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

                                       FORM 10-K/A
                                     Amendment No. 1

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

                       For the fiscal year ended December 31, 1998

                              Commission File Number 1-11422

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

               Delaware                               13-3543540
    (State or other jurisdiction of
    incorporation or organization          (I.R.S. employer identification no.)

c/o Southwestern Financial Services Corporation          75201
       717 North Harwood Street                       (Zip code)
             Dallas, Texas
(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.

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                                            1


<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' 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                                  46
      Item 8.  Financial Statements and Supplementary Data                  51
      Item 9.  Changes in and Disagreements with Accountants on
               Accounting and Financial Disclosure                         120

PART III

      Item 10  Directors and Executive Officers of the Registrant          120
      Item 11  Executive Compensation                                      120
      Item 12  Security Ownership of Certain Beneficial Owners and
               Management                                                  120
      Item 13  Certain Relationships and Related Transactions              120

PART IV

      Item 14  Exhibits, Financial Statement Schedules, and Reports on
               Form 8-K                                                    121



                                      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 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


                                      3


<PAGE>



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."

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).

                                      4


<PAGE>



      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.

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

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

                                      5


<PAGE>



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

                                              ANNUALIZED PREMIUM IN FORCE
                                                  AS OF DECEMBER 31,
                                          -------------------------------------
                                                   ($ in thousands)
                                                                       Pro forma
   INSURANCE PRODUCT TYPE                   1996      1997      1998    1998(1)
   ----------------------                 --------  --------  -------- ---------

   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.

      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.

      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.


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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:

                  Guaranteed Minimum            Funds Under
                   Crediting Rate               Management
                  ------------------          ---------------
                                              ($ in millions)

                  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
                                                =========

      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 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

                                      7


<PAGE>



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.

      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.

                                      8


<PAGE>



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

                  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%
                                          ========        =====

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>


                                      9


<PAGE>



      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 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:

                                                                   Pro forma
   PAYROLL SALES DIVISION                  1996     1997     1998     1998
   ----------------------                -------  -------  -------  -------
                                                   ($ in thousands)
   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

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

                                                                    Pro forma
   INSURANCE PRODUCT TYPE                  1996     1997     1998     1998
   ----------------------                -------  -------  -------  -------
                                                    ($ in millions)

   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
                                         =======  =======  =======  =======


                                      10


<PAGE>



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

                                                                   Pro forma
   INSURANCE PRODUCT TYPE                  1996     1997     1998     1998
   ----------------------                -------  -------  -------  -------

   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

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."

      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.

                                      11


<PAGE>



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

                                                      1996      1997     1998
                                                    --------  -------  -------
                                                            ($ in thousands)
   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

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

   INSURANCE PRODUCT TYPE                           1996     1997     1998
   ----------------------                          ------   ------   ------
                                                        ($ in millions)

   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
                                                   ======   ======   ======

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

   INSURANCE PRODUCT TYPE                           1996     1997     1998
   ----------------------                          ------   ------   ------

   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

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.

                                      12


<PAGE>



      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  (including total invested assets and
cash and cash  equivalents),  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 accounted for
approximately 84.1% 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.

      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
      Other investments.............     17,480        18,762        18,762        0.6
                                     ----------    ----------    ----------      -----
        Total invested assets.......  2,804,754     2,866,010     2,863,527       96.9%
      Cash and cash equivalents.....     92,727        92,727        92,727        3.1
                                     ----------    ----------    ----------      -----
        Total investment portfolio.. $2,897,481    $2,958,737    $2,956,254      100.0%
                                     ==========    ==========    ==========      =====
</TABLE>

      --------------
     (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).

                                      13


<PAGE>



      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:

                                                               Percent of
                                                     Total        Total
                                                   Carrying     Carrying
              Rating                                Value         Value
              ------                              ----------   ----------
                                                      ($ in thousands)

              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).

      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 investment
     portfolio(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%
</TABLE>
     --------------
(1)  Consists of total  investment  portfolio,  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.

      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

                                      14


<PAGE>



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.

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


<PAGE>



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.

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.


<PAGE>



      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.

      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,


<PAGE>



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  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


<PAGE>



      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.

      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.


<PAGE>



      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  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,  principally the less than expected level of
the lapses currently associated with such interest sensitive blocks of business,
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.  A decrease  of 1% in the  assumed  lapse rate would
increase policy reserves  associated with such contracts by  approximately  $9.0
million.  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.

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.


<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.




<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:

                                                SALES PRICE      DIVIDEND
         FOR THE YEAR ENDED DECEMBER 31, 1998   HIGH      LOW    DECLARED
         ------------------------------------  ------   ------   --------
         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

                 (Remainder of Page Intentionally Left Blank)




<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
                                          ==========    ========    ========    ========    ========
</TABLE>

(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.

<TABLE>
<CAPTION>
<S>                                       <C>           <C>           <C>           <C>           <C>
Per Share Information:
Basic:
  Net income (loss) applicable to
    common stock.................         $   (15.23)   $     1.09    $     2.70    $     2.26    $     1.95
  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.................             (15.23)   $     1.07     $    2.42     $    2.12    $     1.88
  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
                                          ==========    ==========    ==========    ==========    ==========
</TABLE>

(2) During 1995, the Company  incurred  restructuring  charges  aggregating $3.9
    million.


<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  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.


<PAGE>



      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.  The Company has  developed  restructuring
plans to realign or consolidate  certain  operations  resulting in restructuring
costs incurred  during the fourth quarter of 1998, the first quarter of 1998 and
1997. The  restructuring  was necessary as a result of the tremendous  growth of
the Company and the resulting diversification of the underlying businesses.

4th Quarter 1998 Plan

      The Company  recorded in the fourth  quarter of 1998  restructuring  costs
aggregating   approximately  $9.3  million  as  a  result  of  the  decision  to
consolidate or merge substantially all of the Company's corporate functions into
the Dallas infrastructure.

      The following  reflects the impact of activity for the year ended December
31, 1998 on the  restructuring  accrual balances under the 4th Quarter 1998 Plan
(in thousands):


<PAGE>



                                                    1998 Activities
                                                ----------------------
                                                Paid or
                                                Charged                   1998
                                       1998     Against                  Ending
                                     Provision  Liability  Adjustments   Balance
                                     ---------  ---------  -----------   -------

  Severance and related benefits...  $  6,259   $  (3,985) $      --     $ 2,274
  Estimated holding costs of
    vacated facilities.............     2,954      (2,954)        --         --
  Estimated contract terminations
    costs..........................        61         (29)        --         32
                                     ---------  ---------  -----------   -------
                                     $  9,274   $  (6,968) $      --     $ 2,306
                                     =========  =========  ===========   =======

      The fourth quarter 1998 plan provided for the  termination of 43 employees
including substantially all of the executive and administrative employees in the
Company's Bethesda and New York offices,  based on the decision to shut down the
Bethesda  and New York  offices  by May 31,  1999.  It is  anticipated  that all
severance  will be paid by September  30, 1999 with the  exception of one former
executive  officer whose severance will be paid monthly  through  December 2003.
The Company had incurred  costs of $4.0 million  which were charged  against the
accrual during 1998 for terminated employees.

      The fourth quarter 1998 plan recognized  abandoned  leasehold  improvement
costs in connection  with the Company's  plan to shut down the New York offices.
The Company expensed $3.0 million  principally as a result of abandoning the New
York leased property.

      The  fourth  quarter  1998  restructuring  plan is  expected  to result in
corporate  operating expense  reductions and cash savings of approximately  $4.2
million annually.

1st Quarter 1998 Plan

      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 $11.8 million for the year ended
December 31, 1998, associated with the divisional restructuring.

      The following  reflects the impact of activity for the year ended December
31, 1998 on the  restructuring  accrual balances under the 1st Quarter 1998 Plan
(in thousands):

                                                    1998 Activities
                                                ----------------------
                                                Paid or
                                                Charged                   1998
                                       1998     Against                  Ending
                                     Provision  Liability  Adjustments   Balance
                                     ---------  ---------  -----------   -------
  Severance and related benefits...  $   3,831  $  (4,417) $     1,205   $   619
  Estimated holding costs of
    vacated facilities.............      2,205         --           --     2,205
  Write-off of certain fixed assets      1,131       (831)        (300)       --
  Estimated contract terminations
    costs..........................      4,600     (3,247)      (1,353)       --
                                     ---------  ---------  -----------   -------
                                     $  11,767  $  (8,495) $      (448)  $ 2,824
                                     =========  =========  ===========   =======

      Approximately  120  and 39  people,  respectively,  were  estimated  to be
terminated,  as a result of the  decision to transfer  all  operations  of Union
Bankers to Raleigh and  transfer  operations  of United Life from Baton Rouge to
Dallas.  In addition,  the Company also  restructured the operations in Raleigh.
Certain  employees in the areas of customer  services,  information  technology,
actuarial, legal, human resources and other policyholder service areas, totaling
54 people were  considered  for  termination  under the  Raleigh  portion of the
restructuring  plan.  The  Company  recognized  severance  costs  totaling  $3.8
million.  The Company charged $4.4 million against the severance  accrual during
1998 as the result of termination payments. In addition, during 1998 the Company
increased the  severance  accrual by $1.6 million as a result of the decision to
terminate all 54 of Security Life's remaining Raleigh  employees.  This increase
was partially  offset in the amount of $405,000,  due to the Company paying less
severance  costs as a result of  natural  attrition  and other  factors  such as
inter-company transfers of employees.

      The first quarter 1998  restructuring  plan provided for vacating  certain
Dallas office space. In connection with the plan, the Company recorded estimated
holding costs of vacated  facilities of $2.2 million which  represented  the net
present value of the rent on the office space to be vacated net of the estimated
sublease rent to be received.


<PAGE>



      The  first  quarter  1998  plan  also  recognized  impairment  of  certain
furniture, fixture and data processing equipment totaling $1.1 million which had
been utilized in the office space to be vacated. The Company charged $831,000 of
such assets against the accrual during 1998.

      As  part  of the  first  quarter  1998  restructuring  plan,  the  Company
terminated  an  information  technology  outsourcing  agreement.   The  original
contract  termination  fee was $4.6 million.  As a result of an amendment to the
termination  agreement,  the Company  exited the agreement for a payment of $3.2
million and the remaining accrual was adjusted during 1998.

1997 Plan

      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 $19.1 million during
the year ended December 31, 1997,  directly and indirectly  associated  with the
initial divisional restructuring which had no future economic benefit.

      The following reflects the impact of activity for the years ended December
31, 1997 and 1998 on the restructuring  accrual balances under the 1997 plan (in
thousands):
<TABLE>
<CAPTION>

                                            1997 Activities                     1998 Activities
                                        -----------------------             -----------------------
                                         Paid or                             Paid or
                                         Charged                   1997      Charged                   1998
                               1997      Against                  Ending     Against                  Ending
                            Provision   Liability   Adjustments   Balance   Liability   Adjustments   Balance
                            ---------   ---------   -----------   -------   ---------   -----------   -------
<S>                         <C>         <C>         <C>           <C>       <C>         <C>           <C>
Severance and related
  benefits..............    $   5,355   $  (2,411)  $    (1,008)  $ 1,936   $      --   $    (1,936)  $    --
Estimated holding costs of
  vacated facilities....        6,166      (1,916)           --     4,250        (841)       (3,409)       --
Write-off of certain
  fixed assets..........        1,526        (332)         (847)      347          --          (347)       --
Estimated contract
  termination costs.....           24          --            --        24          --           (24)       --
Investment in foreign
  operations............        6,000      (5,555)         (445)       --          --             --       --
                            ---------   ---------   -----------   -------   ---------   -----------   -------
                            $  19,071   $ (10,214)  $    (2,300)  $ 6,557   $    (841)  $    (5,716)  $    --
                            =========   =========   ===========   =======   =========   ===========   =======
</TABLE>

      The 1997 plan provided for the termination of approximately  269 employees
in  the  Company's   Raleigh   offices  and  certain   foreign   operations  and
substantially  all of the employees of the Company's Waco  operations,  totaling
114. The 1997 plan anticipated a significant consolidation of operations into an
affiliate's  Dallas offices over a twelve month period. As of December 31, 1997,
the Company had  charged  $2.4  million  against the accrual for  severance  and
related benefits.  The Company adjusted the remaining  severance accrual by $1.0
million  during  1997  due to  natural  attrition  thus  reducing  the  level of
severance  required  coupled  with the  decision  to  retain  certain  employees
indefinitely.  As of December 31, 1997,  the severance  accrual was $1.9 million
which was  adjusted  during  1998 as a result of the  decision  not to merge the
Company's Waco operations into Dallas.

      The plan also  provided  for  vacating of certain  leased  facilities  and
abandoning  certain Company owned real estate.  The Company accrued $6.2 million
for holding and abandonment costs associated with these facilities. During 1997,
the Company  charged $1.9 million to such accrued lease costs.  During 1998, the
Company further charged  $841,000 to the accrued costs. As of December 31, 1998,
the  remaining  accrual was no longer  necessary  as a result of the decision to
retain the Waco operating platform.

      In addition, the 1997 plan recognized the impairment of certain furniture,
fixture  and data  processing  equipment  of $1.5  million  as a  result  of the
decision to abandon certain Company owned and leased facilities. During 1998 and
1997, the Company charged off furniture,  fixtures and data processing equipment
totaling $-- and $332,000,  respectively,  and adjusted the original  impairment
provision by $347,000 and $847,000, respectively.

      Contract termination costs provided in the 1997 plan were adjusted to zero
during 1998 as a result of the ultimate  settlement of certain contracts without
penalty.

      Restructuring  charges  in the 1997  plan  also  included  a $6.0  million
provision  for the  write-off of the  Company's  investment  in certain  foreign
operations,  principally Argentina. In 1997, the Company disposed of the foreign
operations at a cost of $5.6 million and the balance of $449,000 was adjusted to
zero.


<PAGE>



Other Costs

      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  Consolidated  Statements of Operations  and
Comprehensive Income (Loss) 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 $7.6
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 impairment
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  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


<PAGE>



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 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.


<PAGE>



      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 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.


<PAGE>



      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.

      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").


<PAGE>



      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.

      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.  With the  consummation of the March 31, 1999 amendment,  the Company
and its  subsidiaries  were in  compliance  with all  applicable  covenants,  as
amended at December 31, 1998. Should the sale transactions not close within


<PAGE>



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
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.


<PAGE>



     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 and realized a loss of $28,000.

      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  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)").  The Company considers operating income (loss) to reflect a division's
"core  earnings  (loss)" and to be the most relevant and useful  information  to
evaluate trends impacting each of the Company's  divisions.  This information is
used by the Company's  principal  decision makers to evaluate the performance of
each  division  as it  eliminates  the impact of  transactions  that the Company
considers to be unrelated to the core operating results of the divisions.  Other
companies that operate  primarily in the life insurance  industry may or may not
use similar  measures.  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.


<PAGE>



      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

                                                    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)         --         --
   Eliminate effects of including acquisition
     of the SW Financial Controlling  Interest
     and the Fickes and Stone Knightsbridge
     Interests as though each had occurred
     on January 1, 1996......................        --      (49,816)   (41,490)
                                               ---------   ---------  ---------
                                                  20,906      32,587     40,003
                                               ---------   ---------  ---------
  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)         --         --
   Eliminate effects of including acquisition
     of the SW Financial Controlling Interest
     and the Fickes and Stone Knightsbridge
     Interests as though each had occurred on
     January 1, 1996.........................         --      (7,717)   (23,755)
                                               ---------   ---------  ---------
                                                (354,858)     47,481     64,434
                                               ---------   ---------  ---------
  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)        --
   Eliminate effects of including acquisition
     of the SW Financial Controlling Interest
     and the Fickes and Stone Knightsbridge
     Interests as though each had occurred on
     January 1, 1996.........................        --       24,126     19,911
                                               ---------   ---------  ---------
                                                 (87,912)    (55,139)   (16,478)
                                               ---------   ---------  ---------

  Income (loss) before income taxes and
    extraor$inary charge.....................  $(424,628)  $  51,543  $ 110,579
                                               =========   =========  =========




<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

                                                  Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               --------- ---------  ---------
                                                         ($ in thousands)
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
                                               ========= =========  =========

      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>

      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


<PAGE>



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:

                                                  Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               --------- ---------  ---------
                                                         ($ in thousands)

  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
                                               ========= =========  =========

      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 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, principally the less than expected level of


<PAGE>



the lapses currently associated with such interest sensitive blocks of business,
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.  A decrease  of 1% in the  assumed  lapse rate would
increase policy reserves  associated with such contracts by  approximately  $9.0
million.  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 of future
interest rates, lapses, expenses and mortality which effect the estimated 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  of future  interest  rates,  lapses and mortality  which effect the
estimated  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.


<PAGE>



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.

                   SELECTED PRO FORMA FINANCIAL INFORMATION

                                                  Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               --------- ---------  ---------
                                                         ($ in thousands)
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
                                               =========  ========  =========

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

                                                  Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               --------- ---------  ---------
                                                         ($ in thousands)
  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
                                               ========= =========  =========

      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


<PAGE>



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.

      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:

                                                   Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               --------- ---------  ---------
                                                         ($ in thousands)

  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
                                               ========= =========  =========

      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 of future interest rates, lapses,  expenses
and mortality which effect the estimated 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 of future  interest rates,  lapses,  expenses
and mortality which effects the estimated 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


<PAGE>



programs.  United Life principally  markets fixed and variable annuities through
financial institutions and independent general agents, primarily in the southern
and western United States.

                   SELECTED PRO FORMA FINANCIAL INFORMATION

                                                  Year ended December 31,
                                               ------------------------------
                                                 1998       1997      1996
                                               ---------  --------  ---------
                                                         ($ in thousands)
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
                                               =========  ========  =========

      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  has been  closely  monitoring  the  development  of its claim
reserve  experience  associated with the Career Sales  Division.  The historical
method of establishing claims reserves  principally utilized claims lag factors.
Based on results of independent calculations of the claim lag factors, performed
annually, this methodology indicated a deterioration


<PAGE>



in the adequacy of claim reserves  associated with Penn Life's disability income
products  underwritten  prior to PennCorp's  ownership of Penn Life.  Disability
claim  adequacy  analysis  included  statutory  claim  information,  independent
third-party  review of claim lag  method  and  factors  and other  claim  tests.
Previous  results  indicated no reason to consider a new  methodology as results
appeared  consistent between periods and claim reserves appeared adequate.  Once
results of such  analysis  began to vary outside an  acceptable  tolerance,  the
Company reviewed its methods to determine the reasons for the variances.

      The lag factor method (an actuarial  method to estimate  aggregate  claims
reserves  which  utilizes the ratio of actual  claims paid to what is ultimately
paid as a  function  of time  since  the date  incurred  based  upon  historical
experience) is one method which utilized Penn Life's experience  considering its
products and market.  The Company  believes  that  available  industry  data for
establishing  claim reserves was not  appropriate  for Penn Life's  products and
market.  The  utilization  of a case reserve method (which  estimates  aggregate
claims reserves based on the total estimates of all cases  outstanding) for Penn
Life required experience, in addition to that utilized by the lag factor method,
to create case reserves based on Penn Life's experience. This experience was not
sufficient until recently.  With recent system  upgrades,  Penn Life was able to
obtain  better  benefit  data  distinguishing  disability  benefits  from  other
benefits  which may be payable  under the same  policy  form.  With the  systems
upgrades  and more  robust  experience  the  Company was able to consider a more
refined  claims  methodology  such as seriatim  case reserves  (which  estimates
aggregate  claims  reserves based upon the sum of estimates for each  individual
unsettled case).  During 1998, Penn Life implemented a method which  substituted
case reserves for most disability  claims. The new method utilizes more detailed
information  by  policy  and by line of  business  resulting  in a more  refined
estimate.  As a result,  the  accident  and health  claim  reserve for Penn Life
increased by $25.7 million  during 1998. The effect of the change in methodology
is  inseparable  from the effect of the  change in  accounting  estimate  and is
accordingly  reflected in operations  for the year ended  December 31, 1998. 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 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.


<PAGE>



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.

      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.


<PAGE>



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  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.


<PAGE>



      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  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.  Convexity  is a  measure  of the  responsiveness  of the price of a
security  to  changes  in yields  and is  normally  a  positive  attribute  of a
portfolio.  The Company manages the portfolio  convexity risk within the context
of  the  overall  asset  and   liability   model  and  the   quantification   of
disintermediation  risk.  Generally,  disintermediation  risk is a risk that net
cash  outflows  may  occur  at a time  when  the  sale  of  assets  can  only be
accomplished  at  undesirable  prices.  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


<PAGE>



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.

      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.


<PAGE>



      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 1.3% 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.


<PAGE>



Item 8.Financial Statements and Supplementary Data

                                                                  Page

            Management's Responsibility for Financial Statements.  52

            PennCorp Financial Group, Inc. and Subsidiaries......  54

            Southwestern Financial Corporation and Subsidiaries..  97




<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




<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


<PAGE>

<TABLE>


                PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
     CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                   (In thousands, except per share amounts)

<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
                                                  ==========   ========   ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements


<PAGE>


<TABLE>

                PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                     (In thousands, except share amounts)
<CAPTION>

                                                                   As of December 31,
                                                                ------------------------
                                                                   1998          1997
                                                                ----------    ----------
<S>                                                             <C>           <C>
ASSETS:
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
  Other investments........................................         27,406        95,875
                                                                ----------    ----------
  Total investments ......................................       2,863,527     3,231,101
Cash and cash equivalents..................................         92,727       109,013
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 (including cash and
  cash equivalents of $131,531)............................      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


<PAGE>

<TABLE>


                PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
          CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                (In thousands)
<CAPTION>
                                                For the years ended December 31,
                                                --------------------------------
                                                    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


<PAGE>


<TABLE>

                PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (In thousands)
<CAPTION>
                                                                    For the years ended December 31,
                                                                  -----------------------------------
                                                                     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 cash equivalents at beginning of year...................     109,013     102,577     444,731
                                                                  -----------   ---------   ---------
Cash and cash equivalents at end of year (including $131,531 of
  cash and cash equivalents 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


<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


<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.

Cash and Cash Equivalents

      Cash and  cash  equivalents  include  cash on hand  and  investments  with
original maturities of three months or less.

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."


<PAGE>



      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.

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.


<PAGE>



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  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.


<PAGE>



      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 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


<PAGE>



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.

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


<PAGE>



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 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.


<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)




<PAGE>



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

                                                 1998      1997       1996
                                               --------   --------   --------
   Total revenues:
      Segments--premiums and policy product
        charges..............................  $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
                                              ==========  ==========  ==========

(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
                                                 ==========   ==========    ==========   ==========



<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>




<PAGE>



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

                                                Amortized      Fair
                                                  Cost         Value
                                               ----------   ----------


        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
                                               ==========   ==========

      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:

                                                               Percent of Total
                                             Carrying Value     Carrying Value
                                             --------------    ----------------
         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%
                                                =======            =====

      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.


<PAGE>



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

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

      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
maturity  available for sale as of April 1, 1997.  In  accordance  with SFAS No.
115, the Company  adjusted all  transferred  assets to fair value resulting in a
net increase in shareholders'  equity of $1,800, net of applicable income taxes.
During 1996, the Company sold one security in its held for investment  portfolio
aggregating $4,900 as a result of a dramatic  deterioration in its credit rating
and realized a loss of $28.

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

                                                    1998     1997     1996
                                                  --------  --------  --------
   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
   Cash and cash equivalents....................     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
                                                  ========  ========  ========




<PAGE>



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

                                                      Amortized   Fair
                                                        Cost      Value
                                                      ---------  -------
      Fixed maturities.............................   $  6,762   $   605
      Mortgage loans...............................      5,018     5,018
      Other investments............................      6,630     6,630
                                                      ---------  -------
                                                      $ 18,410   $12,253
                                                      =========  =======

(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)




<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:

                               For the years ended

                                  December 31,

                                                         1997         1996
                                                      ----------   ----------
      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
                                                                   ==========




<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:

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

     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
                                                 =========   ========  ========

      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.

      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 utilizing  expected future cash
flows.  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.


<PAGE>



      Information  related  to the  present  value of  insurance  in force is as
follows:

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

     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,  principally the less than expected level of the lapses
currently  associated with such interest  sensitive blocks, 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.  A decrease of 1% in the assumed  lapse rate would  increase  policy
reserves associated with such contracts by approximately  $9,000.  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  threat  of  litigation.  The  Company  is
continuing to refine its actuarial estimates, likely management action plans and
associated sensitivity testing of such


<PAGE>



interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.

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

                                                          1998        1997
                                                      ----------   ----------
      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
                                                      ==========   ==========

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

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

      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 its claim
reserve  experience  associated with the Career Sales  Division.  The historical
method of establishing claims reserves  principally utilized claims lag factors.
Based on results of independent calculations of the claim lag factors, performed
annually,  this  methodology  indicated a deterioration in the adequacy of claim
reserves  associated with Penn Life's  disability  income products  underwritten
prior to PennCorp's  ownership of Penn Life.  Disability claim adequacy analysis
included  statutory claim information,  independent  third-party review of claim
lag method and factors and other claim  tests.  Previous  results  indicated  no
reason to consider a new


<PAGE>



methodology as results  appeared  consistent  between periods and claim reserves
appeared  adequate.  Once  results  of such  analysis  began to vary  outside an
acceptable tolerance,  the Company reviewed its methods to determine the reasons
for the variances.

      The lag factor method (an actuarial  method to estimate  aggregate  claims
reserves  which  utilizes the ratio of actual  claims paid to what is ultimately
paid as a  function  of time  since  the date  incurred  based  upon  historical
experience) is one method which utilized Penn Life's experience  considering its
products and market.  The Company  believes  that  available  industry  data for
establishing  claim reserves was not  appropriate  for Penn Life's  products and
market.  The  utilization  of a case reserve method (which  estimates  aggregate
claims reserves based on the total estimates of all cases  outstanding) for Penn
Life required experience, in addition to that utilized by the lag factor method,
to create case reserves based on Penn Life's experience. This experience was not
sufficient until recently.  With recent system  upgrades,  Penn Life was able to
obtain  better  benefit  data  distinguishing  disability  benefits  from  other
benefits  which may be payable  under the same  policy  form.  With the  systems
upgrades  and more  robust  experience  the  Company was able to consider a more
refined  claims  methodology  such as seriatim  case reserves  (which  estimates
reserves based upon the sum of estimates for each  individual  unsettled  case).
During 1998, Penn Life implemented a method which  substituted case reserves for
most disability  claims.  The new method  utilizes more detailed  information by
policy  and by line of  business  resulting  in a more  refined  estimate.  As a
result, the accident and health claim reserve for Penn Life increased by $25,691
during 1998. The effect of the change in  methodology  is  inseparable  from the
effect of the change in  accounting  estimate  and is  accordingly  reflected in
operations for the year ended December 31, 1998.

(9) NOTES PAYABLE

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

                                                        1998       1997
                                                      --------   --------
     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
                                                      ========   ========

     --------------
     (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.

      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.
With the consummation of the amendment, the Company and its subsidiaries were in
compliance  with all applicable  covenants,  as amended at December 31, 1998. 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


<PAGE>



     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 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.


<PAGE>



      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
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:

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




<PAGE>



      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:

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

      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:

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

   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
                                                  =========   =======  =======

      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


<PAGE>



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 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.


<PAGE>



(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:

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

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

(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.


<PAGE>



      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 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.


<PAGE>



(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.

      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>




<PAGE>



      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)




<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>



<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:

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

   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

      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).


<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:

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

        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
                                                      ========   =======

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

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

        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
                                                      ========   =======



<PAGE>



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

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

        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
                                                      ========   =======

      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:

                                                           One           One
                                                        Percentage    Percentage
                                                          Point         Point
                                                         Increase      Decrease
                                                        ----------    ----------

      Effect on total of service and interest cost
        components...................................     $  121       $  (104)
      Effect on postretirement benefit obligation....      1,544        (1,331)

(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..............................  $1,842,749
            Insurance assets.............................     329,950
            Other assets.................................     249,105
                                                           ----------
              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  to reduce  costs in  excess  of net  assets
acquired 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 costs in excess of
net assets acquired for the Career Sales Division,  Professional  and the United
Life Assets were $100,138, $3,263 and $11,113,  respectively. To the extent that
additional  impairment  was  necessary,  as was the  case for the  Career  Sales
Division, the Company reduced other intangible assets in accordance with APB No.
17. As a result,  the Company  fully  impaired the present value of insurance in
force and deferred policy  acquisition costs resulting in charges of $98,164 and
191,595,  respectively,  net of related deferred taxes of $95,137. Additionally,
the Company  established  a  liability  aggregating  $33,824  for the  remaining
impairment as a result of all monetary assets of the Career Sales Division being
recorded at fair  value.  The Company  will  continue to evaluate  the terms and
conditions of the definitive agreements relative


<PAGE>



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.

(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.

                                                                     (Unaudited)
                                                        As Reported   Pro Forma
                                                            1998         1998
                                                        -----------  -----------
                                                         (In thousands, except
                                                           per share amounts)

      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)


                                                                     (Unaudited)
                                                        As Reported   Pro Forma
                                                            1997         1997
                                                        -----------  -----------
                                                         (In thousands, except
                                                           per share amounts)

      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)

(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.


<PAGE>



      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.

      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.



<PAGE>



      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  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").


<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


<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



<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:

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

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

(21) RESTRUCTURING AND OTHER COSTS

      The Company has developed  restructuring  plans to realign or  consolidate
certain operations  resulting in restructuring  costs incurred during the fourth
quarter of 1998,  the first  quarter  of 1998 and 1997.  The  restructuring  was
necessary as a result of the tremendous  growth of the Company and the resulting
diversification of the underlying businesses.

4th Quarter 1998 Plan

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

      The following  reflects the impact of activity for the year ended December
31, 1998 on the restructuring accrual balances under the 4th Quarter 1998 Plan:

<TABLE>
<CAPTION>
                                                        1998 Activities
                                                    -----------------------
                                                     Paid or
                                                     Charged                   1998
                                          1998       Against                  Ending
                                        Provision   Liability   Adjustments   Balance
                                        ---------   ---------   -----------   -------

<S>                                     <C>         <C>         <C>           <C>
  Severance and related benefits...     $   6,259   $  (3,985)  $      --     $ 2,274
  Estimated holding costs of
     vacated facilities............         2,954      (2,954)         --          --
  Estimated contract terminations
     costs.........................            61         (29)         --          32
                                        ---------   ---------   ---------     -------
                                        $   9,274   $  (6,968)  $      --     $ 2,306
                                        =========   =========   =========     =======
</TABLE>


      The fourth quarter 1998 plan provided for the  termination of 43 employees
including substantially all of the executive and administrative employees in the
Company's Bethesda and New York offices, based on the Company's decision to shut
down the Bethesda and New York offices by May 31, 1999. It is  anticipated  that
all  severance  will be paid by  September  30, 1999 with the  exception  of one
former  executive  officer whose severance will be paid monthly through December
2003.  The Company had incurred  costs of $3,985 which were charged  against the
accrual during 1998 for terminated employees.

      The fourth quarter 1998 plan recognized  abandoned  leasehold  improvement
costs in connection  with the Company's  plan to shut down the New York offices.
The Company  expensed $2,954  principally as a result of abandoning the New York
leased property.


<PAGE>



1st Quarter 1998 Plan

      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, associated with the divisional restructuring.

      The following  reflects the impact of activity for the year ended December
31, 1998 on the restructuring accrual balances under the 1st Quarter 1998 Plan:

<TABLE>
<CAPTION>
                                                        1998 Activities
                                                    -----------------------
                                                     Paid or
                                                     Charged                   1998
                                          1998       Against                  Ending
                                        Provision   Liability   Adjustments   Balance
                                        ---------   ---------   -----------   -------
<S>                                     <C>         <C>         <C>           <C>

  Severance and related benefits...     $   3,831   $  (4,417)   $   1,205    $   619
  Estimated holding costs of
    vacated facilities.............         2,205          --           --      2,205
  Write-off of certain fixed assets         1,131        (831)        (300)        --
  Estimated contract terminations
    costs..........................         4,600      (3,247)      (1,353)        --
                                        ---------   ---------    ---------   --------
                                        $  11,767   $  (8,495)   $    (448)  $  2,824
                                        =========   =========    =========   ========
</TABLE>

      Approximately  120  and 39  people,  respectively,  were  estimated  to be
terminated,  as a result of the  decision to transfer  all  operations  of Union
Bankers to Raleigh and  transfer  operations  of United Life from Baton Rouge to
Dallas.  In addition,  the Company also  restructured the operations in Raleigh.
Certain  employees in the areas of customer  services,  information  technology,
actuarial, legal, human resources and other policyholder service areas, totaling
54 people were  considered  for  termination  under the  Raleigh  portion of the
restructuring plan. The Company recognized  severance costs totaling $3,831. The
Company  charged $4,417 against the severance  accrual during 1998 as the result
of  termination  payments.  In addition,  during 1998 the Company  increased the
severance  accrual by $1,610 as a result of the decision to terminate  all 54 of
Security Life's remaining Raleigh employees.  This increase was partially offset
in the amount of $405,  due to the  Company  paying  less  severance  costs as a
result of natural attrition and other factors such as inter-company transfers of
employees.

      The first quarter 1998  restructuring  plan provided for vacating  certain
Dallas office space. In connection with the plan, the Company recorded estimated
holding costs of vacated  facilities of $2,205 which represented the net present
value  of the  rent on the  office  space  to be  vacated  net of the  estimated
sublease rent to be received.

      The  first  quarter  1998  plan  also  recognized  impairment  of  certain
furniture,  fixture and data processing equipment totaling $1,131 which had been
utilized in the office  space to be vacated.  The Company  charged  $831 of such
assets against the accrual during 1998.

      As  part  of the  first  quarter  1998  restructuring  plan,  the  Company
terminated  an  information  technology  outsourcing  agreement.   The  original
contract  termination  fee  was  $4,600.  As a  result  of an  amendment  to the
termination agreement,  the Company exited the agreement for a payment of $3,247
and the remaining accrual was adjusted during 1998.

1997 Plan

      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.


<PAGE>



      The following reflects the impact of activity for the years ended December
31, 1997 and 1998 on the restructuring accrual balances under the 1997 plan:
<TABLE>
<CAPTION>

                                              1997 Activities                     1998 Activities
                                          -----------------------             -----------------------
                                           Paid or                             Paid or
                                           Charged                   1997      Charged                   1998
                                 1997      Against                  Ending     Against                  Ending
                              Provision   Liability   Adjustments   Balance   Liability   Adjustments   Balance
                              ---------   ---------   -----------   -------   ---------   -----------   -------
<S>                           <C>         <C>          <C>          <C>        <C>         <C>          <C>

Severance and related
  benefits..............      $   5,355   $  (2,411)   $(1,008)     $ 1,936    $   --      $(1,936)     $   --
Estimated holding costs of
  vacated facilities....          6,166      (1,916)        --        4,250      (841)      (3,409)         --
Write-off of certain
  fixed assets..........          1,526        (332)      (847)         347        --         (347)         --
Estimated contract
  termination costs.....             24          --         --           24        --          (24)         --
Investment in foreign
  operations............          6,000      (5,555)      (445)          --        --           --          --
                                -------    --------    -------      -------    ------      -------      ------
                                $19,071    $(10,214)   $(2,300)     $ 6,557    $ (841)     $(5,716)     $   --
                                =======    ========    =======      =======    ======      =======      ======
</TABLE>


      The 1997 plan provided for the termination of approximately  269 employees
in  the  Company's   Raleigh   offices  and  certain   foreign   operations  and
substantially  all of the employees of the Company's Waco  operations,  totaling
114. The 1997 plan anticipated a significant consolidation of operations into an
affiliate's  Dallas offices over a twelve month period. As of December 31, 1997,
the Company had charged  $2,411  against the accrual for  severance  and related
benefits.  The Company adjusted the remaining severance accrual by $1,008 during
1997 due to natural  attrition  thus  reducing the level of  severance  required
coupled  with the  decision  to retain  certain  employees  indefinitely.  As of
December 31, 1997,  the severance  accrual was $1,936 which was adjusted  during
1998 as a result of the decision not to merge the Company's Waco operations into
Dallas.

      The plan also  provided  for  vacating of certain  leased  facilities  and
abandoning  certain  Company owned real estate.  The Company  accrued $6,166 for
holding and abandonment costs associated with these facilities. During 1997, the
Company  charged  $1,916 to such accrued lease costs.  During 1998,  the Company
further  charged  $841 to the  accrued  costs.  As of  December  31,  1998,  the
remaining  accrual was no longer necessary as a result of the decision to retain
the Waco operating platform.

      In addition, the 1997 plan recognized the impairment of certain furniture,
fixture and data  processing  equipment of $1,526 as a result of the decision to
abandon certain Company owned and leased  facilities.  During 1998 and 1997, the
Company charged off furniture,  fixtures and data processing  equipment totaling
$-- and $332,  respectively,  and adjusted the original impairment  provision by
$347 and $847, respectively.

      Contract termination costs provided in the 1997 plan were adjusted to zero
during 1998 as a result of the ultimate  settlement of certain contracts without
penalty.

      Restructuring  charges in the 1997 plan also  included a $6,000  provision
for the write-off of the Company's  investment  in certain  foreign  operations,
principally  Argentina.  In 1997, the Company disposed of the foreign operations
at a costs of $5,555 and the balance of $445 was adjusted to zero.

Other Costs

      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   Consolidated   Statements   of   Operations   and
Comprehensive Income (Loss) 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.


<PAGE>



(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 cash equivalents ........................  $   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 Cash  Equivalents,  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.

     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.


<PAGE>



(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:

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

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)


<CAPTION>

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

<S>                                                       <C>         <C>         <C>           <C>
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.  The Company  unlocked  actuarial  assumptions of future
interest rates,  lapses,  expenses and mortality on interest sensitive blocks of
business   (principally   interest  sensitive  and  deferred  annuity  products)
resulting in additional  amortization of deferred policy  acquisition  costs and
present value of insurance in force  amounting to  approximately  $16,250.  Such
unlocking was necessary  principally  as a result of  deteriorating  persistency
associated  with certain  blocks of business in the Payroll Sales Division which
aggregated  approximately  $8,575. The remaining  amortization resulted from the
application  of  current  period   assumptions   (unlocking)  for  expenses  and
persistency  for the  Financial  Services  Division.  In  addition,  the Company
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.


<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




<PAGE>

<TABLE>


              SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                       as of December 31, 1997 and 1996
                   (In thousands, except share information)
<CAPTION>

                                                                                                             1997        1996
                                                                                                         ----------   ----------
<S>                                                      <C>             <C>                             <C>          <C>
ASSETS
Investments:
  Fixed maturities available for sale at fair value (cost$$1,643,769 $nd $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 $5615,507 ................................       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.



<PAGE>

<TABLE>


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




<PAGE>

<TABLE>


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

<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, $997......     $    35   $    84     $116,992       $21,870       $ 53,535    $192,516
                                       =======   =======     ========       =======       ========    ========
</TABLE>

         See accompanying Notes to Consolidated Financial Statements.




<PAGE>


<TABLE>

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


                                                                    1997         1996
                                                                ---------      --------
Cash flows from operating activities:
<S>                                                             <C>            <C>
  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)
  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.




<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.


<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


<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


<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>




<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.


<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:

                                               Amortized
                                                 Cost       Fair Value
                                               ---------    ----------

            Fixed maturities.................  $     487    $      66
            Equity securities................        688        1,079
            Other investments................      5,778        5,791
                                               ---------    ---------
                                               $   6,953    $   6,936
                                               =========    =========

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:

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

            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
                                                  =========   =========

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:

                                                           1997        1996
                                                         ---------   ---------
 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)
                                                         =========   =========




<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:

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

  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).

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:

                                                            Percent of Total
                                        Carrying Value       Carrying Total
                                        --------------       --------------

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%
                                            =======               =====

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.


<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:

      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
                                                                   ========

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.


<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:

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

     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
                                                  ========      ========

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.


<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:

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

     Revolving bank debt ..............................   $ 90,250   $ 95,000
     Bank debt with quarterly principal requirements ..      24,50     24,750
     7.0% convertible subordinated note ...............     40,000     40,000
                                                          --------   --------
                                                          $154,750   $159,750
                                                          ========   ========

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


<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:

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

      Current.........................................    $  17,252   $   5,302
      Deferred........................................         (836)     12,847
                                                          ---------   ---------
                                                          $  16,416   $  18,149
                                                          =========   =========

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:

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

     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
                                                           ========    ========



<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:

                                                             1997        1996
                                                           --------   ---------
     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
                                                           ========   =========

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>





<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>





<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>





<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


<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:

                                                         1997      1996
                                                     ---------  ---------
     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
                                                     =========   =========

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.


<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.

Minimum lease commitments are:

            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
                                                        =======

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:

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

     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
                                                     =========   =========




<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 $-- 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.


<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  write-off  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,  excess of liabilities  over assets,  total revenues and
net loss of the SW  Financial  Businesses  Held for  Sale  aggregated  $530,866,
$49,697, $109,387 and $5,201, respectively.


<PAGE>


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



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)





<PAGE>



                                    PART IV

Item 14Exhibits, 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)



<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)




<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)




<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)


<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)    Suchexhibit 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.




<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.


<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
----------------------------------
Keith A. Maib
Director

Date: March 31, 1999



/s/ Kenneth Roman
----------------------------------
Kenneth Roman
Director

Date: March 31, 1999



/s/ David J. Stone
----------------------------------
David J. Stone
Director

Date: March 31, 1999



/s/ Allan D. Greenberg
----------------------------------
Allan D. Greenberg
Director

Date: March 31, 1999



/s/ Thomas A. Player
----------------------------------
Thomas A. Player
Director

Date: March 31, 1999



/s/ Bruce W. Schnitzer
----------------------------------
Bruce W. Schnitzer
Director

Date: March 31, 1999



/s/ David C. Smith
----------------------------------
David C. Smith
Chairman of the Board and Director

Date: March 31, 1999




<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....       129

     Schedule II   Condensed Financial Information of Registrant .....      130
     Schedule III  Supplementary Insurance Information ...............      133
     Schedule IV   Reinsurance .......................................      134
     Schedule V    Valuation and Qualifying Accounts .................      135

*  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.


<PAGE>



INDEPENDENT AUDITORS' REPORT

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

      Under date of March 31,  1999,  we  reported on the  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, as contained
in the annual  report on Form 10-K for the year  1998.  In  connection  with our
audits of the aforementioned  consolidated financial statements, we also audited
the  related  consolidated  financial  statement  schedules  as  listed  in  the
accompanying  index. These financial  statement schedules are the responsibility
of the  Company's  management.  Our  responsibility  is to express an opinion on
these financial statement schedules based on our audits.

      In our opinion,  such financial  statement  schedules,  when considered in
relation  to the  basic  consolidated  financial  statements  taken  as a whole,
present fairly, in all material respects, the information set forth therein.

KPMG LLP

Dallas, Texas
March 31, 1999


<PAGE>


<TABLE>

                                                                   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)
<CAPTION>

                                                                  1998           1997          1996
                                                                ---------      --------       -------
Revenue:
<S>                                                             <C>            <C>            <C>
  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.


<PAGE>




                                                                   SCHEDULE II

                        PENNCORP FINANCIAL GROUP, INC.
                             (PARENT COMPANY ONLY)

                           CONDENSED BALANCE SHEETS
                       As of December 31, 1998 and 1997
                                (In thousands)


                                                        1998           1997
                                                     ----------     ----------
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 cash equivalents ......................       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
                                                     ==========     ==========

                See accompanying independent auditors' report.


<PAGE>


<TABLE>

                                                                   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)

                                                                   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
          subsidiaries ....................................        (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)
     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 cash equivalents at beginning of year .........         4,464          2,099          1,713
                                                                ---------      ---------      ---------
   Cash and cash equivalents 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.


<PAGE>


<TABLE>

                                                                  SCHEDULE III


                        PENNCORP FINANCIAL GROUP, INC.

                      SUPPLEMENTARY INSURANCE INFORMATION
             For the years ended December 31, 1998, 1997 and 1996
                                (In thousands)

<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




<PAGE>


<TABLE>

                                                                   SCHEDULE IV

                        PENNCORP FINANCIAL GROUP, INC.

                                  REINSURANCE
             For the years ended December 31, 1998, 1997, and 1996
                                (In thousands)
<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.


<PAGE>

<TABLE>


                                                                    SCHEDULE V

                        PENNCORP FINANCIAL GROUP, INC.

              VALUATION AND QUALIFYING ACCOUNTS For the years ended
                        December 31, 1998, 1997 and 1996
                                 (In thousands)
<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
</TABLE>
----------
(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.

                See accompanying independent auditors' report.