The following discussion addresses the financial condition of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) as of September 30, 2008, compared with December 31, 2007 and its results of operations and cash flows for the nine month period ending September 30, 2008, compared with the same period last year. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and with our audited consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

This discussion contains forward-looking statements that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors. See "Note Regarding Forward-Looking Statements" contained on Page 3included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 filed with the Securities and Exchange Commission.

The reader is assumed to have access to the Company's 2007 Annual Report. This discussion should be read in conjunction with the Annual Report and with consolidated financial statements on pages 3 through 7 of this form 10-Q.

Information in this management discussion and analysis is presented in whole dollars.

OVERVIEW

The National Security Group operates in the property and casualty and life, accident and supplemental health insurance businesses and markets products primarily through independent agents. The Company has three primary wholly owned subsidiaries, two operating in the property and casualty insurance segment and one operating in the life, accident and health insurance segment. Our insurance companies operate primarily in the Southeastern United States. A brief summary of the subsidiaries follows:

National Security Fire and Casualty Company (NSFC) is a property and casualty insurance company and is the largest of the insurance subsidiaries. NSFC operates primarily in the personal lines segment of the property and casualty insurance market. NSFC has been in operation since 1959. Insurance premium earned in NSFC accounts for over 82% of net premium revenue of the Company. NSFC is licensed and underwrites property and casualty insurance in the states of Alabama, Arkansas, Florida, Georgia, Mississippi, Oklahoma, South Carolina and Tennessee. NSFC also underwrites insurance on a non-admitted or surplus lines basis in the states of Louisiana, Missouri, and Texas.

Omega One Insurance Company (Omega) is a property and casualty insurance company incorporated in 1992. Omega is a wholly owned subsidiary of NSFC and is the smallest of the insurance subsidiaries accounting for less than 5% of premium revenue. Omega is licensed and underwrites property and casualty insurance in the states of Alabama and Louisiana. There is no material product differentiation between those products underwritten by NSFC and Omega as both underwrite similar lines of business. Due to the small amount of premium revenue produced by Omega and the fact that Omega is a wholly owned subsidiary of NSFC underwriting similar lines of business, all references to NSFC in the remainder of this report will include the insurance operations of both NSFC and Omega.

National Security Insurance Company (NSIC) is a life, accident and health insurance company. NSIC is our oldest insurance company and has been underwriting insurance products since 1947. The underwriting of life insurance products in NSIC accounts for 10% of our total premium revenue and the underwriting of accident and health insurance products accounts for 3% of our total premium revenue. Due to the relatively small amount of premium revenue in each line of business produced by NSIC, all references in the remainder of this management discussion and analysis to NSIC will include the combined life, accident and health insurance operations.

All of the insurance subsidiaries are Alabama domiciled insurance companies and therefore the Alabama Department of Insurance is the primary insurance regulator. However, each subsidiary is subject to regulation by the respective insurance regulators of each state in which it is licensed to transact business. Insurance rates charged by each of the insurance subsidiaries are typically reviewed and approved by each insurance department for the respective state to which the rates will apply.

The two primary segments in which we report insurance operations are the personal lines property and casualty insurance segment (NSFC) and the life, accident and health insurance segment (NSIC). Our income is principally derived from written premiums received less claims paid, sales commissions to agents, costs of underwriting and insurance taxes and fees.

We also derive income from investments which includes interest and dividend income and gains and losses on investment holdings. There is no material difference in the philosophy of the management of the investment portfolios as to types of investments that are undertaken and common management oversees the investments of both the property and life segment portfolios therefore the internal management of investments is typically accomplished at the consolidated group level as opposed to the individual insurance segment level.

Critical Accounting Policies

We prepared the accompanying financial statements in the Form 10-Q in accordance with accounting principles generally accepted in the United States of America (GAAP). The use of GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Certain accounting estimates are particularly significant due to the impact these estimates have on our financial statements and because of the likelihood that new information may become available subsequent to the release of our financial statements that may cause management to revise estimates. The most significant items subject to management judgment include reserves for incurred but unpaid property and casualty insurance losses and loss adjustment expenses, reserves for future policy benefits on life insurance contracts, deferred policy acquisition costs, valuation of investments and reserves related to litigation.

Reserves for incurred but unpaid property and casualty insurance losses and loss adjustment expenses are management's best estimates at a given point in time of what we ultimately expect to pay claimants. These estimates typically consist of case loss reserves for reported claims, reserves for claims estimated to have been incurred during the reporting period but not yet reported to us (IBNR), and reserves for associated loss adjustment expense. These reserves are based on known facts and circumstances, analysis of historical trends and emergence patterns, and settlement patterns. Our staff conducts periodic reviews of projected loss information by line of business in order to assist management in making estimates of reserves for ultimate losses and loss adjustment expenses.

Reserves for future policy benefits on life insurance contracts are determined according to the provisions of Statement of Financial Accounting Standard No.
60. The methodology used requires that the present value of future benefits to be paid to or on behalf of policy holders less the present value of future net premiums be determined. The determination requires the use of assumptions including provisions for adverse deviation, expected yields on investments, mortality, terminations and maintenance expenses. These assumptions determine the level and sufficiency of reserves.

Deferred policy acquisition costs consist primarily of commissions, certain underwriting and marketing expenses and premium taxes in which the costs have been deferred to future periods. Policy acquisition costs deferred for property and casualty insurance products are amortized over the period in which the related premiums are earned. The costs considered material components of deferred policy acquisition costs for property and casualty insurance products primarily relate to sales and servicing commissions paid to agents and insurance premium taxes. Policy acquisition costs deferred for life insurance products are amortized over the premium payment period of the related policies using assumptions consistent with those used in conjunction with the calculation of policy benefit reserves.

The valuation of debt and equity securities are typically based on quoted market prices as of the balance sheet date. Unrealized gains and losses on investments are carried net of applicable income taxes, and are reflected in stockholders' equity as a component of accumulated other comprehensive income and therefore, have no impact on net income. The cost basis of investment securities sold are usually determined by using the first-in, first-out methodology except that some equity securities with multiple lots may use the specific identification method. The investment committee monitors the investment portfolio and conducts quarterly reviews of investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Evaluations of potential impairment of investments involve judgment with consideration of the magnitude of the decline, the reason for the decline and the prospect for the fair value to recover in the near term. Declines primarily associated with broad market conditions or industry related events are typically considered to be temporary provided our intent is to hold the investment for a period of time sufficient to allow for recovery or maturity. When a decline in fair value of an investment below its cost is considered to be other than temporary, a charge is reflected in income for the difference between the cost or amortized cost and the estimated fair value.

We are subject to litigation in the normal course of our insurance operations. Management evaluates the merits of each case and determines the need for establishing a reserve for potential settlement and associated legal costs of defending the Company against the allegations. Reserves are re-evaluated at least quarterly and adjusted based on latest available information. Litigation reserves involve considerable uncertainty due to the potential impact of future events and potential for adverse development due to legal climates of jurisdictions in which lawsuits are filed. While we believe current reserves are adequate based on available information there can be no assurance that actual outcomes will not differ from the current assessments made by management.

CONSOLIDATED RESULTS OF OPERATIONS

Premium revenues:

Life, accident and health premium revenue is produced through a network of approximately 200 independent agents appointed by NSIC. Property and casualty premium revenue is underwritten by NSFC and is produced through a network of approximately 1200 independent agents. Insurance premium revenue for the period ended September 30, 2008 was down 26.4% for the quarter and 8.8% year to date with no significant change in the business mix between NSIC and NSFC. The decline in premium revenue for the year to date was driven by decline in the two largest sources of property and casualty premium revenue, dwelling fire and homeowners insurance. However, premium revenue for the quarter and consequently, the year to date as also significantly impacted by an increase in ceded premium associated with catastrophe reinsurance reinstatement premium triggered by Hurricane Gustav.

The following table sets forth premium revenue by major line of business for the nine months ended September 30, 2008 compared to the same period last year:

                                          Nine months ended September 30,
                                                       % of                  % of   % increase
                                               2008    Total          2007   Total  (decrease)
Life, accident and health operations:
Traditional life insurance            $    4,229,304   10.0% $    4,024,516    8.7%       5.1%
Accident and health insurance              1,148,226    2.7%      1,165,801    2.5%      -1.5%
Total life, accident and health            5,337,530   12.6%      5,190,317   11.2%       2.8%

Property and Casualty operations:
Dwelling fire & extended coverage         19,527,709   46.3%     20,133,357   43.4%      -3.0%
Homeowners (Including mobile homeowners)               44.5%     20,184,177   43.5%      -6.9%
Ocean marine                               1,032,756    2.4%      1,286,697    2.8%     -19.7%
Other liability                            1,066,949    2.5%      1,194,583    2.6%     -10.7%
Private passenger auto liability             643,944    1.5%      1,064,212    2.3%     -39.5%
Commercial auto liability                    564,731    1.3%        525,627    1.1%       7.4%
Auto physical damage                         186,180    0.4%        651,293    1.4%     -71.4%
Reinsurance premium ceded                (4,932,848)  -11.7%    (3,868,575)   -8.3%      27.5%
Total property and casualty               36,883,652   87.4%     41,171,371   88.8%     -10.4%

Total earned premium revenue          $   42,221,182  100.0% $   46,361,688  100.0%      -8.9%

Premium revenue in the life insurance subsidiary, NSIC accounts for 12.7% of total premium income of the Company. NSIC has two primary methods of distribution of insurance products: employee agents and independent agents. Employee agents primarily consist of home service agents that sell policies and collect premium primarily in the insured's home. Revenue from business in-force serviced by home service agents accounts for 35% of total NSIC premium revenue. This has been the primary method of product distribution for NSIC since it's founding in 1947. Changing demographics has necessitated a need to diversify to alternative means of distribution. In an effort to increase production of new business and penetrate markets in states outside of Alabama, NSIC began appointing independent agents in 1998. Independent agents now account for over 87% of all new business production in NSIC. Revenue from business in-force serviced by independent agents accounts for 56% of total NSIC premium revenue. In addition to the two primary methods of product distribution, approximately 8% of premium revenue is generated from the servicing of discontinued books of business and inactive programs. The most significant of these discontinued books of business is a block of policies acquired by NSIC from another carrier in 2000.

Premium revenue in NSIC consists of traditional life insurance products and supplemental accident and health products. As set forth in the preceding table, traditional life insurance premium revenue increased 5.1% for the nine-month period ending September 30, 2008 compared to the same period last year. Accident and health insurance premium revenue decreased 1.5%. In total NSIC premium revenue is up 3.6% for the year to date in 2008 compared to the same period last year, driven primarily by sales of new products through the independent agent sales force.

The biggest challenge for NSIC in maintaining higher levels of premium growth remains the ability to retain in force business once it is issued, referred to in the industry as persistency. NSIC primarily serves the lower and middle income markets with lower face value life insurance products (typically $50,000 and below) and supplemental accident and health insurance products. While we believe our customers typically view our products as an important part of their financial plan, our products are also viewed by many lower to middle income households as discretionary in nature and are subject to being cancelled for non-payment of premium in the event of a decline in household income due to job loss or other economic factors. NSIC typically loses as much as 40% of new business produced in a year due to non-payment of premium. Over the past two years, our marketing department has been working to penetrate the worksite market of stable industries in our areas of distribution. Worksite marketing typically involves the sale of products at the customer's place of employment. Payment of premium is typically facilitated through payroll deduction with the employer. We believe that penetrating this market and method of product distribution will improve our persistency as it continues to develop. Premium produced through worksite marketing currently accounts for approximately 12% of life segment premium revenue.

Premium revenue in the property/casualty insurance subsidiaries decreased 10.4% for the nine months ended September 30, 2008 compared to the same period last year. The primary reasons for the decline relate to an overall decrease in the production of new business as well as the increase in ceded premium from the payment of reinstatement premium triggered by Hurricane Gustav. Additional factors contributing to the slowing premium revenue growth compared to prior years relates to the implementation of stricter underwriting standards and fewer new independent agent appointments.

Premium revenue in the dwelling fire line of business decreased 3.0%, or just over $605,000 in the first nine months of 2008 compared to the same period last year. In addition, the homeowners program ended third quarter 2008 with a 6.9% year to date decline in premium revenue compared to 2007. These lines of business composed 43.4% and 43.5%, respectively of premium revenue in 2007 compared to 46.2% and 44.5%, respectively during 2008. The current economic environment along with soft market conditions are the primary factors that have contributed to the decrease on premium revenue. We have experience increased lapse rates that we primarily attribute to current economic conditions as policyholders are typically lower to middle income households and are likely to feel the pinch on household budgets more rapidly in an economic downturn.

Reinsurance premium ceded increased 27.5% in the first nine months of 2008 compared to the same period last year. The primary reason for the increase was the payment of reinstatement premiums triggered by Hurricane Gustav.

Net investment income:

Net investment income is up $116,000 for the quarter and $265,000 for the year to date in 2008 compared to the same period last year primarily due to an increase in book yields on debt securities in 2008.

Realized investment losses totaled $1,304,000 in the first nine months of 2008, down significantly from the realized investment gains of $529,000 realized in the first nine months of 2007. Realized losses were generated primarily from the recognition of other than temporary impairments totaling $1,722,000. The other than temporary impairment losses realized were partially offset by realized capital gain on equity investments of $418,000. In determining whether or not unrealized losses are other-than-temporary impairments, the Company does not use set thresholds as exclusive reliance on thresholds removes the ability of management to apply its judgment, a concept that is inherent to the analysis of impairments. All unrealized losses are reviewed to determine whether the losses are other than temporary. Management utilizes positive and negative information on an investment by investment basis to make the determination as to whether an unrealized loss is other-than-temporary. Impairment losses recognized on bond investments totaled $805,000 and consisted of $566,000 in losses on bonds of Lehman Brothers and $239,000 in losses on Washington Mutual bonds. In addition to losses in the bond portfolio, the Company realized losses of $453,000 and $464,000 respectively on preferred stock holdings of Federal Home Loan Mortgage Corporation and Federal National Mortgage Corporation respectively. Realized gains are generated primarily from the sale of equity portfolio investments of the insurance subsidiaries. An investment committee composed of senior company management manages these investments. We will sell or decrease positions in certain investment holdings only as market conditions warrant which can lead to significant fluctuations in realized capital gains from quarter to quarter and year to year.

Other income:

Other income increased $107,000 in the first nine months compared to last year and declined $7,000 for the quarter. Other income is primarily composed of insurance related fees tied to the non-standard auto line of business. The decrease in fees is primarily attributable to the decline in non-standard auto premium production.

Policyholder benefits and settlement expenses:

Policyholder benefits and settlement expenses (claims) have increased significantly compared to the three month and nine month periods ended September 30 of last year. For the three month period ended September 30, 2008, claims were $15,795,000, or 134.9% of premium revenue, an increase of 76.9% compared to third quarter of last year which totaled $8,927,000, or 56.1% of premium revenue. For the nine month period ended September 30, 2008, claims totaled $37,167,000 or 87.9% of premium revenue, compared to $28,259,000 last year which totaled 60.95% of premium revenue. The increase in claims is primarily attributable to third quarter hurricane losses from Hurricanes Gustav and Ike. Hurricane losses from insurance claims incurred from Hurricane Gustav and Hurricane Ike, net of reinsurance, totaled $8,940,000.

Year to date incurred losses and incurred adjustment expenses in the property and casualty companies totaled $33,600,000 compared to $24,900,000 for the same period last year. The primary reason for the significant increase was the unprecedented storm activity during the first half of 2008 combined with the losses related to both Hurricane Gustav and Hurricane Ike. Nineteen storms classified as catastrophic events by the Property Claims Service affected the property and casualty companies. These storms were characterized by significant damage from tornadoes and high wind. As of September 30, 2008, the losses from these storms totaled $18,600,000 before reinsurance. Hurricane Gustav made landfall on the Louisiana coast with winds of 110 miles per hour on September 1, 2008. Incurred losses and incurred adjustment expenses from this storm added $10,100,000 to total incurred claims through the end of third quarter 2008. Less than two weeks later, Hurricane Ike made landfall on the Texas coast as a category two storm on September 13, 2008. The impact of this storm generated incurred losses and incurred adjustment expenses totaling $3,500,000 as of September 30, 2008. While the company maintains reinsurance to mitigate the effects of catastrophic events such as Hurricanes Gustav and Ike, the Company incurs 100% of losses from each event up to a $3,500,000 retention per event under its catastrophe reinsurance agreement. Upon penetration of the first layer of coverage, beginning at losses in excess of $3,500,000 per event, the company retains 5% co-insurance on losses up to $17,500,000 before 100% reinsurance coverage begins until the maximum reinsurance payout of $57,500,000 has been paid.

Policy acquisition costs:

Policy acquisition costs for the third quarter of 2008 totaled 29% of net premium revenue earned compared to 19% last year. The increase in the ratio of acquisition cost to premium revenue was primarily caused by the increase in net reinsurance premium ceded due to the triggering of a catastrophe reinstatement premium caused by Hurricane Gustav. For the year to date in 2008, policy acquisition costs are 22% of premium revenue compared to 20% for the same period last year. Again, the year to date increase in policy acquisition costs as a percent of premium revenue is the reduction in premium revenue caused by the additional ceded premium paid to reinstate catastrophe reinsurance coverage after the occurrence of Hurricane Gustav.

General expenses

General expenses for the third quarter totaled 18% of premium revenue compared to 14% for the same period last year.

Again, the decrease in earned premium due to an increase in reinsurance ceded due to a catastrophe reinstatement premium is the primary factor contributing to the increase in general expenses as a percent of premium revenue for the quarter. For the year to date in 2008, general expenses totaled 16% of premium revenue compared to 15% for the same period last year and the decrease in year to date earned premium due to additional catastrophe reinstatement premium was the primary factor contributing to the increase in general expenses as a percent of earned premium.

Taxes, licenses, and fees:

Insurance taxes, licenses and fees decreased $257,000 for the quarter and $582,000 for the year to date. The decrease is due to declines in premium revenue for the quarter and year to date.

Interest expense:

Interest expense for the third quarter of 2008 decreased $14,000. This decrease is primarily attributable to the repayment of a $900,000 bank credit line earlier in 2008. Interest expense is up $53,000 for the year due to a higher average balance outstanding on the credit line in the first five months of 2008 compared to 2007.

Income taxes:

The effective tax rate for the three month period ended September 30, 2008 was 32.7% compared to 26.7% for the same period last year and the effective tax rate for the nine month period ended September 30, 2008 was 34.4% compared to 25.4% for the same period last year. Significant losses sustained in the property and casualty subsidiaries have generated significant tax benefits for the quarter and year to date in 2008. Because the effective tax rate in the property and casualty subsidiaries is higher than in the life subsidiary coupled with the higher percentage of total net losses generated from property and casualty subsidiaries the effective tax rate increased in 2008 compared to 2007. Because the property and casualty companies posted profitable results in each of the prior two years, it is expected that the tax benefit of any net operating losses for 2008 will be recovered immediately through carry back provisions of the Federal Tax Code.

Discontinued operations:

As discussed earlier, in April of 2007 we disposed of the majority of our investment in Mobile Attic. The sale included all assets of Mobile Attic and the buyer assumed all Mobile Attic liabilities. Proceeds in excess of assets sold and liabilities assumed by the seller totaled $2,700,000. The net of tax gain on the sale of Mobile Attic was $1,460,000. After deducting a loss from discontinued operations for the first quarter of 2007, net income from discontinued operations for Mobile Attic for the nine months ended September 30, . . .