===========  ===========  ===========  ===========
</TABLE>

                  See accompanying independent auditors' report



                                      126
<PAGE>


                                                                     SCHEDULE IV

                         PENNCORP FINANCIAL GROUP, INC.

                                   REINSURANCE
              For the years ended December 31, 1998, 1997, and 1996
                                 (In thousands)
<TABLE>
<CAPTION>
                                                                                                     Percentage
                                                         Ceded to        Assumed                      Of Amount
                                           Gross           Other       from Other        Net           Assumed
                                          Amount         Companies      Companies      Amount          to Net
                                          ------         ---------      ---------      ------          ------
<S>                                    <C>            <C>             <C>            <C>                <C> 
Year ended December 31, 1998:
     Life insurance in force.........  $  35,350,735  $  5,501,096    $  1,325,067   $  31,174,706
                                       =============  ============    ============   =============

Premiums:
     Accident and health insurance...  $     310,477  $     96,770    $      2,047   $     215,754      0.9%
     Life insurance/accumulation.....        275,840        36,407           3,971         243,404      1.6%
                                       -------------  ------------    ------------   -------------
                                       $     586,317  $    133,177    $      6,018   $     459,158
                                       =============  ============    ============   =============

Year ended December 31, 1997:
     Life insurance in force.........  $  24,618,960  $  4,366,266    $  1,251,538   $  21,504,232
                                       =============  ============    ============   =============

Premiums:
     Accident and health insurance...  $     172,511  $      2,537    $         --   $     169,974       --%
     Life insurance/accumulation.....        203,027        29,962           2,527         175,592      1.4%
                                       -------------  ------------    ------------   -------------
                                       $     375,538  $     32,499    $      2,527   $     345,566
                                       =============  ============    ============   =============

Year ended December 31, 1996:
     Life insurance in force.........  $  31,498,035  $  5,884,609    $  1,779,439   $  27,392,865
                                       =============  ============    ============   =============

Premiums:
     Accident and health insurance...  $     169,727  $        416    $         --   $     169,311       --%
     Life insurance/accumulation.....        189,098        11,639           1,320         178,779      0.7%
                                       -------------  ------------    ------------   -------------
                                       $     358,825  $     12,055    $      1,320   $     348,090
                                       =============  ============    ============   =============
</TABLE>


                 See accompanying independent auditors' report.



                                      127
<PAGE>

                                                                      SCHEDULE V

                         PENNCORP FINANCIAL GROUP, INC.

                      VALUATION AND QUALIFYING ACCOUNTS For
                the years ended December 31, 1998, 1997 and 1996
                                 (In thousands)
<TABLE>
<CAPTION>
                                          Balance at      Charge to      Charge to                     Balance at
                                           Beginning      Cost and       to Other                        End of
                                           Of Period      Expenses       Accounts       Deductions       Period
                                           ---------      --------       --------       ----------       ------
<S>                                     <C>            <C>             <C>            <C>            <C>        
1998:
Mortgage loans on real estate.........  $     6,721(b) $    11,425     $        --    $    13,851(c) $     4,295
Allowance for bond losses.............           --             --              --             --             --
Unearned loan charges.................        1,569             --              --          1,569(c)          --
Accounts and notes receivable.........        9,205(b)       4,449              --          7,453(c)       6,201

1997:
Mortgage loans on real estate.........  $     4,211    $     2,106     $        --    $       276    $     6,041
Allowance for bond losses.............          189             --              --            189             --
Unearned loan charges.................          266          1,806              --            503          1,569
Accounts and notes receivable.........        6,528          9,102              --          6,605          9,025

1996:
Mortgage loans on real estate.........  $     4,211(a) $        --     $        --    $        --    $     4,211
Allowance for bond losses.............          189(a)          --              --             --            189
Unearned loan charges.................          266(a)          --              --             --            266
Accounts and notes receivable.........        8,388          4,082              --          5,942          6,528

--------------
(a)  Amount  recorded as a purchase  GAAP  adjustment  in  conjunction  with the
     acquisition of United Life.

(b)  Includes amounts recorded as a purchase GAAP adjustment in conjunction with
     the acquisition of SW Financial.

(c)  Includes amounts transferred to assets of Businesses Held for Sale.
</TABLE>


                 See accompanying independent auditors' report.



                                      128
<PAGE>



                                INDEX TO EXHIBITS

     2.1  Purchase  Agreement  dated as of  December  31,  1998 among  Universal
          American Financial Corp., PennCorp Financial Group, Inc., Pacific Life
          and Accident Insurance  Company,  Pennsylvania Life Insurance Company,
          Southwestern  Financial   Corporation,   Constitution  Life  Insurance
          Company and PennCorp Financial Services, Inc. (23)

     2.2  Stock  Purchase  Agreement  dated as of December  31, 1998  between GE
          Financial  Assurance  Holdings,  Inc.  and Pacific  Life and  Accident
          Insurance Company. (23)

     2.3  Agreement dated as of December 31, 1998 between GE Financial Assurance
          Holdings, Inc. and PennCorp Financial Group, Inc. (23)

     3.1  Restated By-Laws of PennCorp Financial Group, Inc. (9)

     3.2  Third Restated  Certificate  of  Incorporation  of PennCorp  Financial
          Group, Inc. (17)

     4.1  Certificate of Designation of Series C Preferred Stock. (4)

     4.2  Corrected  Certificate of Designation of $3.375 Convertible  Preferred
          Stock. (4)

     4.3  Certificate of  Designation  of $3.50 Series II Convertible  Preferred
          Stock. (3)

     4.4  Indenture  between PennCorp  Financial Group, Inc. and The Bank of New
          York, as trustee,  with respect to 9 1/4% Senior Subordinate Notes due
          2003. (8)

     10.1 Surplus  Debenture  Number Four in the  original  principal  amount of
          $162,539,890, issued by Pacific Life and Accident Insurance Company to
          PennCorp Financial Group, Inc., dated January 1, 1994. (7)

     10.2 Surplus  Debenture  Number Five in the  original  principal  amount of
          $17,606,203,  issued by Pacific Life and Accident Insurance Company to
          PennCorp Financial Group, Inc., dated September 29, 1994. (12)

     10.3 Surplus  Debenture  Number  Six in the  original  principal  amount of
          $55,000,000,  issued by Pacific Life and Accident Insurance Company to
          PennCorp Financial Group, Inc., dated July 24, 1996. (11)

     10.4 10% Promissory Note in the original  principal  amount of $30,661,996,
          issued by American-Amicable  Holdings Corporation to Pennsylvania Life
          Insurance Company, dated July 1, 1996. (11)

                             MANAGEMENT COMPENSATION
                               RELATED AGREEMENTS

          10.5 PennCorp Financial, Inc. Retirement and Savings Plan. (10)

          10.6 PennCorp Financial Group, Inc. Retirement and Savings Plan. (1)

          10.7 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (10)

          10.8 PennCorp  Financial Group, Inc. Senior  Management  Warrant Award
               Program. (10)

          10.9 Form  of  Restricted  Stock  Agreement  by and  between  PennCorp
               Financial Group, Inc. and certain  participants,  effective as of
               April 1, 1994. (6)

         10.10 Employment  Agreement between PennCorp  Financial Group, Inc. and
               David J. Stone entered into June 7, 1996. (11)

         10.11 Employment  Agreement between PennCorp  Financial Group, Inc. and
               Steven W. Fickes entered into June 7, 1996. (11)


                                      129

<PAGE>



         10.12 Amendment  Number One to Employment  Agreement  between  PennCorp
               Financial  Group,  Inc.  and David J. Stone dated April 28, 1997.
               (12)

         10.13 Amendment  Number One to Employment  Agreement  between  PennCorp
               Financial Group,  Inc. and Steven W. Fickes dated April 28, 1997.
               (12)

         10.14 Amendment  No.  2  to  Employment   Agreement   between  PennCorp
               Financial Group,  Inc. and David J. Stone entered into January 5,
               1998. (18)

         10.15 Amendment  No.  2  to  Employment   Agreement   between  PennCorp
               Financial  Group,  Inc. and Steven W. Fickes entered into January
               5, 1998. (18)

         10.16 Amendment  No. 3 to  Employment  Agreement  dated the 10th day of
               November,  1998 and effective as of the 21st day of August,  1998
               by and between PennCorp Financial Group, Inc. and David J. Stone.
               (21)

         10.17 Executive  Retention  Agreement  between Charles  Lubochinski and
               PennCorp Financial Group, Inc. (18)

         10.18 Schedule of similar Executive Retention Agreements. (18)

         10.19 PennCorp  Financial Group, Inc. 1996 Stock Award and Stock Option
               Plan. (11)

         10.20 Amendment  Number One to  PennCorp  Financial  Group,  Inc.  1996
               Stock Award and Stock Option Plan. (17)

         10.21 Amendment  Number Two to  PennCorp  Financial  Group,  Inc.  1996
               Stock Award and Stock Option Plan. (1)

         10.22 PennCorp  Financial  Group,  Inc.  1996 Senior  Executive  Annual
               Incentive Award Plan. (11)

         10.23 Amendment  Agreement  dated July 29, 1998 to Executive  Retention
               Agreement by and between  Michael  Prager and PennCorp  Financial
               Group, Inc. (21)

         10.24 Accommodation  Agreement  entered  into as of July 6, 1998 by and
               between PennCorp Financial Group, Inc. and David J. Stone. (21)

         10.25 Executive  Employment Agreement dated May 22, 1998 by and between
               PennCorp Financial Group, Inc. and James P. McDermott. (19)

         10.26 Executive  Retention  Agreement dated May 22, 1998 by and between
               PennCorp Financial Group, Inc. and James P. McDermott. (19)

         10.27 Executive  Employment Agreement dated May 22, 1998 by and between
               PennCorp Financial Group, Inc. and Scott D. Silverman. (19)

         10.28 Executive  Retention  Agreement dated May 22, 1998 by and between
               PennCorp Financial Group, Inc. and Scott D. Silverman. (19)

         10.29 Executive  Employment Agreement dated July 1, 1998 by and between
               PennCorp Financial Group, Inc. and Keith A. Maib. (19)

         10.30 Executive  Retention  Agreement dated July 1, 1998 by and between
               PennCorp Financial Group, Inc. and Keith A. Maib. (19)

         10.31 Letter  Agreement  dated  May 21,  1998 for  Option  to  Purchase
               Shares  of ACO  Brokerage  Holdings  Corporation  by and  between
               PennCorp Financial Group, Inc. and James P. McDermott. (1)


                                      130

<PAGE>



         10.32 Letter  Agreement  dated  May 21,  1998 for  Option  to  Purchase
               Shares  of ACO  Brokerage  Holdings  Corporation  by and  between
               PennCorp Financial Group, Inc. and Scott D. Silverman (1)

         10.33 Letter  Agreement  dated  May 21,  1998 for  Option  to  Purchase
               Shares  of ACO  Brokerage  Holdings  Corporation  by and  between
               PennCorp Financial Group, Inc. and Charles Lubochinski (1)

         10.34 Letter  Agreement  dated  May 21,  1998 for  Option  to  Purchase
               Shares  of ACO  Brokerage  Holdings  Corporation  by and  between
               PennCorp Financial Group, Inc. and Michael Prager (1)

    10.35 Conversion,  Standstill  and  Registration  Rights  Agreement  between
          United Companies  Financial  Corporation and PennCorp Financial Group,
          Inc. dated as of July 24, 1996. (11)

    10.36 Registration Rights Agreement dated as of August 2, 1996, by and among
          PennCorp Financial Group, Inc., Smith Barney Inc., Donaldson, Lufkin &
          Jenrette Securities  Corporation and Merrill Lynch,  Pierce,  Fenner &
          Smith Incorporated. (11)

    10.37 Credit Agreement dated March 12, 1997 by and among PennCorp  Financial
          Group,  Inc. and The Chase  Manhattan Bank, The First National Bank of
          Chicago,  and  NationsBank,  NA., as Managing  Agents,  Fleet National
          Bank,  Mellon Bank,  N.A.,  Bank of Montreal,  CIBC Inc., and Dresdner
          Bank AG, New York Branch and Grand Cayman  Branch as Co-Agents and The
          Bank of New York, as Administrative Agent. (13)

    10.38 Amendment  No.  1 and  Waiver  dated  as of June  13,  1997 to  Credit
          Agreement  dated as of March 12, 1997 by and among PennCorp  Financial
          Group, Inc., lenders signatory to the Credit Agreement and The Bank of
          New York. (19)

    10.39 Amendment  No.  2 and  Waiver  dated as of April  17,  1998 to  Credit
          Agreement  dated as of March 12, 1997 by and among PennCorp  Financial
          Group, Inc., lenders signatory to the Credit Agreement and The Bank of
          New York. (19)

    10.40 Waiver  dated as of August 14,  1998 to Credit  Agreement  dated as of
          March 12, 1997 by and among PennCorp  Financial Group,  Inc.,  lenders
          signatory to the Credit Agreement and The Bank of New York. (1)

    10.41 Amendment  No. 3 dated as of  September  11, 1998 to Credit  Agreement
          dated as of March 12,  1997 by and  among  PennCorp  Financial  Group,
          Inc.,  lenders  signatory to the Credit  Agreement and The Bank of New
          York. (20)

    10.42 Amendment  No. 4 and Waiver  dated as of  November  16, 1998 to Credit
          Agreement  dated as of March 12, 1997 by and among PennCorp  Financial
          Group, Inc., lenders signatory to the Credit Agreement and The Bank of
          New York. (22)

    10.43 Amendment  No. 5 dated as of  December  31,  1998 to Credit  Agreement
          dated as of March 12,  1997 by and  among  PennCorp  Financial  Group,
          Inc.,  lenders  signatory to the Credit  Agreement and The Bank of New
          York. (23)

    10.44 United Life Consent  Agreement  dated as of March 5, 1999 by and among
          PennCorp  Financial  Group,  Inc.,  lenders  signatory  to the  Credit
          Agreement dated as of March 12, 1997 and The Bank of New York. (24)

    10.45 Revision  Agreement,  dated as of May 30,  1997,  by and among  United
          Companies  Financial  Corporation,  PennCorp  Financial  Group,  Inc.,
          Pacific Life and Accident  Insurance Company and each additional party
          set forth on the signature pages thereto. (14)

    10.46 Amendment to Surplus  Debenture in the  original  principal  amount of
          $73,000,000  issued by  Pioneer  Security  Life  Insurance  Company to
          American-Amicable Holdings Corporation, dated May 17, 1996. (14)

    10.47 Second  Amendment  to  Surplus  Debenture  in the  original  principal
          amount  of  $73,000,000  issued by  Pioneer  Security  Life  Insurance
          Company to American-Amicable  Holdings Corporation,  effective January
          1, 1997. (14)


                                      131

<PAGE>



    10.48 Third Amendment to Surplus Debenture in the original  principal amount
          of $73,000,000  issued by Pioneer  Security Life Insurance  Company to
          American-Amicable Holdings Corporation, effective May 14, 1997. (14)

    10.49 Amendment to Surplus  Debenture Number Four in the original  principal
          amount of $162,539,890,  issued by Pacific Life and Accident Insurance
          Company to PennCorp Financial Group, Inc.,  effective January 1, 1997.
          (14)

    10.50 Second  Amendment  to Surplus  Debenture  Number Four in the  original
          principal amount of $162,539,890,  issued by Pacific Life and Accident
          Insurance Company to PennCorp Financial Group, Inc., effective May 14,
          1997. (14)

    10.51 Amendment to Surplus  Debenture Number Five in the original  principal
          amount of $17,606,203,  issued by Pacific Life and Accident  Insurance
          Company to PennCorp Financial Group, Inc.,  effective January 1, 1997.
          (14)

    10.52 Second  Amendment  to Surplus  Debenture  Number Five in the  original
          principal  amount of $17,606,203,  issued by Pacific Life and Accident
          Insurance Company to PennCorp Financial Group, Inc., effective May 14,
          1997. (14)

    10.53 Amendment to Surplus  Debenture  Number Six in the original  principal
          amount of $55,000,000,  issued by Pacific Life and Accident  Insurance
          Company to PennCorp Financial Group, Inc.,  effective January 1, 1997.
          (14)

    10.54 Second  Amendment  to Surplus  Debenture  Number  Six in the  original
          principal  amount of $55,000,000,  issued by Pacific Life and Accident
          Insurance Company to PennCorp Financial Group, Inc., effective May 14,
          1997. (14)

    10.55 Amendment  to  Surplus  Debenture  dated  December  14,  1995  in  the
          original  principal amount of $80,000,000  issued by Constitution Life
          Insurance Company to Southwestern Financial Corporation. (19)

    10.56 Amendment to Surplus  Debenture  dated January 1, 1996 in the original
          principal amount of $40,000,000  issued by Constitution Life Insurance
          Company to Southwestern Financial Corporation. (19)

    10.57 Note Purchase,  Release and Settlement Agreement, dated July 13, 1997,
          executed by Lone Star  Liquidating  Trust,  PennCorp  Financial Group,
          Inc. and Southwestern Financial Corporation . (15)

    10.58 Amended and Restated Assignment  Agreement dated as of January 2, 1998
          by and  between  PennCorp  Financial  Group,  Inc.  and  Knightsbridge
          Capital Fund I, L.P. (16)

    10.59 Amended and Restated Assignment  Agreement dated as of January 2, 1998
          by and between PennCorp Financial Group, Inc., David J. Stone,  Steven
          W. Fickes,  the Steven Wayne Fickes, Jr. Trust dated December 21, 1995
          and the Kathryn Elizabeth Fickes Trust dated December 21, 1995. (16)

    10.60 Agreement dated September 22, 1998 by PennCorp  Financial Group,  Inc.
          and certain  subsidiaries  signatory  to the  Agreement  and the Texas
          Department of Insurance. (21)

     12   Computation of ratio of earnings to fixed charges. (1)

     21   List of subsidiaries of the Registrant. (1)

     23.1 Auditors consent. (1)

     23.2 Auditors consent. (1)

     27   Financial Data Schedule. (1)

(1)  Filed herewith.


                                      132

<PAGE>



(2)  Such exhibit is  incorporated  by reference to the Form 8-K dated  November
     25, 1996,  which was filed with the Securities  and Exchange  Commission by
     PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the
     Amended and Restated Agreement and Plan of Merger with Washington  National
     Corporation.

(3)  Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-3  (Registration  No. 333- 13285) of PennCorp  Financial Group, Inc.
     filed with the Securities and Exchange Commission on October 10, 1996.

(4)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1995 of PennCorp  Financial  Group,
     Inc.

(5)  Such  exhibit is  incorporated  by reference to the Form 8-A dated July 11,
     1995 which was filed by PennCorp  Financial Group, Inc. with the Securities
     and Exchange Commission on July 12, 1995.

(6)  Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1994 of PennCorp  Financial
     Group, Inc.

(7)  Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1994 of PennCorp  Financial Group,
     Inc.

(8)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1993 of PennCorp  Financial  Group,
     Inc.

(9)  Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1992 of PennCorp  Financial  Group,
     Inc.

(10) Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-1  (Registration  No. 33-50530) of PennCorp  Financial  Group,  Inc.
     filed on August 6, 1992.

(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1996 of PennCorp  Financial  Group,
     Inc.

(12) Such exhibit is  incorporated  by  reference  to Amendment  Number 2 to the
     Annual  Report on Form 10-K for fiscal  year  ended  December  31,  1996 of
     PennCorp Financial Group, Inc.

(13) Such exhibit is  incorporated  by reference  to the  Amendment  Number 1 to
     Annual  Report on Form 10-K for the fiscal year ended  December 31, 1996 of
     PennCorp Financial Group, Inc.

(14) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1997 of PennCorp  Financial Group,
     Inc.

(15) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1997 of PennCorp  Financial
     Group, Inc.

(16) Such exhibit is incorporated by reference to the Form 8-K dated January 13,
     1998  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc.  on  January  13,  1998  relating  to the
     acquisition  of common  stock and common  stock  warrants  of  Southwestern
     Financial  Corporation not previously  owned by PennCorp  Financial  Group,
     Inc.

(17) Such exhibit is incorporated by reference to the Registration  Statement on
     Form S-8  (Registration  No.  333-48629) of PennCorp  Financial Group, Inc.
     filed on March 24, 1998.

(18) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
     for the fiscal year ended  December 31, 1997 of PennCorp  Financial  Group,
     Inc.

(19) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended June 30, 1998 of PennCorp  Financial Group,
     Inc.


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<PAGE>


(20) Such exhibit is  incorporated  by reference to the Form 8-K dated September
     15, 1998 which was filed with the  Securities  and Exchange  Commission  by
     PennCorp  Financial Group, Inc. on September 15, 1998 relating to Amendment
     No. 3 to Credit Agreement.

(21) Such exhibit is incorporated  by reference to the Quarterly  Report on Form
     10-Q for the three months ended  September  30, 1998 of PennCorp  Financial
     Group, Inc.

(22) Such exhibit is  incorporated  by reference to the Form 8-K dated  November
     17, 1998 which was filed with the  Securities  and Exchange  Commission  by
     PennCorp  Financial Group,  Inc. on November 17, 1998 relating to Amendment
     No. 4 and Waiver of Credit Agreement.

(23) Such exhibit is incorporated by reference to the Form 8-K dated January 11,
     1999  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc.  on  January  11,  1999  relating  to the
     acquisition of Pennsylvania Life Insurance Company, Union Bankers Insurance
     Company and related  entities,  the acquisition of  Professional  Insurance
     Company, and Amendment No. 5 to Credit Agreement.

(24) Such exhibit is  incorporated  by reference to the Form 8-K dated March 11,
     1999  which  was filed  with the  Securities  and  Exchange  Commission  by
     PennCorp  Financial  Group,  Inc. on March 11, 1999  relating to the United
     Life Consent Agreement by and among PennCorp  Financial Group, Inc. lenders
     signatory to the Credit  Agreement  dated as of March 12, 1997 and The Bank
     of New York.


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